TECHNOLOGY, FINANCE AND CONSUMER DISCRETIONARY SECTORS WEIGH -- DOW FAILS AT 200-DAY -- A BAD START IN MAY -- LONG-TERM BREADTH INDICATOR HITS RESISTANCE -- INFLATION INDEXED BONDS SHOW RELATIVE STRENGTH
KEY SECTORS LEAD BROAD DECLINE... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor
The Dow lost over 200 points on Monday with major weakness coming from the Finance, Consumer Discretionary and Technology sectors. Finance represents the banks, brokers and insurers, which form the backbone of the financial system. Consumer Discretionary represents the most economically sensitive stocks. Technology represents the appetite for risk and the high-beta stocks. Severe weakness in these three sectors is not a good sign for the broader market. Chart 1 shows the Finance SPDR (XLF) breaking flag support with a gap down on Tuesday and continuing lower on Wednesday. Chart 2 shows the Consumer Discretionary SPDR (XLY) failing at the 200-day and breaking the March trendline with a sharp decline over the last two days. Chart 3 shows the Technology SPDR (XLK) stalling with a doji on Monday and then breaking back below its 200-day line on Wednesday. XLK remains above the March trendline, but the failure at the 200-day is bearish.
Chart 1
Chart 2
Chart 3
DOW FAILS AT LONG-TERM RESISTANCE... Recent weakness in the Dow not only reinforces long-term resistance, but it also signals a continuation of the long-term downtrend. Chart 4 shows a large head-and-shoulders reversal pattern using weekly candlesticks. The July high formed the left shoulder, the October high formed the head and the December high formed the right shoulder. With a sharp decline in December-January, the Dow broke neckline support like a hot knife through warm butter. This is the breakdown that established a long-term downtrend.
Chart 4
The Dow Jones Industrials Average represents 30 stocks with various weightings. With 30 different stocks influencing the Average on any given day, picking exact support and resistance levels is challenging. Instead of exact levels, I often look for support or resistance zones. The Dow established support around 13,000 from late July to early September. Once broken, the 13,000 area then acts as resistance. This level is also confirmed by the falling 40-week moving average. With two long red candlesticks (sharp declines) over the last three weeks, it looks like resistance is going to hold. Moreover, this failure at resistance signals a continuation of the long-term downtrend and a move below the January-March lows is expected.
SHOOTING STAR AT THE 200-DAY... Chart 5 shows daily candlesticks with a shooting star at the 200-day. After moving higher from mid March to early May, the Dow met resistance around 13000 over the last three weeks. A shooting star formed on Monday as the intraday rally above 13100 failed to hold. These are bearish candlestick reversal patterns that look like upside down hammers. The inability to hold intraday gains signaled that something was amiss. With a sharp decline the last two days, the shooting star has been confirmed. More importantly, the Dow also broke the March trendline and the early May low. This lower low indicates that a new downtrend is underway.
Chart 5
SELL IN MAY AND GO AWAY... There is a six-month cycle at work in the stock market. The bullish half extends from November to April and the bearish half runs from May to October. "Sell in May and Go Away" is the old Wall Street adage. Research from the Stock Traders Almanac shows that the Dow performs better from November to April. So far the month of May has been mixed for the stock market with notable pockets of weakness. Among the major index ETFs, the Dow Diamonds and S&P 100 ETF are down for the month, which shows relative weakness in large-caps. The S&P 400 Midcap ETF (MDY) is way up in May, which shows relative strength in mid-caps.
Chart 6
Chart 7
Among the sectors, the Materials SPDR (XLB) and the Energy SPDR (XLE) are the clear leaders and the Utilities SPDR (XLU) is holding up well. Trouble starts when we look at the Finance SPDR (XLF), which is down over 7% this month. With Finance contributing over 16% to the S&P 500, the broader market is not going far as long as Finance shows relative weakness.
LONG-TERM BREADTH INDICATOR HITS RESISTANCE... For long-term breadth, I like to look at the percentage of NYSE stocks above the 200-day moving average. Chart 8 shows this indicator over the last 5 1/2 years. Beginning in March 2003, the indicator bottomed and surged above 90% to start a multi-year bull market. Notice that the 40-50 zone acted as support with at least five successful tests (green arrows). The plunge below 40% in July broke the bull's back and started a bear market. Any doubts were erased when the indicator sank below 20% earlier this year. This kind of weakness does not happen in a bull market. Now that a bear market is underway, the 50-60 zone should act as resistance. The rally from mid March to early May carried the indicator back above 50 and into the resistance zone. You can click on this chart to see the settings and save it to your favorites.
Chart 8
INFLATION INDEXED BONDS OUTPERFORMING... With the Consumer Price Index last week and the Producer Price Index this week, there has been lots of talk concerning inflation. In yesterday's commentary, John Murphy noted that gas prices were up in April, not down as reported in the CPI and PPI. Over the last few weeks, the iShares Inflation-indexed Bond ETF (TIP) has started outperforming the iShares 20+ Year Bond ETF (TLT). Relative strength in TIP suggests that bond traders are more concerned with inflation and they are looking for some protection. Chart 9 shows the TIP surging in early May and breaking its 50-day moving average over the last two days. The bottom indicator compares the performance of TIP to TLT. This price relative is rising, which means TIP is outperforming TLT. Chart 10 shows TLT firming at support around 90-91. In contrast to TIP, TLT has yet to break above its 50-day and is lagging.
Chart 9
Chart 10
