The Bifurcation of This Market

| About: Energy Select (XLE)

Reading market reports last night, I noticed the market was described as being bifurcated. Wanting to expand my knowledge, I had to learn more about this process. The definition of the word is 'to divide or fork into two branches.' Thus, the application to the market indicates there are two paths or branches the market is taking currently. Not sure I like the word in context of the market, but the definition does apply to what is currently playing out in the broad market.

The S&P 500 index has held up better than the NASDAQ, and the S&P 600 Small Cap index has not broken support at the 410 level from January. The NASDAQ has struggled, and technically the chart is anything but bullish. The bounce off the low last week was anemic, and the selling prior to it was aggressive. The S&P 500 index bounced back to the previous support near the 1300 level and shows signs of making a move higher. Thus, there are two branches of the market, one showing weakness and the other, strength.

Semiconductors have been the Achilles Heel of the NASDAQ. After hitting a high of 473 on February 17th, the index hit a low of 412 on March 16th or a decline of 12.9% in four weeks. As for the bounce off the low, 10 points to 422 or 2.4%. Support for the SOX is 405 and it remains a possibility to test support level near term. The weakness is Asia has been the primary driver pushing the sector lower.

The energy sector has been the strength of the S&P 500 index. Using the SPDRs Select Energy ETF (NYSEARCA:XLE) as a benchmark, the fund hit a high on March 3rd at $78.84 and a low on March 16th at $73.75 or a decline of 6.5%, followed by a bounce back to $77.51 or 5.1%. Crude oil has been the push behind the energy sector with a climb to $105.10 per barrel.

As the quote states, “a house divided cannot stand”. The market will reunite and become a single path but the question is, will it be energy lifting the other sectors to join the upside or will semiconductors bring the others down?

If energy is the leader it is hard for the balance of the market to join the trend. The impact of higher energy costs have a negative impact on the balance of the economy. That effect is debilitating to the production costs of goods. The Producer Price Index [PPI] showed a steep rise in costs the last two months at the producer level for goods. The pressure to pass on the rise in costs is a challenge for business when wages are not keeping pace. This squeezes margins or profits for the business and in turn will show up in the earnings reports looking forward. We don’t have to look back very far to see the impact of rising commodity prices on the economy. 2008 shows very well what can happen when prices rise and wages stagnate.

Semiconductors may be leading the market lower as technology companies find the global economy already in slowdown mode. China has been raising rates to stall inflation pressures. The slowing has already shown in earning announcements stating first, a slowing in sales for Asia, and second, a lack of clarity looking forward for sales or revenue growth from Asia.

Liquidity from the Federal Reserve in the form of quantitative easing has been given credit for the markets continued rally. However, that comes to an end in two months. There are rumblings about QE3 (quantitative easing part 3) in Washington. We all know that sequels in the movie business don’t generally work, and the same is true for the Fed. They need to listen to Mr. Fisher’s comments of “intoxication of capital” and its relation to inflation. Further easing would fuel global inflation, especially in the emerging markets. With an absence of liquidity fueling the market, one would have to look for the bifurcation to end, and the route of the NASDAQ to be the branch that directs the market.

Disclosure: I am long XLE.

Additional disclosure: Some of Money Strategies, Inc. clients may or may not have positions in the stocks or ETFs mentioned in the article above.