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How To Invest In The 4th Quarter

|Includes:DIA, PowerShares QQQ Trust ETF (QQQ), XHB, XLK, XRT

As we head in to the fourth quarter of the year, the government is currently shut down and the debt ceiling deadline is just two weeks away. There is no question that "black swan" events or wars can have an immediate impact on the financial markets and are often not predictable in advance. Technical analysts look at historical tendencies, key price levels, and technical studies along with chart patterns to plan a strategy.

In this lesson, I will take a look at some of the longer-term technical readings for the key markets, as well as the quarterly pivot analysis, to determine an outlook for stocks, bonds, and other key markets as we head into the last quarter of the year.

For the past 50 years, the S&P has been up 0.60% in October with 38 up years and 25 down years. The month of November was even better as it has an average gain of 1.33% with almost twice as many positive years as negative ones. On an average basis, December was the best month of the quarter, up 1.61%. Even more impressive was that the S&P was up 48 of those years and down just 15 years.

In a column last year Mark Hulbert commented that "since 1896, we find that the average Dow gain in the fourth quarter is a gain of 2.7% versus a 1.6% average for the other three quarters."

Of course, October has a reputation as a tough month for the stock market that goes back to the crash of 1907 that was followed by the stock market bubble in October 1929. There were other bad years, the most notable being in 1987. The major averages also made their pre-financial crisis highs in October 2007.

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In addition to the monthly, weekly, and daily charts I also look at the quarterly charts for a view of the longer-term trends. This chart of the S&P 500 and its on-balance volume (OBV) goes back to 1993. Since then, the quarterly OBV has crossed its 21-period WMA a total of five times.

The first positive cross was at the end of the 1st quarter in 1995, line 1. That month, the S&P 500 also triggered a high-close doji buy signal (point a). The OBV stayed above its WMA until the end of 2000, line 2, as the S&P 500 made its high in the 1st quarter of the year.

The OBV stayed negative for the next 12 quarters until the end of 2003 when it moved back above its WMA (line 3). The next signal did not come until the 2nd quarter of 2008, line 4, when the quarterly OBV closed below its WMA. The positive signal from the end of 2009, line 5, is still in force as the OBV did make new highs in the last quarter and is well above its rising WMA.

If you look at the monthly and weekly OBV analysis with its 21-period WMA, you will find that they gave more timely signals at these turning points. Both are currently positive for the S&P 500 and show no signs yet of topping out.

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Another tool I have found to be useful since John Person introduced them to me is the quarterly pivot analysis. As I recently discussed, they have done a good job, so far, of keeping me on the right side of the stock, bond, and gold markets in 2013.

The table above details the quarterly pivots for the key ETFs that I follow, as well as the pivot support and resistance levels for the 4th quarter. I have also included the closing price for October 1, the first trading day of the quarter. Those ETFs that closed above their pivots are highlighted in green while those that closed below their pivots are in red. The weekly closes on Friday will be even more important.

For the stock market, it is not only important to determine whether you should be buying or selling but also to determine which sectors are the strongest and weakest.

The performance of the Nasdaq 100 and the Dow Industrials since the March 2009 lows clearly illustrates the importance of being in the right market segments at the right time. Since the 2009 lows of $25.05, the PowerShares QQQ Trust (QQQ) is up 218% as of Tuesday's close. By comparison, the SPDR Dow Industrials (DIA) is up 134%.

The quarterly chart of the PowerShares QQQ Trust (QQQ) shows that it formed a doji at the end of 2007 (point a) and the following month triggered a low-close doji sell signal. The quarterly starc- band was exceeded in the last quarter of 2008, which was an indication of the extreme level of selling (point b).

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The starc- band was also tested in the 1st quarter of 2009 but the relative performance was already above its rising WMA and had formed higher lows, line a. The RS line tested its rising WMA in the 1st quarter of 2013 and has again turned higher.

The quarterly OBV dropped below its WMA at the end of 2008 but by the next quarter had moved back above its WMA. The OBV exceeded the 2007 highs (dashed line) at the end of 2010 and is still well above its WMA.

The quarterly S1 at $74.11 is 3.6% below current levels with the R1 at $82.48 or 3.5% higher. The quarterly starc+ band is at $84.92.

The SPDR Dow Industrials (DIA) dropped below the quarterly starc- bands in both the last quarter of 2008 and the 1st quarter of 2009 (point 3). In the last quarter, DIA had a tight range with a high of $157.02. For the 4th quarter, the R1 is at $155.02 with the S1 at $143.93.

The relative performance turned lower in the 2nd quarter of 2012 and violated the uptrend from the 2005 lows, line d, at the end of the 3rd quarter (point 4). As I noted during the summer, the weekly RS line did form a divergence at the June highs and then broke support.

The OBV was only able to make it above the declining WMA at the end of the 3rd quarter of 2012. It is still holding above its steep uptrend but is well below the 2007 highs, unlike the QQQ.

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The Select Sector SPDR Health Care (XLV) has been one of the star performers since May 2012. Over the last three quarters, it has risen from a low of $40.38 to last quarter's high at $52.19. This is a gain of over 29%. The ETF has tested its quarterly starc+ band for the past three quarters, which means it is becoming more vulnerable.

