MATERIALS SECTOR RIDES COMMODITY WAVE -- SOX UPTURN AIDS BREAKOUT IN TAIWAN ETF -- YIELD CURVE STEEPENS AS BOND YIELDS JUMP -- DOLLAR BOUNCES OFF 200-DAY LINE

MATERIALS ARE WEEK'S TOP SECTOR ... There's generally a pretty close correlation between the direction of commodity prices and basic material stocks that are tied to those commodities. I've suggested in the past that one way to participate in the commodity bull market is through the Materials Select Sector SPDR (XLB). With commodities on the rise again, materials were the week's strongest group. Chart 1 shows the CRB Index having just reached a new 25-year high. [It gained again today led by energy and copper prices]. While gold stocks have contributed to the recent gains, this week's leadership came mainly from copper and steel stocks. Chart 2 shows the impressive chart action by the XLB. Friday's move to a new 2006 high also resulted in a bullish breakout through its spring 2005 high at 31.31. Its relative strength line has been rising since October and is now trading at a new ten-month high. That's what you'd expect to see when commodities are the still the strongest asset class.

Chart 1

Chart 2

SEMIS AND TAIWAN ARE BREAKING OUT TOGETHER ... Earlier this month I wrote a piece that tied the trend of the Semiconductor (SOX) Index to the stock market of Taiwan because that country has the heaviest weighting in chip stocks (January 05, 2006). I wrote about potentially bullish breakouts in Taiwan iShares (EWT) and Taiwan Semiconductor which is the biggest stock in the EWT. After some short-term slippage over the past two weeks, it now looks like all three entities are moving up together again. The weekly bars in Chart 3 show the Semiconductor (SOX) Index trading at a new two-year high today and challenging its early 2004 peak near 560. Needless to say, that's a very important test. A decisive close through that major chart barrier would represent a significant bullish breakout for the chip group. Chart 4 shows this week's surge in the Taiwan iShares whose 8% gain made it one of the week's strongest foreign ETFs [behind Brazil (EWZ) and South Korea (EWY)]. The chart shows the EWT having already broken through its early 2004 high in heavy trading. Chart 5 shows Taiwan Semiconductor (which has a 12% weight in the EWT) achieving a bullish breakout through its 2003 high -- also on strong volume.

Chart 3

Chart 4

Chart 5

PROFUNDS RISING RATES FUND ... One of our readers asked if there was a direct way to take advantage of this week's jump in the yield of the 10-year T note. The answer is yes and it's shown in Chart 6. The name of the mutual fund is the ProFunds Rising Rates 10 Fund (RTPIX). It's tied directly to the yield (interest rate) on the 10-year T-note yield. To the right, you can see that this week's surge in yields has pushed the fund back over its 50-day moving average. If you think long-term rates are starting to rise (which means that bond prices should fall), this is one way to profit from that trend. The line at the bottom of Chart 6 is the yield on the 10-year T-note. You can how closely they're matched.

Chart 6

YIELD CURVE STEEPENS ... There's been some concern of late about the flat yield curve and the potential for the yield curve turning negative. That happens when the yield on the 10-year T-note falls below the yield on the 2-year T-note. The reason for the concern is that a negative yield curve has in the past been a negative sign for the economy and stock market. Chart 7 shows a ratio of the 10-year yield to the 2-year which has become flat (1.00). The last time the yield turned negative was at the start of 2000 and we all know what happened after that. Now for the good news. Chart 7 shows that the spread between the 10-year and 2-year has moved up this week (the yield curve has steepened). That's primarily due to the jump in the 10-year T-note yield. That gave bank stocks a big boost yesterday. It may also be contributing to the strong buying of stocks later in the week.

Chart 7

Chart 8

DOLLAR STILL TESTING 200-DAY LINE ... The jump in U.S. bond yields this week may also be giving a boost to the U.S. Dollar. And it's coming at a crucial time. Chart 9 shows that the U.S. Dollar Index has been testing its 200-day moving average which is an important long-term support line. After dipping below it earlier in the week, a late rally is pushing the greenback back over that support line. The main reason for that can be seen in Chart 10 which shows the Euro falling back below its 200-day line. [The Japanese yen has also weakened while the Canadian Dollar has remained strong].

Chart 9

Chart 10

WEEKLY MARKET TREND IS STILL UP... The late-week buying of stocks has kept most stock indexes over their 50-day moving averages and and moved a couple of others (like the Dow and the Nasdaq 100) back over that short-term support line. I have to admit to being surprised by this week's upturn after the previous week's heavy-volume downturn. But the market is always right even if I'm not. While I've been focused on this week's short-term action, it's now time to revisit the long-term picture. The good news is that the major trend is still up. The uptrend is old by historical standards and is again in overbought territory. But it's still up which is all that really matters. The weekly bars in Chart 11 show the S&P closing the week back over its 10-week moving average line after slipping below it the previous week. [On the daily chart, the 50-day line held]. The weekly MACD bars which turned positive last November are still positive. [Although the daily MACD lines are still negative, the positive weekly lines carry more weight]. There's been some slippage in the weekly MACD histogram bars. But no sell signal has been given.

Chart 11

Chart 12

MONTHLY MACD STILL POSTIVE... The monthly bars in Chart 12 provide the best view of the market's "big picture". The bad news is the monthly bars are once again in overbought territory and the S&P is nearing its next resistance level just above 1300. It's also recovered roughly two-thirds of its 2000-2002 bear market which is another sign of an over-extended market. The good news is that the major trend is still up. The monthly MACD histogram bars are encouraging. They gave a major buy signal in the spring of 2003 (circle) and have yet to give a sell signal. They came dangerously close to the zero line in 2005 but have bounced since then. In other words the market "bent" last fall but didn't "break". The chart also shows that the 20-month exponentially smoothed moving average (blue line) has acted as good support over the last three years. The last sell signal was given by that indicator in late 2000. Until that line is broken, the major trend will remain up. For a number of reasons, I entered 2006 with a cautious view of the market. And I remain so. What I think, however, isn't as important as the market's trend. In my view, the best way to participate in the market rally is through those sectors and industry groups that show superior relative strength. That would include some of this week's leaders like basic material stocks and semiconductors. Globally, the two major markets that I continue to favor are Canada and Japan. The Canadian market hit a new record high this week on the back of rising commodity prices. The Japanese market has stabilized after its recent downside correction and appears to have presented another buying opportunity.