FINANCIALS DRAG DOW DOWN -- QQQQ PULLS BACK FROM RESISTANCE -- HOMEBUILDER ETF SHOWS RELATIVE WEAKNESS -- PULTE LEADS LOWER -- USING STOCHRSI WITH THE MARKET CARPET

FINANCE SECTOR LEADS MARKET LOWER... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor

Led by weakness in technology and financials, the stock market moved sharply lower on Wednesday. All of the major indices were down well over 1% with the Dow dropping over 200 points. John Murphy pointed out resistance for the Regional Bank HOLDRS (RKH) yesterday and this ETF declined over 3.5%. Weakness in banks, brokers, REITs and insurers contributed to a sharp decline in the Financials SPDR (XLF). At around 17%, the financial sector is still the biggest sector in the S&P 500. Information technology is second at around 16%. Chart 1 shows the Financials SPDR with a failed breakout four days ago and a long red candlestick today. Resistance around 27-28 stems from reaction highs in late February, late March, April and now May. Also notice that XLF is well below its 200-day moving average and did not come close to this key level on the most recent rally. In contrast, the Dow managed to reach its 200-day moving average over the last few days (Chart 2).

Chart 1

Chart 2

Chart 3

Chart 4

Chart 5

QQQQ RUNS INTO RESISTANCE... The Nasdaq 100 ETF (QQQQ) had a heck of a run over the last seven weeks, but finally ran into a resistance zone over the last four days. Resistance on Chart 6 stems from two items. First, broken support from the Nov-Dec lows turns into resistance around 49. Second, a 62% retracement of the Dec-Mar decline marks resistance around 49. It is common for an advance to retrace between 38 and 62% of the prior decline. With QQQQ at the upper end of this range, it has reached the maximum for a retracement rally. In addition to resistance, the ETF is overbought as the Stochastic Oscillator remains above 80. The combination of resistance and overbought conditions argues for at least a pullback from current levels. Look for the Stochastic Oscillator to move back below 80 to signal the start of a pullback.

Chart 6

HOMEBUILDERS FAILING AT RESISTANCE... The HomeBuilders SPDR (XHB) is part of the consumer discretionary sector and this key ETF is also meeting stiff resistance. Chart 7 shows XBH breaking resistance in early April, but the ETF failed to hold this breakout and then consolidated below resistance. After trading flat the last four weeks, the direction of the breakout will provide the next signal. A break above consolidation resistance would be bullish, but a break below consolidation support (21) would be bearish for this key group. The bottom indicator window shows the price relative, which compares the performance of XHB to the S&P 500 ETF (SPY). XHB has underperformed since early April and this increases the chances of a support break.

Chart 7

Within the HomeBuilders SPDR (XHB), Pulte Homes (PHM) is losing the battle for the 200-day moving average (Chart 8). With a big surge in January, the stock met resistance around 16. This level held in February, March and April. Pulte tried at least four times to break through 16, but failed and resistance here looks mighty stiff. While the market rallied from mid April to early May, PHM worked its way lower and showed relative weakness. Notice that the price relative peaked in early April.

Chart 8

MARKET CARPET WITH STOCHRSI ... StochRSI can be used with the Market Carpet to identify leading and lagging sectors. StochRSI ranges from zero to one with readings above .80 deemed overbought and readings below .20 deemed oversold. As noted last week, StochRSI is an indicator (Stochastics) of an indicator (RSI). StochRSI measures the momentum of RSI, which is also a momentum oscillator. Therefore, a strong Stochastic Oscillator reflects strengthening RSI. Even though .80 may be deemed overbought, it also shows strength or improving RSI. Moreover, stocks can become overbought and remain overbought in uptrends. Leading sectors have stocks with the highest StochRSI readings, while lagging sectors have stocks with the lowest readings. Because the Market Carpets are color coded, it is easy to visually determine which sectors are leading and which are lagging.

Chart 9

The first Market Carpet shows a detailed view of the nine S&P Sector SPDRs. Boxes are dark green when StochRSI hits its maximum (1) and dark red when it hits its minimum (0). Sectors with the most green have the strongest stocks, while sectors with the most red have the weakest stocks. As you can see, the technology, industrials and financial sectors have lots of green. In contrast, the utilities sector has lots of red. In the bottom right corner, you can see the top five stocks and the bottom five stocks (by StochRSI score). Charts 10 and 11 focus on two of these stocks: Ebay (EBAY) and Nisource (GAS). Nisource shows strength because its StochRSI is trading at 1. StochRSI surged above .80 in mid March and Nisource followed with a resistance breakout in late March. Notice how .50 acted as support the last six weeks.

Chart 10

Chart 11

Ebay is at the other end of the spectrum. The stock surged above resistance and StochRSI surged above .80 in mid March. StochRSI weakened in mid April and has been largely below .50 the last four weeks. This confirms that EBAY has been underperforming the last few weeks. Look for EBAY to break 32 and StochRSI to surge above .80 for a bullish signal.

Chart 12

Turning back to the Market Carpet, there is an alternative way to determine the sector leaders. There is an arrow next to "Current View" at the upper left. Click on this arrow to view the average StochRSI reading for all stocks in the sector. Instead of a checkerboard Market Carpet, one color and one value are assigned to each sector (Chart 12). The StochRSI average for the technology, financial and industrials sectors is .70, which is the highest of the nine. According to StochRSI, these are the leaders in the current market. Even though the Financials SPDR (XLF) did not reach its 200-day moving average, upside momentum (StochRSI) over the last few weeks was strong enough to put in on the leader board. Also keep in mind that StochRSI is quite sensitive. The charts shown are based on Tuesday's close and do not take into account today's sharp decline. The StochRSI average for the utilities sector is .4, which is below .50 and this means it is the laggard.