The quarterly R1 resistance is at $53.20, which is just over 5% above current levels with the pivot now at $50.22. It held well above the 3rd quarter pivot at $48.05 for the prior quarter, and for the 4th quarter, the S1 support is at $48.24.

In the second quarter of 2012, XLV closed just barely above the 2007 high, line a, at $37.89. This is now the level of the rising 20-month EMA. The relative performance formed high lows in 2007 and 2011, line b, and then rested its rising WMA in March 2012. It is still rising strongly.

The OBV rose above its WMA at the end of 2009 and then retested its WMA at the end of 2nd quarter of 2010 (see circle). This was a classic bullish setup as I discussed in the Best Volume Indicator. The OBV has subsequently made a series of higher highs and has confirmed the price action.

Another sector ETF that has been strong technically for some time has been the Select Sector SPDR Consumer Discretionary (XLY), which was up 7.5% in the 3rd quarter. It did test the starc+ band last quarter with the R2 resistance for this quarter at $63.08. The S1 support is at $57.83.

The relative performance broke its downtrend, line e, at the end of the 1st quarter of 2009. By the end of June, the WMA was also overcome. The RS has been rising strongly since then and made new highs last quarter. It is well above its sharply rising WMA.

At the end of March 2012, XLY overcame the highs from 2007 highs, line d. The OBV overcame the resistance going back to 2007, line f, at the end of the 2012. It continues to look very strong and the monthly OBV has also confirmed the highs. The XLY looks less overextended than the XLV.

The chart of the Sector Select SPDR Consumer Staples (XLP) shows that it formed dojis each of the past two quarters. This is potentially quite negative and a quarterly close below $38.80 at the end of December would generate an LCD sell signal.

It closed on October 1st at $40.04, which was just below the quarterly pivot at $40.31. The 2nd quarter high was $42.20 with the 3rd quarter high at $41.85. The R1 level for this quarter is at $41.58 with the S1 support at $38.78. The major chart support, line a, is now at $33.55.

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The relative performance broke both its uptrend from the 2007 lows, line c, as well as the WMA in the 2nd quarter of 2012. The RS line had been diverging for several years, line b. The WMA of the RS line has now flattened out and the monthly RS analysis (not shown) has completed a top.

The OBV peaked in the 3rd quarter of 2012 and formed lower highs, line d, in the 1st quarter of 2013. It turned up in the last quarter and is well above its rising WMA. The monthly OBV (not shown) did confirm the May highs and is above its WMA.

The Sector Select SPDR Utilities (XLU) is another defensive sector that opened the 4th quarter below its pivot at $37.93. The S1 support is at $36.06 with the 20-month EMA at $34.62. The longer-term uptrend, line e, is at $33.75. The R1 resistance is at $39.36 with the past quarter high at $39.81.

The relative performance formed lower highs, line f, since it peaked in 2009. The lows in the RS, line g, that go back to 2005 were broken at the end of the 2nd quarter of 2013. The monthly RS line has been in a downtrend since early in the year.

The quarterly OBV formed a negative divergence in 2012, line h, and dropped below long-term support at the end of June. It has declined even further in the last quarter. The monthly OBV does look better as XLU had a higher close in September.

In a recent daily column, I reviewed how the quarterly pivots on SPDR Gold Trust (GLD) had performed, so far, in 2013. For the 4th quarter, the table shows that the pivot is at $126.29 with the R1 at $135.85. The August high was at $137.55, so a strong move above this level would be positive. The S1 support is at $115.04.

The Market Vectors Gold Miners ETF (GDX) also opened the 4th quarter below its pivot at $26.18. After dropping sharply over the prior three quarters, it formed a doji in the 3rd quarter. The R1 resistance is at $29.57 with last quarter's high at $31.35. Therefore, if GDX closes above this level at the end of the year, it will trigger an HCD.

The RS line broke its quarterly support, line b, at the end of the 1st quarter of 2012. It then rebounded back to this resistance at the end of the 3rd quarter before dropping sharply. It is well below its WMA and the monthly (not shown) shows no signs yet of bottoming. The quarterly downtrend, line a, is now at $47.80.

The OBV moved through its steep downtrend in the 3rd quarter and closed back above its WMA. The monthly OBV is well above the 2nd quarter lows so there is the potential for a bullish divergence to form. The weekly OBV, as it have mentioned previously, was very strong in August but needs a few consecutive higher weekly closes to complete a bottom.

The iShares Barclays 20+ year Treasury (TLT) also opened the quarter below its pivot at $106.24 as it peaked in the 3rd quarter of 2012 when yields were hitting their lows. The 3rd quarter of 2013 was the fifth consecutive lower quarterly close with R1 resistance now at $110.36. The high during the 2nd quarter was $124.26. The last quarter's low was $102.21 with the S1 support at $101.67.

The relative performance formed lower lows in 2011, line f, and then broke below support, line g, at the end of March 2013. This was a good warning of higher rates to come. The monthly relative performance did confirm the recent lows.

The OBV did make a new high with prices in the summer of 2012 but at the end of the year dropped below the important support at line h, completing the top formation. The monthly OBV is still negative while the weekly is positive and did form a positive divergence at the August lows.

NEXT PAGE: Where the Action Will Be in the 4th Quarter

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.