SMALL-CAPS LEAD CORRECTION -- QQQ BEGINS A FLAT OR TRIANGLE 4TH WAVE -- QQQ AND XLK FORM FLAG PATTERNS -- NETWORKING ETF REMAINS WEAK -- SEMICONDUCTOR HOLDRS HITS RESISTANCE -- LUMBER BREAKS DOWN AS ITB STALLS AT RESISTANCE
SMALL-CAPS LEAD CORRECTIVE PHASE... Link for todays video. There are two ways to work off an overbought condition: pullback or consolidate. Actually, there is a third that is somewhere in between a pullback and a consolidation. Many indices and ETFs became overbought after the surge from mid March to early April. Some sort of corrective process is needed to alleviate these overbought conditions and provide the pause that refreshes before continuation higher. Small-caps, which led the advance, are also leading the pullback with the sharpest declines. Chart 1 shows the S&P 500 ETF (SPY) surging to its February high and stalling the last seven days. The ETF has traded in the 132-134 range since March 30th, a 1.5% range for nine days. Sounds like a volatility contraction. A break above last weeks highs would end the consolidation and signal a continuation higher.
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Chart 1
While SPY trades flat, the small-cap dominated Russell 2000 ETF (IWM) pulled back rather sharply with three black candlesticks. Chart 2 shows this ETF leading the market on the way up and breaking above its February high. Even though the pullback is sharp, broken resistance levels around 83 turns into the first support zone. The indicator window shows the IWM:SPY ratio hitting a new high in early April as small-caps led the way higher. The decline over the last three days shows small-caps leading the correction has well.
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Chart 2
QQQ BEGINS A FLAT OR TRIANGLE 4TH WAVE... Lets open Pandoras box and take a stab at the Elliott Wave outlook for QQQ. The surge from September to February is clearly an impulsive wave. In fact, momentum was so strong that I would label it as Wave 3 and work on ether side of this label for the other counts. Intermediate Wave 1 extends from the July low. Wave 2 corrected a large portion of 1 with a sharp ABC pattern, but held above the low of 1. Wave 3 was huge. This means we are currently in Wave 4. Using the alternation guideline, we would expect Wave 4 to be a flat or a triangle, not a Zigzag like Wave 2. The decline from mid February to mid March traced out a three wave sequence. We know that Flats and Triangle start with a three wave move. A Flat is an ABC sideways move with 3 down, 3 up and 5 down (3-3-5). A Triangle is an ABCDE sideways move with 3 legs in each move (3-3-3-3-3). Either way, a period of flat trading is expected. A 3-3-5 Flat could see another move towards the February high to complete Wave B and then a five wave decline for Wave C. This would complete the corrective Wave 4 and argue for a bigger Wave 5 higher.
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Chart 3
QQQ AND XLK FORM FLAG PATTERNS... Two key technology ETFs show bullish flag patterns over the last two weeks. Chart 4 shows QQQ peaking on April 1st and pulling back over the last two weeks. At least five black candlesticks formed as selling pressure took hold. As shown in the Elliott count above, this pullback could be Wave B of a bigger Wave B. The flag, however, is still falling and a breakout is needed to start wave C higher. A breakout would target a move to the February highs around 59. Chart 5 shows the Technology ETF (XLK) with a flat flag. After a surge from 24.5 to 26, the ETF moved into a consolidation to digest these gains. A move above last weeks high would break flag resistance and argue for a continuation of the March surge.
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Chart 4
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Chart 5
NETWORKING ETF REMAINS RELATIVELY WEAK... Relative weakness in the Networking iShares (IGN) is a concern for the technology sector and the Nasdaq. Chart 6 shows IGN breaking down in early March with a move to 34 and then forming a rising flag the last few weeks, With a decline the last three days, the ETF broke flag support and shows relative weakness. The indicator window shows the IGN:SPY ratio in a clear downtrend since early March.
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Chart 6
SEMICONDUCTOR HOLDRS HITS RESISTANCE... The Semiconductor HOLDRS (SMH) appeared to break down at the beginning of the month, but rebounded sharply with a bounce back to 35 early last week. Chart 7 shows this level marking the 62% retracement and resistance from the late March high. Technically, the swing since mid March remains up and the bigger trend is up. A move below the March trendline and the early April low would reverse this swing and argue for a continuation of the early March decline. The indicator window shows SMH relative to SPY with a ratio chart. SMH remains relatively weak because the ratio has yet to clear the late March high.
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Chart 7
LUMBER BREAKS DOWN AS HOME CONSTRUCTION ETF STALLS AT RESISTANCE... The Home Construction iShares (ITB) represents another group that has been lagging the overall market. Chart 8 shows ITB breaking the wedge trendline with the surge in the second half of March, but failing to follow through and break above resistance. The ETF hit resistance just above 13.50 a few times since early March and needs to clear this level to get the bulls on tract. The indicator window shows the Price Relative moving lower since mid January as ITB underperforms. A breakout here is needed to show relative strength. There is some concern with lumber prices though. Even though falling lumber prices decrease costs for the homebuilders, declining prices also signal weakness in demand and this could mean fewer houses being built. Chart 9 shows Lumber Futures ($LUMBER) breaking to new lows for 2011.
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Chart 8
