Tech Is Walking the Bear-Market Walk

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Tech Is Walking the Bear-Market Walk

Sector Alert

WHEN THE MARKET LIMPED into the weekend after a dreary start to the new year, one of the biggest casualties was the computer hardware sector. Considering that the high-flying Apple is one of its more prominent members, that is saying something.

Technology in general is starting to walk the bear-market walk. Computer hardware was thumped last week. Semiconductors have been sliding since July. And networking has confirmed a major technical topping pattern. Clearly, something is not well and risk levels remain high.

In technical analysis and trading in general we are often advised to trade what we see and not what we think. While many still believe the economy is sound or at least not heading towards recession the tech sector is walking a different walk. I won't pretend to know where the economy is heading but if a growth-stock area such as technology is heading south then I've got to believe that the stock market is trying to tell us something.

The Morgan Stanley High Tech index completed a rather ominous pattern last week – a head-and-shoulders top (see Chart 1). By falling below 590 and setting an eight-month low, the implications for even lower prices are fairly strong.

Chart 1

A head-and-shoulders is a common chart pattern that is marked by a failed rally and a break of support. Its overall tone is one of transition from bull to bear and it has a good track record of forecasting lower prices to come.

Chart watchers forecast just how low by projecting the pattern's height down from the breakdown point. Using round numbers, the difference between the peak price level at 695 and the support level at 590 is 105. Subtracting that from support yields a target price of 485 -- about 18% below today's trading.

There are a few more advanced tweaks needed to firm up the forecast so don't hold me to 485. It is likely to be a few percent higher to coincide with other chart support at 515. But the point to be made here is that there is a good deal of risk in the tech sector and buying dips is the wrong strategy to follow.

To be sure, after the pounding that the index and the market as a whole took since the year began a lot of people are going to think bargains abound. After all, prices are down significantly without much change on the fundamental front. But technically, a small rebound is not going to change the big picture, which is rather weak.

As hinted earlier, Apple has been the flagship tech stock for quite some time so let's take a look at where it is today. Clearly, the long-term trend remains up here (see Chart 2). Further, it has continued to forge higher highs and higher lows -- the classic definition of a bullish trend -- despite the sector and broad market's inability to do the same.

Chart 2

In other words, don't bet against this winner just yet. What needs to be monitored is the waning of price momentum and increase in selling pressure over the past week because if Apple succumbs to the bear then the rest of the sector does not have a chance.

Another stock in the sector, Blackberry maker Research in Motion was one of the stars of 2007 as it more than tripled by November (see Chart 3). After easing back in the final weeks of the year, the company announced excellent earnings results Dec 21 to spark what was the last major rally for the entire market.

Chart 3

Unfortunately, the 122-level traded that day has not been seen since and last week ended with the stock below its pre-earnings close of 107. This lack of upside follow through and ensuing downside reversal are typical in a market that is looking for any excuse to fall. If good news cannot push a stock higher then we have to be ready for support to break. In this case, 97 is an important level. It was violated intraday today but a close below will be a better signal that the bulls have lost the fight.

Finally, the semiconductor sector has been falling like a stone for months and even the last bastion of strength, Intel has given in to the selling. It started December at 28 and traded at 22.50 today.

Just a few weeks ago, I wrote here that chip stocks had found a bit of support at a long-term trendline and had the potential to bounce if the market cooperated (see Getting Technical, Fishing for Chip Stocks, Dec. 10, 2007). Indeed, the Philadelphia stock exchange semiconductor index (SOX) was in the middle of a small range that lasted for the rest of the month (see Chart 4)

Chart 4

However, on the first trading day of this year, the index plunged to break both the short-term range and the long-term trendline. Save for periodic oversold bounces, this is a very bad sign for the sector.

With all facets of the technology sector, minus a few individual exceptions, sporting negative patterns or declining trends, investors should approach it with great skepticism. It is always a good idea to remain open to the possibility that a bottom is near but if tech is walking like a bear and growling like a bear then you know the rest.