Technical Tuesday - More Downside? Why Tech Stocks Say Yes

Beginning with an article 5 weeks ago (red arrow below), about why Apple Inc. (Symbol: AAPL) should decline another 100 points, all my recent articles have been about the stock market breaking down. 

In the articles, I wrote about one topic, but mentioned there are "several other signs" I was seeing pointing to a breakdown.

So while this article may seem somewhat redundant, I think it's productive to talk about yet another sign that I've been seeing...


LEADERSHIP DETERIORATION

We thank the market gods for the many early warning signs we can see leading up to almost any strong sell off in stock prices.  One of them is leadership deterioration. 

Most people know that Apple Inc. was a stock that led the market higher.  But did you know that the entire tech sector was one of the two leading sectors coming off of the major October 2011 stock market low?  (The other was financials.)

To understand a relative strength chart, you need to understand that when one index outperforms another index, the relative strength chart shows an advance.  When the first index underperforms the second, the relative strength chart declines.

Let's take a look at the performance of the NASDAQ 100 index (Symbol: $NDX, which is the index the ETF "QQQ" tracks) versus the performance of the S&P 500 index. 

We think it's a fair comparison, as it's the largest 100 NASDAQ stocks -- obviously a tech ridden index -- with a relative strength comparison to the 500 largest stocks in the stock market.  Tech stocks hold a 23% weighting in the S&P 500. 


As you can see above, the NASDAQ 100 outperformed the S&P 500 for the first 4 months of the year.  But when the leadership is lost, trouble usually looms ahead for the bulls.

Let's try another comparison.  We know the market capitalization weighting tends to skew the picture sometimes, which leads investors to make decisions based on a flawed study.  For example, Apple Inc. has an 18.57% weighting in the NASDAQ 100, followed by Microsoft's 9% weighting. 

Below we look at the Rydex equal weighted S&P technology sector ETF (Symbol: RYT) vs. the small cap index "Russell 2000" (Symbol $RUT).  We see another decline since early April. 


For good measure, we even decided to look at the equal weighted tech sector ETF compared to the equally weighted S&P 500.  They all look very much alike.  


We will deviate from the topic of tech for a moment here to note that one other leader has been the financial sector, mainly the banks.  Below is a relative strength comparison between XLF (which is an ETF that consists only of the financial stocks in the S&P 500) and the S&P 500.


While not as pronounced, you can see a decline in strength here too.  (If the decline in financials had been as pronounced as that in tech stocks, this article might be less relevant as a warning, because the general stock market would probably already be much lower as a result.)

One more look at the chart of the NASDAQ 100 below...

You can see the index is moving below the horizontal blue line, which means the index might close today with a lower low after making a lower high last week.  That means many traders will consider the NASDAQ 100, which is the index that led the general market higher, to be in a down trend. 



If you look at the S&P 500, below, you can see that we already broke below an important up trend line (red), and we appear to be ready to close below the horizontal key level of 1,360.



We have seen many signs of market deterioration over the last 5 weeks, as mentioned in my last 5 articles.  While the long-term up trend isn't broken yet, we have been in an intermediate-term down trend for about a month.


BE CAREFUL

It's situations like this when new bears can get hurt, and here's why...

When markets appear to be on the brink of a collapse, like they appear to be today, and when they are sitting at KEY LEVELS like they are today, sometimes there is a major fake-out.  

If the market does crack slightly below the key horizontal levels mentioned above, there will be computers out there automatically shorting the stock market with a "buy stop order" placed slightly above or even at the price at which those institutions took the short position.  

The order to enter the bearish position will be (short) sell orders.  But to unwind that position, the exit order would be buy orders, adding upwards pressure.  Since the horizontal key level is obvious to everyone, the trade would be a big one -- no matter which direction the market moves in.

This doesn't mean you shouldn't participate in an intermediate-term bearish position.  I certainly have my own intermediate-term bearish trades on right now.

It just means you should be ready to exit those bearish positions if the market does turn around.  Fair warning.

Having said that, just by looking at the 10-year monthly chart below, it's not very hard to envision more downside from here. 


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See you next Tuesday!

Chris Rowe
Chief Investment Officer
Technical Analysis Millionaire