March 10, 2010

UNBELIEVABLE ACTION IN THE FINANCIALS

Yesterday Citigroup (C) gained 7.3% on incredible volume of 1.1 billion shares. Today it gained another 3.7% on 1.2 billion shares traded. That volume is more than the entire New York Stock Exchange (NYSE) produces from all the other stocks listed combined!

Until yesterday, Citigroup (C) has been written off by many investors as a ward of the state. But what changed recently is that investors got the message that the last of the credit losses were behind the U.S. banks. Nothing matters more to the banking system than ending the write-offs that have been holding the financial stocks down since the Great Recession started in September/October 2008.

Financials set themselves (and the world) up with Credit Default Swaps (CDS) that were essentially insurance derivatives that were a loophole in the insurance laws unregulated by any government agency. They worked great - until housing prices began to go down. Then all parties involved discovered that the Credit Default Swaps were worthless insurance with no money behind them.

The most recent development is that Citigroup was able to issue preferred stock shares in order to raise capital to pay back the government loans that insured the CDS and other write-offs. Apparently, the market has decided that the credit crisis is behind us.

Many will say that the end of the write-offs is artificial as congress rescinded the 'mark-to-market' policy that had been in effect and which caused the balance sheets of banking stocks to plummet along with real estate prices in 2008. Who knows what these companies are worth? It's all smoke an mirrors that reminds me of the tech-stock bubble in 1999-2000, when stocks were priced based on the number of 'hits' to the site instead of actual revenue.

Artificial or not, balance sheets of the banking stocks are looking much better now. I've said many times in IntelligentValue that the market couldn't make the next step higher without financial stocks recovering. Take a look at a chart of the financial ETF (XLF) for the last six months:

The financial stocks have made a breakout higher in the last four days. Is this a signal for a new leg higher in the stock market? Possibly.

On the other hand, the S&P 500, an index of the 500 leading large-cap stocks, has been unable to break through the 1,150 level. Again, this points out that this level is an extremely critical level for the stock market - just as it has been for the last 12 years.

IS THE MARKET AT AN INTERMEDIATE-TERM TOP?

In recent newsletters and hotlines, I've been making the case for a downturn in the market when the S&P 500 again reached close to the overhead resistance level of 1,150. This level has a history of being support or resistance going back for a dozen years. In early January, we exited our positions as the S&P 500 closed in on 1,150 and were rewarded when we sidestepped a severe decline.

On Monday, the S&P 500 reached 1,140, stalling out 10 points below the threshold level of 1,150. In Sunday's newsletter, I reiterated a theory that today's market action is loosely (and possibly exactly) imitating the market action from the last cyclical bull rally in 2003/2004. In fact, the R-squared correlation of the current chart of the S&P 500 matches the 2003/2004 chart of the market at 0.9 - almost exactly identical!

If that theory holds water, then the market should top at the 1,150 level on the S&P 500 in several attempts over the next several months. The first one could occur tomorrow. See more about the theory's details here.

Although many analysts on TV (especially Mr. Cramer on CNBC) are talking about the market going ballistic from here, we feel that stocks may currently be overextended, with not much more room to move upward without a correction. It's possible that we're at the top end of a range between 1100 - 1150. Virtually all index charts show overbought conditions. Also, the primary support line of the market going back to August 2009 has now been reached from below. With oversold conditions, it's possible that the 1,150 level will become resistance going forward (see chart below).

The S&P 500, overbought for 3 weeks, has reached a Super-Critical level. Chart courtesy of StockCharts.com.

In our opinion, it's better to sell half of our positions into the market strength to lock in profits and reduce risk. Going forward, we'll buy on dips if the market continues higher. It's dangerous to buy long when the market is so overextended already. One of the most difficult investment disciplines to master is to sell into strength, taking profits when prices are still rising. Most amateur investors sell at the bottom, when prices are at their worst and buy at the top when all the news is great.

Therefore, we're going to take some money off the table by selling 50% of each of the 2X-leveraged ETFs in the two portfolios (SSO, UWM, and QLD), as well as sell our position in AmeriSourceBergen (ABC) outright. There's nothing really wrong with ABC as it has a steadily climbing chart, but we've owned it for almost a month with a reward of only 2.41% ( thus, making it a laggard relative to the market). See the tables below for details of the sale.

This leaves us in a position to still profit if the 2X leveraged Nasdaq, S&P 500 and Russell 2000 ETFs continue higher, as well as being set up to profit when bargains are present. We will enter the trades shown below for execution at the market open tomorrow.

OUR PORTFOLIOS

Here are the changes to our portfolios:
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Sincerely,

Christopher Michaels
IntelligentValue.com