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NEW HIGHS BY THE NYSE ADVANCE-DECLINE LINE AND A GROWING NUMBER OF MARKET GROUPS ARGUE FOR A CONTINUATION OF THE BULL MARKET — TRUCKERS LEAD TRANSPORTS TO NEW HIGHS AS WELL — WHERE TO READ UP ON ELLIOTT WAVES

ODDS SHIFT TO FIFTH WAVE RALLY… I addressed a couple of different ways to interpret the current Elliott Wave structure in Monday. The market is at an inflection point in Elliott Wave terms. Let’s briefly review what’s at stake and why. From the low of last March to this January, the S&P 500 rose in a three-wave sequence as shown in Chart 1. That leaves two different ways to read the wave structure. The more bearish view is that the three-wave rally is an ABC corrective wave in an ongoing secular bear market. That’s because corrective waves usually take place in three waves (see red letters). Bull markets, however, take place in five waves. The green numbers in Chart 1 show a more positive wave scenario. That view holds that the decline from January to February is nothing more than a wave four correction. That more positive view holds that the January high will be retested and probably exceeded by the S&P 500. Although the issue is still in doubt, the increasing number of indexes hitting new highs tilts the scale in favor of the more positive wave structure.

SMALL AND MIDSIZE STOCKS HIT NEW HIGHS… Last Tuesday, I showed the NYSE Advance-Decline line hitting a new high as shown in Chart 2. I pointed out that was a positive sign for the market since the NYAD usually peaks “before” the market. Its ability to hit a new high greatly reduced the risk of a market top. I also explained that new highs by small and midsize stocks were largely responsible for the strong breadth figures (Charts 3 and 4). That’s because there are more small stocks than large ones. [Large cap indexes like the S&P 500 are also capitalization- weighted, which means that larger stocks carry more weight than smaller ones]. That’s another reason why the NYAD line usually leads the major market indexes in both directions. The recent move to new highs greatly increases the odds that the major market indexes like the S&P 500 are also headed in the direction. There are several other market groups hitting new highs as well.

NASDAQ INDEXES HIT NEW HIGHS… The Nasdaq Composite has also exceeded its January high (see Chart 5). [The Nasdaq 100 is breaking through its January high today]. Two of the groups most responsible for that strong chart action are the Internet Index (Chart 6) and Network iShares (Chart 7). It’s usually a good sign for the rest of the market when the Nasdaq is leading it higher. The biotech group has also hit a new 2010 high.

MORE UPSIDE BREAKOUTS … I also wrote last week about the positive implications of new highs in the Consumer Discretionary SPDR (Chart and retail stocks (Chart 9). Here’s another one. Chart 10 shows the Dow Jones REIT Index hitting a new 2010 high.

TRANSPORTS RIDE RAILS TO NEW HIGHS… All of the leading groups shown so far are reflective of more optimism on the market and the economy. So is the next group. Chart 11 shows the Dow Tranports in the process of exceeding its January high. Although airlines are certainly helping to push the TRAN higher, even more impressive chart action is seen in rail stocks. That’s important because strength in the rails is usually an indication that companies are moving goods which is usually a sign of economic strength. All of these upside breakouts argue that the stock market has entered another upleg which would qualify as a fifth wave in Eliott Wave terms. There’s good and bad news in that. The good news is that the market is likely to reach new highs. The bad news is that the fifth wave is usually the last upleg in a bull market advance, which is usually followed by some type of corrective action. The message then is to enjoy the ride upward but don’t ride it too long.

by John Murphy

S&P 500 ELLIOTT WAVE REVIEW – FINANCE SECTOR CHALLENGES RESISTANCE – SMH REMAINS BELOW JANUARY HIGH

REACTION LOWS FOR IWM AND RSI… An uptrend is defined by higher highs and higher lows. With the Russell 2000 ETF (IWM) hitting a new 52-week high last week, we can assume that the overall trend remains up. Chart 1 shows weekly candlesticks for IWM over the last 16 months. The green arrows show reaction lows that coincide with RSI lows around 50. RSI found support at 50 as the ETF forged higher lows the last nine months. Momentum favors the bulls as long as RSI holds above 50. The most recent reaction low in IWM now becomes key support that defines the uptrend. An official downtrend would not begin unless IWM breaks below the reaction low at 57.5. In addition, I would also look for RSI to break below 50. This level offered support in early July, late October and late January.

