RETAIL SPDR FORMS PENNANT CONSOLIDATION -- RETAIL HOLDRS STALLS AT SUPPORT -- REVIEWING THE SPX REVERSALS IN 2000 AND 2007 -- SETTING CORRECTION TARGETS FOR THE S&P 500 -- WEAKNESS IN STOCKS WEIGHS ON JUNK BONDS

RETAIL SPDR FORMS PENNANT CONSOLIDATION... Link for todays video. The Commerce Department reported that retail sales increased 1% in February for the eighth straight monthly gain. Not a bad streak at all. On a monthly basis, the Retail SPDR (XRT) has risen 6 of the last 8 months (March excluded). This confirms the strength seen in the retail sale figures. Chart 1 shows XRT surging to a new 52-week high in early February. Admittedly, this caught a few of us by surprise because XRT was showing relative weakness just prior to the surge. The indicator window shows XRT and the S&P 500 (gray). While XRT traded flat in December-January, the S&P 500 ETF (SPY) continued higher with steady gains. Flat price action in the face of gains shows relative weakness. With a matching 52-week high in mid February, XRT got back on track with SPY. XRT also held up well during Thursdays selling pressure. Even so, I am watching the ETF closely as it forms a pennant over the last few weeks. A break below pennant support would be short-term bearish and target further weakness toward the important support zone around 46. The retail group is to the consumer discretionary sector what semiconductors are to technology sector.

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Chart 1

RETAIL HOLDRS STALLS AT SUPPORT... The Retail HOLDRs (RTH) is quite different than the Retail SPDR (XRT) because of its components. The Retail SPDR is a diverse collection of some 63 retail stocks with the top stock weighing around 2% (Jo-Ann Stores). In contrast, RTH consists of just 18 stocks with the top three accounting for over 40% of the ETF (Amazon, Home Depot and Wal-Mart). Keep an eye on these three for clues on RTH. Chart 2 shows RTH testing support in the 104 area for the third time (at least) this year. In fact, a non-symmetrical head-and-shoulders pattern could be taking shape this year. Regardless of the pattern, support is clear. The ETF formed a flat consolidation the last few weeks and a break below 104 would argue for a decline towards the next support zone around 100. Broken resistance, the mid-November low and the 38% retracement mark support here.

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Chart 2

REVIEWING THE SPX REVERSALS IN 2000 AND 2007... A few weeks ago I looked at the last two big bull runs and the tops that ended these advances. Today I would like to look at the reversals in 2000 and 2007 in more detail. While no two tops are the same, understanding the past can help us prepare for the future. In both cases, the S&P 500 formed a clear topping pattern that extended several months and then broke support to confirm a major trend reversal.

Chart 3 shows the S&P 500 with a 9-12 month top forming in 2000 and then breaking support with a weekly close below the February 2000 low. RSI confirmed with a break below the 40-50 zone. Also notice that there was a sizable throw-back rally that stopped short of broken support (turned resistance).

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Chart 3

Chart 4 shows the S&P 500 with a big double top extending over a 6-8 month period. The index broke support with a close below 1425 at the end of 2007. RSI confirmed with a bearish failure swing and a break below 40 in December as well. There was a counter trend rally back to broken support. This move also retraced 50-62% of the trend-reversiing decline.

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Chart 4

SETTING CORRECTION TARGETS FOR THE S&P 500 ... As the chart for the S&P 500 currently stands, I do not see a major topping pattern that would suggest a long-term bearish reversal. Chart 5 shows the S&P 500 forging a new 52-week high last month and the index has yet to form an extended distribution pattern (top). Despite the absence of a major top formation, the index became overbought after a 30% advance from the late June low to the February high. An advance of this magnitude is certainly entitled to a correction. I am looking at the 1200-1220 area in the S&P 500 and the 40-50 zone for RSI as possible correction targets. On the price chart, broken resistance turns into support around 1220. The November consolidation (green circle) also marks a support zone. A 38-50% retracement of the prior advance would extend to the 1180-1220 area. As shown on the first two charts, RSI usually finds support in the 40-50 zone during uptrends. There will be some overshoots, such as late June 2010. Indicators, and markets for that matter, are not perfect. That is why chartist should have more than one tool in the toolbox. RSI is currently moving lower from overbought levels and the next support zone resides in the 40-50 area.

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Chart 5

WEAKNESS IN STOCKS WEIGHS ON JUNK BONDS... Recent weakness in stocks weighed on junk bonds, but lifted investment grade bonds. High-yield (riskier) junk bonds sit at one extreme of the corporate bond spectrum, while lower-yielding (safer) investment-grade bonds sit at the other end. Junk bonds are tied to the economy, just like the stock market. Investment grade corporate bonds are tied more to interest rates, just like US Treasuries. A sharp decline in the stock market is negative for the economy. This in turn weighs on junk bonds and lifts corporate bonds (and Treasuries). Chart 6 shows the High Yield Bond SPDR (JNK) falling sharply over the last few days. Despite this decline, the overall trend remains up. Like the S&P 500, this ETF is overbought and ripe for a correction. Broken resistance turns into support in the 39.5 area. This support zone is further confirmed by the 38-50% retracements. The indicator window shows JNK with the S&P 500 (red). These two have been moving together for at least eight months. Chart 7 shows the iShares High-Yield Bond ETF (HYG) with similar characteristics.

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Chart 6

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Chart 7

Chart 8 shows the Investment-Grade Corporate Bond ETF (LQD) moving higher as the market moved lower the last few days. Investment-Grade Corporate bonds are acting more like Treasury bonds. The ETF formed a higher low in February and edged above its mid January high recently. There is some concern that the advance since mid December could evolve into a rising wedge and fizzle out near the 62% retracement zone. For now, however, the trend since mid December is up. A break below the February low would provide the first sign of weakness.

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Chart 8

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