Trader’s Narrative

We know what the US market is doing, shrugging off every single negative news and floating higher almost effortlessly. But what about the emerging markets?

One of the strongest emerging markets before the recent bear market was Brazil and it has come roaring back with a vengeance. If you think the recent gains, whether a bear market or the real thing, are impressive, then consider Brazil’s gains.

Similar to almost all world markets, the Bovespa started the last bull market in late 2002 and went almost non-stop until late May 2008. As a sign of the impressive relative strength, it shrugged off any signs of a top in October 2007 and went sideways as other markets around the world weakened and fell. Then in early May it surged to new highs, to then reverse and form a top.

Using simple Weinstein stage analysis, it was easy to see the trouble signs. But even after such a strong showing the index still fell 60%. It reached its low in October and in the following months, every single low was higher than the previous one.

While the US market struggled, falling lower still in March, Brazil was already trading 19% higher than its October 2008 low. As of today, it has made an astonishing 70% gain from the extreme low of last year.

I don’t know enough about the fundamentals to make a case but I imagine it would refer to the fact that the Brazilian banks were, for the most part, left unscathed by the financial mess that enveloped US and European banks. And also the turbo boost provided by Brazil’s commodity wealth can’t be ignored. They produce everything from soybeans to precious metals.

But all that can be encapsulated in the relative strength of BOVESPA to the S&P 500 index. It has already surpassed the previous high it set in 2008.

There are a few ETFs for the country:

• iSHARES Brazil ETF (EWZ)
• WisdomTree Dreyfus Brazilian Real Fund (BZF)

As well, there are many ADR’s like:

• Petrobras (PBR)
• Itau (ITU)
• Banco Bradesco (BBD)
• Brasil Telecom (BRP)
• Brasil Telecom (BTM)

While continued heady gains are improbable in the short term, a pull back would bring prices back to the 150 day moving average (in red) which is slowly flattening out. This would then provide a platform from which it can realistically challenge the previous highs.

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Greenspan’s comment which rocked markets yesterday, dominoed into Asia overnight and boomeranged back to the US markets (how many mixed metaphors is that?). But the market didn’t need any help from the Maestro to roll over. We’ve had three days, back to back, where the S&P 500 attempted to rally, only to be driven back by sellers. In Japanese candle-speak it formed three inverted hammers with long upper tails.

As you’ve probably heard ad naseum, the S&P 500 is about to reclaim levels it has not seen since 2000. Does anyone really believe it will plow through that sort of long term resistance without first pausing to catch its breath?

Down days like today are blessings in disguise because they make it easy to identify the really strong sectors and stocks in the market. Nevertheless, the nature of the price decline was a bit surprising.

We saw an extremely low intraday TICK, last seen at the late February 2007 correction and further back at intermediate bottoms (April 2006, May 2004 and the 2002-3 market bottom).

We also had very lopsided market internal: for the NYSE 5 declining issues for each advancer and for the NASDAQ 3 decliners for each advancing issue. The volume was even more crazy with volume in declining issues outpaced advancing ones by 7 to 1 on NASDAQ.

Usually the markets shows this kind of negativity after a significant decline has already been underway and a bottom is being formed. A sort of whoosh cleans out the longs and transfers stocks from weak hands to strong hands. As long as we are still in a bull market, this sort of market internal action is indicative of a buying opportunity.

So what now?

The first strategy is to look for weak sectors and go short (with a short-term timeframe).

A good example is the REIT sector with its anemic relative strength. It made a feeble effort to get back up to its 200 day moving average and rolled over again today. Maybe I’m wrong. Wouldn’t be the first or last time;-) I’m not yet giving up on the bear trap thesis for the REITs but if it plays out, it will work over the medium term (weeks) not over the short term. We’ll see.

The other strategy is to start making a buy list for potential swing trades from among the strong stocks that are undergoing pullbacks to break out levels.

As the funds flow data shows, a lot of the momentum is in the emerging markets. Take a look at Brazilian bank stocks:

• Banco Bradesco (BBD)
• Banco Itau (ITU)
• Uniao de Bancos Brasileiros (UBB)