Sector Watch: A Chance To Play Euro Downside As The Dollar Rallies by Jim Stanton, Technical & Quantitative Analyst According to a well-known investment adage, the past six months was the best time to be invested in the stock market. Really? Tell that to Wall Street and the millions of investors who saw their portfolios get hammered between November and April. According to the Stock Trader's Almanac, although April was stronger, it concluded an otherwise wretched six months, in which the Dow Industrials lost 8%. It was the worst "best six months" for stocks since 1973, when the Dow fell over 12% amid the OPEC oil embargo. But as the phrase, "Sell in May and go away" alludes to, we're now historically into the "worst six months" of the year for stock market investments. However, in an unusually tough year, when the housing and credit crises have sent the economy into a tailspin, plus the added factor of the presidential election in November, this old indicator may not apply. Speaking of presidential elections, some good news… Stocks Love Elections Given that the stock market hates uncertainty, you might assume that it would perform poorly during election years. On the contrary. Despite the unknowns and prospect of a new political regime, stocks actually tend to rise in presidential election years, no matter who wins. For example, Dow Jones Industrial Average has posted positive returns in nine of the past eleven presidential election years. Since 1948, the benchmark S&P 500 index has gained an average of 9.3% during election years. So what does the immediate future hold? Smooth Sailing, Or Just A Teasing Bear? Since it bottomed out in January, the Dow Jones Transportation Average (DJT) has performed the best of all the "leading indexes." For example, when JP Morgan (NYSE: JPM) and the Federal Reserve bailed out Bear Stearns on March 17, most of the indexes tested, or traded below, their January lows. But the Dow Transports didn't even come close to doing so. Since then, it's led the other indexes higher and as of last Friday's close, all the indexes had traded above their February highs, while the Dow Transports traded to within 100 points of breaching its all-time high of 5,487. Does this mean it's clear sailing ahead or are we just witnessing a bear market rally? So far, the indexes have performed admirably since March, but when you look at the daily charts of the Nasdaq Composite and S&P 500 (the most widely followed indexes), both are approaching their 200-day moving averages. The only indexes that are currently above their 200-day moving averages are the Nasdaq 100 and S&P 400 (Mid Cap). In order for the rally to continue, the S&P 500 and Nasdaq Composite need definitive closes above their 200-day moving averages. At the moment, those levels are 1,432 on the S&P 500 and 2,523 for the Nasdaq Composite. If these indexes can close above these levels, while the Dow Transports goes on to set a new all-time high, the presidential cycle should have more influence. Let's dig a little deeper… Sizing Up The Spread For Clues To The Market's Direction One chart that I watch closely in order to gain clues to market direction is a daily chart that plots the difference (spread) between the daily closing prices of the Nasdaq 100 and S&P 500. 
When the price is moving up, it means the Nasdaq 100 is outperforming the S&P 500 and that the markets are generally moving higher. As the charts shows, the past two weeks have seen the spread between the two indexes not only close above the downtrend line drawn off the October highs, but also above the uptrend line, drawn off the 2006 lows. In addition, the 50-day moving average is above the 200-day moving average and the price action is currently above them both. But don't rush out to buy stocks en masse just yet. Although this spread chart currently paints a bullish picture, the indexes are pushing into overbought territory, so I'm expecting a pullback sooner rather than later. In order for the bulls to maintain control, the spread must not close much below the uptrend line off the 2006 lows on the first decent pullback. This level comes in around the 548-550 area. We'll finish today by looking at the currency sector… Dollar Up, Euro Down On Speculation That The Fed Is Finished With Its Rate Cuts Is the Federal Reserve finished with its interest rate-cutting program for the time being? Word on the trading floors is that this might be the case, after the bankers lowered rates by a further 0.25% last week. Speculation that the Fed will now sit back and wait for its moves to kick in caused the U.S. Dollar to close at its highest level in two months. In turn, that led to some selling pressure in many of the commodities, as well as the other currencies. The drop in currencies has triggered some sell signals in the euro, so let's take a look at the ETF that represents it - the CurrencyShares Euro Trust (AMEX: FXE). Below is a daily chart. 
As recently as April 22, FXE hit its all-time high just above $160 a share. Since then, however, it's endured some selling pressure, closing below its 50-day moving average. The chart pattern suggests that the stock should undergo at least an "A-B-C" wave correction: The "A" Move: This is the stock's current performance - headed downward. The "B" Move: Once the initial selloff dries up, we'll see a "B" wave rally. The "C" Move: The selling will resume again, taking the stock down to new correction lows. From current levels, a 38% Fibonacci retracement would take the stock back up to the $156.40 area and a 50% retracement would take it up to the $157.20 area - very close to the middle of the trading channel. If the stock rallies back up around $157 and then struggles in that area, it would present either an opportunity to short the stock, or put options, as it moves down to new correction lows. If the stock moves lower from here, you can recalculate the retracement levels, but be careful. The "B" rally only has to stay above the lows for a little more than a day before the "C" wave can begin. Catch you here again in two weeks. Jim Stanton
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