NASDAQ PULLBACK MAY BE OVER -- FIRMER TECHNOLOGY SECTOR COULD EXTEND SUMMER RALLY -- ENERGY BREAKOUTS, HOWEVER, SHOULD CAP SUMMER GAINS

NASDAQ 100 CORRECTION MAY BE ENDING ... I wrote earlier in the week that the market would have a hard time resuming its uptrend unless the Nasdaq started to move higher as well. That may very well be happening. One of the things I was looking for was a test of the lower Bollinger band. That happened yesterday. Prices in the QQQQ are nearly back over their 20-day average. That's a good sign. The red line on the chart is the QQQQ/SPY ratio. The rising ratio line since early May helped support a market rally. A weaker ratio since the start of June held the market back. It looks like the ratio is trying to turn higher again. If it does, that would be another sign that the Nasdaq pullback is ending and that it's ready to start showing market leadership again. The two oscillators also support a stronger Nasdaq market. The 9-day RSI is bouncing off the 50 level. The 20-day stochastic lines are turning up from oversold territory near 20. The Nasdaq is getting some support from the Semiconductor (SOX) Index which is also bouncing off its lower band (Chart 2).

Chart 1

Chart 2

OIL SERVICE STOCKS BREAK OUT... On Tuesday I suggested that traders keep an eye on the Semiconductor (SOX) and the Oil Service (OSX) Indexes to gauge market direction. Since then the Oil Service Holders (OIH) have broken to a new record high. That greatly increases the odds for a new record in energy prices as well. Over the short-run, that may help the market since oil stocks are rising. Over the longer-run, however, higher energy prices should put a cap on market advances. I suspect that the major market averages will reach the tops of their 2005 trading ranges. I don't expect much more.

Chart 3

OIL SERVICE IS OUTPERFORMING THE SOX ... Chart 4 is a ratio of the Oil Service (OSX) Index divided by the Semiconductor (SOX) Index. Although both may start to rise again, the ratio shows that energy stocks are rising faster than technology stocks. Rising chip stocks are good for the market; rising energy prices aren't. To me, it's a matter of which is rising the fastest. Right now that's energy. I'd watch this ratio very closely. If and when it reaches a new high, the market may have reached a more dangerous spot. In other words, a firmer technology sector may extend the summer rally; but an even firmer energy sector may keep the market from reaching new highs.

Chart 4

WHICH PRICE ARE YOU GOING TO BELIEVE... A lot was made in the financial media this week about the big drops in the May CPI and PPI numbers. Most of that drop came from falling energy prices. The media (and some economists) took comfort in the apparent end of energy inflation. Chart 5 shows the problem with relying on old numbers. The drop in the May inflation gauges simply caught the trough in a crude oil correction that started in March (see box). During those two months, crude fell $10. Those of us who follow market prices, however, can plainly see that crude oil has gained back that $10 since then. And the fact that energy stocks are hitting new highs means that oil will probably do the same. That's why we look at charts of market prices and not backward-looking economic numbers.

Chart 5

BLOOMBERG TV TOMORROW MORNING ... I'm scheduled to do an interview on Bloomberg TV tomorrow (Friday) morning at approximately 7:10 am. Tune in if you're up that early. We'll be talking about recent money flows back into the commodity sector.