HIGH CORE CPI INFLATION WEAKENS MARKET -- BROKERAGE INDEX BREAKS 200-DAY AVERAGE -- SOX RALLY FADES -- TIPS RALLY -- OVERSOLD DOESN'T MEAN MUCH IN A FALLING MARKET

CORE CPI HITS HIGHEST LEVEL IN TWO YEARS ... Inflation starts to build in three stages. The first stage occurs when raw materials (commodities) start to rise. That started a couple of years ago. The second stage occurs with the Producer Price Index (which is what companies pay to buy those raw materials) starts to jump. That started in January. The third stage is when companies start to pass their producer costs on to consumers. And that's where we appear to be now. The March core Consumer Price Index (ex food and energy) jumped 0.4% today for the biggest monthly gain in more than two years. That was twice what economists were expecting. There's no reason for anyone to be too surprised with today's CPI numbers. What goes into one side of the inflation pipeline has to eventually come out the other side. When you see a train going into one side of a tunnel, you don't have to stand on the other side to see if it comes out. It's better to just get out of the way. That's what we've been doing since the start of the year. Getting out of the way of rising inflation -- and a falling stock market. The market reacted badly to today's report of higher consumer inflation. It fell on heavier volume. The biggest losers were in the financial and retailing groups which are especially sensitive to rising rates. But they've been leading the market lower since January. Nothing new there. What was new today was a breakdown in brokerage stocks.

BROKERAGE INDEX BREAKS 200-DAY AVERAGE ... Earlier today I showed the AMEX Broker/Dealer Index (XBD) testing its 200-day moving average. It failed that test by closing under that long-term support line. That puts the broker index at the lowest level in six months. The solid line overlaid on the price bars in Chart 1 is the relative strength line of the brokers versus the S&P 500. The ratio line peaked in early February and has been dropping since then. Although several of the brokerage stocks (including Merrill Lynch) are already trading beneath their 200-day line, Charles Schwab broke under it today. That's got to tell you something about the state of the market when brokerage stocks are giving major sell signals.

Chart 1

Chart 2

SOX RALLY FAILS ... A bullish report from Intel last night, and a higher open in the stock, got the semiconductor group off to a good start. It didn't hold. What's worse, the Semiconductor Holders (SMH) actually fell on heavier volume. That's not good action for the chip group, the technology sector, or the market. In fact, it was a bad day for the market all around. All the major averages fell on higher volume. That's not bullish action.

Chart 3

S&P 500 FAILS AT 200-DAY LINE -- VOLUME PICKS UP ON PRICE DROP... Earlier today I showed the S&P 500 starting to back off from its 200-day moving average at 1154. On Monday, I had suggested than any oversold bounce would meet initial resistance at that line. [Broken support lines -- like moving averages -- usually act as resistance barriers on subsequent bounces]. What's even worse is the fact that all the major market averages fell on heavier volume. That contrasts with low volume during the market bounce on Monday and Tuesday. That negative pattern can be seen on Charts 5 and 6 which show the Dow Diamonds (DIA) and the Nasdaq 100 Shares (QQQQ) falling on heavy volume. Notice that the red volume bars (down days) have been much bigger than the green volume bars (up days). That's symptomatic of a market that's in a downtrend.

Chart 4

Chart 5

Chart 6

TIPS LEAD BONDS HIGHER ... Yesterday I plotted a chart showing bond price doing better than the stock market. Although the bond market closed slightly lower today, it held up remarkably well in the face of the strong inflation report. One bond category that actually rose were TIPS (Treasury Inflation Protected Securities). These are bonds that have some built-in protection against rising inflation. Chart 7 shows Lehman Lehman TIPS iShares (TIP) moving up to challenge their February peak. The ratio line along the bottom of the chart compares the TIP to the S&P 500. The ratio has broken a down trendline starting last August. If you don't like stocks here, but are worried about inflation, TIPS might be a good alternative.

Chart 7

OVERSOLD DOESN'T MEAN MUCH IN A FALLING MARKET... When a market breaks important support levels, it's best to get out of the way. That's why I caution anyone about getting too fancy with short-term timing at this juncture. I'm referring specifically to some feedback I've gotten this week concerning my recent advice to either sell the market or buy a bear mutual fund. Some of the comments were that it "was too late to sell the market" because it was oversold or "too late to buy a bear fund" because they were overbought. In the early stages of important trend changes, terms like overbought and oversold don't mean that much. One of the tools that I use at such times is the Average Directional Index (ADX) line. That's the black line shown at the bottom of Chart 8. When the ADX line is falling (as it's been doing since November), the market is usually in a trading range where oscillator signals are very important. When the ADX line is rising (as its been since mid-March), that means that a new trend is starting. At such times, it's best to disregard oscillator readings. The two other lines are the +Directional Index (green line) and the -Directional Index (red line). When the red line crosses over the green line (as it did in mid-March), that tells us that the trend of the market is down. Falling markets have a way of getting oversold -- and staying oversold -- all the way down.

Chart 8