JUNE HIGHS MARK RESISTANCE FOR SPY - XLY BECOMES OVERBOUGHT - A SECOND CHANCE HEAD-AND-SHOULDERS - SMALL-CAPS LAG - TECHS LEAD - FINANCE STARTS TO LAG - REGIONAL BANKS CONTINUE TO LAG

RESISTANCE LEVELS STILL IN PLAY... Link for todays video. Despite new reaction highs from a number technology related ETFs, other key ETFs have yet to exceed their June highs and some are meeting resistance from the June highs. Basically, ETFs trading above their June highs show relative strength, while ETFs trading below their June highs show relative weakness. The Financials SPDR, Industrials SPDR, Materials SPDR and Energy SPDR (XLE) have yet to exceed their June highs. The S&P 500 ETF (SPY) happens to be trading right at its June highs. Chart 1 shows SPY with a resistance zone around 95-96. While the surge over the last two weeks looks most impressive, dont forget that SPY is at resistance and short-term overbought. The surge may show medium-term strength, but SPY is ripe for a pullback or consolidation over the short-term.

Chart 1

Chart 2 shows the Consumer Discretionary SPDR (XLY) surging above wedge resistance. As with SPY, the two week surge is most impressive, but the ETF is getting overextended for the short-term. The bottom indicator shows CCI moving above 100 last week and holding above 100 this week. Notice how CCI moved above 100 in mid March and oscillated around 100 until early May. This occurs in a strong uptrend. On the flip side, notice how CCI moved above 100 in early June and stayed there a little over a week. This overbought condition and subsequent move below 100 marked a short-term peak. This occurs in a trading range. Will XLY embark on another extended advance or peak near its June high? A move below 100 would show the first loss of upside momentum. At the very least, I would then expect a retracement of the two week advance.

Chart 2

A HEAD-AND-SHOULDERS REVIVAL... Even though the May-June head-and-shoulders in the S&P 500 ETF and the Dow Diamonds was debunked with the rally of the last two weeks, there is still an outside possibility that a head-and-shoulders pattern is taking shape in the S&P Equal Weight ETF (RSP) from Rydex. Chart 3 shows RSP on a closing basis. The May and July highs are currently around 132. In between these shoulders, the June high is slightly higher to form the head. Neckline support is set at 29. Even disregarding this pattern, RSP is bumping against a resistance zone from the May-June highs. In addition, the Commodity Channel Index (CCI) is overbought as it trades above 100. The first sign of upside momentum loss would be a close below 100 in the CCI.

Chart 3

SMALL-CAPS LAGGING... I recently read conflicting forecast from Goldman Sachs and Morgan Stanley. Goldman looks for the rally to continue until yearend, but Morgan Stanley is advising clients to sell into strength. Perhaps Goldman is watching the Nasdaq and Morgan Stanley is watching the Russell 2000. The Nasdaq and the technology sector are leading the market right now. This is good news for the bulls. However, this is being countered by relative weakness in small-caps, which is potentially bad news for the bulls. Chart 4 shows Nasdaq performance relative to the NY Composite. This price relative is simply the ratio of the two indices ($COMPQ:$NYA). The ratio rises as the Nasdaq outperforms the NY Composite and falls as the Nasdaq underperforms. After a precipitous drop in May, the price relative firmed and broke resistance in late June/early July. This started the current period of outperformance (relative strength). Because the Nasdaq represents stocks with higher betas and higher risk, Nasdaq outperformance is bullish for the market overall. It reflects a healthy appetite for risk.

Chart 4

Unfortunately, relative weakness in small-caps could spoil the appetite for risk. Small-caps also represent stocks with higher betas and higher risk. I am using the Russell 2000 ($RUT) for the small-cap index and the S&P 100 ($OEX) for the large-cap index. On chart 5, the $RUT:$OEX price relative has been largely flat since late April. Notice how it oscillated above and below 1.19 for over two months. More importantly, the price relative peaked in early June and moved lower the last 6-7 weeks. Small-caps and the Russell 2000 are underperforming large-caps and the S&P 100. This is something to watch in the coming weeks.

Chart 5

SECTOR LEADERS AND LAGGARDS... The sustainability of a rally can hinge on sector leaders and laggards. As such, the Sector SPDR Perfchart shows the percentage change for the nine sector SPDRs and the S&P 500 over the last 10 days. The blue dotted line marks the S&P 500 gain of 8.53%, which is the benchmark. Six of the nine sectors are outperforming. More importantly, these sectors include consumer discretionary, technology and finance. Of these six, finance is the weakest of the leaders. Healthcare, utilities and consumer staples are lagging the S&P 500. This can be expected because these are the defensive sectors. So far, I would say that sector leadership is healthy overall because the right sectors led the rally.

Chart 6

FINANCE ETF STALLS EARLY... Even though the finance sector is outperforming the S&P 500 over the last 10 days, it is showing some relative weakness on the price chart. As noted above, the S&P 500 ETF is up sharply over the last two weeks. In contrast, chart 7 shows the rally in the Financials SPDR (XLF) stalling five days ago. The ETF surged above 12 last week and then traded flat the last five days. This shows short-term relative weakness. Medium-term, XLF did not break above its June high because there was no follow through to last weeks surge. This is potentially negative for the overall market.

Chart 7

I am also concerned with the Regional Bank SPDR (KRE). Remember, this ETF consists of some 50 regional banks and each stock weighs less than 3%. It serves as an excellent barometer for the group overall. Unfortunately, KRE continues to show relative weakness. Chart 8 shows the ETF surging to 19 last week, but falling back sharply the last four days. Perhaps it is just a test of the early July low. Perhaps not. The trend since May remains down - no question about it. A break above the July high is needed to fully reverse this downtrend. Moreover, the price relative has been trending lower since April and moved to a new low this week. KRE remains an underperformer and this is negative for the overall market. Maybe JP Morgan Chase and Goldman Sachs are healthy, but this ETF does not look healthy right now.

Chart 8