REVISITING THE SUBJECT OF WHETHER TECHNOLOGY STRENGTH IS ENOUGH TO OVERCOME FINANCIAL WEAKNESS -- UPDATE OF JUNE ARTICLE ON SAME SUBJECT -- AT THE MOMENT, BOTH ARE RISING

WHAT'S THE REAL MESSAGE... One of our readers asked a question that I've been thinking a lot about lately. It has to do with the conflicting messages being given by the weak financials and strong technology. Financial stocks are usually viewed as leading indictors for the market. And they've been weak of late. At the same time, technology leadership should be a plus for the market. It's a big question with different parts. For example, is there precedent for the market rallying in the face of a weak financial sector? Or, can technology strength offset that financial weakness? I think a fair observation is that a major bear market in either financials or technology is bad for the stock market. Conversely, the market does better when both groups are doing well. It's also true that financials, technology, and the market generally trend in the same major direction most of the time. But not to the same extent. There have been periods when financials show more strength than technology and vice versa. That's the issue that I'm going to try to deal with here.

Chart 1

UPDATE OF JUNE ARTICLE... I addressed that same issue in a June Market Message entitled "Market Trend May Depend on Whether Technology Strength Can Overcome Financial Weakness" (June 29, 2007). The article shows the role reversal that's taken place during 2007 when financial stocks became market underperformers, while technology became market leaders. That role reversal can be seen in Charts 1 and 2. Chart 1 shows a ratio of the Financials SPDR (XLF) divided by the S&P 500. It's broken down badly during 2007. By contrast, Chart 2 shows the ratio of the Technology SPDR (XLK) divided by the S&P 500 over the same six years which is now rising. After underperforming the S&P from early 2004 to mid-2006, the technology relative strength ratio in Chart 2 broke a six-year resistance line during the spring and has risen to a new three-year high. That's why I wrote on June 29 that "Technology may be one of the most undervalued parts of the market. That's a reversal from the situation in 2000 when technology was the most overvalued". Paragraph 7 in that earlier article also starts by observing "If there's a serious threat to the ongoing bull market in stocks, it's in the financial sector". Which leads us to a more direct comparison of the two sectors.

Chart 2

TECHNOLOGY VERSUS FINANCIALS ... By coincidence, Chart 3 is an updated version of the same Chart 3 shown on June 29. It's a ratio of the Technology SPDR (XLK) divided by the Financial SPDR (XLF). The original chart covered only four years and was intended to show that the ratio had broken a three-year resistance line in favor of technology (see arrow). I've lengthened this version of the chart to show that the XLK:XLF ratio has also broken out to a new six-year high. The chart leaves little doubt that technology was the better place to be on June 29 -- and still is.

Chart 3

THAT DOESN'T RESOLVE MARKET DIRECTION ... All we've established so far is that technology appears undervalued, is showing good relative strength, and is a good place to be at this point. By contrast, financials aren't. It doesn't necessarily resolve the question of market direction. For that we have to look at some individual charts. Chart 4 shows the Financials SPDR stabilizing back over its 50-day average. It hasn't broken out to the upside, but has stopped falling. Chart 5 shows the Technology SPDR having hit a new yearly high. Both are good for the market. As was the case back in June, however, the market's wild card remains the financial sector. Whether or not the market can continue its recent uptrend will depend to a large extent on whether financial stocks can avoid another meltdown. The recent financial rebound is encouraging. So is the upside breakout in technology stocks. At the moment, both of those trends are working in the market's favor.

Chart 4

Chart 5