So how are we supposed to treat Friday's rally? As the start of a new upleg, or an oversold bounce prior to another loop to the downside?

Frankly, I really don't know...but the Semiconductor HLDRs (SMH) and the Q's (QQQQ) are telling me to keep an eye out for the start of a new upleg, while the S&P indices are warning me to beware of another shoe to drop.

That is why we have not covered either of our two model portfolio short positions from yesterday -- the Consumer Discretionary SPDR (XLY) or the China Fund (CHN) -- in case we walk in Monday morning to a air pocket on the downside.

As mentioned, one sector that is acting extremely well is semiconductors. Its exchange-traded fund, the SMH, appears to have ended a pullback off its May 9 high at 38.30 at Thursday's low of 35.54, and has since turned up sharply in what looks like the thrust into a new upleg.

A sustained climb above 36.80 is needed to trigger upside acceleration towards a retest of the May high at 38.30.

Check out some of the charts of the components of the SMH... such as TXN, NSM, SNDK, KLAC, MU, INTC... and you can see why the upside potential of the ETF could be very significant indeed.

While the China equity markets may take a breather in a relative way, Japan could prove to be the Òin vogueÓ market during the second half of 2007.

From a bigger picture perspective, the huge coil pattern that has spanned the past year in the Japan iShares ETF (EWJ) is attached to a massive bullish upmove from 10 to 15.55, which occurred between May '05 and May '06.

The one-year coil has the right look (zigs and zags) to argue that the EWJ (Nikkei, et al) finally has digested the powerful upleg, and is ready to resume its longer-term bull trend Ð that projects to new highs in the upcoming months.

Yes, I am aware that the Nikkei is up all of 3.2% this year so far, lagging the Shanghai Composite (+46.26%) and the Korea Kospi (+20.4%), and the Taiwan Index (+6.10%). But that is part of the allure of this larger developing pattern.

If my work proves correct, then the Japanese equity market will move into favor very soon and will play catch-up in a hurry.