STOCKS FALLS AS DOLLAR BOUNCES - HOMEBUILDERS WEIGH ON STOCK MARKET - FINANCE SECTOR IS STILL THE OVERALL LEADER - RELATIVE PERFORMANCE IN XLY STALLS - QQQQ AND IWM NEAR RETRACEMENTS - MEASURING RETRACEMENTS - USING RETRACEMENT CLUSTERS

DOLLAR BOUNCES AS STOCKS FALL... Video Link (click here)
After an intraday reversal and higher close on Wednesday, the Dollar followed through on Thursday with another gain. Conversely, the S&P 500 ETF followed up on Wednesdays key reversal with further losses. However, it is still too early to call for a major trend reversal in the Dollar or stock market. Chart 1 shows the Dollar Bullish ETF (UUP) becoming oversold last week and bouncing from oversold levels this week. The ETF remains below the March trendline and has yet to even challenge the 50-day moving average. Chart 2 shows the S&P 500 ETF (SPY) with a key reversal on Wednesday and further weakness on Thursday. While these are short-term bearish developments, the ETF remains well above key support, which is marked by the August-September lows.

Chart 1

Chart 2

HOME BUILDERS DRAG MARKET LOWER... An unexpected decline in existing home sales weighed on homebuilders Thursday. Chart 3 shows the Homebuilders SPDR (XHB) falling for the fifth day running. The overall uptrend and breakout remains in place for now though. Broken resistance around 14-14.5 turns into a support zone that held in August-September. This will be the first major test for XHB. Chart 4 shows KB Home (KBH) failing to hold its triangle breakout with a decline back below 19. Chart 5 shows Pulte Homes (PHM) breaking below its August-September lows today. The stock also shows relative weakness as the price relative moves lower. A 50% retracement of the July-August advance would extend to around 10.70.

Chart 3

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Chart 5

FINANCIALS STILL LEADING OVERALL... Even though the finance sector is leading the way lower today, I am going to step back and look at the bigger picture for the nine S&P sectors. Using the sector Perfchart, we can easily see which sectors are leading and which are lagging the S&P 500. Chart 6 shows relative performance for the nine sectors since early March, which was when the bull run began. Relative performance equals the sector gain less the S&P 500 gain. From March 5th to September 23rd, XLF is up around 144% and the S&P 500 is up around 55%. This means that relative performance for XLF is +89% (144 - 55 = 89). Relative performance would be negative if XLF was up less than the S&P 500.

Chart 6

With an 89% relative performance gain, the Financials SPDR (XLF) is the undisputed leader of this bull run. The red dotted lines mark the beginning of three advances within this bull run (early March, early July and early September). Notice that relative performance for XLF accelerated higher during each of these advances (green arrows). Financials are clearly important to the health of this bull run. While the relative performance trend in financials remains up, notice that each surge is getting shorter. The March-May surge was the longer, the July-August surge was shorter and the September could be even shorter. We have yet to see a trend reversal, but it appears the upside momentum is waning.

OTHER SECTORS ARE MIXED... Chart 7 shows the same relative performance Perfchart with the Financials SPDR removed from the mix. Click on the colored boxes (top) to add or remove a sector. With XLF removed, we can see more details from the other eight sectors. The red dotted lines still show when the last three advances started. The red arrows show relative performance for the Utilities SPDR, Healthcare SPDR and Consumer Staples SPDR moving lower as each advance started. These defensive sectors usually underperform during a broad market advance. Incidentally, these three are holding up the best today.

Chart 7

The green arrows show relative performance for the Consumer Discretionary SPDR, Materials SPDR and Industrials SPDR moving higher as each advance started. Strangely, the Technology SPDR is stuck in the middle as XLK performed in-line with the S&P 500 from March to September. I am also concerned with flat relative performance in the Consumer Discretionary sector since early May. Notice that relative performance exceeded 15% in early May (blue arrow) and failed to exceed this May high in August and September. Consumer discretionary represents the most economically sensitive sector.

POTENTIAL RESISTANCE LEVELS FOR IMW AND QQQQ... In the Market Message on September 18th, John Murphy showed the next upside target (1120) for the S&P 500. To recap, the first target was based on a 38% retracement of the prior decline and this second target was based on a 50% retracement. In addition, the trendline extending down from October 2007 marks potential resistance in this area. John also showed RSI approaching overbought levels on the weekly chart. Resistance and target levels are also coming into play for the Russell 2000 ETF (IWM) and Nasdaq 100 ETF (QQQQ). Chart 8 shows IWM nearing a resistance zone around 63-65. This zone stems from a 62% retracement of the prior decline and broken support. Also notice that RSI is close to 70. Chart 9 shows QQQQ hitting its 62% retracement mark this week and RSI moving above 70. Even though the uptrend since March remains in place, the major index ETFs are nearing resistance zones and becoming overbought. These conditions could set the stage for a pullback or sideways market in the near future.

Chart 8

Chart 9

RETRACEMENT TECHNIQUES... Measuring retracements is a subjective exercise. In particular, we must choose which move to base the actual retracement. Using the S&P 500 as a recent example, there are at least four prior declines from which to measure a retracement. The retracement can be based on the entire decline or one of the smaller declines. This is where the art side of technical analysis comes in play. Technical analysis is a little art (subjective) and a little science (objective). The job of the technical analyst is to merge the art and science to form an opinion.

Chart 10

Another alternative is to look for retracement clusters. Using the S&P 500 as an example, chart 11 shows three prior declines with retracements. The black line covers the entire decline. The red line covers the decline from May 2008 to March 2009. The green line covers the decline from August 2008 to March 2009. Again, this is subjective, but it can help identify potential targets and resistance zones. Because this is subjective, it makes sense to work with zones instead of exact levels. This first cluster is around 1000 and the second cluster is around 1100.

Chart 11