TomAspray's  Instablog

Technical weakness in four key global ETFs preceded, or even predicted, the current decline in the US market, making their latest price action especially crucial.

The early-April decline in the German DAX Index below the March lows was a warning to me that stronger world markets, including the US, also had the potential to violate their March lows.

Earlier this week, I was discussing relative performance (RS analysis), or what some refer to as "comparative relative strength analysis," with veteran trader and old friend Linda Raschke. She suggested that I also look at the recent action of some key global ETFs like the iShares MSCI Brazil Index Fund (EWZ), the iShares FTSE China 25 Index Fund (FXI), the WisdomTree India Earnings Fund (EPI), and the iShares MSCI Japan Index Fund (EWJ).

Linda's analysis of these funds last month confirmed her hypothesis that the US markets were also ready to move lower. For those looking to learn more about relative strength analysis, I think you will find this Webcast segment from Linda very informative.

Linda also shared some additional insights "When you want to trade the short side, pick the weakest. If the markets build a bit of a base and look poised for upside again, then you want to buy the relative strength leaders. If there is no confirmation from the other indexes, than the upside is not going to get very far. On this last selloff, all global indexes were making new momentum lows, so one could have traded the short side with added confidence."

These funds often lead the US market both lower and higher, and the relative performance analysis of the iShares MSCI Brazil Index Fund (EWZ) bottomed two months ahead of the US market in January 2009. Let's look at what these funds are telling us now.

Click to Enlarge

Chart Analysis: The weekly chart of the iShares MSCI Brazil Index Fund (EWZ) shows the rally from the October 2011 low at $49.25 to the high of $70.74 in early March. Through last Friday (May 18), EWZ has dropped 27.1% from its highs versus just an 8.8% decline in the Spyder Trust (SPY).

• If the October lows are broken, next good support is in the $44-$45 area
• RS analysis rebounded above its weighted moving average (WMA) late last year but failed to start a new uptrend
• The RS dropped back below its weighted moving average in March (line 1) and then dropped below support at line c. This was a sign of weakness and forecast an even more serious decline
• The RS line is in a clear downtrend and would need to move through its downtrend and above the March highs to turn positive
• Weekly on-balance volume (OBV) just tested its downtrend, line d, in March before dropping below its weighted moving average
• OBV made lower lows in October and was acting weaker than prices
• First strong resistance for EWZ is now in the $56-$57 area

The iShares FTSE China 25 Index Fund (FXI) reached a high of $40.67 in early February and was unable to make it much higher even though the US market continued to make higher highs.

• The break below support at $36 (line e) on May 9 completed the top formation and gave downside price targets in the $30-$31 area
• RS line failed to start a new uptrend while FXI was moving higher in early 2012, and it was unable to move above the October highs
• RS dropped below key support, line g, on March 17 (line 2), which was almost seven weeks before prices broke support
• RS line shows no signs of bottoming. Longer-term resistance is at line f
• OBV was stronger than prices in April, and the break of its support, line h, coincided with the price break
• The former support, line e, at $36 is now the first key level of resistance

Click to Enlarge

The WisdomTree India Earnings Fund (EPI) peaked at $21.59 on February 21 and is now down 26% from those highs. EPI is now very close to the late-2011 lows at $15.44. In 2009, the low was $8.81.

• RS analysis bottomed in January 2012 when the downtrend, line a, was overcome
• RS line stayed above its weighted moving average until February 24 and soon formed a pattern of lower lows
• RS line rebounded back to its now declining weighted moving average on March 13 (line 1). The daily downtrend, line b, is still intact
• OBV shows a similar formation, as it also peaked in February and has been weaker than prices since April, line c
• There is a band of resistance now in the $17-$18 area

The iShares MSCI Japan Index Fund (EWJ) gapped below support on April 4, which completed the daily top formation, lines d and e. EWJ is now down over 12% from the high at $10.21. A violation of weekly chart support in the $8.75 area would be much more negative.

• The RS line started to diverge from prices in early March when it made lower highs (line g) while prices were making higher highs
• In early April, the RS line broke support, line f, which was a negative sign and forecasted that prices would follow lower
• The RS is still in a well-established downtrend, line g
• OBV was much stronger than the RS, as it confirmed the price highs in late March and stayed above its uptrend, line h, until early May
• There is near-term resistance now in the $9.50-$9.70 area

What It Means: I generally use relative performance (RS analysis), or comparative relative strength, as a tool to find market-leading sectors, industries, or stocks. It is an important tool that can help you find the best places to invest, as well as those to avoid.

As Linda pointed out, it can also be a useful tool in supporting or contradicting other methods of analysis.

By April, the RS analysis of these four global ETFs had turned negative while the Dow Industrials, Nasdaq 100, and S&P 500 all continued to move higher. Each of these ETFs still look negative, which suggests that the decline in the US stock market will continue, although I do not expect to see the US indices drop as much as these ETFs.

