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A two percent recovery in the
Semiconductor Index
(
SOX |
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PowerRating) helped spark a broad-based rally that
led the S&P 500 to a new multi-year closing high yesterday. For the first time
since March 1, stocks trended steadily higher throughout the entire session and
finished near their intraday highs. The Nasdaq Composite
(
COMP |
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PowerRating) woke up
yesterday and zoomed 1.3% higher, while the S&P 500
(
SPX |
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PowerRating) kept pace with a
1.0% gain. The Dow
(
DJX |
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PowerRating) lagged a bit with its 0.7% advance, but both the
small-cap Russell 2000
(
RUT |
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PowerRating) and S&P Midcap 400
(
MDY |
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PowerRating) indices rallied
1.1%. Although it still remains below its prior high, we stopped out of MDY
short (S&P Midcap 400) when it rallied back above its 20-day moving average.

Market internals were impressive yesterday, but total volume
levels in the NYSE were surprisingly light. The positive is that advancing
volume exceeded declining volume in the NYSE by nearly 5 to 1! The ratio in the
Nasdaq was positive by more than 3 to 1. Without a doubt, internals that strong
indicate confirmation of widespread buying operations. However, we found it
interesting that total volume in the NYSE was only 4% higher than the previous
day’s level. The higher volume gains made the session a bullish “accumulation
day,” but we would have expected a much larger surge in turnover considering
that the S&P broke out to a new multi-year high. The 4% rise in turnover was not
even enough to push volume over its 50-day average level. Total volume in the
Nasdaq showed a much healthier 17% increase, but it was still below its average
level as well.

For those of you who like to trade or invest in the
international ETFs, take a look at
(
EWJ |
Quote |
Chart |
News |
PowerRating) (iShares Japan Index). At a time
when many of the international ETFs are correcting or breaking their primary
uptrend lines, EWJ just broke out above its two-month daily downtrend line and
is poised to resume the primary uptrend on its weekly chart. Looking at the
daily chart below, notice how EWJ closed yesterday above its intermediate-term
downtrend line after forming a triple bottom since the beginning of this year:

The longer-term weekly chart more clearly illustrates the
primary uptrend that EWJ has been in since it broke out in August 2005:

At a minimum, we expect EWJ to rally back to its January 9
high of 14.30. Beyond that, odds are good that it will subsequently break out to
a new 52-week high as well because due to the lack of overhead supply. If buying
the breakout above its downtrend line, there are two clear areas for protective
stop placement. If you want to play it tight and protect against a failed
breakout, consider a stop about 15 to 20 cents below yesterday’s low. That would
also enable the 20-day moving average to provide support as well. If you have a
longer time frame and are interested in giving it a little more “wiggle room,” a
stop below the triple bottom makes sense. Although EWJ is not very volatile, it
is the kind of play that is ideal for retirement accounts that can’t use margin
to sell short, especially if you don’t like the risk of being long the U.S.
markets right now.

The best thing about yesterday’s action in the S&P is that the
index has finally begun to break out of its lethargic, four-week trading range.
As the chart below illustrates, SPY (S&P 500 SPDR) closed just a few pennies
above the highs of its prior two failed breakouts from February 27 and March 3:

If the S&P (and SPY) holds this breakout for more than a day
or two, it could trigger the return of heavy institutional buying activity that
would help lift the other major indices to new highs as well. But for now, the
S&P is the only broad-based index that cleared its prior high. Conversely, the
small-cap Russell 2000 Index, which has led most broad-based rallies in recent
years, is actually forming the right shoulder of a bearish

“head and shoulders” chart pattern on its daily chart. Below, we have
illustrated this on the chart of IWM (iShares Russell 2000). Moving averages
were removed so you can more easily see the pattern:

Obviously, a rally above the high of the “head” would
represent failure of the pattern to follow through to the downside, but caution
with long positions, particularly in the small-cap arena, is still warranted.
Further, the Nasdaq Composite still remains 1.5% below its January 11 high, but
the index at least managed to recover back above convergence of its 20 and
50-day moving averages.

Because of yesterday’s action, our short-term bias has shifted
from negative to neutral. The lackluster volume levels and divergence among the
major indices tells us we are certainly not “out of the woods” yet, but the
relative strength and new highs in both the S&P and Dow provide good reasons to
be very cautious on the short-side. We feel it may be wise to step away from the
markets for a few days until the market proves it can confirm yesterday’s
strength. If it does, we’ll be ready to follow along and promptly resume trading
in the direction of the primary upward trend. Remember to
trade what you see, not what you think!