MARKET LOOKS VULNERABLE TO AUGUST PROFIT-TAKING -- RISING RATES MAY BE STARTING TO HURT HOUSING

WHY THE S&P 500 LOOKS OVERBOUGHT... Short-term indicators point to an overbought market. The 9-day RSI has been weakening from overbought territory over 70 on the S&P 500. That's creating a short-term negative divergence. The latest peak in the MACD lines barely exceeded the mid-June high and are close to turning negative. That doesn't call for a major downturn (especially with weekly and monthly indicators still positive). But it does suggest that the S&P and the rest of the market could spend the month of August correcting or consolidating. Seasonally, July is usually the strongest summer month while August is usually the weakest. A pullback to the 50-day moving average wouldn't be surprising. Two of the other factors that may be bothering the market are crude oil testing its all-time high near $62 and rising bond yields.

Chart 1

BOND YIELDS CONTINUE TO CLIMB... Since it rose above its June peak in mid-July, the 10-year T-note yield has continued to climb. Not enough to call this a major upturn (yet), but enough to warrant closer attention. That's because historically low bond yields have been a supporting factor behind a stronger economy, a stronger stock market, and a strong housing sector. I recently suggested that housing was one of the sectors most vulnerable to an upturn in bond yields. That's why housing stocks warrant very close scrutiny at this point in time. Chart 2 compares the 10-year yield (bars) to the Housing Index (solid line). For the first time in two months, housing stocks are starting to weaken a bit.

Chart 2

HOUSING INDEX IS LOSING MOMENTUM ... The two short-term momentum indicators in Chart 3 show some slippage taking place beneath the surface in housing stocks. The 9-day RSI and the daily MACD lines both peaked in mid-July at the same time that bond yields exceeded their June high. And both are weakening. The RSI has fallen to the 50 line. A drop below that line would suggest further weakness. The daily MACD lines have already turned negative. That isn't enough to call for a major top in housing stocks. But given their historically high level, and the fact that long-term rates may finally be rising, any hint of short-term weakness is worth paying attention to. Another is any sign that housing is losing its leadership role.

Chart 3

HOUSING LEADERSHIP MAY BE SLIPPING ... Chart 4 is a ratio of the Housing Index divided by the S&P 500. Not surprisingly, the rising ratio throughout most of 2005 confirms the fact that housing has been a big market leader. That's been the case since 2000. There are some small cracks starting to show up in that housing leadership however. The ratio line has broken its 20-day average for the first time in three months. And the MACD lines for the ratio have turned decidedly lower. Again, that's not enough to turn anyone bearish on housing. But it is an early sign that rising rates are starting to chip away at the housing foundation. A lot will depend on whether or not bond yields continue to climb. If they do, these early warning signs may become even more important. Earlier this afternoon, I showed retail stocks losing market leadership they've had since early May. That's another group that's sensitive to rising rates and rising gasoline prices. That's a potentially bad combination for an overbought market that's entering a seasonally weak month.

Chart 4