STOCKS HIT WITH BROAD DECLINE -- LACK OF FOLLOW THROUGH STYMIES THE BULLS -- BEARISH MOMENTUM FOR DIA AND QQQQ -- PERFCHARTS FAVOR DEFENSIVE SECTORS -- EURO REACTS TO POTENTIAL RATE CUTS -- GOLD FOLLOWS EURO

BROAD SELLING HITS WALL STREET... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor

Stocks were hammered on Wednesday with across the board selling pressure. All nine sectors were down sharply on the day. All 30 Dow components were down and breadth was decided negative. Advances outpaced declines 6-7 to 1, while the volume of declining stocks swamped the volume of advancing stocks. The snapshot of the S&P Sector Carpet shows a sea of red with only 11 green squares. All energy stocks were down. Financials got clobbered. In an interesting twist, three of the top five gainers today came from the technology sector.

Chart 1

INABILITY TO FOLLOW THROUGH ... October is often a reversal month, but lack of follow through is preventing a sustainable rally. We have seen firmness and big one-day surges, but we have yet to see convincing follow through on high volume and strong breadth. In addition, we have yet to see resistance breakouts on the price charts or momentum breakouts for key momentum oscillators. Follow through is what separates short oversold bounces from sustainable rallies. I am not advocating the end of the bear market with the next follow-through rally. However, cyclical bull markets or 1-3 month rallies are possible within secular bear markets.

Charts 2 and 3 show the Dow Industrials ETF (DIA) and Nasdaq 100 ETF (QQQQ) over the last four months. First, I will analyze the failed surges. Second, I will then suggest some requirements for a sustainable reversal. Both ETFs became oversold in mid October and firmed with spinning top candlesticks on 10 October (black arrows). These spinning tops were followed by a big surge the following Monday (13 Oct). DIA and QQQQ gapped up and closed strong to form long white candlesticks. Although the advance was huge on percentage gain, it was just one day and there was no follow-through advance. Stocks opened strong the following day (Tuesday, 14 Oct), but closed weak to form a long black candlestick. This intraday reversal was followed by another long black candlestick on Wednesday that wiped out most of Monday's gains.

Chart 2

Chart 3

The second promising recovery occurred the very next day as stocks continued lower early Thursday (16 Oct), but reversed course to close strong (blue arrows). Stocks stalled on Friday and then advanced on Monday with below average volume. This low volume advance lacked firepower and did not qualify as a convincing follow-through day. With a sharp decline over the last two days, the major index ETFs are trading back near their October lows and we have yet to see convincing follow through.

Needless to say, the downtrend remains in place. Stocks are still quite oversold and late October is still a good time to expect a reversal. However, we need to see some convincing bullish evidence on the price charts. With the decline over the last two days, the Friday-Monday highs now mark resistance. A move above these highs would break the September trend line and forge a breakout. Look for above average volume and strong breadth for validation. The bottom indicator windows show RSI and CCI in bear mode. RSI remains below 50, while CCI has yet to surge above +100. Look for these oscillators to break their respective bullish thresholds to signal a momentum reversal.

DEFENSIVE SECTORS DOMINATE RELATIVE PERFORMANCE... The next PerfCharts show the relative performance of the nine sector SPDRs over the last 6 months, 3 months and 1 month. Even though the relative performance figures change, there is one clear constant. Defensive sectors are outperforming the broader market across all three time frames. With the Consumer Staples SPDR (XLP), Healthcare SPDR (XLV) and Utilities SPDR (XLU) holding up the best, the stock market has been constantly on the defensive the last six months. Keep in mind that these are "relative" performance numbers, not absolute performance numbers. The bear market is not going to end until these numbers change. According to the sector rotation model, financials, cyclicals (consumer discretionary) and technology lead the move out of a bear market. While this could still be a way off, it is something to keep in mind over the coming months.

Chart 4

Chart 5

Chart 6

RELATIVE VERSUS ABSOLUTE PERFORMANCE... The next two PerfCharts show the relative performance numbers for the nine sector SPDRs and the absolute performance numbers for the nine sectors plus the S&P 500. It ain't a pretty picture over the last twelve months. While the relative performance histogram shows positive numbers for XLK, XLV, XLP and XLU, the absolute performance histogram shows negative numbers for all nine sectors. The black dotted line corresponds to the S&P 500. All sectors above that line are outperforming the index (down less than SPX). All sectors below the line are underperforming the index (down more than SPX). It is little surprise that the Financials SPDR (-51.37%) is the clear leader here. The Consumer Discretionary SPDR, Technology SPDR, Industrials SPDR and Materials SPDR (XLB) all sport losses similar to the S&P 500. This has been a relatively equal opportunity bear market.

Chart 7

Chart 8

EURO PLUNGES ON RATE CONCERNS... The Euro Trust ETF (FXE) plunged on Wednesday as traders sold euros in anticipation of rate cuts by the European Central Bank (ECB). John Murphy noted the following on Tuesday: "Foreign central banks are going to have to start lowering rates more aggressively to catch up to the U.S. easing program." The federal funds target rate currently stands at 1.5%. In contrast, the European Central Bank's key rate is at 3.75%, which is much higher. A weak economic outlook is driving expectations for a rate cut from the European Central Bank. As a result, the Euro Trust ETF moved to its lowest level since November 2006. Chart 9 shows weekly bars over the last 4 and a half years. The ETF retraced over 62% of its prior advance (Nov. 2006 to Apr. 2008) with an extremely sharp decline over the last four months. Notice that the support zone around 135 failed to hold and the next support zone is around 116-118. Even though FXE is oversold and in a free fall, there is still a ways to go before hitting support.

Chart 9

GOLD PLUNGES AS DOLLAR SURGES ... The U.S. Dollar Index ($USD) continued its upward ways with another big surge on Wednesday (Chart 10). After falling from 92 to 71 over a 2 and a half year period, the index surged above 84 over the last four months. While the euro is oversold, the U.S. Dollar Index is overbought. However, the dollar shows no signs of weakness. The yellow areas mark the next resistance zones around 87-88 and 92. Chart 11 shows the streetTRACKS Gold ETF (GLD) over the same period. GLD is down over 25% from its highs and looks vulnerable to further weakness. If the Euro Trust ETF (FXE) declines to the next support zone and the U.S. Dollar Index advances to its next resistance zone, the streetTRACKS Gold ETF would likely decline to its next support zone. The big triangle in the middle of the chart marks the next support zone around 62-69. Notice its price structure, too: GLD formed lower highs over the last four months, broke the 40-week moving average and broke the trend line extending up from July 2005. Such price action is not indicative of an uptrend.

Chart 10

Chart 11