WEAK GDP REPORT HURTS STOCKS BUT HELPS BONDS -- TIPS LEAD BOND RALLY -- WHY COMMODITY DOWNTURNN IS BAD FOR STOCKS -- LOSS OF ENERGY LEADERSHIP ISN'T GOOD EITHER UNTIL SOMETHING ELSE TURNS UP

FIRST QUARTER GDP CONFIRMS WEAKENING ECONOMY ... The economic news keeps getting worse. Consumer confidence is falling as are durable goods orders, while inventories are building. The drop in consumer confidence suggests a drop in consumer spending (which is two-thirds of the economy). The drop in durable good orders reveals lower capital expenditures by corporations. Today we read that the first quarter GDP came in at a 3.1% gain versus economists' expectations for 3.5%. Economists are now talking about a "soft patch" in the economy. It's about time. As you and I know, the markets have been telling us that since the start of the year. As usual, the economic community has been behind the curve (as have those media outlets that rely on them). It's also educational (but painful) to see the market falling on good earnings news. For weeks, TV analysts have been repeating the mantra that good first quarter earnings would save the market. It hasn't. And the reason is as old as Wall Street. The market doesn't build trends on old news or old earnings. It looks six to nine months into the future. And the market is anticipating that things are getting worse instead of better. I believe that's the message of both the bond and stock markets.

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BOND YIELDS DROP AS TIPS LEAD BOND RALLY ... The weak GDP report had a predictable impact on the markets. Bond prices rose while stocks fell. As bond prices rose, yields fell. Chart 1 shows the 10-Year Treasury Note yield falling to the lowest level in two months. While the GDP report reflected a weakening economy, it also reported higher inflation. That explains why TIPS (Treasury Inflation Protected Securities) were the day's leader in the bond world. Chart 2 shows the TIP ETF (TIP) moving closer to a challenge of its February high. All of the other longer-maturity bond ETFs gained ground. Chart 3 shows the inverse relationship between the 7-10 Year T-bond iShares (IEF) (green line) and the S&P 500 (red line) since last summer. When stocks rose, bonds fell. Now bond prices are rising as stock prices are falling. And for the same reason -- economic slowing.

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WHY FALLING COMMODITIES AREN'T HELPING STOCKS ... Back on April 13 I wrote an article on why falling commodities (and their stocks) might actually hurt the stock market. That's because commodities usually peak after stocks. Commodities are also sensitive to economic trends. A downturn in commodities (which is often preceded by a downturn in commodity shares) is usually a sign that the economy is peaking which increases the downward pressure on stocks. This is especially true when commodity-related stocks (basic materials, gold, and energy) start to fall faster than the rest of the market. And that's what's happening. Chart 4 shows the Materials Select SPDR (XLB), which was one of last year's market leaders, tumbling well below its 200-day moving average. Its relative strength line has also broken down. Commodity-related stocks have a strong cyclical component to them -- especially those tied to industrial commodities.

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DROP IN INDUSTRIAL COMMODITIES LEADS TO CYCLICAL BREAKDOWN ... Which brings us to Chart 5, which shows a similar breakdown in the Morgan Stanley Cyclicals Index (CYC). The reason for their similarity is because both indexes include many of the same basic material stocks (like Alcoa, Dow Chemical, Georgia Pacific, International Paper, Phelps Dodge, US Steel) . When economically-sensitive cyclical stocks start falling faster than the market, it's time to get out of the way of both. Chart 6 shows the recent plunge in Phelps Dodge which is hinting at a copper peak. Copper is a good barometer of global economic trends. A peak in copper would hint at a global economic slowdown. That's one reason why falling commodity stocks hurt stock markets all over the world. The other reason has to do with loss of market leadership and sector rotation.

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WHY IT'S NOT GOOD WHEN MARKET LOSES ENERGY... Energy is usually the last sector to peak. Chart 7 shows the Energy Sector SPDR (XLE) dropping since the start of March. Its relative strength line, which has been moving sideways since then, is starting to drop. [Energy was today's biggest sector loser]. That's bad for the stock market because it removes the market's strongest sector. Unless something else steps up to take over market leadership, the market can react negatively to falling energy shares. In the early stages of a downturn, some money flows into consumer staples and utilities which has been the case. One way we can tell when the downturn is nearing completion is when financial and consumer discretionary stocks turn up. Yesterday I mentioned some nibbling in an oversold financial group. Chart 8 shows, however, that the Financial SPDR (XLF) is still in a downtrend and shows no convincing signs of a bottom. The Consumer Discretionary SPDR (XLY) in Chart 9 hit a new low today and is actually showing relative weakness. Until we see some upside progress by either (or both) of those two groups, the market downturn should continue. Another sector that often leads at a market bottom is technology. There's no sign of that either.

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VIX TURNS UP AGAIN FROM CHART SUPPORT... A couple of weeks ago I showed the CBOE Volatility (VIX) Index breaking out to a new 2005 high. I took that as added confirmation that the market was headed lower. Since then, the VIX has corrected downward (as the market bounced). That's because the VIX trends in the opposite direction of the market. After retesting its January/March highs near 14.5, and its 200-day moving average, the VIX surged today. That's another bearish sign for the market. I continue to recommend a defensive market posture, which includes increased exposure to cash, bonds, and/or a bear market fund. Those on the short side of stock index ETFs can place protective buy stops over this week's rally highs in the DIA, the SPY, or the QQQQ as shown on the last three charts.

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NO FRIDAY MESSAGE... I'll be doing some moving tomorrow (Friday) and Saturday. As a result, I won't be posting a weekly wrap up. Hopefully, I've spelled out my views in this and other market messages this week. Now it's just a matter of seeing how things work out.