TRANPORTS REACH NEW HIGHS -- SO DO BROKERS -- FINANCIALS STILL STRUGGLE AS BOND YIELDS TEST 2007 HIGH -- BUD TAPS OUT NEW HIGH -- MEADWESTVACO LEADS PAPER STOCKS HIGHER -- USING POINT & FIGURE CHARTS FOR PROTECTION

TRANSPORTS BREAK OUT ... On May 14, I showed three groups that were stalled at their early 2007 highs. One of them was the Russell 2000 Small Cap Index. Arthur Hill showed that index hitting a new high yesterday. That resolves the short-term negative divergence between large caps (which had already broken out) and small caps that hadn't until yesterday. The second one was the Dow Transports. Chart 2 shows that index finally breaking out to a new high today. That resolves the negative divergence between the Dow Industrials and Transports. It also keeps Dow Theory bulls happy. The third group I mentioned was the brokers.

Chart 1

AG EDWARDS BOOSTS BROKERAGE STOCKS ... The announcement that Wachovia is purchasing AG Edwards lit a fire under brokerage stocks. That's pushed the AMEX Broker Dealer Index through its January 2007 high to a new record (Chart 2). The biggest part of that gain came from the 13% jump in the stock of AGE (Chart 3) on massive volume. There are several other brokerage winners. TD Ameritrade (Chart 4) has broken out to a new 52-week high. Charles Schwab is trading at the highest level in six years (Chart 5). The bullish breakout by the brokers is another positive sign for the market. What we need next is an upside breakout by the entire financial sector.

Chart 2

Chart 3

Chart 4

Chart 5

FINANCIALS SPDR CONTINUES TO UNDERPERFORM ... Of the nine market sectors that we track, seven are trading higher today. Of those seven, four are hitting new records -- basic materials (XLB), consumer staples (XLP), industrials (XLI), and technology (XLK). The only two losers are energy (XLE) and financials (XLF). Of those two, financials are the only ones that have yet to exceed their February high. Chart 6 shows the Financials SPDR (XLF) stalled at its February peak at 38. The relatively poor performance of financials since the start of the year is seen more clearly in the falling XLB/S&P ratio (bottom of chart). That RS ratio is trading at the lowest level of the year. Financial stocks are one of the most sensitive to the direction of interest rates and don't take well to rising bond yields. And bond yields are threatening to move higher.

Chart 6

BOND YIELDS TEST JANUARY HIGH ... One of the factors keeping the global stock rally intact has been low interest rates. Bond yields are climbing in Europe and Canada, however, and are threatening to climb in the U.S. as well. Chart 7 shows the 10-Year Treasury Note yield testing its January high. A close over that chart barrier would put the bond yield at the highest level since last August. As is always the case, bond prices are falling as yields rise. Chart 8 shows the 20-Year T-Bond ETF (TLT) having fallen below its 200-day moving average, and nearing a test of its February low. Part of the bond selling may be due to some switching into stocks. The problem is that falling bond prices, and rising bond yields, aren't necessarily good for the stock market. That's why the current test in Chart 7 is so important. It may also explain why financial stocks (outside of brokers) are starting to lag behind the rest of the market.

Chart 7

Chart 8

FALLING RATES HAVE FUELED MARKET RALLY ... Chart 9 compares the 10-Year T-Note Yield (green line) to the S&P 500 (red line) since the start of 2006. It shows that the latest stock rally began last July as bond yields peaked. Bond yields climbed last year from January to June and may have contributed to the 8% stock selloff that lasted from May to June. Rising bond yields this January may have also contributed to the late February stock selloff. Although the relationship between bonds and stocks hasn't been as tight as it had been in the years prior to 2000, I don't think that changes a basic intermarket premise that rising bond yields aren't historically good for stocks. Stocks can continue to rise with bond yields for awhile. But corrections inevitably follow.

Chart 9

BUDWEISER TAPS OUT A NEW HIGH ... Summertime is beer season, which may have something to do with today's upside breakout in Anheuser Busch. It's the day's top performer in the consumer staples group. The daily bars in Chart 10 show BUD hitting a new high today. It's been rising on strong volume over the last week. Its relative strength line has also started to jump. But it gets even better. The monthly bars in Chart 11 show the stock tapping out its 2004 high just below 52. Its relative strength ratio (solid line) is starting to rise for the first time in five years.

Chart 10

Chart 11

MEADWESTVACO LEADS STRONG PAPER GROUP ... Forest product stocks are leading the materials group to new highs today. I wrote a positive story on this group on February 6 and again on April 3. In the later article, I showed MeadWestvaco breaking through a "neckline" (green line) and giving a major buy signal. MWV continues to lead the paper group higher. The monthly bars in Chart 12 show the stock trading at a seven-year high and climbing toward its old record reached in 1999. Upside volume has been very strong (see green volume bars). And the stock's relative strength ratio (bottom of chart) appears to be breaking through a descending trendline lasting five years. Although the stock is somewhat extended, its long-term pattern still looks bullish.

Chart 12

POINT & FIGURE SUPPORT POINTS ... It's been awhile since I showed some point & figure charts. I last used them during February to try to pinpoint signs of a market correction. Short-term sell signals were indeed activated on the p&f charts of the Dow and the S&P 500 in late February. Fortunately, they reversed back to buy signals in early March. Those buy signals are still intact. Figure 13 shows the Dow's initial buy signal given at 12350 during March (when the x column exceeded a previous x column). A second buy signal was given at 12550 in early April. The Dow is hitting a new high today (green x). P&f charts give us a way to spot any signs of weakness. To give a short-term sell signal, an o column must close below a previous o column. Two such points are shown in Chart 13. The first would be a Dow close at 13400 or lower. The second would be Dow close at 13200 or lower. For the S&P 500 (Chart 14), some possible short-term sell points would be closes at 1505, 1490, or 1475 (or lower). It's usually a good idea to stagger stopout (sell) points. In other words, use a closer stopout point for a more sensitive (short-term) portion of a position, while using looser stopout points (further away) for another portion. A major portion of one's position should be held until major sell signals are given. We're nowhere near that happening.

Chart 13

Chart 14