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Look for Tom's commentary next time.

The Dow Diamonds (DIA) moved to a new all time high this past week and the S&P 500 ETF (SPY) recorded a multi-year high. En route to these highs, both exceeded their late February highs and large-caps are showing relative strength. In addition, both gapped higher on Monday and held these gaps throughout the week.

On the other side of the market, the Russell 2000 iShares (IWM) is having trouble with resistance from the late February high and small-caps are showing relative weakness. The ETF also pulled back rather sharply on Thursday and actually filled Monday's gap. IWM bounced back on Friday, but remains at resistance and has yet to breakout. The price relative (IWM:SPY) further confirms that IWM is not as strong as SPY. The indicator has been overlaid the IWM chart and it formed a lower high in April.



IWM is close to a breakout and a move above the February high would affirm the breakouts in SPY and DIA. Failure to breakout would show continued weakness and this would cast a shadow on the current rally. At the very least, relative weakness in IWM means we should favor large-caps over small-caps in the coming weeks and months.

Back in November 2006 I speculated that the 4-Year Cycle trough had arrived in June/July 2006, and that the implication was bullish for stocks – bullish because we normally expect an extended rally out of those cycle lows. At this point, I think that assessment is proving to be correct because there has been a substantial rally, and the recent correction low has failed to challenge the 2006 lows. In other words, the first leg of the current 4-Year Cycle has shown unusual strength, and it is reasonable to assume that there could be a few more good up legs before the bull market finally tops out.

In a shorter-term context, we can also note that the March low also marks the cycle trough for the 9-Month Cycle that began last summer in conjunction with the 4-Year Cycle. I had expected the 9-Month Cycle trough to arrive this month (around April 16), but, since the S&P 500 has already exceeded its February high, I have to accept the March 14 low as being the cycle trough – having arrived one month early. Another feature of that cycle is that the high price point in the cycle (the crest) is located on the extreme right side of the cycle arc. This is a bullish configuration.

Assuming that we are beginning a new 9-Month Cycle, and assuming that the bullish configuration (right-hand cresting) persists, it will be about six months or more before the next important price top arrives. Regarding this estimate, I would pencil it in, rather than using chisel in stone.



A casual examination of the cycle chart will reveal that there really is no typical cycle configuration, and the spacing between troughs can be terribly inconsistent for the 9-Month Cycle and subordinate (shorter) cycles; however, cycle analysis does provide a certain context that can be applied to price movement, which can be useful to the intuitive side of the brain.

Bottom Line: Cycle analysis is an imperfect tool, but current cycle orientation is more clear than usual, and it is bullish for stocks, probably for several months.

The positive stock market rally is undergoing significant "rotation" within various indices, which in our opinion is quite important from both an investment and trading perspective. First, when we invest or trade, we want to run with the "fastest horses" in order to outperform the markets or one's particular benchmark. Therefore, it behests us to use technical analysis on specific ratio charts to discern where to put our money in order to earn outsized profits. This is relative investing 101. Last week, we will note that the large caps handily outperformed the small caps. This is a trend that has been ongoing for the past year, but one that hasn't really gotten the attention of the hedge funds and hot money. Well, that is about to change, and the media will begin to pick up on this material change and it shall have repurcussions throughout the trading world. If we analyze the ratio chart between the S&P 500 Large Caps (SPY) and the Russell 2000 Small Caps (IWM), we find a "major low" was forged in April-2006, and since then the ratio has held above its low and formed what appears to be a "right shoulder" of a larger "head & shoulders bottoming pattern." This is of course hugely bullish, for it portends months and years of outperformance by the large caps such as Wal-Mart (WMT), Citigroup (C), 3M (MMM) and Pfizer (PFE).



For this bullish pattern to be confirmed, a move above neckline resistance at 1.86 is required; however, we would become more confident a breakout is developing with a breakout above the longer-term 500-day moving average. The 40-day stochastic is showing strength from a higher low, which further increases the probability this bullish pattern will come to fruition. In other words, the ducks are lining up rather nicely.

And finally, we would also note that SPY isn't only poised to outperform IWM; it showing bullish technical patterns against European and Asian regional indices...and perhaps more importantly...the Emerging Markets. Hence, when we are long - we want to be long large caps; when we are short - we want to be short small caps and certain foreign regions or indices. It's just that simple right now.

