RUSSELL 2000 AND NASDAQ LEAD REBOUND -- FINANCIAL AND CONSUMER DISCRETIONARY SECTORS GET BIG OVERSOLD BOUNCES -- SURGING CPI WEIGHS ON BONDS -- DOW THEORY REMAINS ON SELL SIGNAL
SMALL-CAPS AND TECHS SHOW RELATIVE STRENGTH ... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor
It has been a tale of two markets over the last few months. On one side, the Dow Industrials and S&P 500 were weighed down by large-cap financials. Charts 1 and 2 show both moving to new lows for the year and leading the way lower. On the other hand, the Russell 2000 and the Nasdaq found support near their January-March lows. Charts 3 and 4 show both firming just above January-March lows. The ability to hold above these lows showed less weakness, which can also be interpreted as relative strength. All four bounced with sizable gains on Wednesday with the Russell 2000 and the Nasdaq leading the way. After holding up the best on the way down, these two gained over 3% to lead Wednesday's rebound. Before getting too carried away, don't forget that all four are below their falling 200-day moving averages. In addition, their 50-day moving averages are below their 200-day moving averages. In other words, the long-term trends remain down and any bounce would be viewed as a counter-trend advance. Broken support levels turn into resistance to mark the first test areas for the S&P 500 and Dow. The Russell 2000 and Nasdaq could retrace a portion (38-62%) of the June-July decline. Taking the middle, the orange areas show potential resistance around the 50% retracement mark.
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XLF AND XLY GET OVERSOLD BOUNCE... The Financials SPDR (XLF) and the Consumer Discretionary SPDR (XLY) led the sectors higher on Wednesday with big oversold bounces. XLF was up an outrageous 11.94%%, while XLY was up a mere 4.02%. On Chart 5, XLY broke support around 29-29.3 and this area turns into resistance for the first test. XLF broke support around 22-23 and this area turns into resistance. Needless to say, many of the beaten down financial stocks also surged with outrageous gains. The next few charts show some of the bigger financial names with some of the biggest moves. These advances are coming from deeply oversold levels without much in the way of support. Prior to today's bounce, these stocks were in the falling knife category. Bargain hunting and short covering are enough to trigger oversold bounces, but one day is not enough to undo months of technical damage. Sustainable advances require successful support tests and expanding upside volume. Let's judge the follow-through before jumping to any conclusions.
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BONDS PLUNGE AS INFLATION SURGES ... After a surge in the Producer Price Index (PPI) on Tuesday, it was little surprise that the Consumer Price Index (CPI) ran amok on Wednesday. The CPI surged 5% year-on-year and 1.1% month-on-month. That 1.1% monthly gain translates into an annual rate much higher than 5%. The 5% year-on-year change was the highest since 1991, while the 1.1% month-on-month change was the highest since 1982. For the sake of argument, let's take the 5% year-on-year change as the annual inflation rate. The 10-Year Note Yield ($TNX) is currently around 3.93%, which means the real yield is actually negative (3.93% less 5% equals --1.07%). Chart 11 shows the 10-Year Note Yield ($TNX) breaking resistance from its February highs with a surge above 4% (40). TNX pulled back over the last few weeks, but is finding support around 3.8% (38) and inflationary pressures could push rates higher (bonds lower). Chart 12 shows the iShares 20+ Year Bond ETF (TLT) hitting resistance after retracing 50-62% of the March-June decline. The ETF gapped down today as investors reacted to the news on inflation and the negative real yield.
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DOW THEORY UPDATE... According Dow Theory, the Dow Industrials and Dow Transports can be used to generate buy and sell signals for the general market. Basically, there are three steps to a sell signal. First, both Averages must decline sharply from new highs. Second, one or both Averages must form a lower high on the subsequent rally. Third, both Averages must break below the prior low. Chart 13 shows both Averages recording new highs in July 2007. After a sharp decline, the Dow Industrials rallied to a higher high in October, but the Dow Transports fell well short with a lower high. This produced a non-confirmation. The subsequent support breaks triggered Dow Theory sell signals in November 2007 (red line).
Chart 13
The Dow Transports seemed to ignore the sell signal by racing above its December high around 4800. However, the Dow Industrials never got close to its December high and did not confirm the Dow Transports. The Dow subsequently moved to new lows for the year and the Dow Theory sell signal remains in place. The Dow Transports must move above its June 2008 high and the Dow Industrials must move above its May 2008 high to trigger a Dow Theory buy signal. Note: I used a 5-day simple moving average to smooth the data series.
