S&P 500 IS TESTING JANUARY HIGH -- INVESTMENT GRADE CORPORATE BOND ETF HITS NEW HIGHS -- PULLBACK IN US DOLLAR MAY GIVE TIPS A LIFT -- WEAKNESS IN CHINESE STOCKS MAY BE WEIGHING ON COMMODITIES --REITS HIT NEW HIGHS

S&P 500 TESTS JANUARY HIGH ... I wrote on Tuesday that the number of stock indexes and groups hitting new 2010 highs called for a test of the January high by the S&P 500. Chart 1 shows the S&P in the process of doing that. I also suggested that the S&P 500 would most likely exceed that high. Part of the reason why was based on my view that the market had entered a fifth upwave in Elliott Wave terms which usually results in a new high. Some readers asked what the next upside objective would be if and when the S&P 500 does break out to the upside. Chart 2 helps answer that and, appropriately, uses Fibonacci retracment lines (which are part of the Elliott Wave Theory). The purple lines show that the S&P is now testing the 62% retracement line drawn from the spring 2008 peak to the spring 2009 bottom. That's an important upside target. If it is exceeded in decisive fashion, that raises the possibility that the S&P could retrace 62% of the entire bear market that started in the fourth quarter of 2007. That yields a potential upside target to 1232 (see green lines) which also happens to be the low formed in the spring of 2008 after completing the first wave down of the bear market. The steepness of the recent runup, however, coupled with the presence of overhead resistance near the January high, could cause the market to stall long enough to alleviate its short-term overbought condition.

Chart 1

Chart 2

HIGH-GRADE CORPORATE BONDS HIT NEW HIGHS... Another sign that the yearlong bull market has more room to run is the continuing strong action in corporate bonds. Chart 3 shows Investment Grade Corpote Bond iShares (LQD) breaking out to a new 52-week high. Corporate bonds bottomed along with stocks and usually trend in the same direction. Chart 4 shows High-Yield Corporate Bonds (HYG) testing their January highs. Although some potential resistance is possible at that level, an eventual upside breakout would be another sign that investors are still willing to embrace risk.

Chart 3

Chart 4

PULLBACK IN DOLLAR MAY GIVE TIPS A LIFT... Treasury Inflation Protected Treasuries (TIPS) may be starting to bounce as well. The daily bars in Chart 5 show TIPS iShares starting to bounce off chart support formed along the December lows. Another factor that may work in favor of TIPS is this week's pullback in the U.S. Dollar Index (green line). The upturn in the USD during December helped start the three-month pullback in TIPS. A downturn in the USD could have the opposite effect and give TIPS a boost. The reason is simple. A falling dollar is potentially inflationary. A weaker dollar might also give a boost to commodities which have been under some pressure of late.

Chart 5

CHINA WEAKNESS MAY BE WEIGHING ON COMMODITIES... Commodities have lagged behind stocks during 2010. Chart 6 shows the CRB Index trading below its 50-day average and well below its January high. Part of the reason for that weakness may have been the first quarter rally in the U.S. Dollar (which could be ending). That's because the dollar and commodities usually trend in opposite directions. Another factor weighing on commodities may be weakness in Chinese stocks. Chart 7 shows the the Shanghai Index ending the week below its 200-day moving average. Arthur Hill sounded a potential warning at midweek if that weakness persists. Given the fact that China is the world's biggest importer of commodities, any weakness there would be negative for that asset class. Although the Chinese economy is still booming, fears of further tightening could be weighing on stocks. And, as you know, stocks are a leading indicator of the economy.

Chart 6

Chart 7

REITS RALLY TO NEW HIGH ... The strongest part of the financial sector over the past week was in the Real Estate Investment Trust (REIT) category. Chart 8 shows the MSCI REIT Index (RMZ) hitting the highest level since the fourth quarter of 2008. The rising relative strength ratio (top of chart) also shows the REIT group outperforming the S&P 500 since November. REITs helped lead the market lower during 2007 and 2008 and higher since the spring of 2009. And they're still leading it higher.

Chart 8