NEW DOW LEADERSHIP IS A SIGN OF MORE DEFENSIVE MARKET -- CONSUMER STAPLES BECOME NEW LEADERS AFTER ENERGY PEAKS -- CRB INDEX FALLS BELOW 200-DAY LINE

STAPLES COME AFTER ENERGY ... In the latter stages of an economic expansion and and bull market in stocks, basic material and energy stocks take over market leadership. We've seen that over the last two years. Energy stocks are usually the last group to peak at a market top. That is often a signal that the stock market is peaking and the economy along with it. With global rates starting to climb for the first time in years and talk of more global tightening, commodity prices have come under heavy selling pressure along with their related stocks. Basic materials, gold, and energy stocks have been the weakest stock groups over the past week. Most of the selling has been in the energy group. Chart 1 shows why. At the start of 2006, crude oil futures failed a test of their August 2005 high. In today's trading, crude has fallen back below $60, is back under its 200-day moving average, and appears headed for a test of its fourth quarter lows. Whether or not it holds above that late 2005 low will determine if crude oil prices have peaked for the cycle. Chart 2 shows the sharp downturn in the Energy Sector SPDR (XLE). The XLE is bearing down on its 200-day moving average which will be another test of its long-term uptrend. The XLE hasn't fallen below that line in three years. Energy weakness is being confirmed by selling in other commodities.

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CRB INDEX BREAKS 200-DAY LINE ... Chart 3 shows the Reuters/Jefferies CRB Index falling below its 200-day moving average. That puts it in position to challenge its late 2005 low near 310. It also raises the distinct possibility that commodity prices have also peaked for this cycle. That's normally bad for the stock market and is usually an early warning that the economy is headed for trouble later in the year. If money is leaving commodity-related stocks, where's it going? After energy stocks peak, the next sector that normally takes over market leadership is consumer staples. And it just so happens that consumer staples have been the strongest sector today and over the past week.

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CONSUMER STAPLES TURN UP ... Chart 4 shows the relatively strong action in the Consumer Staples Sector SPDR (XLP) over the last week. It's bouncing impressively off its 50-day moving average. Its relative strength line has broken a five-month down trendline and is starting to turn up. That makes sense. Food, beverage, drug, and tobacco stocks have longed been viewed as defensive in nature. They don't depend on the business cycle and, in fact, do better when that cycle starts to weaken.

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STAPLE LEADERS ... Two of today's biggest percentage gainers in the consumer staples ETF are CVS (Chart 5) and Colgate Palmolive (Chart 6). The next two charts show their strong chart action. Note the upturn in their RS lines over the past week. Procter & Gamble (Chart 7) has been one of the standouts in the Dow Industrials over the past week and helps explain why the Dow has held up better than the Nasdaq and small cap stocks. Other staples leaders are Molson (TAP), Walgreen (WAG), Alberto Culver (ACV), Coca Cola (KO), and UST. People are still going to eat, drink, and smoke in a weak market. They may even make more trips to the drugstore. That's why money flows to that sector in the early stages of a market top and a slowing economy. Healthcare is another sector that does well at this point in the economic cycle. But we'll save that for another day.

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NEW DOW LEADERSHIP IS A DEFENSIVE SIGN ... For the first time in more than a year, the Dow Industrials are showing market leadership. That can be seen in its ability to stay above its 50-day line and its rising relative strength ratio which has outperformed the S&P since the end of January. I take that a sign that the market is turning more defensive. When investors get nervous about the direction of the market and economy, they become risk averse. That's why this past week saw heavy selling in riskier areas like emerging markets and small caps. At such time, investors start to favor the larger and more stable stocks that reside in the Dow. It just so happens that many of those Dow stocks are also in the consumer staples area. The new Dow popularity isn't isn't a vote of confidence in the rest of the market or the economy.

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