Thursday's 4.5% drop in Chinese stocks caused nervous selling in other Asian markets. By the time the U.S. market opened, however, Europe had already started to recover and initial U.S. losses were modest. By day's end, the Dow had closed at a new record high. A strong Friday open in Asian markets set the stage for a strong day in global stock markets. Chart 1 is an hourly bar chart of the last ten days. It shows the Pacific Ex-Japan iShares (EPP) gapping down on Thursday (red arrow). The good news is that the EPP then gapped back up on Friday (green arrow). Thursday's isolated price bars (see circle) created an "island" bottom which is a short-term bullish pattern. [An ""island"" bottom occurs when a "down gap" is immediately followed by an "up gap"]. The U.S. market also got a big boost from large industrials like Caterpillar and Honeywell which led the Dow Industrials to a new record high. A big jump in Google pushed the Nasdaq up against its 2007 highs. Commodity markets like gold and oil that pulled back on Thursday (owing to concerns about higher Chinese interest rates) recovered strongly on Friday. Commodity-related stocks – like basic materials, energy, and precious metals – were among Friday's strongest groups. A weaker dollar is continuing to feed the commodity rally.

The markets did great this week with the Dow hitting record highs and closing in on 13,000 however almost no one here at StockCharts.com was paying much attention. As most ChartWatchers know, we spent much of the week wrestling with technical glitches. I thought I'd take some time to explain what we've learned about the problems and the steps we are taking to prevent them from happening again. If you are not interested in computers and networks, now might be a good time to skip down to the other articles .

About a year ago we started upgrading all of the equipment here at StockCharts.com from the slower 100 Megabit networking speed to the newer 1 Gigabit speed. (Most home networking equipment works at 100 Megabits although - like us - you can upgrade your stuff to 1 Gigabit relatively inexpensively these days.) Upgrading our network to the faster speed has many benefits to all of our users: our servers send around stock price data faster, the charts we create get sent out faster, we can backup our server data faster, etc. In order to upgrade a network, you have to replace (or upgrade) both the computers and the switches on the network. (A switch is a device that connects all of the wires from all the different computers. Most home networks have a switch built into the router/firewire device that the broadband modem plugs into.)

Now, there is a hidden problem with upgrading the speed of any network - a problem that most of the network equipment people don't tell you about. With few exceptions, there is always a point where your high speed network meets a slower speed device. In our case, our three connections to the Internet work at 45 Megabits and so, at some point, all of our outbound traffic has to slow dramatically in order to get out one of those wires.

The situation is analogous to a sink with a slow drain and a big faucet. The slow drain represents the slow connections to the Internet, The big faucet represents the fast connections to our charting servers, and the water represents all of the bits that make up our charts. The overall goal of the network is to keep the sink from overflowing.

If the water is able to go down the drain as fast as it is coming out of the faucet, everything is fine. The sink remains almost completely empty. Even if there are occasional high-speed bursts of water from the faucet, things are probably fine also. The extra water just stays in the sink until the drain has a chance to "catch up." The sink "buffers" the extra water for the drain.

Problems happen when the amount of water coming out of the faucet exceeds the amount of water going down the drain for a "long time" and the sink becomes completely full. At that point, any additional water that comes out of the faucet will get spilled (i.e., lost).

Coming back to the world of networking, this process of "buffering" (i.e., the sink) happens inside whichever device is connecting the high-speed network to the slower speed network - typically the switch (or the router/modem in most homes).

Now, when we started to upgrade our network to gigabit speed, the first thing we did was go out and buy some very nice, high-speed switches from a very well known network equipment manufacturer. Where a consumer level gigabit switch might cost $50 these days, the ones we got cost several thousand dollars (which is typical for enterprise networking). In return for that money, we supposedly got three things - long-lasting hardware, big sinks, and software that would tell us if the sinks ever overflowed. (See where I'm going with this?)

Ultimately, most of last week's problems were caused by a buffer overflowing inside one of those new switches. That is no surprise to any of us - it was one of the first things we looked for. The bigger problem was that everyone was confused by four facts:

1. The switch didn't give us any indication that it was having problems.
2. Everything had been working great up until last Wednesday.
3. Even at our busiest times, we were only sending out about 70 megabits of data - much less than the 100 megabits that our "drain" allows.
4. When data went out through our slower ISP, everything worked fine.

Ironically, the answer to the mystery lay in the article that I wrote in the last newsletter - the one where I sort of bragged about how much faster we were able to generate charts these days. By increasing the speed at which we create our charts, we metaphorically increased the speed at which water was bursting into the sink from the faucet. The result was an overwhelmed sink and thus, data loss.

The immediate solution was to slow our network back down to 100 megabits. That smoothed out the flow of data and stopped the data loss at the switch. Obviously that is not the right long-term solution though because we lose all of the other advantages of gigabit networking. The long-term solution is to upgrade our switches to ones with HUGE sinks (i.e., memory buffers) which we will be doing this weekend. Once that work is complete, you can expect our site to be faster than ever.

In case you missed the announcements on the website, we have credited ALL subscribers with an additional two free weeks of service to make up for last week's problems. Thanks for continuing to support StockCharts.com.

