INFLATION REPORT RATTLES STOCKS -- HOMEBUILDERS ARE NEAR 52-WEEK LOWS -- BEAR FUNDS ARE MOVING UP

CORE CPI TOPS FORECASTS ... While the CPI numbers creep higher month after month, economists keep telling us there's really no inflation. It's all energy. There's no inflation anywhere else and not much threat of it picking up. Those of us who look ahead, however, and understand that a falling dollar and soaring commodities prices are inflationary, weren't surprised to read that the April core inflation number (excluding food and energy) came in at +0.3% which was higher than economists were expecting. It was bound to happen sooner or later. The newswires were filled today with economists' claims that inflation had suddenly become a problem. We've been writing about the growing inflation threat for weeks if not months. Bond traders saw it coming and have pushed yields to four-year highs. Traders who have pushed homebuilding stocks to 52-week lows saw it coming also. Chart 1 is a weekly chart of the PHLX Housing Index. It peaked last summer and has been dropping ever since. Today's decline puts it on the verge of breaking its October low which would turn its major trend down. [Several homebuilders are already at 52-week lows]. The relative strength line beneath the chart also peaked last July. Anyone doubting that the housing boom is over need only look at the chart. The main catalyst in the housing collapse is rising bond yields. The solid green line is the 10-Year T-Note yield. Notice that it turned up last summer just as housing stocks peaked. Here's the scenario. Housing stocks fall when bond yields turn up. Bond yields turn up on increased inflation expectations. Increasing inflation keeps short-term rates rising which eventually hurts stocks. That's how we use intermarket analysis to make market forecasts. It's also another example of the simple reality that financials markets are the best leading indicators of future economic trends. That's because the markets are looking six months into the future. Most economic data (and those who rely on it) look backwards.

Chart 1

NYSE INDEX FINALLY TURNS DOWN ... Throughout the market rally that started last October, the NYSE Composite Index has been a pillar of strength. I've been asked on several occasions to explain why. I believe it has to do with the fact that the NYSE has a fairly heavy weighting in basic material and energy stocks (which are now falling), and an under weighting in large technology stocks that have been pulling the Nasdaq market lower. Whatever the reason for its former strength, even the NYSE is finally caving. The chart shows it plunging below its 50-day moving average for the first time since the beginning of November. That pretty much confirms that the market has entered into a serious downside correction. I wouldn't be surprised to see the NYSE drop all the way to its 200-day moving average. The market took the higher inflation news very badly. That's not surprising considering that most technical indicators were already flashing sell signals. All the market needed was a catalyst to start falling. It got that today. Chart 3 shows the Materials Sector SPDR (XLB) also breaking its 50-day line today. That's one of the reasons the NYSE is falling.

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MARKET INDEXES FALL ON HEAVY VOLUME... I've been showing a lot of bearish indicators recently so there's no need to show them again. All we can do now is show the chart damage in the three major stock ETFs. The charts speak for themselves. All three fell sharply today on heavy volume. The Dow Diamonds (DIA) have broken their 50-day average. The next downside target there is the mid-April low at 110. The S&P 500 SPDRs (SPY) broke their mid-April low at 128 (which corresponds to the S&P 500 number of 1280). The SPY is heading for a challenge of its 200-day average at 125. That number corresponds to its first quarter lows as well. The worst performer all year has been the Nasdaq 100 Shares (QQQQ). Chart 6 shows the cubes having already broken its first quarter lows and its 200-day line. The big red volume bars over the last week show pretty serious selling. [The Nasdaq Composite broke its 200-day average today].

Chart 4

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TIME TO LOOK AT BEAR FUNDS... My advice today is the same that I've been giving over the last week. Move some money over to a money market fund and/or rotate into some defensive sectors like consumer staples and healthcare. I continue to advocate some profit-taking in commodity-related stocks and ETFs which broke their 50-day lines today. Several international stock ETFS (including Japan iShares) did the same. More aggressive traders can buy a bear market fund. One that I recommended last Friday is the ProFunds Short OTC Investment Fund (SOPIX) and is shown in Chart 7 (through Tuesday). It's an inverse of the Nasdaq 100. And it's one of the first to rise above its 200-day moving average line. You'll find eight "inverse" (or bear) funds on the Stockcharts.com Profunds Carpet. You'll see that the "ultra" funds are the fastest gainers over the last week. That's because they move up at twice the rate of the index they're tied to. They're also the riskiest. All of the inverse funds are mirror images of the market. The same technical indicators that are giving market sell signals are giving bear fund buy signals. Chart 8 shows the ProFunds Bear Fund (BRPIX) through yesterday. It's a mirror image of the S&P 500. My guess is that it broke its April high today (since the S&P broke its April low) and is heading for a challenge of its 200-day moving average. I view bear funds as trading vehicles and not long-term holdings. They can be used to profit from a market drop or to hedge one's stock portfolio against possible losses. They only work while the market is dropping.

Chart 7

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