HOMEBUILDERS CONTINUE TO CRUMBLE -- RECENT MARKET ROTATIONS SHOW INCREASINGLY DEFENSIVE MARKET

HOUSING INDEX HITS NEW 52-WEEK LOW ... More bad news on the housing front pushed the PHLX Housing Index to the lowest level in eighteen months. The weekly bars in Chart 1 leave little doubt that housing stocks have peaked. The recent breaking of the late 2005 lows has left a bearish pattern of falling peaks and falling troughs. In other words, the major trend is now down. The poor performance by the housing group is confirmed by its relative strength ratio which also peaked last summer. That's also trading at a new eighteen-month low. I believe that the main reason for the housing peak is rising bond yields. Mr. Bernanke made some hawkish inflation comments today which pushed bond yields higher and housing stocks lower. He also acknowledged some slowing in consumer spending. That's not surprising considering that consumers are struggling with historically high energy prices and loss of equity in their homes. That also accounts for recent drops in consumer confidence. That puts the Fed in an awkward situation. Mr. Bernanke stated today that he would remain vigilante against rising inflation pressures. How can he do that when the stock market and the economy are showing signs of weakness? If the Fed keeps raising rates to combat inflation, it risks pushing the market and the economy into a larger decline. If the Fed stops raising rates, it loses its inflation-fighting credibility. In other words, the Fed is losing control of the situation. And most investors aren't waiting around to find out what the Fed decides to do. They've been selling riskier assets over the last month and rotating into more conservative investments.

Chart 1

MARKET GOES ON THE DEFENSIVE ... If you consult John's Latest Performance Chart, you'll see the best and worst market groups over the last month. It paints a very clear picture. The strongest groups have been utilities, consumer staples, healthcare, and financials. All are defensive groups. The weakest have been emerging markets, small caps, technology, and basic materials. Those former leaders are being sold the hardest. Basic materials and technology are cyclical in nature and suffer from a weakening economy. Emerging markets and small caps are among the riskiest stocks and are being sold as well. Chart 2 is a relative strength ratio of consumer staples (blue line) and utilities (green line). They've been rising. Chart 3 shows the relative strength ratios of emerging markets (black line) and small caps (purple) line falling. These defensive rotations are also symptomatic of a weakening stock market.

Chart 2

Chart 3

MARKET SELLS OFF AGAIN ... There's not much to say about the next three charts. They pretty much speak for themselves. Chart 4 shows the Dow Industrials (the strongest of the three) failing another test of its 50-day moving average. Chart 5 shows the S&P 500 tumbling 22 points after climbing to within five points of its falling 50-day line. Its 200-day line is in jeopardy again. Chart 6 shows the Nasdaq Composite (the weakest of the three) meeting serious selling at its 200-day moving average. That's because broken support lines usually become new resistance lines. The fact that the two weakest groups today were the Nasdaq and small caps isn't a good sign either. The only positive was the fact that volume dropped a bit. But I wouldn't take too much encouragement in that. Higher market prices need higher volume. Falling market prices don't. Last week I expressed skepticism about the staying power of the recent rebound based on negative readings on weekly and monthly charts. That situation hasn't changed and neither has my negative view on the market.

Chart 4

Chart 5

Chart 6