NASDAQ LEADS THE MARKET LOWER -- BIOTECH AND INTERNET STOCKS NEAR TEST OF 200-DAY AVERAGES -- MARKET VECTORS SEMICONDUCTOR ETF PLUNGES 3% ON FRIDAY TO LEAD TECH DECLINE -- SECTOR ALIGNMENT REMAINS DEFENSIVE

NASDAQ RALLY ATTEMPT MAY BE FAILING... The Nasdaq lost -1.75% on Friday to lead the market lower once again. The relative strength line (top of Chart 1) shows the Nasdaq/S&P 500 ratio peaking at the start of March and falling to the lowest level in eight months. That's not a good sign for the Nasdaq or the rest of the market. That's because the Nasdaq usually acts as a leading indicator for the rest of the market, both on the upside and the downside. Last year, it was to the upside. This year, it's to the downside. Chart 1 also shows the low volume rally attempt in the Nasdaq Composite Index failing to reach initial chart resistance at 4185, or a resistance line extending back to mid-March. It also failed to reach its 50-day average (blue arrow). The Nasdaq may now retest its mid-April low and 200-day moving average. Other analysts have pointed out the possibility that the recent bounce may be a "right shoulder" in a potential "head and shoulders" topping pattern. Two of the biggest drags on the Nasdaq were once again biotech and internet groups, both of which are nearing tests of their 200-day averages (as shown in Charts 2 and 3). Since March 1, biotechs have lost -14% and internet stocks -15%, and have been the biggest drags on the Nasdaq. More bad news for the technology sector and the Nasdaq may be Friday's heavy selling in semiconductors.

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Chart 1

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Chart 2

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Chart 3

SEMICONDUCTORS MAY BE PEAKING... Semiconductors have been one of the strongest parts of the technology sector -- up until Friday. A plunge in the group on Friday made them the weakest group in a weak technology sector. The daily bars in Chart 4 show the Market Vectors Semiconductor ETF (SMH) plunging 3% at week's end to put it in danger of breaking its 50-day average. The fact that the SMH has already formed a negative pattern of "declining peaks" also increases the odds that its mid-April low may be broken as well. The volume pattern isn't encouraging. A glance at the volume bars (below chart) show much heavier volume on down days (red bars) than on up days (green bars). Yesterday's selloff also came on rising volume. The SMH/Nasdaq ratio (top of chart) has been rising over the last two months and has helped support the Nasdaq market. The ratio, however, may now be peaking. Loss of semiconductor support comes at a bad time for the Nasdaq market which can use all the support it can get. Chart 5 shows the biggest SMH loser -- KLA-Tencor (KLAC) -- plunging 7% in heavy trading. Other big chip losers include Teradyne (-5%), Analog Devices (-4%), Broadcom (-4%) and Texas Instruments (-4%).

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Chart 4

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Chart 5

SECTOR ALIGNMENT REMAINS DEFENSIVE... Market rotations have turned negative over the last month, and remain so. Chart 6 plots the "relative strength" lines for three winning sectors -- and two losers since March 1 when the market started to weaken. [All five lines are plotted above and below the S&P 500 which is the flat back line]. The three sector leaders have been utilities, energy, and consumer staples. Utilities have done 7% better than the S&P 500 since March 1, energy 6% better, and staples nearly 4% better. Staples and utilities are defensive in nature. They also pay dividends which makes them more appealing during a market correction. Falling bond yields also favor dividend paying stocks which helps explain why Real Estate Investment Trusts (REITS) have also been market leaders. Energy leadership is often associated with a market correction as well. The weakest sector has been consumer discretionary which has underperformed the S&P 500 by -5% since the start of March. Part of that weakness comes from a weak homebuilding group. A big drag, however, has come from retailers which have underperformed the S&P 500 by -4%. It's never a good sign for the market when discretionary stocks are leading it lower.

Chart 6

ANOTHER REASON TO WATCH NASDAQ... I continue to believe that the Nasdaq market holds the key to overall market direction. The weekly bars in Chart 7 show another reason why the April lows are so important for the Nasdaq Composite Index. The April low touched a rising support line extending back to late 2012 (the last time the Nasdaq suffered a 12% correction). Needless to say, it's important that the support line hold. Unfortunately, Chart 7 also shows that weekly MACD lines (above chart) turned negative at the start of the year, and remain so. That increases the odds for more downside testing and a deeper market correction.

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Chart 7

IT'S NEARLY MAY ... Next Thursday is May 1. As you know, I've been writing since last December about the possibility of a serious market correction starting in the spring. I've also explained that April marks the end of the "best six month" period that lasts from the start of November to the end of April. That makes April a good month to take some money off the table, or take a more defensive approach. Many investors are already doing that. I've also explained that 2014 being a midterm election year (which is the most dangerous of the four-year presidential cycle) could make the "sell in May" strategy more relevant this year. According to the Stock Traders Almanac, one way to play the "best six month" strategy is to hold stocks between November and April, and then switch to fixed income between May and October. It also notes, however, that the timing of those seasonal entry and exit points can be improved by using the MACD indicator. Turns in that indicator can help an investor anticipate those turns even earlier, or cause one to hold off a little longer. Chart 8 applies daily MACD lines to the S&P 500. The two lines turned negative twice since the start of March. It flipped back to slightly positive last week, although it remains in a downtrend. I find daily signals too sensitive to be used for seasonal timing purposes. I like weekly signals better.

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Chart 8

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Chart 9

WEEKLY MACD INDICATORS ARE NEGATIVE ... I generally put more faith in weekly as opposed to daily signals. Daily signals are good for short-term trading, but less helpful for spotting more important market turns. For that, I rely more heavily on weekly signals. As a result, I put more more faith in the "weekly" version of the two MACD lines for spotting potential market turns. And the news there isn't encouraging. Chart 9 overlays the weekly MACD bars on the S&P 500. The two lines turned negative during January and are still negative. As a rule, weekly signals trump daily ones. Those negative weekly MACD lines (among other things) are keeping me very cautious on this market, especially as we enter the more seasonally dangerous month of May.