A breakout in the Semiconductor Index ($SOX) enabled the Nasdaq to post another session of gains, but a lack of strength in the other sectors held the S&P and Dow in check. Unlike the previous three days in which stocks gapped down in the morning and recovered in the afternoon, yesterday's action was the opposite. The broad market began the day higher, then sold off later in the morning. The bulls lifted stocks off their lows in the final hour of trading, minimizing the loss in the S&P and pushing the Nasdaq back into positive territory, but the intraday action was not overly bullish. The Nasdaq Composite gained 0.3%, but the S&P 500 and Dow Jones Industrial Average were lower by 0.1% and 0.4% respectively. The small-cap Russell 2000 matched the Nasdaq's gain, while the S&P Midcap 400 ticked 0.1% higher.

Total volume in the NYSE increased by 4% yesterday, while volume in the Nasdaq was 1% higher than the previous day's level. As with the previous session, the modest 0.1% loss in the S&P was not enough to declare the session a "distribution day." However, the inability of the market to hold most of its opening gains was again indicative of institutional selling into strength ("churning"). Market internals were mixed. Declining volume in the NYSE exceeded advancing volume by a narrow margin of 1.2 to 1, but the Nasdaq ratio was positive by 1.8 to 1.

All but three of the major industry sectors we follow closed within one percent of the flat line yesterday. On the downside, Home Construction ($DJUSHB) fell 1.9%. On the upside, Oil Service ($OSX) gained 1.8% and Semiconductors ($SOX) surged 2.8%. Both of the latter sectors have been laggards of the broad market for several months, but now are seeing positive institutional money flow. Perhaps the most significant technical event in the market yesterday was the break of the one-year downtrend line in the $SOX index. This is illustrated on the weekly chart below:



Last month, the $SOX also attempted to break out above its long-term downtrend line, but failed after probing just above it. This time, however, the $SOX significantly pierced resistance of its downtrend line. If it closes the week at or above its current level, it will have a good chance of following through to the upside next week. As listed on the Morpheus ETF Roundup, the following ETFs are correlated to the chip sector: Semiconductor HOLDR (SMH), iShares Semiconductor (IGW), PowerShares Dynamic Semiconductor (PSI), and the StreetTRACKS Semiconductor (XSD). Of these, PSI and XSD are showing the most relative strength because both have already broken out above their bands of consolidation. IGW and SMH have been laggards, but SMH could generate decent short-term momentum if it breaks out above its October 2006 high. The horizontal line on the weekly chart below marks the pivotal breakout level:



The other leading sector yesterday, Oil Service, may also be poised for short-term upside momentum. After rallying off its January low, the Oil Service HOLDR (OIH) ran into resistance of its 200-day moving average earlier this month. But after a brief correction, it snapped back and closed yesterday above its 200-day MA for the first time since December 21, 2006. As you can see on the daily chart below, a rally above the February 14 high of 140.16 should confirm the breakout:



The breakout in the Semiconductor Index is definitely a positive for the Nasdaq. Where the heavily-weighted $SOX Index goes, the Nasdaq tends to follow. The Nasdaq was stuck in a choppy, sideways range for several months because the $SOX was too. As long as the $SOX holds up, it is difficult to imagine the Nasdaq correcting significantly. Nevertheless, both the S&P and Dow are showing signs of "churning," which could counteract the strength in the $SOX. Consider avoiding the long side of sectors that are directly correlated to the S&P and Dow, and be on alert for short-selling opportunities if the S&P and Dow win the tug-of-war to the downside. Conversely, it's fine to buy the strength in the Nasdaq, but tread lightly with a minimal number of positions and reduced share size.

Deron Wagner is the Founder and Head Trader of both Morpheus Capital LP, a U.S. hedge fund, and Morpheus Trading Group, a trader education firm launched in 2001 that provides daily technical analysis of the leading ETFs and stocks. For a free trial to the full version of The Wagner Daily or to learn about Wagner's other services, visit MorpheusTrading.com or send an e-mail to deron@morpheustrading.com.