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Saturday, September 1, 2007

ETF charts at crossroads

Looking at some of the ETFs we track, we are seeing some interesting developments starting to play out on the charts. It is looking suspiciously like there are head-and-shoulders patterns forming on a number of charts. The head-and-shoulders is traditionally viewed as a strong indicator of a reversal about to happen with the inverse H&S pointing to a rally and the standard H&S pointing to a downturn.

Here are some comments on the chart patterns we see emerging using traditional technical analysis rather than the TradeRadar software (click the "charts" link to view the three charts for each ETF at stockcharts.com):

Dow Diamonds (DIA, charts) - inverse H&S is forming on daily chart. With Friday's action DIA closed just above its downward trendline but still below its 50-day MA. Looking at the weekly chart, however, things are not quite so hopeful as the pattern is indeterminate. The point-and-figure chart looks like a triangle is being formed. Hard to say what direction DIA will take. Outlook: uncertain.

S&P 500 SPDRs (SPY, charts) - inverse H&S is forming on daily chart. With Friday's action SPY closed a bit above its downward trend line and its 20-day MA is just below its 200-day MA. On the weekly chart, the H&S is not nearly so apparent and it looks more like SPY is carving out a trading range. On the point-and-figure chart it looks like SPY has topped out. Outlook: uncertain to negative.

PowerShares QQQ Trust (QQQQ, charts) - inverse H&S is forming just about confirmed on the daily chart tough the volume on the right shoulder is somewhat weak. Based on the size of the H&S, we could see the QQQQ make a new high in the low 50's. On the weekly chart, the pattern looks less like a H&S and more like a pullback turning into a new uptrend. This is a pretty optimistic chart; however, on the point-and-figure chart it looks like a triangle is being formed. This contributes some uncertainty. Outlook: positive.

Financials Select Sector SPDR (XLF, charts) - here we see a sloppy but potential H&S forming. The right side of the pattern is not yet near what could be the neckline. The weekly chart indicates XLF is still under pressure and trending down. The point-and-figure chart shows a down trend but offers some hope if the pattern develops into a descending triangle from which the next move is often up. Still, that implies more pain for XLF before we see a clear reversal to the upside. Outlook: uncertain to negative.

iShares Real Estate (IYR, charts) - despite strong moves at the end of the week, IYR was unable to close above its downward trend line and the H&S pattern, like that of XLF, is sloppy and exhibiting an unclear neckline. Volume on the right shoulder is not confirming as clearly as one would like. The weekly chart shows a steep downtrend that may be forming a bottom. The point-and-figure chart may be confirming the bottom as it shows a very recent up-trend forming. Outlook: uncertain to negative.

Conclusion: if looks like there is still quite a bit of uncertainty in the charts. Despite talk of rate cuts, benign inflation and the government bailing out borrowers and lenders, the charts are reflective of investors who are reevaluating risk and stock valuations. These daily charts may presage a short-term rally that runs out of steam when third quarter earnings come out after September.

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