SMALL-CAPS AND FINANCIALS POWER THE MARKET HIGHER -- THE YIELD CURVE STEEPENS -- DOW TRANSPORTS GET A BIG LIFT -- TECHNOLOGY LAGS

SMALL-CAPS LEAD MARKET REBOUND... Today's Market Message was written by Arthur Hill. John Murphy will return next week. - Editor

The stock market rebounded in the afternoon with the Russell 2000 leading the major indices higher. This small-cap index gained over 3% and market volume was well above average. Chart 1 shows the Russell 2000 ETF (IWM) opening weak and closing strong for the second day running. Notice the two long white candlesticks over the last two days. White candlesticks form when the close is above the open. The first white candlestick has a red outline, which indicates that the ETF closed lower on Tuesday than it did on the previous day. The second candlestick has a black outline, which indicates that the ETF closed higher today than it did on Tuesday. The ETF was oversold as RSI dipped below 30 for the second time this month and it looks like an oversold bounce is underway. Broken support around 73-74 turns into resistance to mark the first test for this bounce. The financial services sector is the single largest sector in the Russell 2000 ETF and the rebound in this sector explains the strength in small-caps today.

Chart 1

Chart 2

YIELD CURVE NORMALIZES... The finance sector stocks are benefiting from the steeper yield curve. Chart 3 shows the Dynamic Yield Curve. The red line shows the shape of the curve in mid May. Notice that short-term rates were higher than long-term rates then. This is an inverted yield curve. The scale at the bottom left goes from 3 months (3M) to 30 years (30Y). The 3-month rates were higher than the 30-year rates in mid May. This was not good for banks and other financial institutions. With the sharp decline in rates over the last few months, the yield curve has become normal again (black line). In fact, one could even argue that it is relatively steep with short-term rates well below long-term rates. This is the way financial institutions like it.

Chart 3

FINANCE STOCKS STEAL THE SHOW... The finance sector likes what it sees with interest rates. The Finance SPDR (XLF) surged over 7% today to lead all sectors. The Consumer Discretionary SPDR (XLY) was a distant second with a 3.65% gain. Chart 4 shows XLF with a big bullish engulfing pattern on Tuesday. This was followed by today's big surge and the ETF is nearing its resistance zone around 28-30. The two-day move is certainly impressive, but still in the context of a larger downtrend. XLF remains below its falling 50-day moving average and below the October trend line. Chart 5 shows the Broker Dealer iShares (IAI) with a gain in excess of 5% today. This follows a big bullish engulfing on Tuesday. Again, the two-day move is impressive, but the ETF is nearing resistance from broken support around 47-48.

Chart 4

Chart 5

DOW TRANSPORTS POWER HIGHER ... The Dow Transports had a huge day with a 7.04% gain and a break above its mid January highs. Chart 6 shows the Dow Transports with the price relative or relative strength comparative. This indicator plots the ratio of the Dow Transports (close) divided by the S&P 500 (close). The ratio rises when the Dow Transports shows relative strength and falls when the Dow Transports shows relative weakness. Relative strength or weakness is often a precursor to absolute strength or weakness.

Chart 6

The Dow Transports fell off a cliff from mid December until early January. The price relative also moved lower as the Dow Transports underperformed the S&P 500 late last year. Things began to change in mid January as the Dow Transports held above its 9 January low. The S&P 500 moved to new lows over the last two weeks, but the Dow Transports held firm. Notice that the price relative shot higher as the Dow Transports firmed in the face of broad market weakness. This showed relative strength and preceded the big breakout. Today's move certainly has some power behind it and the rally could extend to the resistance zone around 4900-5000.

AIRLINES, TRUCKERS AND RAILS PARTAKE ... The next three charts show the DJ US Airline Index ($DJUSAR), the DJ US Trucking Index ($DJUSTK) and the DJ US Railroad Index ($DJUSRR). These are the three main groups within the Dow Transports. The DJ US Airline Index surged to 90 two weeks ago and held most of its gains the last two weeks, which was when the broader market fell apart. This show of relative strength preceded a 9% surge today. The next resistance zone is around 110-115. The DJ US Trucking Index found support from its November low and surged over 9% today. The DJ US Railroad Index was the laggard of the group with a mere 5.95% gain today.

Chart 7

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Chart 9

TECHS REMAIN UNDER PRESSURE ... While most of the stock market put in an impressive performance today, the technology sector lagged as the Nasdaq 100 ETF (QQQQ) closed down on the day. QQQQ managed to recover after a sharply lower open, but failed to move above Tuesday's close. On Chart 10, the white candlesticks over the last two days indicate that QQQQ closed well above its opening price. However, the red outline shows that QQQQ closed below the prior close the last two days. The ETF remains oversold and weak as RSI wallows below 30. Remember, RSI is based on closing prices. The indicator is not concerned with intraday price action from open to close. Look for RSI to break back above 30 and QQQQ to fill Monday's gap to trigger an oversold bounce. Broken support from the November-December lows turns into resistance.

Chart 10