Increasingly Selective

by: Financial Sense

By Thomas J. Smith, CFA

As we are nearing a high in the S&P 500 there was a sharp retreat in the Nasdaq and Russell 2000 averages last week. The Dow has remained under its old high and failed to confirm the move to new highs in the transports. The number of names in attractive technical condition declined last week.

There are still more than 60% of names in the S&P 500 that are in sound technical shape. There was an aggressive move out of the more high-flying momentum type names in the broader markets last week. Many names in the more speculative areas of the market became overextended over the past few months and have seen sharp corrections over the past few weeks. After this action there are fewer names in the broader markets with attractive chart patterns.

The mega-cap healthcare and technology names that were in favor at the turn of the century have regained leadership positions. Several of the old healthcare leaders are just now approaching prices they reached several years or even a decade ago. These types of companies became victims of their own great success in the late 1990s. There were several major blockbuster drugs launched for a series of years in the pharmaceutical industry. Many of these new drugs went on to become blockbusters that generated multi-billion dollars in annual sales. The trick, of course, was to duplicate this success. As these drugs came off patent and faced generic competition they simply did not have a sufficient pipeline of new offerings to keep their stock prices going.

Well, things have changes over the past few years. Many pharmaceutical companies remain very well run and pay attractive dividends. They also trade at price/earnings multiples far below their heights in the glory days. They have seen an acceleration in revenue growth over the past few years and have been acting well.

As speculative issues sold off over the past few weeks, the old stalwarts of the technology sector have regained some of their lost luster. A look at the leadership board in the tech space last week looked like a replay of the 1990s. Similar to the pharma stocks mentioned above, these companies have great management teams and are trading at multiples that are in several cases below the market average multiple. These companies frequently pay attractive dividends now and have seen their growth prospects improve over the past few years.

The economic numbers that have been released over the past few weeks have been, for the most part, better than expected. The weakness seen in the early part of the year does appear to be influenced by the awful weather. So, over the next few months, the direction of economic surprises and the continued tea-leaf reading regarding future Fed decisions will impact our markets.

The Dow and S&P 500 held above the technical levels I gave last week, while the Nasdaq and Russell 2000 did not. This is setting us up for a potential positive divergence. Support levels for the major averages S&P 500/Dow/Nasdaq/Russell 2000 are: 1830/16,000/4200/1160. For signs that the market is strengthening, we will need to see the following levels taken out: 1885/16,590/4373/1214.