One main reason for my skepticism, among many, of the durability of this rally is how the sentiment indicators, usually among the most reliable, have failed to have any predictive impact on the traders. In short, the sentiment indicators have simply been ignored by them. The last time I saw such complete distain for the bull/bear ratio, overbought/oversold indicators and even the put/call and the new highs/new lows numbers was during the last major domestic financial crisis in 1990 as the Savings and Loan crisis unwound. Even the VIX has failed to demonstrate any real market fear as hedge and mutual funds have faced record redemptions. I think that’s why these rallies have so far failed to hold. While the bulls are now reported as the fewest this year, the dip buyers won’t let us have the major market washout we need to put in any type of sustainable bottom. But that’s not the only problem confronting this market.   

Until today, any attempt by the bulls to mount any rally has been met by news of a financial’s blowup or their need for further cash infusion. This scenario has now played out right on cue to the 1990 script. As we now know, 1990 took a major governmental program via the Resolution Trust Corporation (RTC) to resolve the market’s issues. We may have seen the beginning of that process today as the Bernanke and Paulson well-timed and undoubtedly synchronized speeches did outline some indication of government possible plans for financial reconstruction.

However, for me, the real story today was the pullback in crude, Nat. gas, the minerals, the materials and agriculture. The commodity pullback was both technically and more importantly, fundamentally inspired as an increase in overseas supplies and a decrease in seasonal demand hit the commodities. Is the run in these sectors over? I truly do not think so and was in the market today picking small in my favorite names in these sectors. I was buying back the stock I sold at much higher prices. Did I get them at the bottom today? Well if I did, it will be the first time in my life. But I will buy small again on any further pullback as my Disciplines require I do until my overall thesis changes and it has not.

Was it easy buying ECA at 81 when I just sold a quarter at 96? No, it was scary as hell and looking at the chart the next support level appears to be around 75. That’s a long way down on a big trading position. But that is my own investment approach and style of investing and my Disciplines require it and they have served me well. Of course, having a very low cost basis in a core position helps a lot and allows me to buy the sell offs and sell into strength with confidence.

That’s what I have been trying to convey to you and how it has worked for me. I have made money with this approach and I believe you can too. This sell off is providing the opportunity to create very low cost basis positions in some of the excellent core positions in this market, particularly in the financials and other out of favor sectors in best of breed stocks. That’s how you build low cost basis long-term core positions.

Last week I noted that the Biotech sector was beginning to show signs of some strength after a prolonged downturn in the sector.

Yachtsman, Tuesday, July 1. 2008 said:  

“Today I had one solid green screen. It was Biotech. But as I pondered on it I realized there were many reasons for the green. First, biotech is recession proof. They also have replaced big pharma as the “safe” place to hide during economic uncertainty. Also, there was a swing today in the daily polls toward McCain as the Israel-Iran showdown heated up and McCain and the Republicans are viewed as more favorable toward biotech than Obama and the Dem’s toward big pharma. The thinking being that the Democrats are beholden to big pharma and the Republicans favor upstart biotech technology. I’m not making any political statement here, but that is the Wall Street’s perception. I’m an investor, not a pollster, but what moves the market moves me. Investors prefer biotech over big pharma and many Biotech’s are potential take-over targets for big pharma. I like biotech as an overweight sector and will be adding to my favorites.”

The Spider S&P Biotech Index ETF (XBI) shows what I was referring to at the time and the pending break out from the volatility squeeze it was forming. That is what I was watching as the Biotech’s began to move. As you can see from the XBI chart below, the Biotech’s have gone through a basing process and have now begun to break out. Also notice the huge increase in volume on the breakout and the strength in the RSI indicator. This is what I was anticipating last week as I watched the specific Biotech issues begin to move above their resistance levels and their volumes increase. I began accumulating the ETF and adding to my DNA, GILD and CELG positions on their breakouts.     

As you can see, the Biotech’s have taken the lead role in the defensive posture formerly held by the big pharma drug stocks. 

This action in the Biotech’s is yet another example of the market action we saw in the 1990 Savings and Loan recovery. Sectors with no exposure to the financial crisis or mortgage meltdowns were somewhat shielded from the sell off and outperformed the broader indices over every significant period of comparison. 

As you can see, we are now beginning to see the big pharma names start to gain some traction as the market seeks exposure away from the financials and from anything attached to sub-prime or mortgage backed securities. As the index of the ($DRG) Pharmaceutical sector shows below, the large cap drug names are now beginning to attract attention.

I believe the medical device, Biotech and big pharma sectors will be attracting the trader’s attention as we move through the resolution of the “mortgage crisis” as referred to today by Jamie Dimon. This market action would directly coincide with the market response we saw in 1990 in reaction to the S&L crisis. Keep a close eye on these sectors and take advantage of the defensive positions the hedge fund and mutual fund managers will be seeking as we move through the turbulent summer months. They will be seeking a place to hide from the “crisis” and volatility of the market and from my experience the medical and pharma related sectors are their favorites.

I hope you had a profitable day.

Smooth sailing,

Yacht