StockCharts.com - Blogs

The Materials sector was all the rage in 2004, but fell on hard times in 2005. After a run from 23.59 to 31.99 (35%), the Materials SPDR (XLB) declined below 27 with a sharp decline. Was this enough to break the uptrend or is this just a sharp correction? The bulk of the evidence points to the latter.

Even though the decline was sharp and a classic corrective pattern failed to take shape, other technical signs point to a correction. First, the decline retraced around 62% of the prior advance. This Fibonacci number (percent) is normal for a correction. Second, the decline returned to broken resistance. Notice that the resistance zone around 26-27.5 turned into a support zone. This is also typical for a correction as there is often a throwback to broken resistance after the breakout. Third, the lower channel trendline confirms support around 27-28. I drew the upper trendline first and then based the lower trendline (parallel) on this upper trendline. The stock pierced the lower trendline, but quickly recovered and managed to stabilize over the last few weeks.

Stability is one thing, but a reversal is another. The stock formed a long black candlestick in May and then recovered the very next week (gray oval). A piercing pattern formed and this is a bullish candlestick reversal pattern. Confirmation is required though and I would look for a move above 30 to complete a reversal and expect a move higher.

While persistently rising prices are frustrating the bears and encouraging the bulls, there is evidence that distribution is taking place.

On the first chart I have circled areas where daily volume has scooped below its 250-EMA line, indicating that there was inadequate sponsorship of the rising trend. In each of the first three cases shallow volume preceded price corrections. The current volume dip, which has lasted about six weeks, has yet to be resolved, but it seems reasonable to expect a correction fairly soon, probably starting soon after we see final expansion of volume.

The second chart shows a five-week period of NYSE Member Net Selling, which is a fairly unusual because these insiders are normally accumulating shares into declines (shares that will be sold during the next advance). The NYSE delays reporting of these numbers by two weeks, so there is a big question mark as to what Members have been doing during the last three weeks; however, the large amount of net selling raises a red flag, especially when viewed in the context of the shallow volume problems discussed above.

The recent S&P 500 price action above the 1190 level is rather impressive, and can be considered a correction in 'time' rather than in price. This suggests new highs; however, those highs aren't expected to be accompanied by new highs in the Nasdaq Composite.

As the chart shows, S&P 500 large caps have outperformed the technology sector since January-2004 in a 'sawtooth' pattern. I think the S&P 500 is ready to outperform once again…and those hedge funds that want to increase beta via technology will left to their own devices given they are chasing performance. Further, this is suggestive of an overall 'market top' in the weeks/months ahead rather than a continuation pattern. Thus we would be sellers of rallies at the appropriate time.

We add new books all the time. Click here frequently to see the latest additions.

While a lot of attention has been paid to rising energy and basic material stocks this week, not much has been written about healthcare. It's time to correct that. Chart 1 shows the Health Care Sector SPDR (XLV) closing the week at a new 52-week high. [The only two other sector SPDRS to hit new highs were energy and utilities]. The relative strength ratio shows that healthcare started to do better than the S&P 500 near the end of last year. Although the relative strength line has been slipping of late, its trend is still higher. How much higher can be seen more plainly Chart 2 which shows that the healthcare relative strength ratio has broken a down trendline starting in the spring of 2003. That makes some sense. Healthcare is considered to be a defensive sector and would be expected to underperform during a cyclical bull market. Its stronger performance during 2005 is another sign that investors have been favoring more defensive stock sectors. Earlier in the year I listed healthcare as one of my favorite picks for the year. I haven't changed my mind. Chart 2 also shows that the XLV is challenging its 2004 peak. A lot of today's buying came from biotechs.

Seven straight days of gains has moved the Dow back above the 10,600 level - something that looks even more impressive given Friday's significant volume increase. Next week should see a test of 10,600 as the index tries to consolidate its gains. Watch closely to see if 10,600 has turned into support or not. If it has, the market should be able to move towards the next resistance level (10,800) relatively quickly.

