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Weak First Quarter Yields Opportunities


Near-term rally likely, but in context of bear market.

The first quarter of 2008 surely started off the year with a bang, but unfortunately it was to the downside. Good riddance 1Q - which happened to be the worst quarter for equities since 2002.

Financials continued to lead the way to the downside as massive writedowns, the continued credit crunch and repercussions from the subprime crisis dragged the equity market lower. While the trend is still clearly down, it does look like we could be setting up for a decent bounce higher in 2Q. Sentiment has become overwhelmingly bearish, and this is clearly evident when you start to see positive reactions in stocks following negative news.

As you can see in the below weekly chart of the S&P 500, there was a slight positive divergence in the RSI oscillator at the March lows, and so far the S&P has been able to hold above the 200 week moving average at 1300. As long as we can hold above this key 1300 support level, we should be able to grind higher on the S&P 500 up into the 1400-1450 resistance area.

However, keep in mind that this would be a rally in an overall downtrend and should be treated as an opportunity to lighten up on underperforming equities. Be especially careful if the rally loses steam and we start to see closes below the 1300 level, and especially last ditch support near 1250.

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In my January 9th piece, I highlighted the potential for biotech to outperform and a good group for long side trades. The Biotech HOLDRs Trust (BBH) actually finished Q1 in positive territory!

I continue to like biotech and it's definitely my favorite group for potential outperformance in 2Q. We are entering a seasonally strong period for biotech and any group that performs positively in such horrible market conditions warrants further consideration. I think the BBH offers an excellent risk reward buying opportunity here with support at the 170 level and clear upside into the 200-210 level.

I would like to see confirmation of upside potential with a close above the weekly downtrend line just below 180. Make a shopping list of your favorite biotech names in 2Q because they should continue to outperform!

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I'd like to update readers on my three trading ideas I highlighted at the beginning of the year. The Japanese yen had a huge first quarter and proved to be a great hedge for the credit crisis and leverage unwind. In my March 13th buzz I recommended shorter term traders to take partial profits on yen longs as it had achieved my near term target of 100.

The yen continues to be my favorite longer term currency trading idea, so I'm still very bullish. However, I think we could see a pullback here into the 93-95 level which should offer much better risk reward buying opportunities. These levels coincide with the .382 and .500 Fibonacci retracement levels which frequently offer support in bull markets. Hopefully some readers have followed me into the yen because this has been a very profitable trade to start off an ugly year.

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The PowerShares Water Resource Portfolio (PHO) was my second pick for 2008, if you had to have some long equity exposure. While the PHO certainly finished 1Q lower, it did outperform the broader indexes. I would look for the PHO to consolidate here around the 18-20 level to create a solid base for further upside later in the year. Keep an eye on this one, as I think this has a great longer term macro theme and should outperform on the upside later this year as it has held up well in a tough tape.

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Gold was my third pick for 2008, and as I mentioned previously, should prove to be one of the more volatile markets this year. Gold hit my $1000 target and I lightened up. Since then the metal is off more than $100 and is close to breaking the $900 level.

I think we're going to see continued downside volatility in Gold prices especially as the dollar strengthens from oversold levels. I'm looking for a pullback in Gold to at least the $800 level near term, which would coincide with the previous 4th wave lows in late 2007. Longer term I think Gold could test the $550-$600 level if it cannot find support around $750-$775.

Note the negative divergence on the weekly chart that coincided with the push to $1000. Hopefully readers enjoyed some nice profits near $1000 on another solid trade during one of the toughest quarters this decade!

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Position in PHO
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