RUSSELL 2000 REACHES 200-DAY -- A LONG-TERM HEAD-AND-SHOULDERS FOR THE DOW UTILITIES -- MATERIALS SECTOR SHOWS RELATIVE WEAKNESS -- STEEL ETF BREAKS 200-DAY -- LOOKING AT RETRACEMENTS IN THE LAST BEAR MARKET

RUSSELL 2000 SURGES TO 200-DAY ... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor

The Russell 2000 surged to its 200-day moving average with an extremely sharp move over the last seven days. This small-cap index showed less weakness by holding above its January-March lows in July and then showed relative strength by leading the market higher the last 7 days. Chart 1 shows a performance chart with the Russell 2000 and four major indices. With a gain in excess of 8%, the Russell 2000 is easily the top performer over the last seven days. The S&P 100 is a distant second with a gain just over 5%. All the gains are respectable, but the gain in the Russell 2000 is simply remarkable.

Chart 1

Last week I showed the Russell 2000 chart with the Fibonacci Retracements Tool. Chart 2 shows the index blowing through the 50% retracement mark and hitting its 62% retracement mark already. Even though the surge off support was exceptional, Chart 3 shows two other reasons to expect resistance around 720. First, there is resistance from the falling 200-day moving average around 730. Second, broken support around 720 turns into resistance. Chart 2 shows a third reason: Resistance can also be expected near the 62% retracement. Resistance is already being felt as the index closed below its intraday high and stalled around 720 today.

Chart 2

Chart 3

UTILITIES GET SLAMMED... Chart 4 shows the Dow Jones Utility Average ($UTIL) coming under severe pressure on Wednesday. After surging higher from mid March to mid May, the Average consolidated and established a support zone around 503-510. While the market fell sharply in June, the Utility Average held firm and showed relative strength into early July. This changed over the last two weeks with a sharp decline that clearly broke support. The bottom indicator window shows the price relative, which compares performance against the S&P 500. This indicator moved sharply lower over the last two weeks as the Utility Average underperformed the S&P 500. Chart 5 shows a weekly perspective with a large head-and-shoulders pattern taking shape. Neckline support slopes up to around 470. There is also a support zone around 460-470 from the August 2007 and March 2008 lows. A break below this support zone would be most bearish.

Chart 4

Chart 5

MATERIALS LAG MARKET... The market surged over the last seven days with big gains in the major indices. While the Materials SPDR (XLB) advanced as well, the gains pale in comparison to the broader market and other sector leaders. On the Chart 6, XLB broke support from the January trend line and May lows in early July. The ETF firmed after this support break with a consolidation over the last few weeks. With a slight upward slope, the consolidation looks like a rising flag, which is a bearish consolidation pattern. A break below flag support would signal a continuation lower and target further weakness towards the January lows. The bottom window shows the price relative forming a lower high in July and turning lower over the last two weeks. XLB is falling out of favor and a flag break could be in the cards. Within the materials sector, the Market Vectors Steel ETF (SLX) is showing signs of weakness with a break below the 200-day moving average (Chart 7). Also notice that the price relative moved lower in July and SLX is underperforming the S&P 500.

Chart 6

Chart 7

BEAR MARKET RALLIES... Now is a good time to look in detail at the last bear market, which ran from March 2000 to October 2002. In particular, I am interested in the retracement rallies. How much did they retrace? How many were there? On Chart 8, the S&P 500 declined from 1527 to 797 and lost almost 50% during this 31-month period. The ZigZag (Retracements) indicator is overlaid on the chart and set at 10%. Only moves 10% or more are shown with the magenta lines. According to this nifty indicator, there were four bear market rallies greater than 10%. Three of the four are highlighted in yellow. The first retracement rally peaked in September 2000 and retraced almost all of the prior decline.

Chart 8

THE THREE RETRACEMENTS ... Chart 9 focuses on three of these bear market rallies. The first retraced 50% of the prior decline with two smaller bounces along the way (green arrows). The second retraced 60% of the prior decline with a sharp advance after 9-11 (September 2001). The third retraced 44% of an exceptionally steep decline. There are two items we can take from this analysis. First, there will be bear market rallies. Second, these rallies will retrace between 1/3 and 2/3 of the prior decline. Keep this in mind as the major indices retrace a portion of the prior decline.

Chart 9