Forecasting The Market’s Behavior

The Smart Profits Report: Issue #350
Friday, September 1, 2006

Forecasting The Market’s Behavior: The “One-Stop” Website For Identifying Sector Trends
By Jim Stanton
Advisory Panelist, Mt. Vernon Research

While there are no absolutes when it comes to forecasting the markets’ behavior, one thing is clear: The downward trend during the mid-term election cycle has proven to be accurate for decades. Here’s the deal…

History Repeating: A Trend of Mid-Term Election Year Lows

The performance of the Dow Industrials this year is treading a familiar mid-term election year path. The year begins strongly, with the index rallying until May. Then it slumps until mid-summer. After picking up again briefly, it then falls back down again at some point during the September-November mid-term election cycle, before embarking on a year-end rally.

A couple of striking statistics for you:

Ned Davis Research states that since 1950, the market has lost 3.5% from April 30 to September 30 during mid-term election years, versus a gain of 0.9% over that period in all years, and a gain of 5.6% in the other half of the year - September 30 to April 30.

Since 1990, the market has established a significant low at some point during the four three-month periods leading into the mid-term elections, before the traditional year-end rally begins. The earliest date on which this low occurred was during the week of September 4, 1998. The latest time of year the low happened was during the week of November 25, 1994.

And if history repeats itself this year, knowing which sectors could be affected the most can enhance your gains when playing the short side of the market. Let’s find out how you do that.

Ten Charts… One Website: The “One-Stop Shop” For Identifying Sector Trends

Personally, I find it invaluable to take some time each weekend to look at about two dozen sector charts. This is crucial in helping me see the “big picture” and identify subtle changes taking place in different areas of the market, and analyze which sectors are driving the current trends and which sectors are underperforming. And one of my favorite sites for sector research is Stockcharts.com

It’s an extremely useful website for technical traders, as it allows you to set up groups of 10 charts on one page. It’s a very handy “one-stop” look at all the sectors, and it immediately focuses my attention on the more interesting ones. Check it out at: www.stockcharts.com/charts/indices.

My technical analysis focuses mainly on a concept called pattern recognition, so the first thing I do is to check out the chart patterns on the daily sector charts. I use my proprietary trading model to scan for these patterns, and use it in tandem with a sector’s recent performance.

So let’s see what the patterns tell us about the mid-term election selloff…

Picking Out Two Patterns to Find Mid-Term Election Year Profits

The major indexes bottomed out in June and July, so if we’re going to get another mid-term election selloff, the key is to look for sectors or indexes that have underperformed the rest of the market over the last couple of months. There are two ways to play it…

Stock Indexes: The Dow Transportation Index and the various small-cap indexes have not fared as well as the larger-cap indexes, so if you are looking for individual stocks to short or buy put options on, I would look in those areas.

Sector Indexes: One chart that has caught my eye is the AMEX Securities and Broker Dealer Index (^XBD). As you can see from the chart below, ^XBD has underperformed most of the large-cap indexes, as well as many of the other individual sector charts since June.

AMEX Securities and Broker Dealer Index

Chart Courtesy of Trade Navigator Software

As you can see, the chart pattern since June has an upward bias, but now appears to be in a bearish flag or pennant formation. In contrast to most of the large-cap indexes, which have made new recovery highs, ^XBD has been edging lower since mid-August.

Although there is a high probability that we will see another selloff in the September-November timeframe, a close below the trendline at 203.50 is necessary in order to negate the current uptrend. A break below the June low should take ^XBD down to at least the 179.30 area. So pay close attention, as that could present a put-buying opportunity.

Great trading,

Jim Stanton

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Today’s Smart Profits Cribsheet

Not sure which way a stock is going to break next? Simply remember the old investment adage that “the trend is your friend,” and then read Smart Profits #317: Continuation Patterns: Cashing In On Technical Analysis for some key tips.

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