Take Profits in This Group Before it Sells Off

by Sam Collins | January 28, 2013 7:38 am

The week ended much as it began — with a spurt of buying in the final hour. That influx of buyers closed the S&P 500 higher for the eighth consecutive day, accomplishing the longest string of gains since 2004. And it closed at its highest level since Dec. 10, 2007. The Dow Jones Industrial Average closed higher for the sixth consecutive day.

Despite the continued decline of Apple (NASDAQ:AAPL[1]), the Nasdaq led the other major indices, gaining 0.62%. Apple fell again, off 2.4%, extending its loss for the year to 17%, but technology stocks still managed to close with a gain of 0.1%. The leading sector was the discretionary sector, up 1%.

At Friday’s close, the Dow was up 71 points to 13,896, the S&P 500 rose 8 points to 1,503, and the Nasdaq gained 19 points at 3,150. The NYSE traded 692 million shares and the Nasdaq crossed 425 million. On the Big Board, advancers outpaced decliners by 1.6-to-1, and on the Nasdaq, advancers were ahead by 1.3-to-1. For the week, the Dow gained 1.8%, the S&P 500 rose 1.1%, and the Nasdaq gained 0.5%.

SPX Chart
Click to Enlarge

The most commonly asked questions that I receive in e-mails are: “Is the market close to a top?” and “How much longer can the market advance?”

Most technicians subscribe to either the “Three-Phase Bull Market” or the “Five-Phase Bull Market” theories. I subscribe to the five-phase up (bull market) and three-phase down (bear market) theory but won’t bore you with the details as to why. However, generally, what I label as the phase 1 is often referred to as the doubt phase and generally has low volume. Phase 3 is an accumulation phase (institutions) and phase 5 is the public participation phase.

I believe that we have entered phase 5, but the low volume suggests that we are at the very beginning of that phase. Phase 5 is characterized by high volume, high volatility, and gains that eventually dwarf the first two phases of the advance. It is also the longest phase in terms of time and extent, often taking two to three times longer than the others.

Some technicians are saying that we are in phase 3 (of 5) now and that the final phase with public participation is yet to come. If they are correct, then the bull market’s top is far in the future.

I tend to believe that the old highs will be exceeded but don’t see the enormous blow-off that others expect. Some believe that the S&P 500 could double from the current level. I see a 30% to 40% move higher from the current prices.

Russell 2000 Chart
Click to Enlarge

Trade of the Day Chart Key

Getting down to the here and now, the small-cap Russell 2000 is clearly overbought. Friday’s close is 10% above the index’s 200-day moving average and 10% is considered “very overbought.” And the Russell 2000’s Relative Strength Index (RSI) is at 76.82, the highest reading of the past 12 months.

SPX Chart
Click to Enlarge

On the other hand, the S&P 500, while slightly overbought, is not as dangerously extended at just 7.6% above its 200-day moving average compared with the Russell’s 10%. Having just broken from the much-discussed neckline, it appears to be at the beginning of a major move higher.

Conclusion: As we enter the phase in which we expect the greatest gains, we should enter it with caution, especially when buying small-cap stocks. The chart of the Russell 2000 is a warning that a small-cap correction within the next two weeks is very likely.

However, while the small caps are overbought, midcap and large-cap stocks appear to be at the beginning of a major advance. Investors should be accumulating high-quality growth stocks now, while traders should take profits in small caps and wait for a correction before going long again.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[2].

For a list of this week’s economic reports due out, click here[3].

  1. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  2. click here: http://online.wsj.com/mdc/public/page/markets_calendar.html?mod=topnav_2_3024
  3. click here: http://www.briefing.com/investor/calendars/economic/

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