INDUSTRIAL METALS UNDERPERFORM STOCK MARKET -- DOLLAR WEAKNESS FAILS TO TRIGGER BREAKOUT IN OIL -- SHANGHAI COMPOSITE FALLS SHARPLY AND UNDERPERFORMS -- SIX-MONTH CYCLE TURNS BEARISH IN MAY -- FRENCH AND UK STOCKS SHOW RELATIVE WEAKNESS

INDUSTRIAL METALS UNDERPERFORM STOCK MARKET... Link for todays video. While the major stock indices pushed to new highs this month, the Base Metals ETF (DBB) and the Copper ETF (JJC) failed to break their February highs and are on the verge of breaking support. The working assumption here is that industrial metals prices are influenced by the global economy. A strengthening economy means more demand and translates into higher prices. Conversely, a weakening economy means less demand and translates into lower prices. Chart 1 shows the Base Metals ETF hitting resistance around 21.50 from late January to late February. While US stocks moved higher in March, the Base Metals ETF moved lower and is now testing support. Relative weakness in industrial metals is a potential negative sign for the economy and the stock market.

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Chart 1

As the Correlation Coefficient shows, DBB and SPY are positively correlated for the most part. However, this positive correlation turned negative in February and late March as DBB moved lower. Something needs to give. Either DBB moves higher and plays catch up with the stock market or stocks move lower and play catch up with DBB. Chart 2 shows the Copper ETF consolidating the last two months. Watch these boundaries for the next directional signal.

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Chart 2

DOLLAR WEAKNESS FAILS TO TRIGGER BREAKOUT IN OIL... With the Dollar falling sharply over the last two weeks and the S&P 500 moving to another 52-week high this week, one would expect oil to benefit and move higher. This was not the case. Despite this bullish backdrop, Spot Light Crude ($WTIC) remained stuck in a consolidation and failed to break resistance. Chart 3 shows Spot Light Crude within a falling flag consolidation the last 4-5 weeks. The overall trend is up after the inverse head-and-shoulders breakout in February. After the sharp February advance, a correction is normal and the falling flag fits the bill. A this point, a break above last weeks high (call it 108.5) is needed to reverse the falling flag and signal a continuation higher. The mid March low marks key support and a break below this level would negate the inverse head-and-shoulders breakout. Chart 4 shows the US Oil Fund (USO) with a similar pattern and flag resistance at 41.50.

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Chart 3

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Chart 4

SHANGHAI COMPOSITE FALLS SHARPLY AND CONTINUES TO UNDERPERFORM... Weakness in the stock market started in the Far East with the Shanghai Composite ($SSEC) plunging over 2%. Selling pressure spread to Europe where the German DAX Index ($DAX), French CAC Index ($CAC) and London FTSE 100 ($FTSE) fell over 1%. Chart 5 shows the Shanghai Composite hitting resistance in the 2475 area a few times and then breaking down with a long black candlestick in mid March. This move broke support and the index fell below 2300 today. Although this is an end-of-day (EOD) index, I drew a thick black line to mark todays price action, and it was ugly. The indicator window shows the $SSEC:$SPX ratio falling below its January low this week as Chinese stocks continue to underperform US stocks. China is a major player in the global economy and relative weakness in its key stock index is not a good sign. Perhaps renewed weakness in China is weighing on industrial metals, oil and Europe.

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Chart 5

SIX MONTH CYCLE TURNS BEARISH IN MAY... The six month cycle defines a bullish cycle running from November to April and a bearish cycle running from May to October. This is where the phrase sell in May and go away comes from. While this cycle is certainly not infallible, statistics from the Stock Traders Almanac show the stock market seriously outperforming during the bullish six month period and underperforming during the bearish six month period. Over the last 50 years, the average gain for the Dow was less than 1% from May to October. In contrast, the average gain was more than 7% from November to April. Chart 6 shows the S&P 500 with the six month cycle over the last ten years. The red arrows mark the start of May (bearish cycle) and the green arrows mark the start of November (bullish cycle).

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Chart 6

Looking at the most recent cycle, there was clearly a bullish bias from November to late March as the S&P 500 advanced over 12%. This means two things  at least. First, the bullish six month cycle is one track so far, which means we could see a subpar performance during the bearish cycle May to October. Second, a 12+ percent advance in less than six months is nothing short of spectacular. Even though stocks can become overbought and remain overbought, the odds of a correction or pullback remain high after such an advance. But what about the timing? Sy Harding developed a system using MACD to time the six month cycle and this dramatically improved performance. Basically, traders look for bullish MACD signals when the cycle is bullish and bearish MACD signals when the cycle is bearish. A bullish signal triggers when MACD moves above its signal line or into positive territory. A bearish signal triggers when MACD moves below its signal line or into negative territory. Chart 7 shows the S&P 500 with a bearish signal line cross in early May 2011 and a bullish signal line cross in early December.

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Chart 7

FRENCH AND UK STOCKS SHOW RELATIVE WEAKNESS ... US stocks remain strong as the major indices moved to new highs this week, but European stocks peaked last week and failed to confirm new highs. Even though the latest round of the European debt crisis has past, chartists should keep an eye on European stocks because selling pressure across the pond could put a damper on US stocks. Instead of using the usual country indices, I am using stock indices produced by Dow Jones. Country indices, such as the German DAX Index ($DAX) or London FTSE 100 ($FTSE), are end-of-day (EOD) indices, which means the data is not updated until after the close. SharpCharts users can use Dow Jones country indices to track price movements during the day. Moreover, these indices track their counter parts quite well. Users can search the symbol catalog for the term stock index (without quotes) to see a list of available symbols or just click here.

Chart 8 shows the DJ Germany Index ($DEDOW) within a clear uptrend since late November. After surging above 265 in mid March, the index pulled back last week and this weeks bounce fell short of last weeks high. First support is set at 260. Chart 9 shows the DJ France Index ($FRDOW) failing to bounce this week and breaking the December trendline. The early March low marks key support. In the indicator window, the Price Relative ($FRDOW:$SPX ratio) broke below its early March low and French stocks are now underperforming US stocks. Chart 10 shows the UK Dow Index ($GBDOW) stalling in the 255 area since early February and the early March low marking key support. Relative to the S&P 500, the FTSE has seriously underperformed since mid February and the Price Relative hit a new low this week.

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Chart 8

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Chart 9

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Chart 10

SPANISH STOCKS MOVE SHARPLY LOWER... The potential for trouble becomes apparent when we move south. Chart 11 shows the DJ Italy Index ($ITDOW) stalling since early February with a choppy range the last 6-7 weeks. The lows from mid February to March mark key support, a break of which would be bearish for Italian stocks. Chart 12 shows the DJ Spain Index ($ESDOW) moving sharply lower since the second week of February. The index got a decent bounce in mid March, but gave it all back with a steep decline the last six days. Relative to the S&P 500, this Spanish index has been underperforming for well over six months and the Price Relative hit a new low this week.

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Chart 11

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Chart 12

UPCOMING VACATION... Note that I will be taking a family vacation the next two weeks and will return on Monday, April 16th. John Murphy will cover the Market Message during this time.

Chart 13