LEHMAN LEADS BROKERS LOWER -- MARKET STAYS ON THE DEFENSIVE -- JUST AS BOND TOPS LEAD TO STOCK TOPS, STOCK TOPS LEAD TO COMMODITY TOPS
LEHMAN BREAKS 200-DAY AVERAGE ... We've been showing a lot of markets threatening or breaking their 200-day moving averages lately. Here's another one. Despite a 47% jump in second quarter earnings, Lehman Brothers has fallen 4% and, in so doing, has broken its 200-day moving average. That's the first violation of that long-term support line since 2004. And it's doing so on rising volume. That's a bearish combination. Lehman isn't the only brokerage stock being sold today. Chart 2 shows the AMEX Broker/Dealer Index also in the process of threatening its 200-day line. The relative strength for the group peaked in mid-April and has been falling since then. That's could carry bad news for the market as well. That's because brokerage stocks are often considered to be leading indicators (or at least bellwethers) of the health of the stock market. A breakdown in that key group would be another nail in the coffin for the three-year cyclical bull market that appears to be peaking.
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BEAR FUND UPDATE... With the market continuing to drop, bear funds had another good week. Chart 3 shows the ProFunds Bear fund (which is the inverse of the S&P 500) closing at a new seven-month high on Friday. The bear fund is moving up to test its April-October 2005 down trendline. Chart 4 shows that the ProFunds Short OTC fund has already exceeded that resistance line. It ended last week at a new 12-month high. That's not surprising since it's the inverse of the Nasdaq 100 which is one of the market's weakest indexes. There's no sign of a peak in either bear fund. Other inverse Profunds that have done especially well over the last month are in emerging and international markets, precious metals, and small caps. Not surprisingly, ultra bear funds(which move twice as fast as their underlying indexes) have done better than more conservative bear funds.
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BONDS USUALLY PEAK FIRST, STOCKS SECOND, THEN COMMODITIES ... This seems like an opportune time to review the normal intermarket sequence that takes place at market tops. I'm referring here to the normal topping sequence that usually takes place between bonds, stocks, and commodities. Historically, the three markets have peaked and troughed in a consistent order and here it is. Bonds peak first, stocks peak second, and commodities third. In the middle stages of a bull market, all three markets are rising. In time, rising commodity prices raise inflation fears and cause the Fed to start raising rates. Bond yields usually rise as bond prices peak. A peak in bond prices warns that the bull market in stocks is in its late stages. That makes bond prices leading indicators for stocks. Bonds can peak as early as six months to a year before stocks. The August bond peak was eight months ago. Bond prices have been trading under their 200-day average for at least three months (see red circle). Chart 6 shows the NYSE Composite turning down in early May and threatening its 200-day average (it closed below it today). A decisive close below that long-term support line raises the odds of a stock market peak. That's a bad sign for commodities.
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COMMODITIES PEAK AFTER STOCKS ... In the normal sequence, commodities peak after stocks. That's because a market peak signals economic weakness which reduces demand for economically-sensitive commodities. A peak in commodities often signals a period of economic weakness. Chart 7 shows the CRB Index still trading well above its 200-day moving average. That makes sense since commodities are usually the stronger asset class at this stage of the cycle. A serious breakdown in stocks, however, puts downside pressure on commodities and their related stocks. The fact that basic material, precious metal, and energy stocks have been so weak of late increases downward pressure on commodities as well. That doesn't necessarily mean that the long-term uptrend in commodities is over. But it could mean a period of weakness or consolidation until the stock market stabilizes. That might not be until this autumn when the next important stock market bottom is due. Just as the fate of stocks ultimately depends on the direction of bonds (interest rates), the fate of commodities ultimately depends on the direction of stocks.