How to Profit: No new buy recommendations at this time.

Portfolio Update: Buyers should be 50% long the ProShares Short S&P 500 ETF (SH) at $36.26 and 50% long at $36.06. Use a stop at $36.88 and sell half the position at $39.22 or better.

Some of the stocks in Warren Buffett's Berkshire Hathaway portfolio are now correcting near favorable entry levels where value- and income-minded investors can smartly buy in.

It is always interesting to look at the stocks that high-profile investment gurus like Warren Buffett are buying. Last year, however, was not a great year for Berkshire Hathaway (BRK.B), which was weaker than the S&P 500, losing 4.7%.

The weekly volume pattern in BRK.B does show some signs of accumulation, so 2012 could be a better year for Berkshire Hathaway. One of the stocks that Buffett bought more of in the first quarter, Bank of New York Mellon (BK), has had a rough two months and has dropped 16% so far this quarter.

Coincidentally, Buffett's top holding, Coca Cola Co (KO), is also the largest holding in my "Charts in Play" portfolio, and two of his other top holdings now also look attractive for new purchases.

Click to Enlarge

Chart Analysis: The Coca-Cola Co (KO) made a high in April of $77.82 but dropped to a low of $73.47 last week. KO currently yields 2.8%. It makes up 19.7% of Berkshire Hathaway's portfolio.

• The breakout in March above resistance at line a was very positive, and KO has retraced 38.2% of the rally from the January low at $6.56
• There is additional support at $72 (line a) along with the rising 20-week exponential moving average (EMA)
• The 61.8% support is now at $71
• Relative performance, or RS analysis, surged sharply on the breakout and shows a pattern of higher lows, line b
• On-balance volume (OBV) confirmed the breakout when it moved through resistance at line c. It is still well above its weighted moving average (WMA)
• Daily OBV (not shown) has dropped below its weighted moving average
• There is initial resistance now in the $75.30-$76 area

American Express (AXP) has corrected sharply from the recent high at $61.42 and has now dropped back to its rising 20-week moving average at $55. The stock makes up 11.6% of Berkshire Hathaway's portfolio.

• AXP broke through longer-term resistance, line d, in the $54 area last March
• The relative performance line also made new highs in April, which is positive. It has good support at line f
• Weekly OBV was also able to overcome major resistance, line g, in March
• Daily OBV (not shown) did confirm the recent highs but has now dropped back below its weighted moving average, suggesting the correction is not yet over
• Next resistance for AXP is in the $57.30-$58 area

Click to Enlarge

ConocoPhillips (COP) has dropped sharply from the high at $59.68 and hit a low of $50.66 last week. This is a drop of just over 15%. COP currently yields 5.2% and makes up 2.9% of Berkshire Hathaway's portfolio.

• The uptrend from the 2009 lows, line c, was broken last week, and there is further support, line b, in the $49.50-$50 area (line b)
• There is additional support now in the $48.50-$47 area
• RS line has pulled back to long-term support at line e, but it needs to move through resistance at line d to signal that COP is outperforming the S&P 500
• Weekly OBV dropped below its weighted moving average in the middle of April and is now back to good support at line g
• Daily OBV (not shown) turned negative in March and still has not bottomed out

What It Means: Since I am no expert in fundamental stock analysis, it is often helpful to look at the stocks that investing giants like Warren Buffett and George Soros are buying. I believe that looking at their picks from a technical standpoint can help identify good entry levels and also better control risk.

Since I have previously recommended Coca Cola Co (KO), I will not be doing additional buying for my model portfolio, but for those who are not currently long, I would still buy as suggested below.

Even though ConocoPhillips (COP) is still in a downtrend, the long-term positive outlook for crude oil prices and its very attractive yield make it look favorable on a test of stronger support.

Other major holdings of Berkshire Hathaway include International Business Machines (IBM), 17.8%; Wells Fargo & Co (WFC), 17.8%; and Procter & Gamble (PG), 6.5%.

How to Profit: For American Express (AXP), go 50% long at $54.62 and 50% long at $53.78 with a stop at $50.48 (risk of approx. 6.8%).

For ConocoPhillips (COP), go 50% long at $50.32 and 50% long at $49.58 with a stop at $46.88 (risk of approx. 6.1%).

Those not currently long Coca Cola Co (KO) could go 50% long at $73.58 and 50% long at $73.04 with a stop at $70.77 (risk of approx. 3.5%).

Technical signals suggest two of the most oversold stocks on the Nasdaq 100 are likely to underperform the broad markets, while two others appear to be good buys for after the ongoing correction.

The PowerShares QQQ Trust (QQQ), which tracks the Nasdaq 100 Index, was hit hard last week, declining 4.3% for the week, 1% worse than the Spyder Trust (SPY). QQQ is down 11.3% from the April 3 highs and closed last week just 0.6% above its weekly Starc- band.

