RUSSELL 2000 AND SMALL-CAPS LEAD BROAD DECLINE -- MATERIALS SECTOR BREAKS DOWN -- STEEL STOCKS FEEL THE HEAT -- RAILROADS LEAD THE DOW TRANSPORTS SHARPLY LOWER -- DEFENSIVE SECTORS SHOW RELATIVE STRENGTH

SMALL-CAPS LEAD THE MARKET LOWER ... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor

The Russell 2000 led the market lower on Wednesday as selling intensified in small-caps. Chart 1 shows the Russell 2000 relative to the S&P 100, which represents large-caps. The $RUT:$OEX ratio broke resistance in May and surged into mid June. Small-caps led the market higher from mid March to early June. While the S&P 100 peaked in early May and broke down in early June, the Russell 2000 held up longer and continued showing relative strength. Times they are a changing. Even though the Russell 2000 remains above its March low, it bore the brunt of selling pressure over the last two weeks and small-caps are making up for lost ground. OEX broke its March low last week and it looks like the Russell 2000 is heading for a test of this support area. The market lost one of its leaders and this is further evidence that the bear is expanding its grip on the market.

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MATERIALS SECTOR BREAKS KEY MOVING AVERAGE ... Chart 3 shows the Materials SPDR (XLB) leading the market lower on Wednesday with a break below its 200-day moving average. Key industry groups within this sector include chemicals, aluminum, steel and gold mining. XLB led the market higher from January to mid May. After peaking in mid May, the ETF consolidated a few weeks and then broke down over the last two weeks. In addition to the 200-day moving average, the ETF broke the May low and the January trendline. The market lost one of its sector leaders and this furthers the bearish argument. Selling pressure is expanding, not contracting. Simply put, the pickings are getting even slimmer as it gets harder and harder to find strong sectors, industry groups or stocks.

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STEEL STOCKS LEAD MATERIALS SECTOR LOWER... There were a number of groups within the materials sector that were especially hard hit on Wednesday. Last week I featured Dow Chemical (DOW) and Dupont (DD) as chemical stocks came under pressure from rising energy costs. In particular, Dow Chemical announced its second price increase in two months. Dow Chemical is obviously not alone as other stocks in the materials sector are coming under pressure. Chart 4 shows Nucor (NUE) breaking down with its second high volume decline in two months. NUE declined sharply in late May, consolidated with a triangle in June and broke triangle support over the last two days. The stock is currently trading near its 200-day moving average, but the breakdown over the last few days is clearly bearish. On chart 5, US Steel (X) formed a small broadening pattern in June and broke below its 50-day moving average with a sharp decline the last two days. Volume surged to its highest levels of the year as selling pressure intensified.

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TRANSPORTS WEIGHED DOWN BY OIL... Stocks in the Dow Transports are no stranger to rising energy costs. Chart 6 shows West Texas Intermediate Crude ($WTIC) continuing its relentless rise on Wednesday and this weighed transport related stocks. The airlines have been pummeled over the last 12 months. John Murphy pointed out new lows in UPS and FedEx on Tuesday. Today, weakness in the railroad group pushed the Dow Transports below its 200-day moving average. Like the Materials SPDR (XLB), the Dow Transports led the market higher from January to May. Chart 7 shows the Average meeting resistance around 5500 in May-June and then breaking below the May lows in mid June. There was a short bounce back above 5200, but this bounce failed and the Average tumbled over the last two weeks. Another leader bites the dust. Rising energy costs and a weakening economy are taking their toll on the group. Within the Dow Transports, the four big railroad stocks were down over 4% each.

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DEFENSIVE SECTORS HOLDING UP ... John Murphy noted on Friday that money was rotating into defensive sectors. There was more evidence of this rotation on Wednesday as the key defensive sectors held up relatively well. The Financials SPDR (XLF) and the Consumer Discretionary SPDR (XLY) have already taken a beating over the last two months. Chart 12 shows a PerfChart with sector performance from 1-May until 2-June, which is basically the month of May. XLF and XLY led the way lower in May. Notice that the Industrials SPDR (XLI), Materials SPDR (XLB) and Technology SPDR (XLK) held up relatively well in May. In fact, selling pressure in May was pretty much limited to the financial and consumer discretionary sectors.

Chart 12

Chart 13 shows a PerfChart with sector performance from 3-June to 1-July, which is basically the month of June. There are two items worth noting here. First, the Technology SPDR, Industrials SPDR and Materials SPDR declined rather sharply in June. These three held up in May and fell apart in June as selling pressure expanded into these three sectors. Second, the Utilities SPDR (XLU), Consumer Staples SPDR (XLP) and Healthcare SPDR (XLV) held up the best in June. Well, outside of the Energy SPDR (XLE) that is.

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Utilities, healthcare and consumer staples represent the defensive sectors. No matter what happens in the economy, we still need electricity (XLU), toothpaste (XLP) and medicine (XLV). While the S&P 500 moved lower in May and June, XLU edged higher both months and showed relative strength. XLV and XLP are down over the last two months, but less than the S&P 500 and this shows less weakness, which can also be interpreted as relative strength. Fund managers that are required to be fully-invested in stocks are no doubt watching these relative performance numbers and looking for the sectors that are holding up the best.