SECTOR ROTATIONS ARE SIMILAR TO THE SPRING OF 2000 -- WHY ENERGY AND CONSUMER STAPLE LEADERSHIP ISN'T GOOD -- DEFENSIVE MONEY ALSO MOVING TO UTILITIES AND REITS

FOURTH ANNIVERSARY OF NASDAQ TOP... In my latest book on Intermarket Analysis, Chapter 7 discusses the sequence of sector rotations that normally take place at market tops. Although the magnitude of the current selling in stocks isn't the same as the market top four years ago, the current sector rotations are similar to those in the spring of 2000. Page 110 in the book includes a diagram showing how sectors rotate at different stages of the economic cycle. At the start of upturns, technology leads the way as it did last year. Sector leadership then moves through services, capital goods, basic materials, and energy. Energy leadership is usually a sign that a market rally is nearing completion since rising energy prices are a drag on the economy. Chart 1 shows energy assuming a leadership role last November. Chart 2 shows consumer staples doing the same during January. When the energy jump starts to hurt economic expectations, market leadership switches to defensive sectors. That why consumer staples turn up after energy. At the start of a downturn, consumer staples and utilities are the two strongest groups followed closely behind by financials. That pretty much sums up the current situation. [Although REITs aren't included in the sector diagram, they also assumed a leadership role in the spring of 2000 as the Nasdaq started to fall]. Consumer staples, utilities, and REITS have been market leaders this week. And, as happened in March 2000, the Nasdaq was the first major average to peak.

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ENERGY AND STAPLE LEADERSHIP AREN'T GOOD... The preceding headline was taken from my February 10 Market Message # 2 which said: "There's another warning associated with energy sector leadership. That's when it coincides with new leadership in consumer staples. That combination is usually a warning that the market is turning more defensive". Another sign is when consumer staples start to outperform cyclical stocks. Chart 3 plots a ratio of consumer staples divided by cyclicals. The ratio bottomed in mid-January. Another sign that rising oil prices are taking a toll in when transports start to underperform utilities. Chart 4 shows the transportation/utility ratio peaking last November when energy stocks started to move higher. Transportation stocks are cyclical. Utilities are defensive. Utilities also benefit from falling interest rates and pay dividends. REITs also pay high dividends. Another sign that the market is peaking is when basic material stocks start to weaken. Yesterday's Market Message showed basic material stocks leading the market lower. They're down heavily again today. The basic conclusion is that current sector rotations are consistent with a market top in the making and are similar to those that took place in March 2000. This top isn't as big as the last one four years ago; but the short-term implications are still negative. With stocks trading down sharply today, it's instructive to see where the main weakness is and the main strength. The two weakest sectors are basic materials and oil service. That means that the stock correction is now in force. Not surprisingly, consumer staples are the only sector in the black today and are now the main leadership group. Other defensive sectors holding up the best are REITS and utilities. That follows the same rotation pattern from the spring of 2000 when the market was peaking.

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DOW LOSES 160 POINTS AS MARKET SINKS... The last three charts show the serious deteriotion in the market averages. The Dow has fallen to the lowest level for the year. The S&P 500 has cracked its 50-day average. The Nasdaq fell even further below 2000 and is now headed toward its December low and its 200-day moving average. Volume continues to pick up as the market falls, which is a bad combination. Big board decliners led advancers by a three-to-one market. Action in the market averages -- as well as sector rotations described above -- are consistent with the most serious market downturn since the rally started last March.

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