Bubble on the Horizon for the Internet Sector?

Bubble on the Horizon for the Internet SectorI’m beginning to hear whispers that due to current selling pressure in the Internet sector, there may be a bubble on the horizon.

While the selling has picked up, it is normal to see this given the rapid advance we have seen in many of the Internet stocks that have, in many cases, moved up too fast. At this point, I simply see the action in the Internet space as the sector adjusting its price to a more normalized pace. (See “Why I Would Buy This $1,000 Stock Over a $10 Stock.”)

The buying, while somewhat euphoric, is nowhere near the scope we witnessed in tech stocks some 13 years ago in late 1999 to early 2000. As a trader, I would be taking some profits off the table. It’s normal and prudent to do so when a sector is sizzling on the chart.

Take a look at the chart of the Internet Index:

Internet Index Chart

Chart courtesy of www.StockCharts.com

First, notice the upward trend from 2003 to late 2007, which was followed by the reversal to the bottom in late 2008. The relative strength index (RSI) topped in late 2007, as shown by the shaded oval, along with a sell signal by the moving average convergence/divergence (MACD), shown in the bottom of the chart.

The second upturn was driven by a reversal of the RSI to the upside and a buy signal by the MACD, as shown by the shaded ovals on the chart above. The RSI hasn’t declined below 50 since then, with the exception of a brief period in mid-2011. The chart now shows a double top for the RSI, which is generating some concern. The MACD continues to show a buy.

At this time, I’m not that concerned, as the profit-taking is normal. I’d be worried if the RSI begins to move lower toward the 50 level. A sustained decline below would be quite bearish and would signal a reversal in the Internet sector, based on my technical analysis.

These are keys to watch for on the chart, as they will help to foreshadow a possible sustained reversal. Until this happens, it may be worth a look to accumulate on weakness, as long as the RSI doesn’t rapidly decline. In early 2011, when the RSI topped, the Internet Index retrenched about 23% from 325 to 250, prior to the RSI and index rallying. Keep this in mind should the RSI decline towards 50, as there could be a buying opportunity surfacing in the Internet sector at that point, as long as the 50 threshold holds.