Starc band analysis gives a reading of whether a stock is a high- or low-risk buy at the time. Close proximity to the upper Starc band (Starc+) means it is a high-risk time to buy since the stock is likely to at least move sideways, if not decline. Conversely, when a stock closes near its lower Starc band (Starc-), it is a high risk time to sell since the chances of a rebound are high.

For more on trading with Starc bands, click here.

The table below shows the 15 Nasdaq 100 stocks that are closest to their weekly Starc- bands. At the top of the list is Cisco Systems (CSCO), which closed last week 1.5% below its weekly Starc- band.

Just because a stock is oversold does not automatically make it a buy, as one needs to do further analysis to isolate those stocks that are in intermediate uptrends and where the relative performance analysis indicates they are outperforming the S&P 500.

Click to Enlarge

The top two stocks on the list have chart patterns and technical readings that indicate their recent strength was just a rebound within the major downtrends. Two of the most oversold stocks do look like long term buys on a test of more important chart and Fibonacci retracement support.

Click to Enlarge

Chart Analysis: Cisco Systems Inc. (CSCO) peaked at $27.74 in April 2010 and lost just over half its value by August 2011 when it made a low of $13.30. By early-April 2012, it has rebounded to $21.30, which was just above the major 50% Fibonacci retracement resistance at $20.52.

• It is important to note the 61.8% retracement resistance at $22.23 was not exceeded, suggesting that the rally was just a rebound within the overall downtrend
• CSCO plunged on May 10 in reaction to disappointing guidance in its earnings report
• It is already down 22.7% from its highs and has been below its weekly Starc- band for the past two weeks
• Next major support on the weekly chart, line a, is in the $15 area
• As CSCO was moving higher, the relative performance, or RS analysis, was flat, line b. It has now dropped sharply, indicating CSCO is weaker than the S&P 500
• On-balance-volume (OBV) has dropped below its weighted moving average (WMA) and failed to even reach the major resistance at line c
• Near-term resistance for CSCO now stands at $18

Teva Pharmaceutical Industries (TEVA) is a $33 billion maker of generic drugs. TEVA closed below its uptrend, line d, two weeks ago, and is down 16% in the past three weeks. This completed the continuation pattern.

• The rally from the 2011 lows just reached the major 38.2% Fibonacci retracement resistance from the 2010 high at $64.95
• Next support is between $36.88 and $35
• RS analysis declined, line e, as TEVA was moving higher. This was a sign of weakness, and it has continued to act weaker than the S&P 500
• Weekly OBV is also in a longer-term downtrend, line f, suggesting that the buying was weak on the rally
• There is first resistance for TEVA in the $41-$42 area

Click to Enlarge

Starbucks Corp (SBUX) closed above its weekly Starc+ band in late March and peaked in April at $62.

• With last Friday's close at $51.53, the stock is down 16.9% from its highs
• Weekly chart has next good support in the $47.80-$49 area with more important support at $44.50-$45
• The longer-term uptrend, line a, is at $42.30 with the major 38.2% retracement support from the 2009 lows at $40.94
• RS analysis did make new highs with prices in April but has since turned lower. The long-term uptrend in the RS, line b, is positive for the intermediate-term uptrend
• Weekly OBV also made new highs with prices but has now dropped below its weighted moving average. It is still above its uptrend, line c
• There is initial resistance for SBUX at $53.50

Priceline.com Inc. (PCLN) also tested its weekly Starc+ band in early April before reversing to the downside. It closed last week on its lows and is just 1.6% above its weekly Starc- band at $621.79. PCLN is down 18.4% from its highs.

• The weekly chart shows good support in the $560-$554 area with the 38.2% Fibonacci retracement support from the 2010 lows now at $544
• Weekly uptrend, line d, is in the $520 area
• The RS line did confirm the April price highs but is in a strong uptrend, line e
• Weekly OBV did make new highs with prices, which is positive, but it has now dropped back below its weighted moving average
• The January breakout in the OBV above resistance, line f, signaled the 40% rally
• Initial resistance is now at $675-$700

What It Means: The Fibonacci retracement resistance and RS analysis indicate that the two most oversold Nasdaq stocks, Cisco Systems Inc. (CSCO) and Teva Pharmaceutical Industries (TEVA), are likely to stay weaker than the S&P 500. Both could test, if not break, the 2011 lows, and though many analysts are touting CSCO as a great value buy, the technical outlook suggests otherwise.

On the other hand, the OBV and RS analysis suggests that after the current correction runs its course,Starbucks Corp. (SBUX) and Priceline.com Inc. (PCLN) should continue to outperform the S&P 500.

How to Profit: For Starbucks Corp. (SBUX), go 50% long at $50.58 and 50% long at $49.46 with a stop at $46.74 (risk of approx. 6.4%).

For Priceline.com Inc. (PCLN), go 50% long at $574.60 and 50% long at $550.46 with a stop at $524.44 (risk of approx. 6.8%).