SMALL CAPS SHOWING LEADERSHIP -- CHIP/ENERGY RATIO MAY DETERMINE MARKET DIRECTION -- SO WILL THE TRANSPORTS
SMALL CAPS HIT THREE-WEEK HIGH... New signs of leadership by small and midsize stocks may hold good news for large-cap stocks. Chart 1 shows the S&P 600 Small Cap Index rising to a new three-week high after clearing its 50-day moving average. [The Russell 2000 small cap index is also trading over its 50-day line]. The rising relative strength line shows the S&P 600 close to a new high versus the large cap S&P 500 Index. The S&P 400 Mid Cap Index is also moving over its 50-day average as shown in Chart 2. Midcap stocks are lagging behind small caps, but are doing better than large caps. Chart 3 shows the S&P 500 Large Cap Index still trading under its 50-day line and testing initial chart resistance near 1125. The fact that smaller stocks have already cleared initial resistance increases the odds that the S&P 500 will do the same.
Chart 1
Chart 2
Chart 3
BATTLE BETWEEN CHIPS AND OIL... One of the key battles going on in the market is between the oil service and semiconductor groups. I suggested last week that money had started rotating out of energy stocks and back into technology -- and semiconductors in particular. That showed that the market was especially nervous about the direction of crude oil. With OPEC meeting tomorrow, the direction of crude is playing on the rest of the market. Last week, Semiconductor iShares were the top group while Oil Service Holders were the weakest. Today, those situations are reversed. With oil bouncing today, oil service stocks are strong while the semis are weak. OPEC's decision will probably decide which group will win. And that should help determine the direction of the entire market. One of the best ways to study the battle is with a ratio chart.
Chart 4
Chart 5
IGW/OIH RATIO... The next chart plots a ratio of the Semiconductor ETF divided by the Oil Service ETF. The ratio peaked during November when crude prices started rising and money rotated out of the chips into energy. The jump in the ratio last week held out hope that the downtrend in the ratio would be reversed. That's where the blue 50-day average comes into play. The ratio needs to break through that 50-day line (and eventually the 200-day line) to signal that the tide has definitely turned away from energy and back to the semiconductors. An upturn in the ratio line would be a positive sign for the rest of the market and would support the idea that the market bottomed last week. Failure of the ratio to rise would have a more negative meaning. I think the odds favor the ratio rising, which should be good news. That, however, will probably be determined by what OPEC does this week. Transportation stocks are also at a critical chart point.
Chart 6
TRANPORTS TESTING 50-DAY LINE... I also suggested last week that the drop in crude oil was supporting the Dow Transports at its 200-day moving average. I suggested that an upturn in the tranports would be a positive turn for the market. Chart 7 shows the Transports testing their 50-day line. Here again, whether or not that resistance line is broken will probably be determined by the direction of crude oil. The action of the transports will also help determine if last week's bottom was for real. I believe it was. But we need to see more upside follow-through.
Chart 7
