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Technology Gathering Strength as Equities Waver


Semiconductors and some health-care names should also be acknowledged.

Summary of Yesterday's Notable Technical Developments

Bonds sold off hard Monday sending yields sharply higher as money flew out of the "safety" trade and into stocks; the yield on the benchmark 10-year Treasury note is approaching the wave iii target of 3.779% to 3.88%.

Stocks rallied Monday as semiconductors and most of technology set the pace to the upside; the S&P and the Dow are still stuck in their respective trading ranges, however.

sold off mildly yesterday as the US dollar traded modestly higher; gold is weighing the group down as it continues to retrace some of its recent up move.

The US Dollar Index was higher Monday, finishing very near the high of the day and closing above 78 for the first time since early September. This level represents an area of congestion on the charts and may be a likely place for the index to pause on its way to the 81 to 83 range.

Market Internals
(Figures are rounded)

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Critical Market Components

S&P 500: the S&P is in the midst of a "rectangle" consolidation formation with 1119.01 and 1084.90 as its resistance and support, respectively; on a breakout to the downside, the next support is the ascending 75-day moving average (currently at 1076.76); any breakout to the upside will make the next meaningful resistance 1139, which is a convergence of Fibonacci levels.

NASDAQ: the critical level on a weekly closing basis is 2212.49 -- that level will act as support as long as this breakout continues; the next level of resistance is the 61.8% Fibonacci retracement level of 2251.84 (if drawn using the intraday extremes of the 2008-09 bear market instead of the closing extremes). The NASDAQ and semis are really asserting themselves as the leadership areas of the market at this point.

Dow Jones Industrials: support at rising trend line at 10,200, which corresponds with the 50-day moving average; resistance at 10,507.59 on a weekly close remains unchanged; it's interesting that the Dow and the S&P remain range-bound while the NASDAQ it setting new highs on a daily basis.

10-Year US Treasury Yield: rates on the 10-year Treasury continue to march higher; support has been raised to horizontal line at 3.603% (December 15 close); resistance is now the 3.78% to 3.88% range -- the wave iii of 5 target.

Commodity ETF (DBC): minor support at the 80-day moving average at 23.34 with major support close below that at the horizontal line at 22.79; substantial resistance at 25; the drag on the sector continues to be gold.

US Dollar Index (DXY): new short-term support at previous resistance of 77.47; our short-term target of 78 has been reached; the intermediate-term target is the 81 to 83 area; the DXY is clearly in a short-term uptrend so use every countertrend move to buy PowerShares DB US Dollar Index Bullish (UUP) and/or lighten up on commodities -- note that stocks haven't shown the inverse correlation to the rising dollar of late.

Semiconductor Index (SOX): the SOX is providing new market leadership along with certain health care sectors; the new ultimate target on the upside is now at 366.52 (Fibonacci projection) with a max upside of 384.28 (bottom of first wave lower from July 21, 2006); horizontal line support exists at 332.11.

Bank Index (BKX): a second day of gains yesterday set the banks squarely in the middle of the recent trading range; critical support exists at 41.62; staunch resistance at 44.82.

Crude Oil: crude is starting to pull back again after its recent short-term rally; the new resistance is the intraday rally high from December 18 -- $75.65; the closest support remains at 70; crude and gold may be the real areas of weakness as the DXY continues higher.

Gold: gold reversed lower intraday yesterday, broke its first uptrend line support at 1100, and appears to be headed down to the next uptrend line and Fibonacci convergence at the 1046 level; resistance is the peak of the recent short-term rally attempt at 1120.80.

Key Inter-Market Charts

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  • Based on ThirdWave's work, the benchmark 10-year note is in the middle of wave iii of 5 of A of a larger ABC correction off of the December 2008 lows (which marked a wave III low in the wave count of an even larger set).

  • The upside target range for this wave iii move higher remains the 3.779% to 3.88% range. The market has approached this level already today, with a high yield of 3.76%. After an expected wave iv flat/consolidation, the ultimate target for this five wave set (which will complete wave A as noted above) will be the 4.10% area on the 10-year Treasury yield.

  • Typically we would observe increased asset allocation into Treasuries as certain yield thresholds are reached. However, the perceptions and dynamics surrounding the sovereign debt of the United States may be changing, which could permanently and significantly alter the supply-demand equation. I'll be carefully monitoring the technical condition of the Treasury securities for more evidence of such changes.

