HEALTHCARE AND FINANCIALS LEAD FRIDAY DECLINE -- VIX IS STARTING TO BOUNCE -- SEASONALS ARE TURNING NEGATIVE

HEALTHCARE AND FINANCIALS BREAK MOVING AVERAGE SUPPORT... All market sectors lost ground on Friday. Two of the biggest losers, however, were the healthcare and financial groups. The Dow Jones Healthcare Index fell decisively under its 50-day moving average. Drugs were hit especially hard. In the financial sector, banks and brokers lost 2%. The Financials Select Sector SPDR also broke its 50-day average. And it did so on rising volume. That's not a good sign. To make matters worse, several of the major stock averages also broke their 50-day averages.

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STOCK AVERAGES BREAK 50-DAY LINES... The NYSE Composite and the S&P 500 Indexes closed the week below their 50-day moving averages. Chart 4 shows that the S&P 500 hasn't closed beneath that support line since mid-March when the current rally began. That's another sign to us that this phase of the advance has run its course. For the S&P 500, it now looks like the next test of support will be at the July 2 intra-low of 962.

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VIX IS STARTING TO BOUNCE... On Wednesday, I pointed out that that CBOE Volatility Index (or VIX) was trading in dangerously low territory around 20. Levels that low are usually associated with market corrections to the downside. I also pointed out, however, that the VIX needed to start rising to send a more serious sell signal. Chart 5 shows that the VIX jumped sharply on Friday. Normally, a move over 25 is needed to confirm a bottom in the VIX. However, any move over a previous peak has to be taken seriously. The VIX closed at 22.78 on Friday. It would have to clear its July 17 intra-day high at 23.47 to signal an upturn. That would more bearish for stocks. Charts 6 and 7 show why.

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VIX AND THE S&P... The next two charts compare the VIX and the S&P 500 since 1998. The red circles on the VIX chart show the last four times that the VIX fell as low as the 20 level and then started to move higher. The corresponding circles on the S&P 500 chart show that each VIX upturn from 20 resulted in a market downturn of some sort. A lot of media types have been dismissing this indicator recently because it's stayed so low without a corresponding downturn in stocks. This week's upturn in the VIX suggests that it's negative impact has yet to be felt. The VIX doesn't tell us how far down the market has to correct. But it's enough to warrant a more defensive posture in stocks. Seasonal factors have also turned against the stock market. The traditional summer rally usually runs its course during July. That's why July is usually a good month to take some profits during market rally. The rest of the third quarter isn't as promising.

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SECTOR-WATCH... All market sectors lost ground this week. The biggest losers were utilities (-3.12%), financials (-2.5%), consumer staples (-1.5%) and healthcare (-1%). The three sectors that held up the best were basic materials, industrials, and technology with only marginal losses. Semiconductors were one of the few groups to gain some ground on Friday. The combination of rising rates and a firm dollar caused profit-taking in gold. Bullion lost $8.00 on Friday (Chart 8). Even so, gold stocks held up relatively well. Bullion has been following the trend of the Euro pretty closely. On Friday, the Euro bounced off chart support at its mid-July low (as the dollar weakened (Chart 9). If stocks do start to weaken from here, that could cause more dollar selling. A weaker dollar and weaker stocks would be good for gold stocks.

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EUROPEAN INDEXES LAG U.S.... Speaking about the Euro gets me thinking about the relatively poor showing in European stock markets. I point this out because the two main European markets -- Britain and Germany -- have failed to exceed their highs from last November. That has created a negative divergence with the U.S. market which has exceeded those highs. Britian as already started to weaken. Germany closed down today right at that resistance barrier. Chartwise, this would be a logical spot to expect some profit-taking in Europe. That would undoubtedly spill over to the U.S. as well. That's because global markets usually trend together.

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