STOCKS REVERSE AFTER EARLY GAINS - ENERGY LEADS THE WAY LOWER - AIRLINES BOUNCE ON FALLING OIL PRICES - SOUTHWEST BREAKS MAY HIGH - RISING RATES HURT UTILITIES - NET NEW HIGHS REMAIN POSITIVE

BEARISH ENGULFING PATTERNS ABOUND... Today's Market Message was written by Arthur Hill. John Murphy will be back tomorrow. - Editor

Stocks opened strong this morning, but selling pressure took over and the major indices finished the day weak. As a result, bearish engulfing patterns or outside reversals formed in a number of ETFs and stocks. The bearish engulfing forms when the open is above the prior close and the close is below the prior open. The first candlestick is white and the second candlestick is black (or red). As its name implies, the second candlestick completely engulfs the first and this signals an intraday reversal. Candlestick reversal patterns are short-term oriented and valid for 1-2 weeks. In addition, many require confirmation with further weakness. This includes the bearish engulfing pattern. Using the S&P 500 ETF (SPY) as an example, the bearish engulfing reinforces resistance from the early June high and a lower high has now formed. Another long black candlestick would confirm the bearish engulfing and we could then expect a move below the early June low in the next week or two.

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ENERGY STOCKS LEAD THE MARKET LOWER... The Energy Department reported a rise in crude oil supplies and this put downward pressure on the U.S. Oil Fund ETF (USO). Total supplies were 3.2% above last year's levels and USO fell around 1% on today's news. On the price chart, USO is hitting resistance from the 200-day moving average around 51.5 and stalling. Despite this stall and today's weakness, the ETF is still holding its breakout at 51 and remains in bull mode. The June advance produced a gap, broke falling price channel resistance and exceeded the mid May high. Broken resistance at 51 turns into support and this breakout is holding so far. A move back below 51 would be negative, but I would not give up on this breakout unless USO moves below 49.

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With weakness in oil, investors took some profits in energy related stocks and started bottom fishing in airlines. The Energy SPDR (XLE) fell back below 70 on above average volume. Today's decline was the steepest since 27-Feb. The ETF remains in a clear uptrend, but is still overbought and vulnerable to a deeper correction or consolidation. XLE has support around 66.5 from the late May and early June lows. In addition, the rising 50-day moving average offers support in this area.

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AIRLINES GET A LIFT... The Amex Airline Index ($XAL) was one of few industry groups with a decent gain today. Even so, one day is not enough to reverse the downtrend on the daily chart. The February trendline and the 50-day moving average converge around 51.5-52 to mark the first resistance test. There is also resistance in this area from the prior support break. Airlines and Energy have a history of moving in opposite directions. While XLE is overbought and ripe for a correction, XAL is oversold and ripe for an oversold bounce. XLE has been one of the top performers in 2007 and XAL has been one of the worst performers.

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SOUTHWEST AIRLINES BREAKS RESISTANCE... Southwest Airlines (LUV) took the lead within the Airline group and the broke above its May highs today. However, the overall trend remains down as LUV trades well below its falling 200-day moving average. The 200-day offered resistance in January, February and April. The current bounce is viewed as a counter trend move and I would expect resistance from this key moving average again.

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UTILITIES GET HAMMERED... The 10-year T-Note Yield ($TNX) edged back above 5.1% today and investors dumped interest rate sensitive utility stocks. The Utility SPDR (XLU) declined over 2% and was the second weakest sector SPDR (XLE was the weakest). This looks like the start of the third decline in two months and XLU is heading for a date with its 200-day moving average. The ETF broke rising flag support in early June and then bounced around 39. Another rising flag formed over the last two weeks and the ETF broke support with a decline this week. This signals another continuation lower and the downside target is the 200-day around 38.

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NEW HIGHS AND LOWS... Before moving on to some analysis of Net New Highs, let's start with a refresher on this indicator. Net New Highs equals the number of stocks making 52-week highs less the number hitting 52-week lows. In general, the market is strong when more stocks are making 52-week highs and weaker when more stocks are making 52-week lows. Yes, it is deceptively simple! I applied a 10-day simple moving average (SMA) to smooth the indicator and help prevent whipsaws. The top charts show the 10-day SMA of Net New Highs and the bottom chart shows the daily readings for Net New Highs. Which one looks the smoothest?

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To reproduce Net New Highs on SharpCharts, enter $NYHL for NYSE stocks, $NAHL for Nasdaq stocks or $AMHL for Amex stocks. Under "chart attributes", set the "type" as "invisible" and then move to the "overlays" section. Select "simple moving average" in the first drop down box, "10" for periods and "area" for style. To overlay an index, move down to the "indicators" section and select "price". Enter your desired symbol and select "behind price" for position. Click update and you are ready to go.

This next chart shows the 10-day SMA for Net New Highs (NYSE) and the NYSE Composite over the last three years. The trend for the NYSE Composite is clearly up and Net New Highs remain strong. The 10-day SMA dipped into negative territory six times and these dips coincided with corrections in the index. The last correction occurred from mid May to late August in 2006. The indicator has been in positive territory since late August 2006. There was a sharp dip in March this year, but the indicator held in positive territory and the market subsequently recovered. We should not expect a correction or an extended pullback until the 10-day SMA for Net New Highs moves into negative territory.

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The next chart shows the same indicator for the Nasdaq. The 10-day SMA for Net New Highs dipped into negative territory five times over the last three years and each dip was accompanied by a correction. The subsequent recovery back into positive territory signaled a resumption of the long-term uptrend and provided a pretty good entry signal for the Nasdaq. The last entry signal occurred in late March and the indicator remains bullish. We should not expect a correction or extended pullback until the 10-day SMA for Net New Highs moves into negative territory.

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