DOW COMPOSITE IMPROVES -- INTERNET LEADS NASDAQ TO FIVE-MONTH HIGH -- NEW CONSUMER DISCRETIONARY LEADERSHIP -- EARLY OIL PEAK MAY HAVE CAUSED EARLY FOUR-YEAR LOW

DOW COMPOSITE BREAKS RESISTANCE LINE ... With all of the attention focused on the new record high reached by the Dow Industrials, I thought it a good time to revisit the Dow Jones Composite Index. The DJA includes all 65 stocks in the three Averages (30 industrials, 20 transports, and 15 utilities). The last time I showed it the DJA was testing the resistance line drawn over its May/July highs. Chart 1 shows that the resistance line has been broken in pretty decisive fashion. Although most of this week's upside breakout in the DJA comes from the Dow Industrials, we have to note the short-term improvement in the transports. I wrote yesterday about the negative divergence between the industrials and the transports, Chart 2 shows the Dow Transports climbing back over their 200-day moving average in today's trading (led by airline stocks). That doesn't resolve the Dow Theory divergence between the transports and the industrials, but it does strengthen the short-term trend in the Dow complex.

Chart 1

Chart 2

INTERNET GROUP LEADS NASDAQ TO FIVE-MONTH HIGH ... I wrote yesterday about the importance of continuing strength in the Nasdaq market. Chart 3 shows the Nasdaq Composite reaching a new five-month high in today's trading after bouncing off its 200-day line yesterday. The Nasdaq is outpacing both the Dow and the S&P 500 in percentage terms which is also a positive sign for the market. A lot of the Nasdaq leadership is coming from Internet stocks. Chart 4 shows the Interactive Internet Index also climbing to a new five-month high. Internet leadership isn't new. What is new is buying in the biotech group.

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BIOTECH BREAKOUT ... Biotech stocks have been the weakest part of a revived healthcare sector. At least until now. Chart 5 shows the Biotech Index trading over its 200-day moving average for the first time since May. Chart 6 shows the Biotech Holders (BBH) also trading at a six-month high after exceeding its 200-day moving average. This is the first time in awhile that biotechs have appeared on the list of market leaders. Chart 7 shows Amgen, the bellwether of the group, helping to lead the biotech resurgence.

Chart 5

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GOLD REMAINS UNDER PRESSURE ... One of the driving forces behind the market rally is the drop in commodity prices and the reduced threat of inflation. Gold has suffered as a result. Chart 8 shows the StreetTracks Gold Trust Shares (GLD) bearing down on their June low after breaking their 200-day average. Chart 9 shows the Gold & Silver (XAU) Index also threatening its June low. That's an immportant test for the stocks and the commodity. Falling copper prices are also pressuring copper shares. Chart 10 shows Phelps Dodge closing below its 200-day moving average.

Chart 8

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Chart 10

NEW CONSUMER DISCRETIONARY LEADERSHIP ... It's no secret that the collapse in energy prices that started in August helped launch the current market rally. Falling oil prices also accounted for sector rotations that have taken place since August. Basic materials, gold, and energy have been the market's weakest sectors over the last two months (defensive groups like utilities and healthcare have also softened). The sectors that have turned into the strongest have been technology, consumer discretionary (mainly retail), financials, and industrials. I've already touched on the new technology leadership since August. Chart 11 shows the impressive breakout by the Consumer Discretionary SPDR (XLY) that's taken place. The XLY is now trading at a record high. Their change in fortune is most evident in the XLY/SPX ratio (solid line). It had been falling since the start of 2005 as surging oil prices (and rising interest rates) kept a lid on their performance. The relative strength line bottomed in August (see circle) and has reached a new high for the year. That new-found confidence by consumers is helping to fuel the current rally.

Chart 11

OIL PEAK STARTED LAST FOUR-YEAR LOW ... I keep getting a lot of questions about the four-year cycle low which is due again this year. I thought I'd revisit the last cycle low and discuss oil's impact on that one. Chart 12 compares the Dow Industrials (red line) to crude oil (black line) from the middle of 2002 to mid-2003. The last four-year low occurred in October 2002. Notice that it coincided with a peak in oil prices (which usually peak in October). Another rally in oil in the first quarter of 2003 (leading up to the Iraq invasion) weakened stocks. A collapse in oil prices in March 2003 (after the invasion) helped launch the second leg of the new bull market. As I've suggested before, most of the four-year cycle lows have occurred during October. This year, however, oil prices peaked in August just as the Dow and rest of the market bottomed (Chart 13). That suggests to me that an early energy peak may have moved the four-year cycle low this year from October to August. Which suggests no October bottom this year.

Chart 12

Chart 13