Four Ways to Play Defense

The major indices face rough going, but these blue-chip Pentagon contractors are likely to escape the undertow.
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This column was originally published on RealMoney on Sept. 25 at 11:59 a.m. EDT. It's being republished as a bonus for TheStreet.com readers.

The

FOMC's

decision to hold rates steady failed to inspire a follow-through rally last week, leaving the major indices stalled at resistance.

The two-day downturn has drawn market bears out of midyear hibernation and back onto radio and television, but it's still way too early to declare the third-quarter rally dead and buried.

I'm taking a neutral stance here and waiting for the market to show its hand.

Last week's reversal was likely the first stage of a sideways consolidation that will eventually yield a strong rally above resistance or a selloff toward this year's lows. It's just too early to place aggressive bets on either side of the market.

How long will it take for the indices to break resistance or give up the ghost and roll over? I don't think either will happen this week.

The end of the quarter tends to be a cherry-picking period in which top performers get most of the buying attention. This can trigger a handful of strong rallies but leave entire sectors behind.

We're also approaching the October reporting period. It makes sense that the major indices will tread water into earnings season while everyone gauges the impact of plunging commodities and slowing growth on 2007 profits.

I really hope they like what they see, or the market clouds could grow dark and dangerous well before Halloween.

To deal with this schizoid period, I'm turning my full attention to corners of the market that can trade independently of the broad indices. Perhaps these issues will offer better opportunities while we wait for broader-scale movement to kick into gear. In a nutshell, I want to take on long-side risk, but reduce my exposure to those big resistance levels.

Defense and aerospace stocks are a good bet in this regard. Homeland security issues don't care about the calendar, and we still live in a very dangerous world.

Blue chips in the sector held down the group over the summer, but they're now perking up. It's possible that many of these stocks will hit 52-week highs in the fourth quarter.

Boeing

(BA) - Get Report

reached an all-time high near $90 in May then pulled back. That selloff broke the 200-day moving average in August, triggering a final plunge to $72. The stock has perked up considerably this month and rallied back above moving average resistance. This bullish action could set the stage for a broader recovery in October.

Its price action looks even more interesting on a weekly chart.

Notice how the summer correction took shape as a bull flag after the stock's multiyear rally. This is a natural formation for an eventual follow-through rally to new highs. But patience is required here because it hasn't broken out of the longer-term corrective pattern yet.

Raytheon

(RTN) - Get Report

rallied to an all-time high at $47 in May and pulled back to its 200-day moving average. It retested that level one month later and started to recover. The stock returned to the high in mid-August and dropped into a broad rising channel. It shows little upside progress in the last five weeks.

A channel breakout would offer the most profitable trade, but there could be one more pullback before strong upside momentum kicks into gear. If the stock drops out of the channel, I'll look for support to develop near $45. A base near that price level might offer a stable launching pad for a run up and though the recent highs.

General Dynamics

(GD) - Get Report

, which I recommended in my newsletter

The Daily Swing Trade

, broke out of a five-month cup and handle during expiration week, rallying over $72 before starting to pull back. It's been moving sideways in a volatile pattern for the last week, trying to establish a base at higher levels.

The breakout should hold as long as it stays above the 50-day moving average at $68.54. The choppy action after the breakout isn't surprising because accumulation is weak, but I'm going with the setup anyway because the pattern is picture-perfect.

Also, defense issues trade according to their own logic, so this one could move considerably higher, despite my reservations.

Teledyne Technologies

(TDY) - Get Report

is a lesser-known defense issue that could offer excellent returns in the weeks ahead. It broke out of a 13-month cup and handle two weeks ago. It's been grinding higher since then in a choppy pattern. The broad price pattern is similar to General Dynamics, but this stock shows much stronger accumulation.

The volatile pattern hasn't offered good trade entries in the last week. The best scenario would be a deeper pullback that carries it down to support at $39 -- but that might not happen with window-dressing on the calendar this week. My second choice for an entry would be a selloff to channel support, currently at $39.80.

At the time of publication, Farley was long General Dynamics, although holdings can change at any time.

Alan Farley is a professional trader and author of

The Master Swing Trader

. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;

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