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Toe the Line: Here We Are Again at a Technical Point Which Will Direct for Months to Come

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Here's a granular breakdown on what's happening on the Nasdaq.

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Skill and confidence are an unconquerable army.
– George Herbert

John Illsley, founding member of Dire Straits, delivers the sentiment this Monday morning with a top single from his 2010 Streets of Heaven album, "Toe the Line." And here we are again -- a technical point at which, depending on a breach or not, will most likely dictate the following month(s) action and placate the all-too-common Wall Street adage, "sell in May and go away." Some may find it somewhat uncanny how the market has once again gotten itself to another inflection point. And yet, some believe this just might be par for the course in the coming years – including my firm (a discussion for a different time).

Since April 10, when the short-term bull trend was broken, there have been a lot of questions regarding the depth and duration of a correction. As such, we have been discussing the 1,340 level on the S&P 500 Index (^GSPC) over the last few weeks. But today we turn our attention to the Nasdaq 100 Index (^NDX) – the more concentrated index. Last week the NDX traded in a band between 2,590 and 2,640 and provided two reversal days within – a good sign for the bulls. With this knowledge investors are asking if this level will hold and whether the May phenomenon is just that -- a phenomenon.


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Break It Down

This index, for the most part, is made up of six of the 10 GICS sectors (Global Industry Classification Standard); or getting even more granular, it holds only 12 of the 24 GICS industry groups – hence the concentration. Most investors understand the financials are excluded, but what else is left out? Or better yet, what is it made of and why is this important?

We'll begin with the first – what is it made of? (Disclosure: The following figures are not the weighting percentages, merely the number of equities within the index as the index has a proprietary hybrid weighting of market cap and equal weight.) The majority of its makeup is rather obvious: 48% in the information technology sector (which is comprised of three industry groups, see below). As for the other heavily weighted sectors, it's 23% consumer discretionary (retail) and 17% health care. This makes up 88%.

Nonetheless, GICS sectors still don't get us closer to our second question: why knowing this information is important. Hence, we look further and delve into the smaller, yet important, industry groups. There are four that really provide clarity. software & services (23%), semiconductors & semi equipment (14%), and biotechnology (12%). The fourth-largest (again in terms of number of stocks) is technology hardware & equipment (11%). However, the "hardware" industry group has no ETF to track for today's evaluation. With that said, we decided to list the 11 ticker symbols of the stocks that make up the missing hardware & equipment GICS industry group single tracking ETF: Flir Systems (FLIR), NetApp (NTAP), Dell (DELL), Apple (AAPL), Seagate Technology (STX), Cisco (CSCO), Flextronics (FLEX), SanDisk (SNDK), F5 Networks (FFIV), Qualcomm (QCOM) and Research in Motion (RIMM). These four industry groups make up 60%.

Now that that's out of the way, we delve into this information to see if there is further clarity. The NDX, as previously stated, is at an important inflection point. Sometimes a top down approach is enough, but sometimes a bottom up approach is what is necessary to assist with overall confidence of analysis.


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The comparison chart above shows the NDX (Nasdaq 100 Index), the Semiconductors Vector Trust (SMH), the Biotech Vectors Trust (BBH), and the S&P Software & Services (XSW). Bearing in mind that there is no hardware ETF and considering its weighting is between 17.5-20% (depending on the day), we included Apple as well. By analyzing the bottom-up data (comparisons) investors can get an idea of overall health of the index. With this investors can see that biotech is the only "heavily weighted" industry group bucking the trend.

But this is not where a technician's analysis should stop. Considering the attempt to keep this article short, we did not extend out the analysis one more step. The final step, which you can easily do on your own, is to analyze each of the majority-weighted sectors (or stocks) to find their own technical health (support and resistance levels).

This type of analysis can be extremely enlightening when ascertaining not only direction, but money flow. My firm often does this exercise (once or twice a month) to complement our traditional day to day analysis.

We hope this helped and finds you well!

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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