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Technical Update of the State of the Market


...unless the negative divergences move the market immediately lower, the benefit of the doubt must be given to the bulls here.

Before I hit the road for the next week and a half I wanted to share an update on the technical state of the market and revisit some of the charts I've been watching. Equities continue to churn higher, although there remain some concerns.

The S&P 500 seems to be magnetized up into the all time closing high of 1527 (Intraday 1553). After breaking out of the uptrend channel in late 2006, and subsequent retest during the sub-prime swoon of late February and early March of this year, we are starting to see some signs of negative divergence on the RSI oscillator. This worries me in that it could foreshadow a false breakout near these all time highs, and we all know what happened back in 2000 when this 1500 level provided serious resistance. It is interesting that the channel breakout projects right into the 1500 range. (1400-1300 = 100, 100 points up from 1400 is 1500).

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The Russell 2000 will be a key index to keep an eye on in the near future. After almost five years of persistent small cap out-performance, we are now seeing early signs that small caps are lagging their larger brethren. As you can see in the below chart, this 830 level has proved to be formidable resistance for the small caps. This also leads me to the conclusion that fewer stocks are leading the market to new highs, which is evident in the weak breadth figures as of late.

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Another caution flag is being raised by the poor action in the BKX (KBW Banking Index). While the market has pushed to new highs over the past month the financials have seriously under-performed and have barely made any headway. Because they are such a large percentage weight in the indexes, it will be hard for the market to continue higher without the banks on board.

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The OSX (Oil Service Index) has continued to lead the market higher and is now up a whopping 22.6% for the year. Talk about "the Trend is your Friend!" While this uptrend is certainly still intact, I would not be surprised to see some consolidation of these gains or a pullback before moving meaningfully higher.

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Gold remains in a clear uptrend although it has pulled back in recent weeks, most likely due to the benign inflation data as of late (believe it or not). It should find support here in the mid $600's, but if for some reason the 50 day near $640 breaks to the downside we could see the mid $500's. We are also entering a seasonally weak period for gold so be careful with buys, you might get a better opportunity this summer.

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The dollar index remains firmly locked in a downtrend as another short term bounce seems to have fizzled out and lost steam. Sentiment is bearish and some contrarians have been looking for a bounce off this 80 level. With this steep downtrend still intact, it is more likely we see a downside break of the 80 level. This could coincide with upcoming China currency talks so keep a close eye on the dollar!

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The above dollar downtrend will certainly be putting a pinch on my wallet as I am traveling to Italy next week for some much needed R&R. Last time I was in Italy was near the Euro's lows against the dollar (it took about 0.82 cents to buy a Euro) and things were so cheap! It will be quite a different story this time as it will now take me $1.35+ dollars to buy that same Euro. So there's a great example of what happens when you pump a ton of liquidity (dollars) into the system!

As I said about a month ago, unless the negative divergences move the market immediately lower, the benefit of the doubt must be given to the bulls here. Watch the S&P 500 near the all-time highs and this important 1500 level. Once we get past May Options Expiration it might be time to digest some of these recent gains if not start a larger corrective pullback. Also focus on the Russell 2000 as continued small cap underperformance does not bode well for the broader market. Same thing with the BKX and finacials underperforming. That being said there is certainly no stopping some of these larger cap breakouts as they lead the market higher. Happy Trading!
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