Sentiment among analysts has turned negative, but favorable technical signals for the small-cap sector give good reason not to rule out a potentially aggressive rally.
The recent deterioration in the market’s technical outlook improved considerably after Tuesday’s sharp gains. Still, there needs to be further gains and positive market internals to firmly shift the evidence in favor of much higher stock prices. This would help dispel the view that Tuesday was just a short-covering rally. The stock index futures were flat ahead of the opening on Wednesday.
Though the sentiment numbers from the individual investors and financial newsletter writers are not giving any strong signals currently, the big brokerage houses and financial media seem to be getting more negative.
I was surprised to see segments on how to protect your portfolio from lower stock prices through put strategies on one of the major financial TV networks last week. Also, Merrill Lynch analysts see no “Santa Claus rally” and commented that small-cap stocks are “damaged goods.” They are not expecting a strong “January Effect” for this year.
JPMorgan Chase is also “skeptical that the typical January Effect in spreads will play out this year.” The technical evidence, however, suggests that the relative performance, or RS analysis, for the Russell 2000 Index is very close to turning positive.
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Chart Analysis: The Spyder Trust (SPY) closed well above the prior four days’ highs with next resistance at $125.57, and the downtrend, line a, is at $126.40.
- Clearly the recent low at $120 is key support, and if it is broken, a drop to the November lows at $116.20 is likely
- Other than the Advance/Decline (A/D) line, my other favorite indicator that uses the market internals is the McClellan Oscillator, which is still holding its uptrend (line d) and testing its downtrend, line c
- A strong move in the Oscillator above its recent high would be very positive
The iShares Russell 2000 Index Fund (IWM) was up just over 4% on Tuesday as compared to the 3% gain in SPY. The next resistance is in the $74.47-$75.39 area.
- A move through this level is likely to signal a move to key resistance at $77
- The daily RS analysis has moved just slightly above the key resistance at line g
- A confirmed breakout would complete the base formation (line h) and confirm that IWM was outperforming the S&P 500
- The daily on-balance volume (OBV) is barely above its weighted moving average (WMA) but needs to overcome the downtrend, line i, to turn strongly positive
NEXT: 2 Promising Small-Caps to Buy on Pullbacks
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Double Eagle Petroleum Co (DBLE) is an $80 million independent oil and gas company that trades just over 100,000 shares daily, but has a very interesting long-term chart. The stock was up 20% Tuesday on heavy volume.
- The weekly chart shows support going back to 2009 in the $5.40 area that was retested in October
- The downtrend, line a, is at $8.30 and appears to be part of a major continuation pattern. There is further resistance at $11.25 with the 2011 highs at $13
- Weekly RS analysis has formed lower lows, line d, but has now turned up. A move through the downtrend, line c, would be positive
- Weekly OBV shows a strong uptrend, line e, and is acting much stronger than prices
- There is initial support now at $6.80-$7.00 with more important support in the $6.20-$6.40 area
Volterra Semiconductor Corporation (VLTR) is a $550 million semiconductor company that I recommended on November 25, and its chart has gotten even stronger since.
- The daily chart shows key resistance now at $25.68, which also corresponds to the upper boundary of its two-year continuation pattern
- The resistance in the RS analysis, line h, has just been overcome, as VLTR has been outperforming the S&P 500 since October (line i)
- The daily OBV has not yet confirmed the price action, as it has key resistance at line j. The weekly OBV (not shown) looks much more positive
- There is initial support now at $23.90-$24.40 with stronger support at $23.30
What It Means: The action of the next two days will be important, especially in the iShares Russell 2000 Index Fund (IWM). A strong positive signal from the RS analysis would be a reason to look more aggressively at the small-cap sector.
Those not currently long Volterra Semiconductor Corporation (VLTR) could still buy on a slight pullback. For aggressive accounts, I would look to buy Double Eagle Petroleum Co (DBLE) on a pullback following Tuesday’s sharp gains.
How to Profit: Go 50% long VLTR at $24.56 and 50% long at $23.92 with a stop at $23.08 (risk of approx. 4.8%).
For Double Eagle Petroleum Co (DBLE), go 50% long at $6.88 and 50% long at $6.56 with a stop at $5.57 (risk of approx. 16%).
Portfolio Update
Updating past recommendations from the November 25 column:
- Buyers should be 50% long the iShares Russell 2000 Index Fund (IWM) at $68.72 and 50% long at $66.88. Sell half the position at $74.68 and use a stop now $69.62 on the remaining position.
- Buyers should be 50% long the iShares S&P SmallCap 600 Growth Index Fund (IJT) at $68.64. Raise the stop to $71.28 on the open position.
- Buyers should be 50% long the Royce Value Trust (RVT) at $11.62 and using a stop at that same price level.
- Buyers should be 50% long Volterra Semiconductor Corporation (VLTR) at $21.64 and using a stop at $23.08.
