DOW STALLS WITH HIGH VOLUME NEAR APRIL HIGH -- SMH BACKS OFF RESISTANCE AFTER CHANNEL BREAKOUT -- THREE OF THE FOUR OFFENSIVE SECTORS LEADING -- VOLATILITY INDICES MOVE INTO LONG-TERM SUPPORT ZONE -- NET NEW HIGHS TAKE A HIT, BUT REMAIN POSITIVE OVERALL
DOW STALLS WITH HIGH VOLUME NEAR APRIL HIGH... With a surge from 10000 to 11200, the Dow is trading near its April highs and close to a 52-week high. However, the senior Average has started to stall with high volume. Chart 1 shows the Dow battling the 11100 area with above average volume the last seven days. The trend since late August is still up, but this high volume stall could give way to a short-term reversal that starts a correction. High volume is often present at or near inflection points. The yellow areas on the chart show volume surges that occurred at or turning points. The April high is punctuated with a high volume spike. High volume declines in May, June and July marked capitulation that preceded reversals. For now, the Dow has yet to show any signs of weakness on the price chart. The Average established support at 10900 with two lows over the last few weeks. This support level looks similar to the April support level. Notice how the April support break provided a clear signal. The bulls are in good shape as long as current support holds. A move below 10900 would argue for a correction that would be expected to retrace a portion of the prior advance.
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Chart 1
SMH BACKS OFF RESISTANCE AFTER CHANNEL BREAKOUT... Semis were a big part of the September rally with the Semiconductor HOLDRS (SMH) surging over 15%. Chart 2 shows SMH breaking above the upper trendline of a falling channel this month. This breakout is holding so far, but the ETF is meeting resistance from the summer highs. Like the Finance SPDR, SMH has yet to break above its summer highs. In this regard, SMH is lagging the broader market and the technology sector. The indicator window shows the MACD-Histogram (5,35,5) flipping from positive to negative over the last 12 months. This indicator turns positive when MACD(5,35,5) moves above its signal line and negative when it moves below its signal line. The bulls have a momentum edge as long as the MACD-Histogram remains positive.
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Chart 2
Chart 3 shows daily candlesticks for more detail. SMH hit resistance in the 28.5 area in June, July and now October. Even though SMH pulled back from resistance, the swing remains up with first support at 27.5. A move below this level would break the late August trendline and this weeks low. Such a move would also put the channel breakout in jeopardy. The decline back below 28 does, however, looks like a falling flag and a break above this weeks high would reverse the fall.
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Chart 3
THREE OF THE FOUR OFFENSIVE SECTORS LEADING... Relative weakness in the finance remains the biggest drag on the market. Outside of finance, the other three offensive sectors are showing upside leadership. Perchart 4 shows the percentage change for the nine sector SPDRs and the S&P 500 since early September. All nine are up with consumer discretionary, technology and industrials leading the way higher. Together with finance, I consider these the offensive sectors that are critical to broad market performance. Technology represents the growth end of the market, Consumer discretionary represents the most economically sensitive (retailers). Industrials represent the big manufacturers. Technology, industrials and consumer discretionary are showing relative strength because they are up more than the S&P 500. Finance, while up, shows relative weakness because it is up considerably less than the S&P 500. Outside of finance, the three defensive sectors are also showing relative weakness. Notice that consumer staples, healthcare and utilities are up less than the S&P 500. This is normal for broad market advance.
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Chart 4
Chart 5 shows the Finance SPDR (XLF) consolidating below resistance that extends back to late May. The ETF surged in early September with the rest of the market and then moved into a trading range consolidation. XLF gapped down from resistance last week, but has yet to break support at 14.25. The direction of this break will have important consequences for the broader market. A break above 15 would fill last weeks gap and put XLF on board with the bulls. A break below support at 14.25 keeps the bears in the drivers seat.
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Chart 5
VOLATILITY INDICES MOVE INTO LONG-TERM SUPPORT ZONE... There are two things to watch when it comes to the volatility indices: direction and level. The CBOE Volatility Index ($VIX) and Nasdaq Volatility Index ($VXN) are both trending lower and this is bullish. Chart 6 shows the VIX spiking in May with the flash crash and then working its way lower the last five months. This weeks move below 19 puts the VIX at its lowest level since April. Falling volatility is actually positive for the market because is represents less risk. At some point, the VIX will fall to a level that represents complacency. The chart shows VIX support in the 15-19 area extending all the way back to October 2007. Prior movements into this area foreshadowed pullbacks or declines in the S&P 500. There was, however, some lag time.
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Chart 6
The red dotted lines show when the VIX first moved below 19. The S&P 500 peaked 1-5 weeks later in the first five instances. The blue arrow shows the sixth instance, which is when the S&P 500 peaked seven weeks later. Thats quite a bit of lag. We can use the VIX to warn of pending pullback or decline, but the timing is not exact. Also keep in mind that there is no guarantee that the market will reverse immediately after the VIX dips below 19. The indicator could continue to 15 or lower, which would likely coincide with further gains in stocks. On a medium-term basis (1-4 months), the VIX should be considered bullish as long as it is falling. I am marking resistance at 25. A surge above this level would reverse the downtrend and call for higher volatility. Chat 7 shows the Nasdaq Volatility Index ($VXN) for reference.
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Chart 7
NET NEW HIGHS TAKE A HIT, BUT REMAIN POSITIVE OVERALL... Net New Highs peaked last week and then plunged with Tuesdays sharp decline in the stock market. Net New Highs equals new 52-week highs less new 52-week lows. Even though new highs and lows are lagging indicators, they can help define the overall trend. Chart 8 shows NYSE Net New Highs in the lower indicator window and the cumulative Net New Highs line overlaid the NY Composite. Net New Highs were riding high when the NY Composite was hitting new 52-week highs in March-April. Notice that Net New Highs were regularly above +500 during this period. The May plunge pushed Net New Highs into negative territory and the indicator then oscillated above/below the zero line until early July. Except for a brief dip at the end of August, new highs have been mostly positive for over almost four months. Net New Highs peaked with just over 400 on October 13th. Despite Tuesdays sharp decline, the indicator remains in positive territory to favor the bulls.
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Chart 8
The cumulative Net New Highs line is shown with the NY Composite chart. Notice how the indicator turned flat in May to signal the start of a decline or corrective period. The July upturn and breakout signaled the start of the current bull run. The Cumulative Net New Highs line remains above its 10-day EMA and bullish. A move below the 10-day EMA would signal deteriorating breadth that could lead to another range bound market or a decline. A moving average cross occurs when Net New Highs turn negative for several days. I showed the McClellan Summation Index last week with its 5-day EMA. This is a short-term term indicator. In contrast, Net New Highs would be considered a medium-term indicator. Chart 9 shows Nasdaq Net New Highs ($NYHL) with the same indicators.
