EURO RISES AND TREASURIES FALL AS MARKET TAKES ON SOME RISK -- FINANCE SECTOR LEADS OVERSOLD BOUNCE IN STOCKS -- SEMICONDUCTOR ETF BOUNCES OFF FIBONACCI RETRACEMENT -- REVISITING THE 2010 AND 2011 CORRECTIONS IN THE S&P 500

EURO RISES AND TREASURIES FALL AS MARKET TAKES ON SOME RISK... Link for todays video. Stocks are getting an oversold bounce this week as the Euro rebounds from oversold levels and treasuries correct their excesses. Chart 1 shows the Euro Currency Trust (FXE) rebounding back towards 125 the last four days. After the decline from 132 to 123 (6.8%), the Euro was due for a bounce to alleviate oversold conditions. Broken support in the 126 area turns into the first resistance zone.

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Chart 1

With the appetite for risk improving and treasuries overbought, the 7-10 year T-Bond ETF (IEF) fell sharply the last three days. Chart 2 shows IEF falling below 108 today with the sharpest three day decline since March. Even so, this looks like an overbought correction within a bigger uptrend. The late May consolidation zone (yellow) marks the first potential support zone. Below this level, broken resistance marks support in the 105.50 area.

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Chart 2

FINANCE SECTOR LEADS OVERSOLD BOUNCE IN STOCKS... The Finance SPDR (XLF) is leading the sectors higher with a 2+ percent gain on the day. Financial stocks were hit hard in May and became quite oversold in early June. Chart 3 shows XLF hitting support from the 61.80% retracement mark on Monday and surging back above its 200-day moving average today. Also notice that broken resistance from the December high marks support in the 13.25 area. The two day bounce is impressive, but it is not enough to undo the technical damage seen in May. At the very least, XLF needs to break above the late May highs and resistance at 14.25. This will require follow through to the Tuesday-Wednesday advance. Also notice that XLF remains relatively weak as the Price Relative (XLF:SPY ratio) continues to trend lower.

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Chart 3

Chart 4 shows the Regional Bank SPDR (KRE) holding above its 200-day and bouncing within the 50-61.80% retracement zone. Even though the ETF is above its 200-day, the May support break at 28 looks most ominous. Moreover, this support break remains in place and I would not be impressed with an oversold bounce unless it broke above the late May high. The indicator window shows the Price Relative (KRE:SPY ratio) plunging over the last two weeks as KRE leads lower.

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Chart 4

Why are financial stocks leading and why are the Euro and treasuries falling? Fundamentally, traders can look no further than EU rumors, the European Central Bank (ECB) and the Fed. There are rumors around that the EU leaders will act to shore up the banking system. ECB chairman Draghi noted that there were risks to the economy and said the ECB stands ready to act. Hmm.... that sounds familiar. Fed chairman Bernanke is set to testify before congress on Thursday. Given recent weakness in economic reports, the Fed chairman just may hint at more quantitative easing. Just as in August 2011, the markets are reacting to potential action on the EU crisis and the prospects for more liquidity from central banks around the world. Admittedly, it is hard to fight the Fed and liquidity.

SEMICONDUCTOR ETF BOUNCES OFF FIBONACCI RETRACEMENT... With many ETFs becoming oversold last week and hitting some key retracements, we can make the case for support and an oversold bounce. However, this does not override the bearish signals from mid May. It will take more than just an oversold bounce to put the bulls back in the drivers seat. Chart 5 shows the Market Vectors Semiconductor ETF (SMH) breaking support at 33 and falling over 15% from its May high, a mere five weeks ago. We do not need a momentum oscillator to figure out that this ETF is oversold. With this decline, SMH retraced 61.80% of the September-March advance. This key retracement, combined with oversold conditions, paved the way for a bounce. But how far? Last weeks high marks first resistance at 32 and broken support marks second resistance at 33. Taken together, I would mark a resistance zone in the 32-33 area. The indicator window shows the Price Relative (SMH:SPY ratio) trending lower since mid February. Semis show relative weakness and any upside breakout needs to be accompanied by a breakout in the Price Relative. Chart 6 shows the PowerShares Networking ETF (PXQ) with similar characteristics.

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Chart 5

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Chart 6

Chart 7 shows the FirstTrust Internet ETF (FDN) bouncing off the 50% retracement. Relative to SMH and PXQ above, FDN shows some relative strength because it firmed at a higher retracement (50% versus 61.80%). Support in the 33 area also stems from broken resistance. Combined with oversold conditions from last week, the ETF is ripe for a bounce back towards first resistance just above 35.

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Chart 7

REVISITING THE 2010 AND 2011 CORRECTIONS IN THE S&P 500... Why expect a bounce and then another leg lower? A look back at the last two corrections shows a clear three wave sequence. First, the S&P 500 was hit with sharp high-volume declines in May 2010 and August 2011. Second, there were oversold bounces that lasted 2-3 weeks (green arrows). Third, there were subsequent declines that broke the prior lows. The 2010 correction ended with the July surge and breakout around 1133, while the 2011 correction ended with the October surge and breakout around 1236. These breakouts occurred with strong moves on strong breadth.

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Chart 8

Looking at the current decline, I can only see one sharp decline with average volume. Even though we cannot always expect the past to repeat itself, this leads me to believe that selling pressure is not exhausted and the decline has not yet run its course. This means we could see an oversold bounce and then a second leg lower.

FORECASTING THE CURRENT DOWNTREND... Chart 9 shows weekly bars for the S&P 500 over the last three years. The index hit the upper trendline of a rising channel in March and declined back to the middle of the channel in May. With the index firming and bouncing this week, we could see an oversold bounce and then a continuation lower (dotted blue line). Such a forecast suggests an oversold bounce this month and then a continuation lower into September-October. The 61.80% retracement and lower trendline mark the downside target in the low 1200s.

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Chart 9

The indicator window shows the 13-week slope indicator moving below -10 for the third time since June 2010. $SPX bottomed soon after the slope broke -10 in June 2010, but carried on below -15 in September 2011. I would consider the slope bearish as long as it is pointed down. A sharp u-turn, such as those marked in July 2010 and October 2011, would suggest a trend change for the S&P 500.