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Opportunities Abound in 2008

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Where do we hide if it looks like the market is heading lower in the near term?

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Before we go on to look at what 2008 holds for some different markets, let's revisit my three highlighted picks for 2008 from my December article.


1) Japanese Yen

This continues to be one of my favorite currency plays for 2008. The Yen is a great hedge for a continuing credit crisis as carry trade unwinding should keep a firm bid under this highly levered currency. See the below longer term chart which shows how my 1.00 target for the Yen future in 2008 is fairly conservative. There is strong support below the 0.90 level and we are seeing an upside range expansion here which I believe is the start of a promising uptrend. Longer term I think we can test the 1995 highs.


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2) PowerShares Water Resource Portfolio (PHO) Long

If you must have some equity exposure I think this is a great diversified vehicle with a solid long term macro theme. We've heard the stories about the water shortage the world is facing, and if that plays out, PHO will benefit to the upside. I think you have an attractive entry point here at the 200 day moving average and I think the PHO will see $25 in 2008 if not higher. Louis Bacon's Moore Capital owns 4.8 mln shares of PHO; last time I checked he was a pretty smart guy and happens to run one of the top performing macro hedge funds in the world. Not bad company!


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3) Gold

Now this is a tough one. I think Gold will be one of the most dynamic markets in 2008 with some very dramatic moves and great opportunities to make money. However, a good bit of the upside has already been seen in gold early this year. Gold broke out to the upside of a bullish triangle continuation pattern and is within spitting distance of my near term target of $900. While I do think we could see a $1000 handle on gold at some point in 2008, I would be worried that the risk reward is not as favorably skewed anymore.

This will be one of the most volatile markets of 2008 and as an example you should look at the first quarter of 1980 which until recently was the previous all time high for gold. Gold opened 1980 at $566, ran all the way up to $873, and then fell all the way down to $453 before closing just back above $500. I think we could see the same high volatility in gold this year so I would be very careful! As I said earlier, I think we will see a $1000 handle on gold at some point in 2008, but I also think we could see very sharp pullbacks to the $700's if not lower. Don't get too greedy!


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Now let's look at the stock market and see if we can't chart a course for 2008…

The longer term chart below of the S&P 500 sure looks like a double top to me. Notice how the 1550 level proved to be important resistance and we are very close to breaking longer term uptrend lines. I think we will see the SPX test the 200 week moving average which would mean we will see the 1200's on the S&P 500. Hopefully the market can stabilize above 1250 to create the potential for a longer term cup and handle bullish pattern although it could be quite some time before we see a upside resolution to this pattern. Starting 2008 just under 50 and 200 day moving average resistance will make it hard for the S&P 500 to get going higher right out of the gate. The all-time high for the S&P 500 in 2007 was 1576 so keep that number in mind, it will be important some date in the future…


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The Dow Industrials are forming a head and shoulders top with a neckline near 12,700 (we're right there!). Closing below this level would project to 11,400 which just so happens to coincide with the 200 week moving average. Look for the Dow 30 to hold up better on the downside as portfolio managers try to hide in larger cap names.


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The NDX is just now breaking the 50 week moving average after some serious under-performance to start off 2008. This is after some solid out-performance in the latter half of 2007. While these higher beta names probably continue to catch up on the downside, they will most likely also perform well on the upside when the market does stabilize. Look for support to show up near the 1800 level which would coincide with the 2006 highs, but keep in mind a test of 200 week moving average region (1650-1700) could play out. Watch for a potential right shoulder if a rally from 1800 starts to fail near 2000, that could foreshadow some distribution.


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So where do we hide if it looks like the market is heading lower in the near term? Health care. A simple look at the IYH (Health care iShares) shows how well this sector has held up during the recent volatility and I think it might prove to be one of the best performing sectors in 2008. Nice uptrend and the IYH should have solid moving average support in the low $70's to start off 2008. Make your shopping list of health care names now so you can be ready to pick up the ones you want at good prices, because with 2008 being an election year, we could certainly get a chance to pick up this sector on the cheap if there is political downside momentum.


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On the health care note, if you simply must have some growth names in your portfolio, biotech could be an interesting place to look for defensive growth. The BBH (Biotech HOLDRs Trust) looks to be forming a potential double bottom here in the $160 area and this group should participate when the market does stabilize and move higher along with providing more defensive health care exposure. This vehicle provides a good way for exposure to a sector I believe could have very positive returns this coming year.


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The BKX (KBW Banking Index) will certainly be one of the main battlegrounds for the bulls and bears in 2008. The BKX kicked off 2008 breaking out to the downside of an inverted cup and handle pattern which shows how strong the downside momentum has been in this group. Below $80 the BKX is starting to get very oversold and with so many portfolio managers underweight financials there will come a time in 2008 when we see some very sharp short covering rallies. After a strong move in one direction, it is a good idea to keep an idea on Fibonacci retracement levels to determine targets for counter-trend rallies. I would highlight the 50% retracement near $100 as a median expectation for rally potential when that market is able to stabilize and move higher.


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While we are talking about the financials, let's look at a longer term chart of the XBD (Broker Dealer Index). As you can see the group formed a large head and shoulders top in 2007 with a down-sloping neckline which is bearish. However, with the XBD breaking 180 it has achieved the downside target from this pattern and might be due for a bounce here. Again, use retracement levels on a short term chart to determine targets for bounce potential. It looks like the 220 level should provide neckline resistance at some point in 2008 and could be an ideal point to reduce exposure to the group.


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Another group I think will experience significant volatility in 2008 will be the Oil Service Index (OSX). After putting in a stellar performance in 2007, the OSX looks to be losing some upside momentum as you can see in the non-confirmation of new highs by the RSI oscillator. The OSX is also sitting right on a very steep uptrend line and has achieved the $300 target from the bullish pennant formed in 2006. Keep an eye on the RSI as a break below 50 which coincides with a steep trend line break could bring downside momentum quickly.


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What group would benefit if the OSX rolls over? Airlines. The XAL (AMEX Airline Index) was an absolute dog in 2007. This is not surprising considering oil basically doubled to push $100/barrel at year end. While I am not a fan of buying in a clear downtrend, I would watch the XAL for stabilization near the 2003 lows and finding support there could lead to a very sizable bounce. If Oil pulls back significantly in 2008 I think the XAL could rally as much as 50%.


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One last battleground for the bulls and bears in 2008 will be the consumer discretionary sector. Rising oil prices, credit concerns, and consumer worries were significant headwinds for the RTH (Retail HOLDRS Trust) in 2007. This is another group in a clear downtrend, so I would not try to catch any falling knives until the market as able to firm. Watch for a counter-trend rally back up into resistance in the high $90's on the RTH as a potential right shoulder to lighten up on exposure to this group.


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I hope you find this useful in charting a potential course for what may lie ahead in 2008. Focus your buying on strong groups and lighten up on exposure in weak groups. It certainly looks like 2008 will be another very interesting year for the market so stay on your toes! Best wishes to all...
No positions in stocks mentioned.
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