RETAILERS OVERSOLD -- MARKET REMAINS NERVOUS -- DIA HITS RESISTANCE - FINANCIALS LEAD LOWER -- SHORT-TERM RATES FALL -- DOLLAR INDEX BACKS OFF OVERBOUGHT LEVELS

RETAILERS FEELING THE PINCH... Today's Market Message was written by Arthur Hill. John Murphy will return tomorrow. - Editor

As expected the Fed cut the federal funds rate by 0.5% and this key rate now stands at 1%. In its policy statement, the Fed noted a decline in consumer spending, a slowdown in industrial production and deceased export demand as the global economy weakens. The prospects for a decline in consumer spending are evident in Charts 1 and 2, the Retail SPDR (XRT) and the Retail HOLDRS (RTH). Both held up relatively well the first nine months as trading ranges took shape. The bottom fell out in October as both ETFs broke range support levels with exceedingly sharp declines. Perhaps, the market is already pricing in a blue Christmas. Even though the range support breaks are clearly bearish, these ETFs are oversold and ripe for an oversold bounce. With broken supports turning into resistance, we could see an oversold bounce back to these levels.

Chart 1

Chart 2

MARKET REMAINS SKITTISH... After a big rally on Tuesday, trading turned mixed on Wednesday. Five sectors were down and four were up. The Materials SPDR (XLB) led the way higher, while the Technology SPDR (XLK) and Financials SPDR (XLF) led the way lower with rather sharp losses. The S&P 500 ETF (SPY) moved higher in early trading and even surged after the Fed announcement. SPY was headed for a higher close, but sellers pushed stocks sharply lower towards the close. I usually don't focus on such short time frames, but SPY went from a decent gain to a modest loss in a few minutes. Such sharp-and sudden-declines reflect continued nervousness in the market.

Chart 3

IS THE THIRD TIME A CHARM?... Chart 4 shows the Dow Industrials ETF (DIA) surging off support for the third time in four weeks (green arrows). Spurred by a G7 meeting over the weekend, the first surge above 90 occurred on 13 Oct. It failed with a sharp decline below 85 over the next two days. DIA recovered just above the prior low and again surged above 90 on 20 October. However, this surge occurred on low volume (red arrow) and the ETF was back at support a few days later. Even though Tuesday's high volume surge looks promising, we have yet to see follow through with a resistance breakout. The bottom indicator window shows the Commodity Channel Index (CCI) with a positive divergence and a break above the August trend line (red). Momentum is trying to turn the corner as well. A break above zero would be positive, both literally and figuratively. I am looking for a move above +100 to show real strength and give this rally some legs.

Chart 4

FINANCIAL SECTOR WEIGHS ... The Financials SPDR (XLF) led the sectors lower with a 6.16% loss on Wednesday. Chart 5 shows XLF surging off its October low with a big move on Tuesday. Some sort of pullback can be expected after such a big move. Accordingly, the ETF declined back below 15 with a red candlestick today. There is clearly support around 13 from the October lows, but the ETF remains well short of a trend reversal or breakout. Tuesday's surge is just one day and one day does not a trend reversal make. Bargain hunting and short covering can trigger one day bounces. New buying and follow through are required for sustainable rallies. In addition to pending follow through, I am also concerned with relative weakness. The bottom indicator window shows the relative strength comparative, which compares XLF to SPY. The indicator moved lower over the last two weeks as financials showed relative weakness. This is not a good sign. Financials got the market into its current mess and they are needed to get the market out of its mess. Look for follow through on the price chart and an upturn in the relative strength comparative for bullish signals.

Chart 5

SHORT-TERM RATES FALL ... The 13-week TBill Yield ($IRX) fell back below .6% today and this reflects continued uncertainty in the markets. John Murphy showed charts for the 13-week TBill Yield and 3-month Libor ($LIBOR3) last week. He explained that the market meltdown spurred a sharp drop in the 13-week TBill Yield and a sharp rise in Libor (London Interbank Offer Rate). Investors bought TBills in a flight to safety and this pushed the yield lower. All the way to zero percent on 17 Sept! At the same time, banks were refusing to lend to one another and this pushed 3-month Libor sharply higher. Chart 6 shows Libor continuing to fall and this is positive. However, the 13-week TBill Yield also fell over the last six days. This is negative because it shows a preference for safety over return. The decline looks like a falling wedge, which could be just a correction of the prior surge. Problem is the wedge is still falling. Look for a move above 9 (.9%) to break wedge resistance and show money moving out of TBills. Such a breakout could spur a rally in the financial sector-and the broader market.

Chart 6

DOLLAR FINALLY HITS RESISTANCE ... The U.S. Dollar Index ($USD) finally hit some resistance and declined sharply on Wednesday. After a 13% run the last five weeks, the index reached its first resistance level on the weekly chart and became overbought on the daily chart. Chart 7 shows weekly bars with the first resistance zone around 88, which stems from the Jul-Oct 2006 highs. Chart 8 shows daily candlesticks with 14-day RSI. Notice that RSI became overbought for at least the third time in three months. These overbought readings are a sign of strength, not weakness. Strong securities reach overbought levels. Weak ones do not. Yes, it is that simple. Overbought conditions simply warn traders to be prepared for a pullback. I am marking a support zone in the low 80s. This zone stems from the early October consolidation and a 50-62% retracement of the Sept-Oct surge.

Chart 7

Chart 8