DROP IN RATES GIVES BOOST TO RATE-SENSITIVE STOCKS -- FANNIE MAE AND FREDDIE MAC BREAK OUT -- SCHLUMBERGER LEADS OIL SERVICE RALLY -- RECENT ROTATIONS

YIELDS BOUNCE BACK OVER 4%... The 10-Year T-note yield has been dropping since the start of January. Last week the yield fell below 4% for the first time in three months -- and slipped under its 200-day moving average. Although the short-term rate in trends has been down, Chart 1 shows that the yield is testing the old low hit near the start of October. That's an important test. A jump in bond yields on Friday pushed the 10-year yield back over the 4% level. This week's rally in interest-rate sensitive stocks like financials, utilities, and housing stocks has been based on expectations that long-term rates could fall further -- or at least not rise.

Chart 1

HOUSING STOCKS JUMP... The drop in long-term rates earlier in the week may explain this week's jump in housing-related stocks. Homebuilders had been in a corrective phase. Most of them, however, have climbed back over their 50-day moving averages. Centex has risen on good volume and is nearing its old high. Friday's jump in rates, however, appears to have caused some selling near 110. The Morgan Stanley REIT Index has been consolidating since the start of January. The trend of housing-related stocks are closely tied to the direction of interest rates.

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FANNIE MAE AND FREDDIE MAC TURN UP... These two mortgage-related stocks had a spectacular week. Freddie Mac broke out to the highest level in a year. Fannie Mae was even more impressive. It broke out to the highest level in eighteen months.

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SCHLUMBERGER LEADS OIL SERVICE STOCKS HIGHER... Energy was the top-performing sector for the week. On Friday, the PHLX Oil Service Index rose more than 4% and continues to lead the sector higher. Chart 7 shows the PHLX Oil Service Index climbing to the highest level in twenty months. The relative strength line has also turned up versus the S&P 500. That's a good combination. The star performer on Friday was Schlumberger which jumped 7% and is moving up to challenge its early 2002 peak near 60. Its rising relative strength line shows SLB leading the OSX higher. That makes the stock a leader in the strongest industry group in a sector that's starting to show new leadership.

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RECENT ROTATIONS... There was more evidence of some sector rotations going on this week. The two weakest sectors were Materials and Technology, which were former leaders but lost ground during the week. New leadership came from Energy, Utilities, Financials, and Healthcare. Chart 8 plots a ratio of the AMEX Energy SPDR divided by the S&P 500. The ratio line had been dropping throughout 2003. However, it turned up sharply at the start of December and has reached the highest level in seven months. Most of that is based on rising energy prices. Ratio charts like this one are extremely helpful in spotting new leadership sectors. Simple trendline or moving average analysis can be applied right on the ratio chart. Most other technical indicators can be applied to the ratio line as well.

Chart 8