SMALL-CAPS AND TECHS LEAD FEBRUARY BOUNCE - IWM OUTPERFORMS SPY ON THE CHART - S&P 500 EQUAL WEIGHT OUTPERFORMS - CONSUMER DISCRETIONARY AND STAPLES LEADING - KEY LEVELS FOR XLY AND XLF

SMALL-CAPS AND TECHS LEAD THE BOUNCE... Link for todays video. Small-caps and tech stocks are showing relative strength over the last few weeks. There are many ways to measure relative strength or relative weakness. Comparing percentage gains is perhaps the easiest and most straight forward. Perfchart 1 shows the Major US Market Averages since February 8th, which corresponds with the last reaction low. Small-caps, as measured by the Russell 2000 ($RUT), are leading the way higher with a 7.17% gain. The Nasdaq, which represents techs, is second with a 5.28% gain. Taken together, we can see that small-caps and techs led the market higher the last three weeks.

Chart 1

IWM OUTPERFORMS SPY ON THE CHART... There are, of course, many ways to measure relative strength or relative weakness. Comparing performance is just one. We can look at relative chart performance by comparing one indicator on two different charts. Chart 2 shows the S&P 500 ETF (SPY) with a 50-day moving average, Fibonacci Retracements and MACD. Notice that SPY is meeting resistance near the 62% retracement and the 50-day moving average. Also notice that MACD just moved into positive territory at the end of last week. Chart 3 shows the Russell 2000 ETF (IWM) with the same indicators. In addition to higher percentage performance, IWM is also showing more strength on the price chart. IWM has been above its 50-day moving average for over a week. The small-cap ETF also closed above the 62% retracement eight days ago and MACD moved into positive territory six days ago.

Chart 2

Chart 3

Even though small-caps are showing relative strength and these two ETFs are trading well above their February lows, I will be watching last weeks lows with particular interest. IWM and SPY opened down with sizable gaps last Thursday. Instead of continuing down after the gap, stocks recovered during the day and closed strong. The resulting low now marks an important support level to watch. A break below these lows would likely signal the end of the current bounce. More importantly, it would signal a continuation of the January-February decline and target a move below the February lows. I will also be watching MACD, which is currently bullish because it is in positive territory and above its signal line. A move below the signal line would provide a negative signal for momentum. The signal line (red) is a 9-day EMA of MACD (black). Also note that the MACD-Histogram turns negative when there is a bearish signal line crossover.

S&P 500 EQUAL WEIGHT OUTPERFORMS... The price relative provides us with another method for comparing performance. This is simply the ratio of two securities. Chart 4 shows the price relative comparing the Rydex S&P 500 Equal Weight ETF (RSP) to the S&P 500 ETF (SPY). RSP outperforms as the ratio rises and underperforms as the ratio falls. These two ETFs are good for comparison purposes because they represent the same stocks in a different way. Both ETFs contain the stocks of the S&P 500. SPY is based on the market-capitalization weighted S&P 500, but RSP is based on an equal weight S&P 500. This means the biggest stock in the S&P 500 (Exxon Mobil) counts the same as one of the smallest stocks (TECO Energy). TECO Energy (TECO) has a market cap of $3.25 billion, while Exxon Mobil (XOM) weighs in at $307.26 billion. It is only $304 billion larger than TECO. As a market-capitalization weighted ETF, SPY represents the large-caps within the S&P 500. As an equal-weight ETF, RSP represents the small and mid-caps within the S&P 500. Think of large-caps as the generals. Small and mid-caps represent the troops.

Turning back to chart 4, we can see the price relative breaking out of a consolidation over the last few weeks. Also notice that normal technical analysis can be applied to these charts. We can use patterns, retracements and indicators for analysis. There was a corrective period from mid September to late November as the price relative formed a large falling price channel. The mid December breakout opened the door to more relative strength. Even when the market declined in January-February, the price relative held up as small-mid caps held up better than large caps. The subsequent consolidation breakout is positive overall.

Chart 4

CONSUMER DISCRETIONARY AND STAPLES LEADING... Looking at sector performance this year, we have a strange combination at the top of the leader board. The Consumer Discretionary SPDR (XLY) and the Consumer Staples SPDR (XLP) are both showing relative strength. PerfChart 5 shows sector performance from January 13th to February 26th. This period marks the January top in the market and includes the February rebound. The S&P 500 and seven sectors are still in negative territory, which means they are below their January high. Only the consumer discretionary and consumer staples sectors are positive, which means they are above their January high. Keep in mind that PerfCharts deal with closing prices only, not intraday highs or lows. Relative strength in the consumer staples sector reflects a defensive oriented market. However, this is clearly offset by relative strength in the consumer discretionary sector.

Chart 5

Chart 6

PerfChart 6 shows the sector performance from the February low until Fridays close. All nine sectors are up, but only four are outperforming the S&P 500 over the last three weeks. In order of performance, the finance, industrials, consumer discretionary and materials sectors are showing relative strength by outperforming the S&P 500. Finance is particularly strong and this is positive for the market overall. I am also impressed by relative strength from the consumer discretionary sector. The consumer staples sector is up 4.16%, which is less than the S&P 500 and makes it an underperformer.

KEY LEVELS FOR XLY AND XLF ... The consumer discretionary and finance sectors are important to the overall health of the market. We already know that both sectors are showing relative strength, which is positive. Now lets look at their individual charts. Chart 7 shows the Financials SPDR (XLF) surging to the middle of its 2010 range. The ETF consolidated with a pennant formation last week and broke pennant resistance with a strong close on Friday. So far so good for finance. As with SPY and IWM, I am watching last weeks lows for clues. XLF overcame a weak open on Thursday and closed strong. Failure to hold the lows of this reversal day would be quite negative. Chart 8 shows the Consumer Discretionary SPDR (XLY) challenging its January high. The ETF also opened weak on Thursday, but closed strong to form a long white candlestick. It is important that this low holds. A break below last weeks low would affirm resistance and a potential double top could then emerge.

Chart 7

Chart 8