Strategy: Limit fixed income exposure to iShares Barclays TIPS Bond (TIP), global fixed income securities and selected high-yield fixed income (opportunistically). US Treasuries and investment-grade corporate debt may be good for yield/income only (and not so much for capital appreciation) for quite a while as yields continue to rise.

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  • Stocks continue to rise in this low-volume environment and certain parts of the market (namely the NASDAQ, technology, and semiconductors) are breaking out above very important technical levels. The S&P 500 and the Dow Jones Industrials remain range-bound, however.

  • The S&P may be set to break out of the short-term "rectangle" consolidation pattern (the aforementioned trading range) to the upside. Given where we are on the calendar, I'd expect the breakout to occur and would be disappointed if it didn't.

  • The upside target out of this pattern is the 1139 level, which is the confluence of two Fibonacci numbers: the 61.80% retracement of the May 2008 to March 2009 wave III move and the 100% price extension projection of the ABC correction in which the S&P is currently.

  • The "strength" of the overall equity rally is in serious question as volume, market internals, and negative divergences (such as the one highlighted in the RSI for the S&P chart above) are all problems under the surface.

Strategy: Stay with current longs and ride the equity wave as long as it continues. However, be alert for signs of a downside reversal as the next big move will be lower.

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  • Commodities -- namely the precious metals and to a lesser degree crude oil -- seem to be bearing the brunt of the recent turnaround in the US dollar.

  • While the DB Commodity Tracking Index Fund (DBC) certainly rallied off the lows set earlier this year, the magnitude of the rally in DBC shares was far less than some of the relief rallies seen in financials, technology, and other areas of the financial markets.

  • We may have seen the top in commodities already, but I'm not ready to make that declaration just yet. Confirmation in the form of a break of the uptrend line and of the 190-day moving average prior is necessary before turning bearish on the commodities complex in general.

  • Given that ThirdWave's work on gold suggests more upside is likely following its current corrective move, I'd expect the DBC to similarly pull back further but hold its support levels and proceed higher once this correction is done.

Strategy: Look for continued weakness in the shares of DBC down to the $22.80 to $23 area. At that level, I'd advocate taking long positions in DBC and other commodities-related holdings with stops in place on any close below $22.75 in DBC.

Click to enlarge

  • The US Dollar Index ($DXY) is the fourth and final core inter-market chart used by ThirdWave. A long-term view of the weekly DXY chart reveals that the DXY is in the beginning stages of wave b of an abc corrective move, which will make up wave B of a larger corrective move.

  • The upside target range for the current wave b will be the 81.40 to 83.10 range -- the 50% and 61.80% retracements of the wave a move lower that just finished at the end of November.

  • Such a move should continue to weigh on the commodities complex (and specifically the precious metals area) and perhaps equities (maybe they'll see weakness when all market participants return after the holidays).

  • Yesterday's call for gold to pull back to the $1,045 level may be too conservative given the magnitude of the anticipated rally in the DXY. I'm sticking with the short-term downside target for gold at $1,045 for now, but it's worth noting that gold can pull all the way back to just below $1,000 without violating any Elliott Wave rules for its wave 4 correction status (and subsequent outlook for a big wave 5 rally).

Strategy: Dollar bears and owners of commodities should expect the stronger dollar-weaker commodities trade to continue. Be prepared to ride it out and take the pain; trim holdings to minimize the pain; or, cut and run right now with the idea of re-entering at better prices.

Putting It All Together

Inter-Market Observations:

Bond Prices (falling): Our long-term view is that inflation is going to be a problem and that rates will continue to trend higher. We're beginning to see this play out in the longer-dated Treasury securities.

Stocks (neutral/rising still): The strength and technical breakouts that I'm seeing in technology, the semiconductors, and the NASDAQ in general have us in "re-evaluation" mode for equities here. At the same time, the continued weakness in financials and the relative underperformance in the Dow and the S&P are bearish factors to consider. Given that my outlook calls for higher rates and a stronger dollar, I have to remain cautious on equities in general while acknowledging and participating in the areas of strength (technology, semiconductors, specific health care names, consumer and business staples).

Commodities (pausing):
Dollar strength should continue to weigh on commodities for the time being. Tread lightly here until we see a confirmed downside reversal in the greenback.

US Dollar Index (rising):
Despite any pullbacks that may occur (at any point), our intermediate-term target for the buck is the 81 to 83 area.

Stock sectors to be emphasized: technology and health care (based on the strength in the charts); consumer and business staples (based on the market cycle).

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