FINANCE SECTOR SHOWS RELATIVE STRENGTH FOR A DAY - OIL LEADS ENERGY SECTOR REBOUND - RETAILERS KEEP MARKET ADVANCE IN CHECK - STOCKS BENEFIT FROM WEAKNESS IN BONDS AND DOLLAR - ANALYZING THE AD LINE AND AD VOLUME LINE

FINANCIALS LEAD THE MARKET HIGHER... Link for todays video.

After commenting about relative weakness in the finance sector just yesterday, the Financials SPDR (XLF) perked up with a nice bounce on Thursday. This bounce keeps the medium-term uptrend alive and reinforces support from the late May lows (11.5). Despite todays bounce, chart 1 shows XLF still lagging over the last few weeks. While SPY remains above its May high, XLF has yet to exceed its May high. In addition, the price relative remains in a downtrend over the last few weeks. Nevertheless, XLF has yet to actually break down and reverse the medium-term uptrend. For now, the pennant breakout has yet to be proven otherwise. Chart 2 shows the Regional Bank SPDR (KRE) firming at support from the April-May low. Like the finance sector, KRE is also showing relative weakness over the last 3-4 weeks. The price relative peaked in early May and moved below its March low this month. On the price chart, KRE is consolidating just above support at 19 and a break below this level would be bearish.

Chart 1

Chart 2

CONCERN WITH THE CONSUMER DISCRETIONARY SECTOR... In addition to the finance sector, I still have some concerns with relative weakness in the consumer discretionary sector. First, the Consumer Discretionary SPDR (XLY) is lagging the broader market over the last few weeks. Relative weakness in the most economically sensitive sector is not positive overall. Second, retail stocks were hit today after same store sales fell 4.8% for the month of May, which was more than expected. With retail spending driving 2/3 of GDP, relative weakness in this group is not to be ignored. Chart 3 shows the Retail HOLDRS (RTH) with a lower high in early June. The price relative also formed a lower high and RTH is starting to underperform the broader market. For now, support from the May lows around 76 is holding. Chart 4 shows the Retail SPDR (XRT) meeting resistance from its early May high. While the market is up overall today, XRT is down over 2% and showing relative weakness. A little double top could be in the making with support around 25. XRT is also starting to show relative weakness as the price relative formed a lower high in early June. Elsewhere in the consumer discretionary sector, chart 5 shows the Homebuilders SPDR (XHB) underperforming over the last few weeks. Even though the May decline looks like a falling wedge and the ETF broke above the upper trendline, it is still showing relative weakness as the price relative moves lower.

Chart 3

Chart 4

Chart 5

ENERGY AND OIL REBOUND... After a rather sharp setback on Wednesday, the Energy SPDR (XLE) and the US Oil Fund ETF (USO) rebounded on Thursday. Chart 6 shows XLE trading near resistance in the low 50s, but the pennant breakout is holding after todays rebound. There is a clear uptrend since early March with a series of higher highs and higher lows. As with many ETFs, the May lows hold the key to the current uptrend. Chart 7 shows the US Oil Fund ETF (USO) pushing up against resistance from the December-January highs. The ETF is now up over 35% from its April low. Even though it is looking overbought and near resistance, there are no signs of weakness yet.

Chart 6

Chart 7

INTERMARKET PICTURE ... There are some intermarket dynamics at work that warrant our attention for clues on the current move and future moves. I am focusing on the last two months because this period captures the dynamics quite well. Chart 8 shows commodities, gold and stocks as the intermarket leaders. Commodities are largely driven by the rise in oil. A positive relationship between oil and stocks is possible because an improving economy means increasing demand for oil. Obviously, an improving economy is beneficial to stocks. The intermarket laggards are the US Dollar and US Treasury Bonds. Weakness in the US Dollar fuelled the advance in gold and provided an extra boost to commodities. Bonds have been the weakest intermarket player by far.

Chart 8

With the stock market strong, there has been no need to own bonds, which are viewed as a safe-haven in times of uncertainty. Moreover, the Treasurys financing needs have created enormous supply that is pushing bond prices lower, and interest rates higher. Wall Street my fret about rising interest rates and rising oil prices in the future, but there are no signs of concern right now. These concerns may be offset by a weak Dollar, which helps the economy by making exports more competitive. In fact, investors and traders selling bonds may even be using some of the proceeds to buy stocks. These proceeds have to go somewhere. Some found its way into corporate bonds, as John Murphy pointed out last week. All in all, the stock market should benefit as long as the Dollar and bonds remain weak. This has been the case the last two months. Taking this a step further, strength in bonds and the Dollar could derail the current rally in stocks, commodities and gold.

AD LINE AND AD VOLUME LINE ... Yesterday I showed the cumulative Net New Highs indicator in an uptrend and this indicator was still bullish for stocks. Today I would like to look at another pair of breadth indicators: the AD Line and the AD Volume Line. The AD Line is a cumulative measure of Net Advances (advances less decline). Advance-Decline statistics favor small and mid-cap stocks because an advance counts as +1 regardless of volume or market cap. In contrast, the AD Volume statistics favor large-caps because these stocks are often the volume leaders. The AD Volume Line is a cumulative measure of Net Advancing Volume (advancing volume less declining volume). Stockcharts.com provides both indicators for the Nasdaq and the NYSE. It is helpful to show the underlying index along with the indicators. Analytically, I am looking at the overall trend and to see if the indicators are keeping pace with the underlying index. A divergence between the indicator and the index can sometimes foreshadow a reversal in the major stock indices. A bearish divergence occurs when Nasdaq moves to a new high, but the AD Line and AD Volume Line fail to follow suit. A bullish divergence occurs when the Nasdaq moves to a new low, but the AD Line and AD Volume Line fail to follow suit.

With the Nasdaq and the NY Composite currently trending higher, I am on the lookout for bearish divergences that may show underlying weakness. Chart 9 shows the Nasdaq AD Line and chart 10 shows the Nasdaq AD Volume Line. Both moved to new reaction highs in early June and are keeping pace with the Nasdaq. This is bullish overall. With the May lows marking uptrend support, a break below these lows would start a downtrend for the AD Line and AD Volume Line.

Chart 9

Chart 10

Chart 11 shows the NYSE AD Line and chart 12 shows the NYSE AD Volume Line. The AD Line is keeping pace with the NY Composite by moving above its May high. However, the AD Volume Line is not keeping pace because it has yet to exceed its May high. A bearish divergence is brewing here and we should keep an eye on this indicator. A break below the May low would reverse the uptrend for both the AD Line and the AD Volume Line.

Chart 11

Chart 12