EARLY 2006 LEADERSHIP FAVORS GOLD, OIL, AND CHIPS -- NEXT UPSIDE TARGET FOR S&P IS 1315 -- WAYS TO DEAL WITH CURRENT MARKET

CONCENTRATING ON STRENGTH ... The market is starting the new year with a bang. Virtually all of the major market averages have risen to new 52-week highs. Some of that new optimism is the result of the Fed minutes released earlier in the week hinting that it might be close to ending its rate-hiking. I've expressed skepticism about the staying power of the early 2006 strength. But only time will tell if that skepticism is warranted. I've also suggested that January is traditionally the best month of the year to take some money out of the market is one is so inclined to do so. An alternative to taking money out of the market is rotating it to those market groups that are leading the market higher. It should come as no surprise that some of those early leaders are commodity-related stocks (especially gold) and foreign stocks. I've been writing about that trend for several months. I suggested earlier in the week that those same Fed minutes that sparked this week's market rally also weakened the dollar. If anything, the falling dollar has accelerated the move into commodity-related stocks and foreign markets this week. Hopefully, our readers are already aboard those moves. Energy stocks are also among early 2006 leaders as oil has climbed back over $64. Oil service stocks are the clear leaders there. Chart 1 shows the Oil Service Holders (OIH) hitting a new record on Friday. The recent pullback stopped just above its 50-day average and chart support along its late September high. That's a textbook example of what an uptrend should do. Its relative strength line is also in new high ground. Chart 2 shows the Energy Sector SPDR (XLE) nearing a challenge of its September high. It too is starting to outperform the S&P 500 again. While that may help boost the S&P over the short run, continued energy leadership is usually bad for the S&P further out in time. Early 2006 leadership is also coming from chip and internet stocks.

Chart 1

Chart 2

CHIP AND INTERNET BREAKOUTS ... I wrote about the buying in semiconductors yesterday. The Semiconductor (SOX) Index traded at a new 52-week high today. Its relative strength line is close to doing the same. The SOX appears headed to its early 2004 peak at 560. Internet stocks had an even more impressive week in the technology sector. Chart 4 shows the Internet Index (IIX) having broken through its late 2004 peak. The recent pullback also found support at the breakout point. The jump in its relative strength line shows some urgent buying late in the week in the internet group. Another more defensive group that's moved to the top sector rankings is healthcare. A lot of that is coming from buying in biotechs and pharmaceuticals.

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BIOTECHS HIT NEW HIGHS -- DRUGS REBOUND ... Biotech stocks continue to advance. Chart 5 shows the Biotech Index climbing over 700 for the first time in five years. Its relative strength line has been climbing for a year. The BTK appears headed to its 2000 high at 800. While the biotech rally has been going on for sometime, the rebound in drug stocks is relatively new. Chart 6 shows that the Pharmaceutical Index (DRG) has been a terrible performer over the last four years. Although its recent bounce isn't enough to turn its major trend higher, there are early signs that money is starting to flow back into the group. Chart 7 shows the sharp jump in the Pharma Holders (PPH) over the last month accompanied by heavy volume. The PPH has also climbed over its 200-day moving average. Most of the other group leaders that I've shown so far have well established uptrends. A new uptrend in the drug group may just be starting.

Chart 5

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LONG-TERM CHARTS... Some of you have been asking for a look at some long-term charts. Chart 8 is a monthly chart of the S&P 500. The S&P traded today at the highest level since early 2001. The S&P is only a couple of percentage points from the next potential chart barrier at 1315 (see circle). That'll be the next test we'll be looking for. The monthly Commodity Channel (CCI) Index is back in overbought territory. But the 12-month (ROC) line has stayed over its zero line which means that the major uptrend is still intact. The weekly bars in Chart 9 show the S&P reaching a new recovery high today. The CCI line is back in overbought territory. But the weekly MACD lines are still positive. The S&P recently bounced off its 10-week (50-day) moving average and support along its August/September highs.

Chart 8

Chart 9

DAILY S&P 500 CHART ... Although the weekly and monthly charts are more important in determining a market's long-term trend, daily charts are more important for timing purposes. Chart 10 shows the S&P reaching a new recovery high at 1285 today which is just 30 points shy of its next upside target. Although the short-term trend is overbought, the daily MACD lines have just turned positive. One of the questions I've gotten a lot recently is how to know when to sell something. One way is to pick an upside target and do some selling as the market approaches that level. In the case of the S&P 500 that could suggest some profit-taking as it reaches the 1300 level. An alternate approach is to hold on until the market starts to break an important support level. For the S&P 500 that would be the recent low at 1245 which happens to also coincide with its 50-day average. In fact, today's move to new high ground has provided with good stopout points under the last week's lows. That would be a a drop below 10684 in the Dow (Chart 11) and 1633 in the Nasdaq 100 (Chart 12).

Chart 10

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Chart 12

TRADING IS A PERSONAL DECISION ... Every trader or investor has a different tolerance for risk and a different time horizon. That's one of the reasons I'm reluctant to offer specific trading advice. What's right for one person may not be right for another. Ultimately, each person has to make these decisions for themselves. In this report, I've offered three alternative ways to deal with the current market. One is to take some money off the table during January as the market is rising. Another is to rotate into groups that are showing market leadership such as those described above. That includes foreign stocks. A third alternative is to stick with the current trend until it shows signs of ending. The best approach may be some combination of those three.