SPY FIRMS AFTER BIG DOWN WEEK -- TECHNOLOGY STILL SHOWING RELATIVE STRENGTH -- CONSUMER DISCRETIONARY BREAKS MARCH LOW -- CISCO MAINTAINS BREAKOUT -- NIKKEI LEADS LOWER -- RISING YEN WEIGHS ON NIKKEI -- OIH TESTS 50-DAY -- VOLUME BASED INDICATORS

SPY BATTLES 40-WEEK MOVING AVERAGE ... Today's Market Message was written by Arthur Hill. John Murphy will be back tomorrow. - Editor

The S&P 500 ETF (SPY) is trying to firm this week and find support. The ETF declined sharply last week on record weekly volume (over 1.5 billion shares). As popularity of this ETF grows, volume has steadily expanded and last week's volume was over three times the highest weekly volume in 2003. This makes it difficult to compare volume across a long time frame. However, we can be rest assured that volume has been extremely high the last few weeks and sellers have come out in force.

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The ETF hit support from the 40-week moving average and broken resistance. The 40-week moving average is equivalent to the 200-day moving average and this level is important to the long-term trend. Resistance stems from the February high and SPY broke this level in April. Securities often return to the their breakouts and this marks an important test as well. A real battle is raging this week as SPY shot up to 149 on Tuesday, dipped to 144 today and then rebounded to close around 146.5. This battle affirms support around 146 and the bulls are not going to go quietly. I would also like to point out that the Feb-Mar decline lasted one week. SPY firmed in early March and started higher in the second half of March. The current decline lasted one week and SPY is already starting to firm. The firmness confirms support, but what happens after the firming is what really counts.

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THE LINE IN THE SAND... There are two types of sector SPDRs right now. Those trading above their June lows are holding up the best and those trading below their June lows are leading the way down. This logic can be applied to other stocks, ETFs and indices. The leaders are holding their June lows and the laggards broke below their June lows. As the charts now stand, the Industrials SPDR (XLI), Energy SPDR (XLE) and Information Technology SPDR (XLK) are holding above their June lows. Only three of the nine sector SPDRs managed to hold their June lows.

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The other six SPDRs broke below their June lows and forged lower lows. This tilts the sector balance squarely in favor of the bears. The Finance SPDR (XLF) is leading the way lower and even broke below its March low. The Consumer Discretionary SPDR (XLY) followed suit today and broke below its March low. XLY is the most economically sensitive sector and downside leadership here is not a good sign for the economy. XLF is the single biggest sector in the S&P 500 and its components form the backbone of the financial system. An advance in the S&P 500 is likely to be hampered with relative weakness in these two sectors.

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CSCO IS HOLDING UP... I noted some relative strength in Applied Materials (AMAT) last week and the stock broke flag resistance over the last three days. Not bad considering the performance of the overall market. In a similar vein, Cisco (CSCO) is also showing some relative strength and remains well above its 50-day moving average. In addition, the stock is well above its June low and has pretty much consolidated the last few weeks. CSCO broke above its January high in early July and broken resistance is turning into support. The stock is holding this breakout with a choppy consolidation. A move above the consolidation highs would be bullish and signal a continuation higher.

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OIL SERVICES HOLDRS TESTS 50-DAY ... The Oil Service HOLDRS (OIH) reversed after early gains and pierced its 50-day moving average in a volatile day. The ETF recovered with a late rally, but OIH has proven that it is not immune to general market weakness. The ETF gapped higher with an open above 190 in mid July. This gap failed to hold and OIH filled it the very next day. The decline continued over the last two weeks and this gap becomes an exhaustion gap. OIH is up over 40% since March and this is the first correction. The ETF is currently down around 10% from low to high and I would expect support around 165-170.

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NIKKEI SHOWS RELATIVE WEAKNESS ... The Nikkei 225 is leading the way lower with a break below its 200-day moving average. The index declined sharply in February-March and then rallied from March to June. However, this rally peaked in June and the index failed to follow the S&P 500 to new highs in July. Instead, the Nikkei met resistance from its March high and stalled just above 18200. The inability to break above the March high showed relative weakness early on and this turned into absolute weakness over the last two weeks. The index broke its 50-day moving average, gapped down and then broke its 200-day moving average. The index is oversold right now, but shows no signs of strength and remains in the falling knife category.

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SURGING YEN HURTS NIKKEI... In addition to weakness in the US and world equity markets, the Nikkei 225 is also under pressure from a rising Yen. The chart below shows the Yen Index ($XJY) and the Nikkei 225 together. There is an inverse relationship between these two with four distinct periods over the last nine months. First, the Yen was weak from December to February and the Nikkei rose. Second, the Yen surged in late February and this coincided with a sharp decline in the Nikkei. Third, the Yen dropped sharply from early March to mid June and the Nikkei rallied back to its February highs. Fourth, the Yen surged in July and this coincided with a sharp decline in the Nikkei. The surging Yen makes Japanese exports more expensive and less competitive. This in turn could affect revenues and ultimately share prices.

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VOLUME BASED INDICATORS ... On Balance Volume and the Accumulation Distribution Line are complementary volume-based indicators that can help quantify buying and selling pressure. On Balance Volume is a cumulative indicator that adds volume when the close is up and subtracts volume when the close is down. The Accumulation Distribution Line is also a cumulative indicator, but it uses a variable based on the level of the close relative to the high-low range. This variable fluctuates between +1 and --1. The variable is positive when the close is above the mid point of this range and negative when the close is below the mid point. A stock that closes on the high for the day would have a variable of +1 and a stock that closes on the low for the day would have variable of --1. The variable is multiplied by the period's volume to form a cumulative indicator.

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Because the calculation is different, these two indicators can be used to confirm or refute each other. On the QQQQ chart above, the Accumulation Distribution Line remains strong and continues higher, but OBV formed a lower high in July and did not confirm strength. The chart below shows the S&P 500 ETF (SPY) with both indicators overlaid. The Accumulation Distribution Line peaked in mid May and On Balance Volume peaked in mid June. Both indicators formed sharp negative divergences in July and broke to new lows over the last two weeks. A negative divergence forms when the security moves to a new reaction high, but the indicator fails to follow suit. These negative divergence reflected weak buying pressure in early July and the break down over the last two weeks shows a serious increase in selling pressure. A simple look at the volume bars confirms the increase in selling pressure. SPY decline four of the last five days and volume exceeded 300 million shares.

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