DOW THEORY UPTREND STILL IN QUESTION -- NEW CHIP LEADERSHIP -- ENERGY PRICES MAY HAVE BOTTOMED -- JAPAN LOOKS OVERBOUGHT

INDUSTRIALS STILL BELOW 2005 HIGH ... One of the oldest technical approaches is the Dow Theory. It simply holds that upside breakouts in either the Dow Industrials or the Dow Transports must be confirmed by the other to signal the start or the resumption of the major bull trend. In this case, we're talking about the resumption of the bull trend that started in the spring of 2003. Chart 1 shows the Dow Transports having broken through their early 2005 highs during the fourth quarter. That was largely due to the drop in oil prices and a rebound in economically-sensitive cyclical stocks. Chart 2 shows, however, that the Dow Industrials are still testing their early 2005 peak at 10984. A short-term overbought condition has probably contributed to this week's sideways action in the industrials (and a rebound in energy prices). A new 2005 closing high may very well take place during the traditionally strong month of December. But until it does, Dow theory is on hold.

Chart 1

Chart 2

SOX IS NEW MARKET LEADER... "John's Latest Performance Chart" for the month of November shows the Semiconductor (SOX) Index having taken over the top spot for the last month. It was also the strongest market group over the last week. Chart 3 plots weekly bars for the Semiconductor Holders (SMH) since the start of 2004. It shows this week's upside breakout (on rising weekly volume) to the highest level since the middle of last year. On Thursday, I wrote that the next significant upside objective was the 41.89 level which was the peak hit in the spring of 2004 (see arrow). One of our readers asked why the 38.95 level wasn't listed as the next resistance level. Actually, 38.95 (see box) is the next resistance level. I just don't believe it's the next "significant" resistance level (the term I used on Thursday). In an uptrend, the simplest way to find resistance levels is to find previous peaks in the last downtrend. The question is which peak. With the SOX and the SMH having just achieved a high-volume bullish breakout, with the weekly MACD histogram having just turned positive (top of chart), I opted for the higher number. And the weekly ADX line (bottom indicator) is nowhere near overbought territory. The SMH ended the week at 38.93 -- just two points shy of 38.95. I thought upside momentum would be sufficient to push it through that initial resistance level to the next higher one at 41.89. We'll see.

Chart 3

CRUDE MAY HAVE BOTTOMED... Energy prices reversed to the upside this week and may have bottomed. There are a number of technical factors supporting that view. The weekly bars in Chart 4 show oil bouncing off two support lines. One is the rising trendline drawn under the January, May reaction lows (see arrows). The other is the horizontal line drawn over the October 2004 peak at 55.65 (see circle). Previous peaks should act as support levels on downside corrections. [It may also be worth noting that the bottom of the fourth quarter 2005 oil pullback has stopped at the top of the fourth quarter 2004 peak. Crude also bottomed in December of last year]. The daily bars in Chart 5 also support an oil bottom. Crude ended the week back over its 200-day moving average. The Commodity Channel (CCI) Index on the top of the chart has crossed over zero for the first time in two months. That suggests a short-term change in trend. The daily MACD lines on the bottom of the chart have crossed positive for the first time since crude peaked at the start of September. Natural gas, which has held up much better than crude, jumped to a six-week high and closed back over its 50-day moving average (Chart 6). The 12-day Rate of Change (ROC) line has climbed back over the zero line for the first time since October. Colder weather in the northeast is no doubt contributing to the energy rebound. Buying of energy shares during the week also hint at firmer energy prices.

Chart 4

Chart 5

Chart 6

OIL SERVICE INDEX HITS NEW HIGH ... Energy stocks had a relatively strong week. Chart 7 shows the Energy SPDR (XLE) on the verge of a two-month high. Its relative strength ratio has broken a two-month down trendline. Oil service stocks were second only to semiconductors in this week's relative performance. Chart 8 shows the Oil Service Holders (OIH) ending the week at new all-time high. As I wrote recently, a new high in oil service stocks seems incompatible with falling energy prices.

Chart 7

Chart 8

JAPAN IS FINALLY OVERBOUGHT ... Ever since I pointed out the bullish breakout in the Japanese market several months ago, I've gotten messages complaining that it was too overbought to commit funds to. Unfortunately, those who took that view missed the better part of the recent Japanese rally. I'm showing the Japan iShares today because it finally has gotten overbought. The move over 70 in the weekly RSI line shows that. I'm more concerned, however, by the trend in the ADX line. I've pointed out before that a market can continue to rise in the face of overbought readings until the black ADX line rises above the bullish green line. When that happens, the market becomes more vulnerable to a setback. The ADX line has just moved over the green line for the first time since the spring of 2004 (see circles). That means that overbought readings in the RSI line have to be taken more seriously. I've written several times about the positive correlation between the Japanese market and gold. Interestingly, gold has reached a level where some profit-taking might also be expected.

Chart 9

Chart 10

GOLD REACHES $500 RESISTANCE ... Chart 10 shows gold ending the week just above $500 for the first time since 1987. Overhead resistance ranges from $502 (1987 peak) to $514 (1983 peak). I believe those highs will eventually be exceeded. But some profit-taking in this region wouldn't surprise me.