UPSIDE BREAKOUT IN RATES PUNISHES STOCKS
ADVANCE-DECLINE LINES PLUNGE EVEN FURTHER... At the end of last week, I showed the recent deterioration in the NYSE and the Nasdaq Advance-Decline lines. The Nasdaq AD line had already broken its 200-day moving average which reflected the greater deterioration in that technology-dominated market. At the end of this week, the Nasdaq AD line had fallen to the lowest level in eight months. The NYSE AD line, which had fallen to a four-month low by the end of April, plunged even further this week. Friday's breadth numbers were especially bad. The number of NYSE decliners swamped advancers by a twelve to one margin, which was the weakest number in more than four years. Most of the breadth deterioration is coming from two main sources -- financial stocks and small caps.
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BANKS AND BROKERS BREAK 200-DAY LINES... The jump in long-term interest rates that started in April took its biggest toll on financial stocks. That's because they're especially rate-sensitive. Historically, financial stocks peak before the rest of the market and are considered to be leading indicators. Since rate-sensitive stocks account for over a third of the big board stocks, any breakdown in that group has a bad effect on market breadth. Charts 3 and 4 show the absolute (and relative) breakdowns in bank and brokerage stocks starting during April. Both indexes have broken their 200-day moving averages. The drop in their relative strength was particularly noticeable during April when long-term term rates started to jump. That was also around the time that the NYSE AD line started to plunge. A second source of breadth deterioration comes from small caps.
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SMALL AND MID CAPS BREAK SUPPORT... There are more small stocks than big stocks. As a result, small (and midsize) stocks have an important bearing on market breadth. The next three charts show that small and midsize stocks have done much worse than the large caps since April. The S&P 600 Small Cap and the S&P 400 Mid Cap Indexes have broken chart support at their 2004 lows (while the S&P 500 Large Cap Index hasn't). The relative strength lines of the two smaller indexes also peaked during April. That's where most of the big board decliners have come from over the last month. With the two smaller stock indexes having already broken chart support, that increases the odds that the S&P 500 Large Cap Index will probably do the same. That would put all three indexes on a lower trajectory toward their 200-day moving averages.
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NASDAQ AND MATERIALS BREAK 200--DAY AVERAGES... Commodity-related Material stocks were the weakest market sector for the week. Chart 8 shows the serious technical damage done to the group. The Materials Select SPDR broke chart support along the February/March lows and ended under its 200-day moving average. Its relative strength line has also broken down. Here again, most of the selling started during April when rates started to rise. The Nasdaq Composite also ended the week under its 200-day line. Interestingly, the Nasdaq suffered the smallest loss on Friday after leading the market lower since January. Volume also declined. Even so, a test of its March low near 1900 is probable. A bounce in the oversold semiconductor group at week's end kept Nasdaq losses relatively small.
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RATES AND DOLLAR RISE -- CRB FALLS... Friday's strong jobs report pushed the 10-year T-note yield over the highs of last summer to the highest level in more than twenty months. The rise in rates since the start of April (when the strong March jobs report was reported) caused profit-taking in the CRB Index (which in turn hurt material stocks). Also hurting commodities was the continuing rise in the dollar. The dollar has been boosted by rising U.S. interest rates. The final chart shows the U.S. Dollar Index closing over its 200-day average on Friday. That jump contributed to heavy selling in gold and other commodity-related stocks. For the week, the sectors that held up the best were consumer staples, healthcare, and energy. Even those defensive groups experiencded profit-taking on Friday. With rates breaking out on the upside, this is a time for extreme caution in the bond and stock markets.
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