DOW AND S&P 500 END WEEK NEAR OLD HIGHS -- WHILE WEAKER NASDAQ AND SMALL CAP INDEXES TRY TO STAY ABOVE CHART SUPPORT -- STRONGER HOMEBUILDERS WOULD MAKE MS. YELLEN FEEL BETTER -- TREASURY YIELDS AND THE DOLLAR BOUNCE
DOW AND S&P 500 END WEEK NEAR OLD HIGHS ... Today's message reads like a tale of two markets. Large cap blue chip indexes turned in a good week and are near record highs. Chart 1 shows the Dow Industrials bouncing off their 50-day average on Wednesday and closing the week near a new intra-day record. Chart 2 shows the S&P 500 Large Cap Index ending the week above its 50-day line as well. Part of the reason for the stronger performance by the Dow and SPX has been money rotating into larger and more stable stocks as investors have grown more defensive over the last couple of months. The disparity between those two indexes and the rest of market is displayed in Chart 3. That chart shows the Dow and SPX gaining 1.6% and 1% respectively since March lst when the market started to weaken. While the large cap indexes gained ground, the Nasdaq Composite Index lost -5.5% and the Russell 2000 Small Cap Index dropped -6.4%. In other words, investors haven't necessarily left the market. But they have been rotating out of riskier growth stocks into safer value stocks. Defensive stocks that pay dividends have been market leaders. That hasn't necessarily hurt the overall market trend, but isn't necessarily a sign of confidence either.
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Chart 1
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Chart 2
Chart 3
NASDAQ AND RUSSELL 2000 ARE HOLDING CHART SUPPORT... In my view, the key to market direction most likely rests with what the weakest sectors of the market are doing. So far, they haven't suffered a serious breakdown, and may even be showing signs of stabilization. Chart 4 shows the Nasdaq Composite Index achieving an upside reversal day on Friday after losing ground the previous two days. More importantly, the COMPQ is still holding above its 200-day moving average (red line) and chart support along its early February lows (black line). It's very important that the Nasdaq stay above those two support lines in order prevent a more serious breakdown (which would hurt large caps as well). To really strengthen the market's short-term picture, however, the Nasdaq would have to clear initial resistance at its mid-April peak and its 50-day moving average (blue line). Chart 5 show the Russell 2000 Small Cap Index having fallen below its 200-day line (red circle). It is, however, still testing important chart support along its early February low. That's an important test for the RUT and the rest of the market. For the current pullback to stay within the bounds of a normal correction, it's important that the Nasdaq and Russell 2000 hold those support levels.
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Chart 4
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Chart 5
HOMEBUILDING STOCKS STILL TESTING SUPPORT... Last Saturday's message showed homebuilding stocks starting to rebound from chart support. That rally attempt fizzled this week, but the test is still going on. Chart 6 shows the Dow Jones U.S. Home Construction iShares (ITB) still testing its 200-day average and a rising trendline extending back to last September. The ITB/SPX ratio (below chart) is currently testing its low from last November. The ITB needs to clear its early May high and its 50-day average to signal an upturn. That would have important implications for the U.S. economy. Janet Yellen this week expressed concern about this year's weak showing in housing, which has been reflected in weak homebuilding stocks. Since homebuilders are a leading indicator of housing activity, an upturn in the ITB might make her feel better. Chart 7 shows the price of lumber trying to climb above its 200-day average (red line) and a falling trendline extending back to last December. A stronger lumber market is usually a positive sign for homebuilders.
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Chart 6
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Chart 7
TREASURY BOND YIELDS AND THE DOLLAR BOUNCE AS EURO TUMBLES... Part of this week's setback in housing stocks might be attributed to a rebound in Treasury bond yields. Chart 8 shows the 10-Year Treasury Note Yield ($TNX) bouncing this week (green circle). Although the TNX is still well below its moving average lines, this week's bounce was enough to prevent a breakdown below its early February low. Janet Yellen's testimony this week may have contributed to the yield bounce which caused some minor profit-taking in bond prices. The bounce in yields may also have contributed a rebound in the dollar. Chart 9 shows the U.S. Dollar Index jumping sharply on Thursday and Friday. That rebound kept the dollar above important support near its October low, and a two-year support line shown last Saturday. The main catalyst for the dollar rally was a sharp drop in the Euro after ECB President Mario Draghi's statement at a Thursday news conference that the ECB was ready to loosen monetary policy at its June meeting. Chart 10 shows the Euro tumbling on Thursday and Friday after those dovish comments. The ECB would like to see a weaker Euro to help combat Euro deflation. The big question now is whether they'll deliver on that June promise, and whether ECB actions are enough to reverse the Euro uptrend and dollar downtrend.
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Chart 8
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Chart 9
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Chart 10
SECTOR ALIGNMENTS ARE STILL DEFENSIVE ... Sector rotations since the start of March show investors rotating out of economically-sensitive cyclical stocks into more defensive stocks that pay dividends. Chart 11 show rising relative strength lines for consumer staples, utilities, and REITs since March (although utilities suffered a setback this week). That's usually where money moves when investors are nervous about the economy and market direction. Falling bond yields during 2014 have also helped dividend payers which compete with bonds for yield. [A weaker dollar during 2014 has also favored large cap stocks which have more international exposure than small cap stocks]. By contrast, Chart 12 shows falling relative strength lines for internet, biotech, bank, and retail stocks since March 1. One way to tell when investors are starting to turn more optimistic is when the relative strength lines in Charts 11 and 12 show signs of reversing.
Chart 11
Chart 12
STAPLES/CYCLICAL RATIO IS STILL RISING ... The best way to tell when investor sentiment is shifting between two market sectors is with ratio analysis. That's especially true of ratios that compare defensive stocks and economically-sensitive ones. The solid black line in Chart 13 plots a "ratio" of the Consumer Staples SPDR (XLP) divided by the Consumer Cyclicals SPDR (XLY). After declining for most of the last year, the staples/cyclicals ratio turned up sharply during March, and is now trading at the highest level since last July. That shows investors moving out of economically-sensitive stocks (that do better in a stronger economy) and into more defensive stocks that pay dividends. Investors also turn to staples when they're worried about a stock market correction (or a period of consolidation). One way to tell when investor sentiment is turning more positive is when the XLP/XLY ratio starts to drop. That can be done in two ways. One would be to watch for the rising ratio line in Chart 13 to drop below its May low to interrupt its pattern of "higher highs and higher lows". A second way is to plot a point & figure chart of the ratio. That's done in Chart 14 which shows the ratio turning up in March when an X column first exceeded a previous X column. [X prices represent rising prices while O columns show falling prices]. For the uptrend in the XLP/XLY ratio to reverse, the p&f chart would have to turn down and fall below the last O column. Until that happens, it's probably best to stick with the trend which favors defensive stocks.
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Chart 13
