Trader’s Narrative

Utilities have been among the few sectors with high relative strength during this recent swoon that began in May. Even Chairman MaoXian recently made note of this. Usually this would make me like the sector because by swimming upstream against the current, it is showing that the ’smart’ money has spoken. But there is more to it when you look beneath the surface.

For one, the breadth in the sector makes the probability of a continued rally very low. Right now, 100% of the constituents of the utilities ETF (XLU) are trading above their 50 day moving average; as well, more than 90% of them are trading above their 200 day moving average. Much like a sprinter after a mad dash, the sector is out of breath having exhausted itself in this recent run up. The best thing that we can hope for is a pause. A fall from these heights is also possible since the sector is up to an old resistance that has pushed it back since August of 2005.

Another reason why I’m suspicious of the sector’s relative strength is that it is not the ’smart’ money that has been buying utilities. Looking to the Rydex utilities sector fund, its assets have swelled from a paltry $10 million from just a few months ago to almost $100 million today. Obviously the retail, Mom’n'Pop investors are crowding into this sector like crazy. Maybe their rational is to take refuge into ’safe’ stocks, maybe they are mo-mo investors who are simply buying because it has gone up, maybe they think the interest rate cycle has peaked… who knows.

All I know is that they are the crowd to fade not emulate. In fact, the last time the Rydex crowd got this excited about the utilities sector fund was back in July 2005 (first red circle). The other times were September 2000 and February 2001. Both great long to intermediate sell signals.

Although I don’t think the utilities are an automatic short here, if you’ve got any, it is prudent to look for exits and tighten stops. This would be especially wise considering that the sector and almost all of the individual stocks within it printed a very bearish wide range dark engulfing candlestick today. This is a very powerful reversal pattern, especially after a significant run up in price as we’ve had in utilities.

After an unforgettable debut last year, Baidu.com spent the next few months deflating but really nowhere in particular. Recently though, it gapped up on a massive volume spike and it has surprisingly stayed aloft while the general market has gone to hell in a handbasket.

And this week it actually broke above its multi-month channel. Although it does have some resistance at these and higher levels, they are not that recent so I don’t think they will have a large effect. If BIDU can continue to act with the relative strength that it has shown up till now, I think we can expect some great things in the weeks and months to come.

Yet, I can’t deny that the chart of Baidu reminds me of Sears Holdings. If you recall, SHLD was acting very strong as well… until it broke support last week and tumbled below $150. Obviously the large instutions that were dumping shares into the spike higher knew something!

Only time will tell if BIDU can actually hold up or whether it will falter like SHLD.

With the tape being so red, it is always interesting to find pockets of relative strength. One area of strength has been the big pharmas. I’ve already mentioned before that I really like this sector and Merck specifically. So far, Merck has performed brilliantly:

During April, May and June, while the general market indices were falling apart, Merck simply tread water. And by the middle of June it had actually begun to climb up, fighting against the current of the general market.

Some other very high relative strength stocks in this sector are Astrazeneca (AZN), Abbott Labs (ABT), Eli Lilly (LLY), Johnson & Johnson (JNJ), and Schering AG (SHR) [being taken over by Bayer]. Take a look at their charts and you’ll see very similar outpeformance relative to the market.

Elan is a British biotech stock that has just zoomed out of a flatish, four month long base. As you can see, it is showing remarkable relative strength in the face of the general market action:

But even so, I would only go long ELN within a short time frame (days rather than weeks or months) since it is notoriously volatile. As well, there is a massive amount of overhead resistance if you zoom out to a longer time frame.

It bears watching to see if it continues to show strength, especially this week, as the general indices may reverse to revisit recent lows. In that case, it would be a fantastic candidate for a swing trade long.

As Sears Holdings was gapping up yesterday and rising, institutions were dumping their holdings. And they are continuing to do so today as SHLD shows no signs of letting up:

Blue and red arrows indicate institutional buying and selling. Source: Thomson.

The strong relative strength of SHLD reminds me of Google in October 2005. As the wider market was careening downhill and all metrics were pointing to a very significant market bottom, GOOG gapped up and zoomed higher. It was among the strongest, if not the strongest stock in the market.

Notice how GOOG’s pullback in October was shallow, not even reaching the August 2005 lows. This is why it pays to keep an eye on the relative strength of a stock.

A similar situation came up in Starbucks this February. As the market was meandering, SBUX gapped up with huge volume and hardly looked back:

I’m not sure if GOOG or SBUX had to climb a wall of institutional selling. In fact, I think it was the opposite. But it the fact that SHLD has such high relative strength gives me enough reason to watch it closely.