S&P 500 ELLIOTT WAVE REVIEW… A reader asks if this week’s advance is enough to negate my Elliott Wave count for the S&P 500. The short answer is no. Before opening Pandora’s box here, just a reminder that Elliott Wave is part objective and part subjective. This is my interpretation of the theory. I opted for the count shown on Chart 2, which makes the current 12-month advance an ABC correction. I have seen other counts, including bullish counts, that make sense too. In particular, some Elliotticians view the advance from March 2009 as much too strong to be considered a corrective advance. They argue that such strength suggest that this advance is part of a five wave move. Chart 3 shows this version of events.

So which one do we believe? As far as I am concerned, the most important aspect is the current 12-month uptrend. It could be an ABC advance, part of a 5-wave advance or something else. Whatever count, the S&P 500 established a new reaction low with the Feb-Mar bounce. As noted above, an uptrend consists of higher highs and higher lows. A downtrend starts with a break below the last reaction low, which is now the February low. Therefore, a break below the latest reaction low is required to reverse the current uptrend. So, while I still have the ABC correction as my current Elliott Wave count, confirmation is dependent on a trend reversal with a break below the February low. A break above the January high would negate this count and favor the alternative.

FINANCE SECTOR CHALLENGES RESISTANCE… The Financials SPDR (XLF)has been featured in the Market Message the last two Mondays. The Market Message on Monday, February 22, showed XLF testing range support. The Market Message on Monday, March 1, featured XLF forming a pennant after the surge off support. With last week’s surge, chart 4 shows XLF moving towards the top of its six month range. XLF has been bound by support in the 13.5 area and resistance in the 16 area since mid August. An important resistance test is looming. A breakout in XLF would be bullish for the sector and the market overall.

Chart 5 focuses on the latest bounce and pennant breakout. The January high is coming into play and could offer resistance. In addition, the ETF is up over 10% in four weeks and getting short-term overbought. Short-term, Friday’s gap is the first zone to watch. This gap is bullish as long as it holds. A decline that fills Friday’s gap would reinforce resistance and keep XLF range bound. The indicator window shows the price relative picking up over the last few weeks. Relative performance for XLF was flat from early December to mid February, but picked up as the price relative turned up at the end of February.

SMH IS LAGGING THE BROADER MARKET… The Semiconductors HOLDRS (SMH) remains in a clear uptrend since November 2008, but the ETF has lagged the broader market over the last four weeks. Chart 6 shows SMH with weekly candlesticks over the last 18 months. First, notice that SMH bottomed several months ahead of the S&P 500 (Nov-08 versus Mar-09). This reinforces the status of semiconductors as a leading group. Second, SMH remains within a clear rising price channel since this November low. These are internal trendlines because they cross the February 2009 low and summer highs. Nevertheless, these trendlines capture the overall uptrend. With a bounce over the last five weeks, SMH forged a reaction low at 24. A break below this level would reverse the current uptrend.

Chart 7 shows daily candlesticks with a five month view. The current swing (four week trend) is clearly up, but SMH is showing some relative weakness recently. First, the current advance is hitting resistance near the 62% retracement mark (~27). In contrast, the major indices exceeded their 62% retracements and many exceeded their January highs. Second, the bottom indicator shows the price relative, which compares the performance of SMH against the S&P 500. A lower high formed in February and the price relative edged lower the last three weeks. SMH is underperforming the S&P 500. Semis are an important group for the technology sector and the overall market. Relative weakness should be watched carefully. On the price chart, a rising wedge is taking shape with support based on the late February low. A break below this level would call for a continuation of the Jan-Feb decline. The bulls have the edge as long as this support holds.

By Arthur Hill