STOCKS STALL WITH MIXED TRADING - FINANCE SECTOR LEADS - REGIONAL BANKS LAG - HOMEBUILDERS CONTINUE TO SHOW RELATIVE WEAKNESS - REIT ISHARES RETURN TO BREAKOUT - SHORT-TERM RATES POSITIVELY CORRELATED TO THE DOLLAR

STOCKS STALL IN MIXED ACTION... Video Link (click here) Trading was mixed on Wednesday as the major indices meandered on either side of unchanged. Chart 1 shows the Dow finishing virtually unchanged with an indecisive candlestick. After two sharp gains on Monday and Tuesday, a little indecision is understandable. Overall, the medium-term trend remains up with a key support zone around 9100-9200.

Chart 1

The last correction occurred from mid June to mid July. Dissecting this move, we can see an initial thrust down, a short-term oversold bounce and then another push lower. The bottom indicator shows the Aroon oscillator turning negative after the oversold bounce (red dotted line). Looking at the current situation, I see some similarities between now and late June. After last weeks initial thrust lower, the Dow bounced back above 9700 and stalled on Wednesday. Also notice that the Aroon oscillator moved into negative territory. Stalling after a bounce signals indecision that could foreshadow a short-term reversal. Keep in mind that I am not calling for a medium-term trend reversal. However, using early July as a guide, a move below todays low could start another push lower and extend the correction.

FINANCIALS LEAD AGAIN... Seven of the nine sectors were higher, but gains were muted. The Financials SPDR (XLF) led the way as the only sector to gain over 1%. With todays gain, XLF is up four days straight. Chart 2 shows XLF bouncing off support with a reversal day on Friday and follow through surge on Monday. The August-October lows mark a support zone that holds the key to the medium-term uptrend. As the second biggest sector in the S&P 500 and the biggest sector in the Russell 2000, financials are important to the overall health of the market.

Chart 2

REGIONAL BANKS LAG THOUGH... Despite relative strength in the finance sector, the regional banks have been lagging the broader market since mid August. Regional banks make up a subset of the finance sector, which is dominated by the biggies (JPM, BAC, WFC, GS, C, USB, MS and AXP). The Regional Bank SPDR (KRE), on the other hand, has over 50 holdings and the largest holding weighs less than 3%. It represents a broad basket of regional banks with risk spread evenly. Chart 3 shows KRE surging in July-August and then forming a large triangle. The more recent decline formed a falling channel and the ETF bounced off support the last three days. Look for follow through above channel resistance to trigger a breakout and another challenge to the August highs.

Chart 3

HOME BUILDERS SHOW RELATIVE WEAKNESS... The Homebuilders SPDR (XHB) continues to lead the market lower. Chart 4 shows XHB peaking in mid September and declining to support around 14-14.5. Support in this area stems from the August-October lows. With the index at support, there is a chance for a bounce. However, XHB needs to break channel resistance to actually reverse the four week slide. Look for a move above 15. The bottom indicator shows the price relative moving lower over the last few weeks, which confirms relative weakness. An upturn and trendline break in the price relative would also be positive.

Chart 4

REIT ISHARES RETURNS TO BREAKOUT... A basic tenet of technical analysis is that broken resistance turns into support. Chart 5 shows the REIT iShares (IYR) breaking resistance with a strong advance in September and returning to this breakout over the last few days. Notice how the ETF firmed around 40-41. The decline over the last few weeks looks like a falling flag or small channel. The bears have a short-term edge as long as this channel falls. Look for a break above this weeks high to signal a resumption of the bigger uptrend.

Chart 5

SHORT-TERM RATES AND THE DOLLAR... Chart 6 shows the US Dollar Index (green) with the one year rate for US Treasuries (red) over the last 10 months. With three joint moves, there is clearly a positive correlation at work here. First. both surged in January and February. Second, the 1-year US Treasury Yield peaked in late February and the Dollar peaked in early March. Incidentally, stocks bottomed in early March. Third, both the Dollar and short-term rates have been on a relentless downtrend since March. We should keep an eye on short-term rates and the US Dollar Index for clues on the current bull run in stocks. As long as both trend lower, I would expect the stock market to continue higher. For reference, I am also showing a chart comparing the 10-Year Treasury Yield (long-term rates), the 1-year Treasury Yield (short-term rates) and the US Dollar Index.

Chart 6

Chart 7

Chart 8 shows these same securities over the last three years. The positive correlation between short-term interest rates and the US Dollar Index is nothing new. Both fell sharply from autumn 2006 to spring 2008 (yellow area). With the financial crisis hitting its stride in July 2008, short-term rates and the Dollar went their separate ways. The abrupt change in this relationship signaled that something was really amiss in the financial markets. Short-term rates fell sharply as money moved into short-term treasuries (safety). At the same time, the stock market plunged and the Dollar surged with the flight to safety. Short-term rates and the Dollar got back to their positive correlation in 2009 (black dotted line). Soon after the Dollar and short-term rates got back on track, the stock market bottomed in March, a few months later.

Chart 8