FEWER JOBS AND HIGHER WAGES HURT STOCKS -- DOW FALLS BELOW 50-DAY AVERAGE -- DEFENSIVE STOCKS RALLY -- NASDAQ 100 CONTINUES TO DRAG MARKET LOWER
A RECIPE FOR STAGFLATION ... The June employment report gave a double dose of bad news to the stock market today. First of all, June job growth was very weak. That hinted at economic slowing. At the same time, June wages jumped at the fastest rate in five years. That's potentially inflationary. That situation isn't unlike the situation that's haunted the stock market since May -- that is, economic slowing combined with rising inflation. That's a recipe for stagflation which hasn't been seen since the 1970's. It also makes the Fed's job a lot harder because it has to deal with both problems at the same time. The reaction in the financial markets was instructive. Bonds rose while stocks fell. At least for today, fears of economic slowing trumped inflation fears. A plunge in the stock of MMM also unsettled the market. The daily bars in Chart 1 show the big industrial stock plunging more than 8% today to fall below its 200-day moving average on massive volume. The stock had been a Dow leader throughout most of 2006. Not anymore. The weekly bars in Chart 2 show MMM failing a test of its 2004 peak near 87. The stock now appears headed toward the lower end of its two-year trading range. That made the Dow the biggest percentage loser today among the major market indexes. That's a change from recent trends.
Chart 1
Chart 2
INDUSTRIALS AND TRANSPORTS WEAKEN WHILE UTILITIES CLIMB... Chart 3 shows the Dow Industrials falling back below their 50-day average today. The daily stochastic lines (below the chart) also show a short-term overbought condition over 80. That's the case with most of the major stock indexes, and may partially explain today's selling. The fact that virtually all of the other major market indexes have failed an attempt to clear their 50-day lines keeps the staying power of the recent rally in doubt. Although the Dow Transports have been the strongest part of the Dow family, it too is starting to back off from resistance at its high near 5000 (Chart 4). Both of its oscillators are in overbought territory. At the moment, the strongest of the Dow indexes is the utilities. Chart 5 shows the Dow Utilities continuing to climb higher. So is their relative strength line. I suspect that's due to the defensive nature of utilities and their dividends. Utilities aren't the only defensive groups to rally this week.
Chart 3
Chart 4
Chart 5
DRUGS AND STAPLES MOVE HIGHER... There may a negative warning in the fact that two of the strongest groups this week are defensive in nature. The Pharmaceutical Index had one of its best weeks of the year and is nearing a test of its spring high. Its relative strength ratio has already reach a new high for the year. Consumer staples usually outperform the market when investors perceive economic slowing. Chart 7 shows the Consumer Staples SPDR (XLP) hitting a new 52-week high this week. Although a lot of that buying came from tobacco companies, its relative strength line has been rising for the last two months. Gold and energy stocks also had a strong week. Another negative market message may be seen in relative weakness in technology stocks.
Chart 6
Chart 7
CHIPS AND INTERNET DRAG NASDAQ LOWER ... I've said it before and I'll say it again. It's extremely hard for the stock market to sustain a rally attempt without help from the technology sector. Relative weakness in this key sector is usually a recipe for a weaker market. That's why the next two charts are so discouraging. The IIX Internet Index fell hard at the end of the week after failing a test of both moving average lines. Even worse, its relative strength ratio fell to a new 2006 low. Semiconductors did even worse. Chart 9 shows the SOX Index and its relative strength line hitting new lows. That kept the Nasdaq market under pressure.
Chart 8
Chart 9
NASDAQ 100 NEARS OLD LOWS ... On June 27, I showed the Nasdaq 100 testing chart support at last October's low (June 27, 2006). A rally attempt did take place from that level, but a very weak one. The QQQQ now appears headed for another test of the October low. If it does, that will be an important test for the entire market. That's because the direction of the Nasdaq is very important to the market as a whole. The fact that the QQQQ/SPX ratio continues to hit new lows is troubling enough. Any violation of the recent lows by the QQQQ itself would spell even more trouble. The poor action in the Nasdaq market, combined with the late week downturn in the rest of the market, leaves the summer rally attempt looking more fragile.
Chart 10
