STOCKS MAKE AFTERNOON RETREAT -- CANDLESTICK PREFERENCES - SPY TURNS INDECISIVE -- INTEREST RATES CONTINUE HIGHER -- REITS MOVING OPPOSITE OF RATES AGAIN -- FINANCE SECTOR REMAINS A LAGGARD -- CHINA ETF HITS RESISTANCE

STOCKS GIVE UP EARLY GAINS... Today's Market Message was written by Arthur Hill. John Murphy will be back tomorrow. - Editor

Stocks were higher throughout the day, but gave up their gains in the late afternoon and closed mixed. Stocks swooned after reports hit the wires that Greenspan considered Chinese stocks ripe for a correction. Even in retirement, Greenspan can still rattle the markets and make the headlines. The NYSE Composite and S&P 100 finished slightly higher, while the Nasdaq and S&P 500 closed lower. The NYSE Composite stalled around 9900 over the last three days and the bulls are looking a bit tired (gray oval). The overall trend remains up, but the index is overbought after a 1000 point run without a correction or consolidation. Prior pullbacks lasted 1-3 days and buyers quickly stepped to keep the rally going. Despite a clear uptrend and strength, this index still looks ripe for either a pullback or a consolidation phase. Unlike Greenspan though, my comments are not likely to be self fulfilling as soon as they hit the wires.

Chart 1

CANDLESTICK PREFERENCES ... Before moving on to candlestick analysis of the S&P 500 ETF (SPY), I would like to voice an opinion on candlestick preferences. When it comes to candlestick analysis, I prefer to use SPY instead of the S&P 500. By extension, I also prefer QQQQ to the Nasdaq 100, DIA to the Dow Industrials and IWM to the Russell 2000. The S&P 500 and other indices are great for medium and long-term analysis, but I find ETF price data more robust for candlestick analysis. Candlesticks require an open, close, high and low. Even though the S&P 500 and other indices have opening price data, it is not based on an actual trade. The indices often start trading before all components are open and the opening level for the index does not reflect a "true" open. In contrast, the opening price for SPY is based on an actual trade and the opening is often more indicative of the prevailing winds. The indices rarely gap open and when they do the gaps are quite small. The next two charts compare candlesticks and gaps for the S&P 500 Index and S&P 500 ETF (SPY).

Chart 2

SPY STALLS FOR THE THIRD DAY... The S&P 500 ETF (SPY) stalled for the third day running and formed its third indecisive candlestick in a row. SPY formed a gravestone doji on Monday and then two small black candlesticks. The gravestone doji looks like an upside down "T". The open is virtually equal to the close and the long upper shadow reflects the intraday high. The bulls pushed SPY higher in early trading Monday, but the bears grabbed control and forced the ETF lower by the close. The same thing happened on Tuesday and Wednesday as early gains were lost and SPY closed near the low for the day. The bulls are losing their punch, but the bears have yet to fully grab control and actually push prices lower. Indecision is often the first step to a short-term trend reversal, but we need some sort of confirmation with some actual weakness to trigger a short-term trend reversal.

Chart 3

INTEREST RATES CONTINUE TO RISE ... The 10-year T-Note Yield ($TNX) extended its advance and moved above 4.85% today (48.5 on the chart). This key rate has risen rather sharply since early March and is fast approaching resistance from its late January high. The 50-day moving average turned up over the last two weeks and looks poised to break above the 200-day moving average. Stocks have held up in the face of rising rates this months, but one must wonder how much Wall Street will stomach.

Chart 4

The next chart shows weekly data extending back two and a half years and we could be seeing a continuation of the prior advance. The 10-year T-Note Yield ($TNX) broke resistance in the first quarter of 2006 and pulled back in the second half of 2006. TNX then firmed around 4.4%-4.5% over the last few months and shot higher in May. A break above the January high would set the stage for a challenge to resistance around 5.25% and further strength in rates could start affecting on stocks.

Chart 5

REITS ALREADY FEELING THE HEAT ... REITs are interest rate sensitive and the recent surge in interest rates is putting downward pressure on this group. This is a relatively recent phenomenon because both interest rates and REITs were strong up until January-February. Both came crashing down in February and both rebounded in March-April. This awkward romance came to an abrupt end as the two took separate paths in May. Interest rates moved sharply higher and REITs moved sharply lower. The REIT iShares (IYR) broke consolidation support in mid May and moved below its March low last week. Not many industry groups are trading below their March lows and REITs are showing some serious relative weakness. The UltraShort Real Estate ProShares (SRS), which moves inverse to the REIT iShares (IYR), broke resistance in mid march and moved above its early March high last week.

Chart 6

Chart 7

Chart 8

FINANCE AND BROKERS STILL LAGGING ... Last week John Murphy pointed out that the Amex Broker Dealer Index ($XBD) had yet to breakout and this key index was not as strong as the S&P 500. The brokers are part of the Finance sector and this sector is the single biggest sector in the S&P 500. Composed of banks, brokers, insurance companies, S&Ls and REITs, this sector is also sensitive to interest rates and merits a close watch as rates rise. The Finance SPDR (XLF) is also meeting resistance from its February high and showing relative weakness. The S&P 500 broke above its February high in mid April and the Finance SPDR (XLF) just managed to pierce this high today. Despite a new high in XLF, the ETF is still severely lagging the S&P 500. The price relative (XLF/SPX ratio) remains well below its February high and this confirms that the Finance sector is much weaker than the market as a whole.

Chart 9

Chart 10

CHINA ETF HITS RESISTANCE... The China Xinhau 25 ETF (FXI) has been one of the best performing ETFs since mid March and over the last 2 1/2 years. FXI has more than doubled since January 2005 and is up around 25% from its March low. The ETF surged back to resistance from its January high and stalled over the last two weeks. A massive double top could be taking shape with support at 90. However, this pattern is just potential until confirmed with a break below the intermittent low (90). On the daily chart, the ETF stalled around 115 and remains above its rising 50-day moving average and early May low. I would watch these two levels for signs of trouble. The emerging market indices and ETFs are like the canaries in the coal mine. If there is going to be trouble, these indices are likely to move first and we should keep a close eye on China.

Chart 11

Chart 12