High Tech High Performance

A Consistent Cut Above The Average

In a quest to highlight market sectors that are out-performing the broad market, we've decided to focus upon the computer technology industry for this article. Everyone is well aware of the impact that computers have had on life today. It's hard to think of any areas of work and play that haven't been made more efficient or more practical with computing!

And despite recent economic tremors, computer technology continues to hold up well. The Amex Computer Technology Index (XCI) is a market capitalization weighted index encompassing a cross section of widely-held U.S. corporations involved in various areas of the computer industry. XCI is composed of 30 companies who are pretty much household names: Microsoft, Google, IBM, Apple, Cisco, Intel, Hewlett-Packard, Oracle, Dell and Texas Instruments round out the top ten holdings.

And here's a two year chart of the XCI as compared to the DJIA:

XCI has consistently outperformed the DJIA at all stages even as it has tracked it rather closely. In fact, you could consider it a DJIA mirror with a higher return.

We've included MACD on this chart for the excellent example of divergence shown between the price and MACD. As compared to February/March 2008, XCI made a lower low in July 2008 which was not confirmed by MACD. Lo and behold, XCI promptly rose 10% as of this writing.

Currently, XCI would have to chew through its 50 week moving average for us to feel truly bullish on it once more, but it has broken through its 200 week average on its first recent attempt and has held up so far.

The Fallout of the Failed MSFT and YHOO Merger

You've probably heard about the recent proposal by Microsoft to buy out Yahoo for as much as $33 per share. The deal fell through due to Yahoo's insistence that Microsoft's offer "substantially undervalued" the company, and perhaps also that Microsoft wasn't as keen on the merger as they claimed.

There is some evidence that Steve Ballmer, CEO of Microsoft since January 2000, was no longer enthusiastic due to highly negative press from the shareholders of both companies as well as the media itself. But the consensus seems to be that Yahoo! gambled and lost by misjudging Microsoft's commitment and asking for too much — as high as $38 per share according to some rumors.

So how have the two companies (both XCI members, not so incidentally) done in recent trading?

Microsoft Takes Rejection Well

Microsoft (NASDAQ: MSFT) is a multinational computer technology corporation which develops, manufactures, licenses, and supports a wide range of software products for computing devices. It’s most (in?)famous for its Windows operating system and the Microsoft Office suite of productivity software, although it’s also involved in the MSNBC cable television network, MSN Internet portal, Microsoft Encarta multimedia encyclopedia and also hardware products such as the Microsoft Mouse, Xbox, Xbox 360, Zune and MSN TV.

Microsoft has risen from humble beginnings to dominate the home computer operating system market via MS-DOS since the mid-1980s. Along the way it's drawn heavy criticism for various reasons, including monopoly status and anti-competitive business practices. However, it remains an enormously profitable and powerful company with $17.7 billion in net income and over 89,000 employees in 105 countries.

It seems that $25 is a solid floor for MSFT — note the double bottom in July and early August — and the price has surged easily past the 50 day moving average. Since this hasn't happened since May (when the entire market caught a cold), this is a significant development. This moving average, currently at $27, should provide good support for the price as it begins to rise.

You should also note the excellent performance of the Stochastic RSI indicator on this chart. It's performed extremely well in calling cyclic tops and bottoms. 

Stochastic RSI – An Indicator of an Indicator

Stochastic RSI combines two popular technical analysis indicators, Stochastics and the Relative Strength Index (RSI) in such a way that Stochastic RSI derives its values from the Relative Strength Index (RSI) rather than the stock price itself.

Essentially, it's nothing more than the Stochastic indicator applied to the RSI indicator and tends to give more profitable buy and sell signals than RSI itself.

This is because RSI will often trade between 80 and 20 for extended periods without reaching an overbought (80 or 70) or an oversold (20 or 30) level — this leaves you the investor/trader on the sidelines and not making any money.

Look for yourself at MSFT's chart and you'll see that RSI permitted very few trades even at the generous 30 and 70 levels for oversold and overbought conditions. If you were waiting for the 30 and 70 levels to be actually penetrated you wouldn't have made any trades at all! In contrast, Stochastic RSI gave many excellent signals for calling tops and bottoms.

As always with oscillators, the more conservative method involves waiting until the indicator has moved back into the middle zone from the colored overbought/oversold levels before placing a trade. The more frequent trader would jump in as soon as 0.8 or 0.2 levels were breached, but this can bring on disastrous results when the market decides to trend after that point.

A good potential method here is to look for support and resistance points on the chart in conjunction with Stochastic RSI buy and sell zones. That would maximize your chances of making a successful trade and minimizing risk.

In fact, MSFT is currently hovering at previous support (which is now resistance as it is rising from below). Combined with an 'overbought' reading on Stochastic RSI, this would indicate that MSFT is a good near-term short and/or that this is a good place to unload if you're currently holding from the $25 range. 

Yahoo!ing Down A Mineshaft?

Yahoo! Inc provides Internet services world-wide including a Web portal, search engine, the Yahoo! Directory, Yahoo! Mail, news, and posting forums. It was founded in 1994, incorporated in 1995 and today is known to literally the entire Internet community as the second most visited website in the U.S. and the most visited website in the world. In its own way, Yahoo! is every bit as much a ubiquitous brand name as Microsoft, which explains the larger company's interest in acquiring it.

Yahoo! generates just over $1 billion in operating income and employs almost 14,000 people. However it hasn't been performing well and currently sits a long way under the proposed $33 share price offered by Microsoft.

On this chart, plain old RSI gave one signal if you were waiting for a true oversold indication below the 30 level. But again, Stochastic RSI provided many more opportunities to make money.

At present, there might be a double bottom forming in the $19 range but it seems a bit early to tell. YHOO might also be forming a bullish rounded bottom but we would need to see a close over $21 (ironically right below resistance at the 50 day moving average) for this to be confirmed.

Right now it seems prudent to wait and see how YHOO interacts with its 50 week moving average before making any serious buying or selling decisions.

Good investing,

Nick Thomas
Analyst, Charts of the Week