Alpha Stocks: Market View 02/01/2008

Friday, February 1, 2008

Market View 02/01/2008

Well, we made it though the first month of 2008.

For the month, the DJIA was off -4.63%

S&P 500 down -6.12&

Nasdaq 100 down -11.68%

Nasdaq Composite -9.89%

Russell 2000 - 6.88%

However, I am seeing strength in the market:

The DJIA broke a double top yesterday at 12,500, closing at 12,650. This is a bullish sign and I would be a buyer of DIA today at 127 with a price target of 138.50. Keep a stop loss at 124.

Interestingly, the Dow Transports have been climbing with little attention. The airline industry on average, recently posted net positive earnings. I can't remember how long it has been since this has happend. The Transports reversed their bearish downtrend on 01/23/08 at 4,200 and closed yesterday at 4,752. It also broke resistance at 4,650. One way to play this is through the iShares IYT. It closed yesterday at 84.87. I would be a buyer at 85. Stop loss at 82.

The Dow Utilities have now broken out of a double top. Again, a bullish sign. It closed yesterday at about 503. XLU closed at 39.22. I would be a buyer of XLU here this morning under 40. Stop loss is 37.

With all three major Dow indices breaking out, we have a very bullish scenario for the Market. Keep in mind that we have had a very volatile market. However, the VIX is coming down, so trade the Market to the upside for now. Be aware that we could have a reversal at DJIA 13,200, where there is some resistance. The heaviest resistance is at DJIA 13,400 so expect the market to stall out between those points. If we blow through those levels, that would be very bullish and we could probably say the bottom is in.

Sector ETFs:

XLP bearish
XLY hold; don't buy- keep on watch list
XLE bearish
XLF hold; don't buy - keep on watch list
XLV bearish
XLI slightly bullish; reversal pattern; buy on a breakout over 38.
XLB slighty bullish; reversal pattern; buy on a breakout above 40.
XLK slightly bullish; reversal pattern; buy on breakout above 24.
IYZ bearish

GLD very bullish; ascending triple top breakout; buy under 92.
USO slightly bullish; reversal pattern; buy breakout above 74.

Keep stops at $3 below entry.

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About Alpha Stocks

Alpha is a risk-adjusted measure of the so-called "excess return" on an investment. It is a common measure of assessing an active manager's performance as it is the return in excess of a benchmark index.

The difference between the fair and actually expected rates of return on a stock is called the stock's alpha.

The alpha coefficient (αi) is a parameter in the capital asset pricing model. In fact it is the intercept of the Security Characteristic Line (SCL). One can prove that in an efficient market, the expected value of the alpha coefficient equals the return of the risk free asset: E(αi) = rf.

Therefore the alpha coefficient can be used to determine whether an investment manager or firm has created economic value:

αi < rf: the manager or firm has destroyed value
αi = rf: the manager or firm has neither created nor destroyed value
αi > rf: the manager or firm has created value

The concept and focus on Alpha comes from an observation increasingly made during the middle of the twentieth century, that around 75 percent of stock investment managers did not make as much money picking investments as someone who simply invested in every stock in proportion to the weight it occupied in the overall market in terms of market capitalization, or indexing.

Many academics felt that this was due to the stock market being "efficient" which means that since so many people were paying attention to the stock market all the time, the prices of stocks rapidly moved to the correct price at any one moment, and that only luck made it possible for one manager to achieve better results than another, before fees or taxes were considered.

A belief in efficient markets spawned the creation of market capitalization weighted index funds that seek to replicate the performance of investing in an entire market in the weights that each of the equity securities comprises in the overall market. The best examples are the S&P 500 and the Wilshire 5000 which approximately represent the 500 largest equities and the largest 5000 securities respectively, accounting for approximately 80%+ and 99%+ of the total market capitalization of the US market as a whole.

In fact, to many investors, this phenomenon created a new standard of performance that must be matched: an investment manager should not only avoid losing money for the client and should make a certain amount of money, but in fact should make more money than the passive strategy of investing in everything equally (since this strategy appeared to be statistically more likely to be successful than the strategy of any one investment manager).The name for the additional return above the expected return of the beta adjusted return of the market is called "Alpha".

The Alpha Stocks blog is my way of documenting and focusing on picking stocks that have capital appreciation potential on a risk-adjusted basis, either on a short term basis or for the long term. From time to time I will also add my thoughts and observations on the market and economy in general. Thanks for reading. You are free to comment.

No guarantees are made here. Investing involves risk and you may lose money. This is not meant to be a thorough and complete analysis of a company's stock. My intention is to merely point you in the right direction so you can perform your own due diligence.

Alpha Stocks

Friday, February 1, 2008

Market View 02/01/2008

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