The put call ratio ("PC") is quite simply the total number of put options divided by the total number of call options. These options include both individual equity options and index options. Every day you can monitor the relationship between put options and call options at www.cboe.com. Once in the site, click on "Data", then "Intra Day Volume". Every half hour, the information is updated. This article is not the appropriate forum to discuss options strategies and definitions, but in its most basic form, put option buyers are expecting the market to decline and call option buyers are expecting the market to advance. The PC gives you a quick, concise picture of the relationship between the put buyers (bears) and call buyers (bulls). The beauty of the PC is that it's a contrarian indicator. When the put call ratio spikes above 1.0, it indicates the market is becoming oversold short-term so expect a rally. When the PC drops below 0.6, the market is becoming overbought short-term so expect a decline. I like to use the 5 day and 21 day moving averages of the PC. Any time the 21 day moving average of the PC approaches 1.0, start looking for a bottom in the market. Historical PC data is available at CBOE beginning in 1995. Let's take a look at how this reading of investor sentiment could have been used to identify recent bottoms in the S&P 500 chart.



Notice that both bottoms formed when the PC was at extreme readings. The PC at the recent March lows was the lowest 21 day moving average reading since the data was compiled. That reading is indicative of a long-term bottom, not a long-term top. Major tops are formed when the market is euphoric. The recent extreme pessimism suggests that this bull market still has legs - strong legs. We remain very bullish on equities for the balance of 2007 and into 2008.

The Nasdaq rally continued into its fourth week with a gap up on Tuesday and move into the late February gap zone. This late February gap started a sharp decline to the March lows and the recovery back above 2460 is quite impressive. Even though volume is not so impressive, the current swing is clearly up and we should at least respect this up swing until it is proven otherwise.

Just what would it take to reverse the current upswing? I am watching three items: Tuesday's gap, the late March lows and RSI. The Nasdaq gapped higher on Tuesday morning, closed strong on Tuesday and continued higher the next two days. This follow through is bullish and the gap is bullish as long as it holds. The index established support around 2400 with three indecisive candlesticks (blue oval). A move below Tuesday's gap and below the late March low would reverse the current upswing. Until these are broken, the bulls have a clear edge and we should expect higher prices.



RSI is trending higher and above 50. RSI turned oversold in early March and moved above 50 over the last few weeks. I drew a trendline extending up from the March low and RSI is also trending higher. Momentum continues to improve and this is also bullish. A break below this trendline and a move below 45 in RSI would reverse the uptrend in momentum. The bulls also have the momentum edge and we should not bet on lower prices until a bearish signal.

Our Thrust/Trend Model (T/TM) is so-named because it treats bottoms and tops differently – tops tend to be rounded trend changes, and bottoms tend to be formed by sharp changes in direction accompanied by internal up thrusts. At price tops, T/TM changes from a buy to neutral (or sell) based upon a downside crossover of the 50-EMA in relation to the 200-EMA, evidence that a change in trend from up to down has occurred. (The T/TM for the S&P 500 is currently in neutral.) At bottoms the model uses a double screen – the PMO (Price Momentum Oscillator) crossing up through its 10-EMA, and the Percent Buy Index (PBI) crossing up through its 32-EMA.

While PMO crossovers alone are useful for short-term work, there are a lot of whipsaws, so we use the additional screen of the PBI crossover to slow the model down, making it more suitable for medium-term work. On the chart below we display all the components of the T/TM. Of particular interest now are the two thrust components – the PMO and PBI. Note that the PMO upside crossover has already occurred (on the day of the giant one-day rally); however, while the PBI still remains below its 32-EMA, it has closed the gap. If the PBI does cross to the upside, the T/TM for the S&P 500 will switch to a buy signal, but my advice would be to not anticipate. Wait for it to happen.



Besides the normal need to maintain model discipline, one of the reasons for caution is that the PBI has still not dropped to the level of previous corrections. It is not absolutely necessary that it do this, but it would be a desirable sign that the correction had run a normal course and that a price bottom would not be suspect. I have drawn ellipses on the PBI in 2005 and 2006 to show the kind of PBI action we might expect.

Another concern is that the PMO looks as if it is trying to turn down below the zero line. If this were to happen, it is extremely negative for the short-term, possibly longer.

Bottom Line: We have had a number of positive events over the last few weeks, and the T/TM is close to generating a buy signal; however, there is reason to believe that the correction still has at least a few more weeks to go.

For the past couple of weeks, the markets have focused in upon crude oil prices and their attendant rise given the Iran hostage situation. The prevailing thought was that "geopolitical premium" was on the order of $4-to-$5 a barrel of the $67/barrel price; and that once the situation was concluded successfully - the premium would be lost rather quickly. Of course the situation was concluded last week, but the price of crude oil didn't "plunge" as expected. In fact, only not been the case as crude oil has lost only -$2.50 off its highs, with the decline quite orderly indeed. We cannot think of a more bullish respone than what was seen; obviously there are other mitigating factors extant in the price of crude oil that haven't allowed it to decline. Therefore, we think the current rally has "legs", with the recent weakness nothing more than a good old bit of profit-taking before an assault on the all-time highs. Technically, we can make the tentative "bullish case" given major support levels have held. Major trendline support has held; and the 200-week moving average has held; and minor trendline resistance was broken above. If the 60-week moving avearge just overhead can be cleared with a bit of authority, then our bullish confidence level will be raised materially.