Let's see what our other commentators think...

As its name implies, the Rydex Equal Weight S&P 500 Index (RSP) treats all component equal, regardless of market capitalization. This means that ExxonMobile (XOM). with market cap of $369 billion, counts the same as Teco Energy TE), which has a market cap of just $3.64 billion. This makes the index a good representation of the average Joe (Joe Stock that is).

RSP remains in a long-term uptrend and has yet to break down. The going is getting tougher, but momentum is still up overall on the weekly chart. First, the index broke resistance at 145 with a surge in Nov-04. This resistance level hounded the index most of 2004. Second, resistance turned into support with a successful test in Apr-05. Third, the trendline extending up from Aug-03 also confirmed this support level and the index remains near its all time highs.

Even though the index has not made much head way over the past year, there is a clear upward bias on chart. Support at 145 holds the key. As long as this level holds, pundits can expect a trading range at worst and a move towards the upper trendline (170) at best. A move below 145 would turn the big trend down and be bearish for the broader market.

Decision Point tracks actual cash flowing into and out of Rydex mutual funds, and, while cash flow normally runs parallel to price, divergences can often appear ahead of price reversals. For example, let's look at Rydex Energy and Rydex Energy Service Funds.

During the last four weeks of the price correction that began at the March top you will notice how cash flow went relatively flat, indicating that the bulls were holding their ground and that accumulation was taking place. However, since the two-week rally that began at the May price low, cash flow has been rather tepid, and was even flat during the first week of the rally.

It is probable that energy stocks have completed a medium-term correction and are poised to move higher, but the lack of sponsorship and overhead resistance warn that we could see a partial retracement of recent gains, particularly in the Energy Service sector.

Cash flow divergences provide valuable clues that can help us prepare for price action others are not expecting, but they don't always result in the kind of price move they imply. Always wait for prices to make the expected break before acting.

My observation is that these cash flow divergences only have short-term implications. Also, it is important to remember that the Rydex sector funds only account for a small slice of the total market in a given sector, and this small picture may not be representative of the big picture.

Rarely do they ring a 'bell' at the bottom, but Friday’s reversal higher in bond yields argues strongly for a sustained move higher in interest rates. Quite simply, Friday's employment report was clearly on the 'weak side'; with the 10-year note yield trading lower and then reversing and trading sharply higher. This 'key reversal' to the upside is likely a 'watershed event' in which bond yields will march higher over the short and intermediate-term time horizons. This pattern is one that we nearly trade with 'blind faith upon', and we did so on Friday by becoming short.

If one chooses to trade this pattern; one can short the 10-yr. or 30-yr. futures contract – or – short the Lehman 20-yr+ bond fund (TLT), but shares appear difficult to borrow at some brokerages – or – buy TLT put options. We don’t recommend options for those who haven’t had experience with them; and those that do must understand the risks.

A lot of recent optimism on the stock market and the economy has been predicated on the view that the historic rise in oil prices has probably ended. A lot of economists have also declared the major bull market in commodities over. Both of those predictions may prove to have been premature. Over the last two weeks, the price of crude oil has bounce off its 200-day moving average and then risen to the highest level in more than a month. After a pullback yesterday, it's trading back over $54 today. The chart below reflects the recent improvement in the price of crude and suggests a possible retest of its early April high. That explains the recent move back into energy stocks. It may also explain why the recent market rally is running into some profit-taking. Crude isn't the only commodity that's turned up recently. The CRB Index of commodities is rising again after bouncing off major support levels.

This week saw the markets move "violently sideways" as large up-days were immediately followed by similarly large down-days. Essentially, the Dow is continuing to lurch around inside of its 10,400 to 10,600 trading range. Check out how much time the Dow has spent in or around that range since the beginning of the year:

The good news? The rising 200-day Moving Average may push the Down up above 10,600 soon.
The bad news? Recent declining volume argues against any upside breakouts soon...

Now let's see what our other commentators think...