MARKET IS IN DANGER OF GIVING FIRST MAJOR SELL SIGNAL IN THREE YEARS -- HOMEBUILDERS PLUNGE TO LOWEST LEVEL IN TWO YEARS AS CONSUMER DISCRETONARY STOCKS LEAD MARKET LOWER
HOMEBUILDERS CONTINUE TO CRUMBLE... Yesterday I wrote about how relative weakness in retail stocks over the last year was an early sign that higher energy prices and rising interest rates were starting to hurt the economy and the stock market. It was reported this morning that June's retail sales fell "unexpectedly" by -0.1%. It was also reported that consumer confidence fell. Outside of retailers, there's another market group that's been falling hard for the last year and has cut into discretionary spending and consumer confidence. That group is the homebuilders. It's no coincidence that they're today's weakest market group at the same time that the consumer discretionary stocks are the day's weakest sector. As investors see equity in their homes drop, they're less inclined (or unable) to use their homes as an ATM card to fund purchases of cars, furniture, and other big ticket items. That's a bad sign for the economy. The impact of homebuilding stocks on the consumer discretionary group is shown in Chart 1. The red line is the Consumer Discretionary SPDR (XLY). It peaked at the start of 2005 and started to underperform the S&P as well. That can be seen by its falling relative strength line (blue arrow). The first XLY peak at the start of 2005 was caused by weakness in retail stocks (which we showed yesterday). The second XLY peak formed last summer was caused by a major top in homebuilders (brown line). Since last July, the PHLX Homebuilding Index ($HGX) has fallen 28% (not counting today) while the XLY has fallen 6%. [Retailers have lost 7%]. That compares to a 1.5% gain in the S&P 500 over the last twelve months. Friday's 3% loss in homebuilders pushed that index to the lowest level in two years. That's weighing on the entire market. What surprises me isn't that these negative trends are playing themselves out. But that Wall Street seems unaware of these trends that have been clearly in place for the last year. Hence the use of the word "unexpected" by today's media headlines. They're not "unexpected" to us or to you.
Chart 1
ANOTHER LOOK AT BEAR FUNDS ... Back in mid-May, I recommended raising cash levels (through a money market fund) and switching to more defensive groups like consumer staples. I also recommended taking positions in bear funds. Two that I mentioned in particular were the ProFunds Short OTC Investment Fund (which trades inversely to the Nasdaq 100) and the ProFunds Bear Fund (which trades in the opposite direction to the S&P 500). Both funds are shown in Charts 2 and 3 (plotted through Thursday). On June 28 I wrote about the possibility of a summer bounce starting in early July that could occur prior to a more serious market downturn into the autumn (June 28, 2006). I wrote that I would "treat any summer bounce as another selling opportunity". I did, however, suggest using some tight stoploss protection on the two bear funds just below their mid-June lows in case a short-term bounce did materialize. I wrote that a close below 19.95 in the SOPIX or 30.26 in the BRPIX would justify some profit-taking. Both stops were hit within days after that article. Chart 2 shows, however, that the SOPIX has since resumed its uptrend, while the BRPIX has bounced off its 50-day moving average and is rising again. I'm operating on the assumption that those who followed my June 28 advice to sell "some" of their position are still holding on to a portion of it. Those with no bear funds might want to use any minor pullback next week (or short-term market bounce) to buy some.
Chart 2
Chart 3
EMERGING MARKETS ARE TOO RISKY ... I've often written in the past that rising commodity markets are usually bullish for emerging markets. Recently, however, commodity prices have risen while emerging markets have fallen. I believe that their recent decoupling is due to other global factors -- like rising global interest rates and growing risk aversion. I recently wrote an article suggesting that the six-year dominance by small cap stocks in the U.S. appeared to be ending. I often think of emerging markets as the global equivalent of the small cap universe (since developed stocks markets tend to be bigger and more liquid). If global stocks are peaking at this point in time (which they appear to be doing), I doubt that investors would choose to put their money into the riskiest stocks of all which are emerging markets. Chart 4 shows the MCSI Emerging Markets iShares (EEM) peaking in May and trading back below its 200-day moving average. The falling relative strength line is even more telling. It shows that emerging markets have fallen faster than the U.S. market since the start of May. Over those two bearish months, the S&P fell 6% while the EAFE (Europe Australia and Far East) ETF lost 10%. The Emerging Market ETF fell by a whopping 20% making them the worst asset class since global markets peaked during May. I don't see any signs of that changing over the short run -- even if commodity prices continue to rise. In the past, I've written bullish articles on Japan and continue to believe that it represents the best global market value. Chart 5, however, shows the Japan iShares (EWJ) also trading well below their 200-day moving average. Although I may like Japan on a longer-range basis, the current downtrend argues against bullish positions at this point in time. The same is true for most other global stock markets.
Chart 4
Chart 5
VIX IS RISING AGAIN ... One of the reasons I turned more bearish on the market back in May was the sharp rise in the CBOE Volatility (VIX) Index. A rising VIX is associated with falling stock prices. After rising into mid-June, the VIX pulled back to its 200-day moving average which helped set the stage for the market bounce that lasted into early July. Over the last two days, however, the VIX has started to climb again as shown in Chart 6. If you compare The VIX to the S&P 500 in Chart 7, you'll see that they trend in opposite directions. Chart 7 shows the S&P trading well below its 200-day average. Notice that the daily MACD histogram has also turned down (red circle). Even more serious is the fact that the weekly and monthly MACD lines are also turning down.
Chart 6
Chart 7
S&P 500 TESTS MAJOR UP TRENDLINE ... Earlier in the week I showed a number of moving averages that appeared to be on the verge of giving major sell signals. Here's another long-term support line to watch. The S&P 500 is bearing down on a two-year support line that starts in the summer of 2004. A break of that important support line would signal a drop to last October's low at 1168. That would be the first double digit percentage loss since the bull market started more than three years ago. I think the odds are pretty good that it's going to happen. The weekly MACD lines have been bearish for the last two months. This week's downturn has widened the spread between the two MACD lines which means that downside momentum is intensifying. The monthly chart is also in a very dangerous position.
Chart 8
MONTHLY MACD LINES TURN NEGATIVE ... This may be the most important chart of all. It's a monthly bar chart of the S&P 500 with the MACD lines (and histogram) bars overlaid. Major buy and sell signals are given when the two lines cross. The last buy signal was given in the spring of 2003 (see green circles). At the same time, the histogram bars moved over zero. [The histogram bars plot the difference between the two MACD lines. Crossings of the zero line by the histogram constitute major buy and sell signals]. The MACD lines are now in negative territory and the histogram bar is below zero (red circle). If that negative pattern continues through the balance of July, it will constitute the first major sell signal in more than three years.
Chart 9
WHERE TO BE AND WHERE NOT TO BE ... Please check out "John's Latest Performance Chart" which shows group rankings for the entire year. It carries a number of messages. The groups to the left show where you might want to be in the market -- like energy, gold, consumer staples, energy, and large cap industrials. The groups to the right show where you don't want to be -- like homebuilders, retailers, semiconductors and the Internet. That type of group alignment also shows a very defensive market with special weakness in consumer discretionary stocks. That's not a good sign for the market or the economy.
