Understanding the Process
Let's go back in time to just over two months ago. The
Dow
was trading around 9100, the
S&P
was around 1210 and the
Nasdaq
was hovering around 2250. On Feb. 19, I began talking about the end of a six-week correction. (For background, please see my
column on that date.) The market provided me with some instant gratification shortly thereafter: The Dow zoomed ahead several hundred points on an economic statistic that boosted the bonds.
But just as easily as stocks rallied, they reversed and sold off -- right back down a few hundred points. Take a look at what happened to the overbought/oversold oscillator during that time: It didn't go down and get more oversold, but it instead stayed steady. In fact, it continued to rise even though the market was selling off.
This is why we use this indicator as a momentum guide. Despite the decline in the market averages, the downside momentum had subsided. A momentum indicator is used to measure the magnitude of the move. In this particular case, we saw very little downside momentum in that decline in the averages. For the most part, those who had wanted to sell had sold.
But notice how long the process took. The oscillator had begun to show an oversold reading in mid-February; however, it was nearly three weeks later that the market took off to the upside. This is a natural process. The news was not good:
Dell
(DELL) - Get Report
had just missed its revenue number, yields were at 5.7% and we were heading into that time of the quarter when earnings warnings are prevalent. You'd have to be foolish to jump in and buy stocks into that scenario, right?
Now, let's come back to the present day. The oscillator is overbought. It has been that way for a week and a half. Despite the DJIA's stretch to new heights yesterday (the S&P and the Nasdaq have thus far failed to follow suit), the oscillator still sits well below its peak overbought momentum reading. This tells us that momentum is waning on this rally. This is the reverse of the mid-February scenario explained above. It's a process; it takes time.
Just over two weeks ago, the Dow hit 10,500 and 173 stocks were making new highs. We're now above Dow 11,000 and only 81 stocks have made it to that exclusive list. That tells us that despite the 500-plus-point rally in the DJIA, most stocks have stalled out. That's what it means to be overbought.
Add to this the fact that the specialists have not reduced their short position in the new weekly reading. They have indeed become a wee bit shorter, climbing now to 52%. This shows us how one-sided the market has become in here. Think of a pendulum which swings too far to one side; it goes just so far before it loses its momentum and must swing back the other way.
It doesn't mean the averages need to tumble, but individual stocks seem to be taking a breather. That's what a correction is: when stocks take time out to catch their breath. Sometimes it happens in the averages, sometimes it happens in individual stocks and sometimes it happens over time. Any way you look at it, it's still a market correction. It is not a negative for the market -- it's simply a breather along the way.
As for individual stocks, the cyclicals are still in the lead, although many of them need a rest.
AlliedSignal
(ALD)
is doing just fine. So are
Boeing
(BA) - Get Report
and
Goodyear
(GT) - Get Report
.
General Motors
(GM) - Get Report
is emerging from its three-month consolidation rather nicely.
Union Carbide
(UK)
will be great going through 56.
But a noncyclical in the DJIA that continues to be in its base-building phase is
Coke
(KO) - Get Report
. I have recommended this stock in the past, only to be disappointed in its performance. But each whack it takes seems to flesh out the base that much more. I don't think Coke is going to run away to the upside, but it does have the type of chart that says somewhere in the mid-60s is the right place to buy.
Elsewhere,
Nike
(NKE) - Get Report
is still OK. So is
Reebok
(RBK)
, especially when it trades through 20.
Nucor
(NUE) - Get Report
has just emerged from a big base. Watch
Texaco
(TX) - Get Report
, which has some resistance up in the mid-60s but will likely get through sooner rather than later. Also,
Xerox
(XRX) - Get Report
spurted up to a new high after an extended consolidation and should go further.
Finally, I have rarely in my career recommended gold stocks. In fact, I can only remember doing it once before. However, I chart
Barrick Gold
(ABX)
by hand each day, and that chart has seen such improvement that it prompted me to look at the weekly chart. Go look at that weekly chart: It's got a giant head-and-shoulders bottom (left shoulder at 15 in early 1998, head at 13 in late September, right shoulder at 16 just recently, a flat line across the tops at 24 marks the neckline). I don't think this is a move into gold stocks as a group since I couldn't find another gold chart that looked like this, but this one was so outstanding that I felt compelled to point it out. It's early in its move and a breakout does not feel imminent, but a move through the neckline would measure to the upper 30s.
On the negative side,
AT&T's
(T) - Get Report
action is still bothersome. Be careful if it breaks 50.
McDonald's
(MCD) - Get Report
is oversold, so sell it on a rally. Same for
Merck
(MRK) - Get Report
-- sell it on a rally back to 74 to 76.
Anheuser-Busch
(BUD) - Get Report
has had such a great run, but it's now stalled out. Take profits on it.
Dayton Hudson
(DH)
should bounce off of 64. Sell it into such a rally.
Home Depot
(HD) - Get Report
grabbed a lot of attention on its downgrade last week. It now needs some more time before it rolls over again.
So let the Dow exhaust itself. Let the overbought process continue; it takes time. We can't rush these things, much as we'd like to.
Helene Meisler, based in Singapore, writes a technical analysis column on the U.S. equity markets on Tuesdays and Fridays, and updates her charts daily on TheStreet.com. Meisler trained at several Wall Street firms, including Goldman Sachs and Cowen, and has worked with the equity trading department at Cargill. At time of publication, she was long AT&T and Nike, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. She appreciates your feedback at
KPMHSM@aol.com.
