FINANCE SECTOR FEELS THE HEAT - TECH ETF BOUNCES OFF SUPPORT - SEMIS TEST SUPPORT- NEW HIGH IN AD LINE AFFIRMS BULL-RUN - AD LINE BEARISH DIVERGENCE PRECEDED 2007 PEAK - CORPORATE BONDS OUTPERFORMING TREASURIES - JUNK BOND ETF HITS NEW HIGH

FINANCE SECTOR FEELS THE HEAT... Link for todays video. With Goldman Sachs under the congressional microscope, the finance sector has been under pressure the last two weeks. The S&P 500 ETF (SPY) hit a new 52-week high (closing) last Friday, but the Financials SPDR (XLF) peaked over a week before SPY and shows relative weakness. Finance is the second biggest sector in the S&P 500 and accounts for around 16.6%. Incidentally, technology is the biggest sector and accounts for 19%. Chart 1 shows XLF peaking in mid April and zigzagging lower the last 12 trading days. A small falling wedge is taking shape to define this short-term downtrend. Like SPY, the bigger trend for XLF remains up. After a big run from 13.5 to 17, the ETF became overbought and ripe for a pullback or consolidation. Broken resistance turns into potential support around 15.30 and this area is confirmed by the 50% retracement mark.

Chart 1

TECHNOLOGY ETF BOUNCES OFF SHORT-TERM SUPPORT... Chart 2 shows the Technology SPDR (XLK) bouncing off support around 23.50 on Wednesday and Thursday. This short-term support level is similar to that seen in DIA, SPY and QQQQ. After a sharp advance above 24, XLK moved into consolidation mode with a trading range. Range support resides around 23.5 and range resistance is set just above 24. A move below the range lows would be short-term negative and argue for a correction that could retrace a portion of the Feb-Apr rally. The Fibonacci Retracements Tool marks the 38.2% retracement around 22.81 and the 50% retracement around 22.39. The indicator window shows the price relative, which compares the performance of XLK to the S&P 500. While not runaway outperformance, XLK has been outperforming the S&P 500 since early February, which is when the price relative bottomed.

Chart 2

SMH TESTS SUPPORT AS SEMIS COME UNDER PRESSURE... Chart 3 shows the Semiconductors HOLDRS (SMH) testing support with a decline in early trading on Friday. After a sharp advance above 30, SMH consolidated with a trading range the last few weeks. Range support is just above 29 and confirmed by the blue-dotted trendline. A break below support would argue for a deeper pullback or retracement of the Feb-Apr advance. I have also placed the Fibonacci Retracements Tool to identify potential pullback levels.

Chart 3

The yellow area marks a four candlestick reversal pattern similar to an evening doji star. Even though evening doji star patterns consist of three candlesticks and form in an uptrend, perfect patterns are the exception rather than the norm. It is hard to find perfection when dealing with emotionally driven traders and investors. Looking at these four candlesticks, we can see a sharp advance with the first two, a doji with the third and a sharp decline with the fourth. The essence of the evening doji star pattern is there: a surge (white candlesticks), a stall (doji) and a reversal (red candlestick).

NEW 52-WEEK HIGH IN AD LINE AFFIRMS BULL-RUN... Chart 4 shows the NYSE AD Line hitting a new 52-week high last week. This is important because significant peaks are often preceded by a bearish divergence in the AD Line. The AD Line pulled back early this week, but bounced back on Wednesday and Thursday. There are two trendlines to watch here. First, the pink-dotted trendline defines the uptrend over the last six weeks (short-term trend). Second, the blue-dotted trendline defines the uptrend over the last six months (medium-term uptrend). The AD Line is most certainly overextended, but this only argues for a correction within the uptrend. A break below the pink trendline would be the first sign that a correction is unfolding.

Chart 4

AD LINE BEARISH DIVERGENCE PRECEDED 2007 PEAK... A large bearish divergence in the AD Line preceded the stock market peak in October 2007. Chart 5 shows the NYSE AD Line and NY Composite in 2007. There are, in fact, two bearish divergences in 2007. A bearish divergence forms when the underlying security (NY Composite) forms a higher high, but the indicator (AD Line) forms a lower high. The indicator fails to confirm the high in the underlying. The NY Composite recorded a higher high in July 2007, but the AD Line formed a lower high (red arrows). This bearish divergence preceded the July-August decline, which was a doozy. Despite this decline, the NY Composite rebounded and exceeded its July high. However, the AD Line did not and formed another bearish divergence, which covered three months. This big bearish divergence foreshadowed the bull market peak and the beginning of a severe decline.

Chart 5

CORPORATE BONDS OUTPERFORMING TREASURIES... Comparing a relatively risky asset to a relatively safe asset is a good way to measure the appetite for risk. Stocks thrive when the appetite for risk is strong. This encourages buying throughout the stock market, not just in a narrow range of stocks. Bond comparisons can provide a measure of risk-appetite that may affect the stock market. Chart 6 shows a chart comparing the 10-Year US Treasury Note ($UST) with the DJ Corporate Bond Index ($DJCBP). Treasuries are considered one of the safest investments in the US. Treasury rates are often used as the risk-free rate when calculating expected returns and making discounted cash-flow models. The Corporate Bond Index bottomed in October 2008, formed a higher low in March 2009 and surged until October 2009. After a one year advance, the index moved into a trading range the last seven months. Even though the advance seems to have stalled, there are no signs of actual weakness because support levels have yet to be broken. Treasuries also surged in October, but peaked soon thereafter and declined from late December until June. Treasuries have been pretty much flat since June and a large head-and-shoulders pattern could be taking shape with neckline support just below 90.

Chart 6

The indicator window shows the price relative comparing the performance of the Corporate Bond Index to US Treasury Bonds ($DJCBP:$UST ratio). This ratio formed a bullish divergence from December to March. The ratio forged a higher low, while the S&P 500 formed a lower low. After a breakout in May 2009, the ratio advanced to a new 52-week high in early January 2010. Even though the ratio flatted over the last nine months, corporate bonds are still holding their own against Treasuries and this shows a healthy appetite for risk. A break down in this ratio would signal a preference for Treasuries and this would be negative for stocks.

JUNK BOND ETF HITS NEW 52-WEEK HIGH... Comparing junk bonds against investment grade bonds is another way to measure risk appetite. The High-Yield Corporate Bond ETF (HYG) represents the risky end of the market, while the Investment Grade Corporate Bond ETF (LQD) represents the safe end. The higher the yield, the higher the risk. Although not corporate, Greek 10-year bonds yield over 9% and US 10-year bonds yield around 3.73%. It is all relative. The appetite for risk is good when high-yield bonds outperform or perform in line with investment-grade bonds. Chart 7 shows the High-Yield Bond ETF and Investment Grade Bond ETF in a clear uptrend with new 52-week highs this month. New highs in the High-Yield Bond ETF show a healthy appetite for risk. The indicator window shows the price relative comparing high-yield against investment grade (black line). This ratio peaked in January and fell just short of its January high this month. A little relative weakness is visible, but not enough to suggest a dramatic change in risk appetite.

Chart 7