DIA AND SPY BREAK SUPPORT -- DECLINE IN RETAIL SALES HITS RETAIL ETFS -- FINANCIALS STILL LEADING LOWER -- SECTOR LAGGARDS IN JANUARY - DOW THEORY WITH A TWIST -- ENERGY IS BIGGER THAN FINANCE

DIA AND SPY BREAK SUPPORT... Today's Market Message was written by Arthur Hill. - Editor

A broad decline in stocks pushed the Dow Industrials ETF (DIA) and the S&P 500 ETF (SPY) below their late-December lows. All sectors were down with financials and energy leading the way lower. Chart 1 shows SPY with a rising wedge advance from late November to early January. The ETF forged higher highs and higher lows during this advance. With a break below the late-December lows, a lower low formed and a trend change is afoot. A lower low is the first step towards a new downtrend. It is also worth noting that the post-Christmas rally has been completely wiped out. After nine trading days, January is clearly not off to a good start. Chart 2 shows the Dow Industrials ETF (DIA) also breaking below its late-December lows. The ETF broke the rising wedge trend line a few days ago and gapped through support today.

Chart 1

Chart 2

RETAIL ETFS EXTEND DECLINE... With the Commerce Department reporting a 2.7% drop in retail sales for December, the Retail HOLDRS (RTH) and the Retail SPDR (XRT) were under pressure on Wednesday. This was the sixth straight decline in retail sales. Chart 3 shows the Retail HOLDRS breaking below its late-December lows with a sharp decline over the last six days. This decline kicked into high gear with a gap down last Wednesday, a gap that can be attributed to the Wal-Mart warning. Today's drop in retail sales is hardly surprising given last week's warning from the nation's largest retailer. Chart 4 shows the Retail SPDR, which represents a broad cross-section of the retail group. XRT broke a rising wedge trend line with today's decline. The ETF remains above the late December lows and an important test lies ahead.

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FINANCIAL SECTOR EXTENDS BREAKDOWN... Last week I showed the Financials SPDR (XLF) with a triangle pattern taking shape. XLF showed relative weakness because it formed lower highs in mid and late December (red arrows) and failed to break above its 50-day moving average. In contrast, the S&P 500 ETF (SPY) forged higher highs in December and broke above its 50-day moving average. With the decline over the last four days, Chart 5 shows XLF breaking triangle support and continuing to lead the market lower. The late-November lows mark the next potential support zone. Chart 6 shows the Regional Bank HOLDRS (RKH) with continuing signs of relative weakness. RKH broke below its late-December lows four days ago, while the price relative broke below its November low. A new low in the price relative confirms relative weakness in this key group.

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SECTOR PERFORMANCE THIS YEAR... Sector performance in January shows relative weakness in the financial and consumer discretionary sectors. This is nothing new. In fact, it was relative weakness in the consumer discretionary and financial sectors that started the bear market. Before taking a few steps back, let's review sector performance since 5 January. The PerfChart below shows the absolute performance of the nine sector SPDRs and the S&P 500 (red). The S&P 500 is down 6%. Anything down more than 6% is underperforming the market. This is another term for relative weakness. Notice that the Consumer Discretionary SPDR (XLY) is down 8.25%, while the Financials SPDR (XLF) is down a whopping 10.84%. The consumer discretionary sector features many retail stocks, which makes it the most economically sensitive. The financial sector features the banks, brokers and REITs, all of which are at the heart of the current crisis. In addition to these two sectors, the Industrials SPDR (XLI) and Energy SPDR (XLE) are also showing relative weakness in January. Of the nine sectors, the Healthcare SPDR (XLV) is holding up the best with the smallest decline. Healthcare is a relatively defensive group. No matter what happens to the economy, we still need our medicine, and possibly even more of it.

Chart 7

DOW THEORY WITH A TWIST... The S&P 500 ETF (SPY) moved to a new high in October 2007, but this new high was not confirmed by two key sectors. I consider the consumer discretionary, financial and technology sectors the most important to overall market performance. Think of it in terms of Dow Theory. If the Dow Industrials move to a new high, then the Dow Transports need to confirm with a new high of its own. Instead of the Dow Transports and the Dow Industrials, substitute these three sectors to confirm or refute broad market moves. When the S&P 500 ETF (SPY) or one of the key sectors moves to a new high, it should be confirmed by the other sectors. Failure results in a non-confirmation that shows underlying weakness. Chart 8 shows the S&P 500 ETF (SPY) and the Technology SPDR (XLK) moving to new highs in October. However, the Financials SPDR (XLF) and Consumer Discretionary SPDR (XLY) did not confirm with new highs. Instead, both formed lower highs and showed relative weakness. Since the October 2007, there have been two more non-confirmations from the Financials SPDR (XLF). XLF failed to confirm in March 2008 and again in January 2009. The financial sector remains the Achilles' heel of the stock market. As long as this key sector shows relative weakness, the bear market is likely to continue.

Chart 8

TOP SECTORS IN S&P 500 ... While on the subject of sectors, I thought it would be helpful to rank the S&P 500 sectors according to market capitalization. Data for the table below comes from the Standard & Poor's website. Information Technology, Healthcare and Energy are the three biggest sectors in the S&P 500. The financial sector dropped to the number five spot over the last two years. Two years ago, the financial sector was the biggest sector in the S&P 500 and accounted for over 20% of the index. Chart 10 shows the performance of the Financials SPDR (XLF) and the Energy SPDR (XLE) over the last 2 and a half years. XLE is down around 17.36%, while XLF is down a whopping 65.95%. With this 2 and a half year decline, the financial sector is just below the consumer staples sector in terms of influence. In another sign of the times, notice that the consumer staples sector is bigger than the consumer discretionary sector. Chart 11 shows the performance of the Consumer Staples SPDR (XLP) and the Consumer Discretionary SPDR (XLY) over the last 2 and a half years. XLP is down less than 5%, but XLY is down over 35%.

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Chart 11