Over the last few weeks, a curious stalemate had developed in the stock market. The bears, encouraged by soaring oil prices, political turmoil in the Middle East and Africa, and fresh worries over European debt problem, have come out of hibernation in a big way for the first time since the seven-month market uptrend started last September. They’ve viciously defended the 2,800 level on the Nasdaq Composite.
For their part, the bulls continue to believe that the Fed’s easy money will win the day and literally paper over the world’s problems with cheap dollars. They’ve defended the Nasdaq’s 50-day moving average.
But on Thursday, the stalemate was broken as the bears eviscerated stocks in leading sector groups like semiconductors, materials, and energy. The rotation out of cyclical, “high-beta” sectors suggests that the bulls are now in full retreat. And that means there is more downside movement yet to come.
Chip stocks have been hit particularly hard with the Semiconductor HOLDRs (NYSE: SMH) ETF fund falling another 1.3% today to cap a -7.6% five-day losing streak in what has been the worst performance for the sector since last August. Versus the S&P 500, the SMH is down 5.4% over the last five days — the worst performance since May 2009.In the process, the SMH has fallen through important technical support including its 50-day moving average.
To take advantage, I’ve recommended a position in the UltraShort Semiconductor (NYSE: SSG) ETF fund and a short position in electronics outsourcing services provider Flextronics (NASDAQ: FLEX) to my newsletter subscribers. Both are still attractive trades at current levels with FLEX accelerating to the downside after falling out of a four-month trading range.
Materials and energy stocks are also weakening. The Materials SPDR (NYSE: XLB) fund has fallen out of its three-month trading range as industrial metals like copper get hit on reduced global growth expectations while gold is taking it on the chin as the U.S. dollar rebounds. My favorite new short idea in the area is Great Basin Gold (AMEX: GBG).
On the other hand, defensive consumer staples, healthcare, and utility stocks continue to demonstrate relative strength. This isn’t a sustainable condition. And it’s a sign that stock market’s current trading range isn’t likely to hold as its pillars of support continue to fall away.
Indeed, the last time we saw cyclical underperformance tied with defensive outperformance was back in August — just ahead of the market swoon that took the S&P 500 down nearly 8%.
For their part, Wall Street traders have already moved to the exits. According to UBS client flow data, U.S. investors have been net sellers of stocks for the fifth straight week. Much of the recent increase in selling has come from long-only mutual funds. Foreign clients have also been selling U.S. stocks for three straight weeks.
For now, these outflows show no signs of slowing. Increased supply, at a time of moribund demand, is a recipe for lower prices in the weeks ahead.
Disclosure: Anthony has recommend SSG long, FLEX short, and GBG short to his newsletter subscribers.
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