Conversely, we can make the tentative "bearish case" that perhaps crude oil prices can "fail" at the 60-week moving average has it has done so for the past several days. Certainly this was the case in 2001 case where the flattening 60-week moving average turned prices lower by -33%. If this were to occur, then a 2001-like decline would target major support near $40. We think this is a remote probability, but a probablity nonetheless. Therefore, our current stance is quite simple: we are bullish of crude oil, energy stocks in general, and oil service shares in particular [Transocean (RIG) noted on Friday that demand for services was high and rising and likley to do so far into the future]. However, we understand the "risk" to the bullish trade, and can manage our risk easiliy using tight position stops.

The U.S. Dollar Index fell during the week and is drawing dangerously close to last December's low (green circle). The foreign currency with the biggest influence on the USD is the Euro. Expectation for continuing economic strength in Europe – and the likelihood for further ECB rate hikes – pushed the Euro (blue line) to a new two-year high against the dollar. The weekly bars in Chart 2 show the Euro (blue line) moving up to challenge its late 2004 peak near 136. A close above that chart barrier would increase the odds for the USD to threaten its corresponding low near 80. That would be a very important test for the U.S. currency.

Hello Fellow ChartWatchers!

This week I thought we'd look at something different - the charts that matter the most to me personally. Now, brace yourself... these charts are not financial charts. Nope. These are the charts that tell us at an instant how well the StockCharts.com website is performing. If there is trouble with the site, these charts frequently help us find and fix the problem. In addition, whenever we add or reconfigure our servers, these charts can tell us if the improvements we expect to see actually occur.

This first chart shows the memory utilization of just one of our 17 charting servers - the computers that actually create the chart images you see. See the even "sawtooth" pattern? That's a good thing. It means that the server is able to keep up with it's charting duties easily. One of the first signs that a server is overloaded is a change is that pattern.

The chart above shows the results of a server stress test. This server was pounded with just over 4,000 chart requests from 40 simulated users in a very short span of time. The little black dots on the chart show the time (in milliseconds) it took for each chart request to be completed. The blue line shows the running average of all those times. In this case, the server was able to create each chart in around 274 milliseconds (on average). Everytime we get new servers or make changes to our system, we rerun these stress tests to make sure our average chart generation time doesn't slip. In fact, since we've started adding our new 4-CPU servers from Sun Microsystems, the average chart generation time has decreased by about 25% - something we are very excited about.

If all of our users were located in our offices, they would get their charts in about the same time it takes the servers to create them - i.e. ~1/3rd of a second. Unfortunately, that isn't the case. There's another factor in site performance that we monitor closely - the speed of the Internet itself. Many people take their Internet connection for granted - we don't. Here's one of the key charts we use to see if everything about our site is working well

This chart was created for us by a company called Keynote Systems. They have computers located all over the world that are programmed to download selected pages from our website and measure how long it takes for those pages to arrive. Each one of the green dots on that chart represents one timing test from one of Keynote's 45 different computers. As you can see, at the time this chart was created, we were able to push complete pages out to those computers in anywhere from 2 to 6 seconds.

Much of the variation in those times have to do with each server's physical distance from our offices - but some of the times are obviously affected by other factors. See the green dots that are near the top of the chart? It turns out that most of those were coming from just one of Keynotes computers - specifically, the server in Pittsburgh, PA on the Savvis.net ISP connection. That means that - at the time this graph was created - some of the people in the Pittsburgh area might have been experiencing slowness because of problems at Savvis.net.

While such problems are not uncommon, they are frustrating to track down because the problems can appear and disappear in a heartbeat. Typically these kind of problems get corrected within 24 hours. If we get reports from our users about slowness that persists for several days, we try to help them report the problem to their ISP because they have the best chance of fixing the problem. Another thing we do is to run more detailed tests from the Keynote server with the problem. In this case, here's what those results look like:

This chart shows the time it took for all of the parts of our homepage to show up in Pittsburgh. In this case, everything worked great. We were actually able to get all of our parts shipped out in around 4.5 seconds. The final 2 seconds were due to the time it took for the banner ad to come down from our advertising partner (something we don't have control over). Since things worked fine this time, we suspect that the problem at Savvis.net has been fixed (or will be soon).

While these charts don't really tell you anything about the market, they help us keep StockCharts.com up and working as quickly as possible. Hopefully you enjoyed this "peek behind the curtain" at some of the charts that we stare at every day.