MARKET TESTING MAJOR SUPPORT LEVELS AGAIN -- DRUGS HAVE A STRONG WEEK -- TRANSPORTS PLUNGE AS UTILITIES SURGE -- SMALL CAPS GIVE MAJOR SELL SIGNAL -- STAY DEFENSIVE

DRUGS LEAD HEALTHCARE HIGHER... Whenever we list defensive groups that usually do better when the market gets into trouble, the usual candidates are consumer staples, utilities, and healthcare. Consumer staples and utilities have continued to be the market's top performers over the last couple of months. It looks like healthcare may finally be starting to attract some defensive money as well. And a lot of that money is going into the big pharmas. That can be seen in Chart 1 which shows the Pharm Holders (PPH) breaking out to a new four-month high. That happened while the rest of the market was falling at week's end. The PPH:SPX relative strength ratio has already hit a new high for the year. That shows that drug stocks are finally fulfilling their traditional role as a safe haven in a falling market. That gave a big boost to the entire healthcare sector. Chart 2 shows the Health Care Sector SPDR (XLV) climbing to a three-month high with a rising relative strength line. It still needs to clear its 200-day line, however, to confirm that the new uptrend has staying power.

Chart 1

Chart 2

SOME DRUG LEADERS ... It just so happens that the most heavily weighted stocks in the two healthcare ETFs shown above are big pharmas. That's why a rally in one usually coincides with a rally in the other. One of this week's stop drug performers was Abbott Labs. Its daily chart shows the stock having broken through its spring high at 45 and heading toward last year's peak near 48 (Chart 3). Its relative strength line is rising as well. The two most heavily weighted stocks in the PPH and the XLV are Johnson & Johnson (JNJ) and Pfizer (PFE). Charts 4 and 5 shows both of those big pharmas surging at week's end. JNJ is the stronger of the two and is on the verge of reaching a new 2006 high. Its relative strength line turned up in May (just as the market peaked) and has been rising since then. Chart 5 shows Pfizer moving over its 200-day average on Friday. Its relative strength line, which had been dropping since March, has also turned up. You might want to add big pharmas to your defensive list.

Chart 3

Chart 4

Chart 5

UTILITIES SURGE WHILE TRANSPORTS PLUNGE ... A week ago Thursday (July 13) I wrote about cyclicals and transportation stocks leading the day's market decline. I showed the Morgan Stanley Cyclical Index breaking its 200-day moving average. I also show the Dow Transports breaking its 50-day line. I pointed out while a lot of the selling came from the airlines, several rails and truckers were starting to break down. That was the case again this week as the transports were one of the worst performers. The daily bars in Chart 6 show the Dow Transports falling all the way to its 200-day moving average. Two of the week's worst performers -- the trucker J.B. Hunt and the railroad Norfolk Southern -- both fell below their 200-day lines (Charts 7 and 8). The Airline Index (XAL) ended back below its 200-day line as well (not shown here). While the transports fell, utilities continued to climb. The green line on top of Chart 6 shows the Dow Utilities hitting a new six-month high. The relative strength ratio beneath the price bars in Chart 6 is the transports divided by the utilities. The line peaked in May and has fallen to a six-month low. That makes sense. Utilities are defensive stocks that do better when the market is week (partially because of dividends and as a proxy for bonds). The transports are cyclical stocks that rise and fall with the economy. The fact that investors are selling the transports and buying utilities is just another sign that the market is weakening in expectation of a slower economy.

Chart 6

Chart 7

Chart 8

MOVING AVERAGES TURN NEGATIVE ... I recently wrote about two moving average crossover signals to watch for. Both turned negative this week. The daily bars in Chart 9 show the blue 50-day average slipping below the red 200-day line (see red circle). That's the first time that's happened in two years. Although not shown here, the 13-week EMA also closed below the 34-week EMA for the first time in more than three years. The third moving average signal (and maybe the most important) is the S&P's test of the green 400-day average (the equivalent of the 20-month average). A close below that long-term support line would leave little doubt that the market is slipping into a bear market.

Chart 9

SMALL CAPS ON MAJOR SELL SIGNAL ... Last Friday I showed the S&P 500 Index on the verge of giving its first "monthly" MACD signal in more than three years. It's been in negative territory for two weeks now and remains on a "preliminary" sell signal. The only thing preventing an "official" signal is a monthly finish in negative ground. One of the more negative features of the recent market slide is that it's being led by the Nasdaq and small cap stocks. I recently wrote an article to the effect that small caps appeared to be ending their six-year run of stronger performance. I also wrote that falling small caps were part of investors' growing aversion to risk. The bad news is that small cap stocks are also flashing major sell signals. The two MACD lines overlaid over the monthly bars of the S&P 600 Small Cap Index turned bullish in the spring of 2003. That can be seen by the MACD histogram bars crossing over zero. The monthly histogram bars have turned bearish for the first time since the bull market began. [The S&P 400 MidCap Index has also turned negative]. Unless the market stages a rally between now and the end of July, it's in danger of giving a major MACD sell signal. Judging from this week's failed Bernanke bounce, I wouldn't bet on much of a rally taking place over the next week.

Chart 10

COMMODITY STOCKS STUMBLE ... Up until this week, commodity stocks had been doing pretty well. On Tuesday, however, I recommended taking profits in gold and gold shares (or holding off on any further buying) for the time being. The Gold and Silver (XAU) ended the week back below its 50-day average and is threatening its 200-day line (Chart 11). Oil Service stocks did much worse. Chart 12 shows the Oil Service Holders (OIH) falling well below its 200-day line and close to a new 2006 low. The Materials Select SPDR (XLB) is also trading beneath its 200-day line. The selling in commodity-related stocks shrinks the list of potential safe havens even further. About all that's left is consumer staples, healthcare (especially big pharmas) and utilities. Money market funds (cash) remain the safest haven of all. Bear market funds are also an excellent way to profit from a more serious market downturn or to hedge one's stock portfolio. At this point, the major market indexes would have to exceed their July highs to warrant the selling of those bear funds.

Chart 11

Chart 12