Trader’s Narrative

It was only a little while ago that I pointed to the energy sector’s bullish percent (BP%) number and suggested that it meant we had a tradeable bottom.

We did get a bounce but it was quite feeble and lasted for only two weeks before prices fell again. I just noticed now that the energy sector’s BP% is 12.5 - a multi-year low.

What does this mean? For starters, BP% can go to zero so it doesn’t have to turn up here just because we think the number is low. At each of the previous low points (green circles above) the energy sector had put in an intermediate bottom. But something has changed this time I suspect.

For one, this time around the sector was unable to mount a meaningful rally from deep oversold levels as it had in the past. Also it has now dropped below its (flattening) long term moving average - something which it had not done since the birth of the bull in May 2003. And finally, BP% has fallen to levels that it has not seen in years. Clearly the energy bull is showing fatigue.

We may very well see a rally from such deep oversold levels - especially since oil has not fallen as much as the energy stocks - but before being convinced of this, I would need to see some sign that buyers are stepping in. For example, seeing the BP% turn up would be a good start.

The Bullish Percent for a sector or index is created by counting the number of stocks within the sector or index that are currently trading with a point and figure buy signal and dividing this by the total number of stocks in that sector or index.

Overbought levels are at 70% and above, while oversold levels are at 30% or below. A signal is given when the BP index trades through these levels and then reverses by atleast 6%. This almost happened within the energy sector today when its BP index rose 5.56% points from its low of 22.5% yesterday.

You might have to squint to see it below but there really is a tiny uptick in the energy BP index from a very deep oversold level. If we go by recent market behaviour, this means we have put in a significant intermediate bottom.

Based on the internal technicals that I watch, the healthcare sector is starting to look really interesting here for a long.

I’m referring to the healthcare sector as defined by the S&P Healthcare Index by the way (the exchange traded fund for the sector is XLV) This index has been in an intermediate downtrend since the middle of March 2006 but there are a number of signs that there is a reprieve around the corner.

For one, the number of 52-week lows in the sector now outnumber the number of 52-week highs - a sign in the past that things are really oversold. As well, the percentage of stocks above their moving averages within the sector is quite low. And finally, the Rydex mutual fund assets for this sector are showing that it is being shunned (to a similar degree that it was in October 2005) by the often wrong but never in doubt, mutual fund trading crowd.

Finally, the bullish percent index of the sector is near levels which have presaged a reversal in the past:

Of course, that doesn’t mean that one jumps in and buys here willy nilly. I’d look for the strongest stocks within the sector and wait for an appropriate entry. One tell, for example, would be when the bullish percent turns up.

You already know that I’m partial to Merck. I still like it because it has one of the better technical pictures from among the big pharma companies.

I would also keep an eye out on biotech because it has similar underlying technical behaviour: