WEAK JOBS REPORT HELPS BONDS BUT HURTS DOLLAR -- THAT SHOULD HELP GOLD -- DEFENSIVE INVESTORS SHIFT TO LARGE CAP VALUE STOCKS -- A MIXED MESSAGE FOR STOCKS

BOND YIELDS HIT FOUR-MONTH LOW... The U.S. economy added fewer jobs than expected during July and the unemployment report rose for the first time in five months to 4.8% from 4.6%. The weak job report is the latest in a string of signs that the economy is weakening. That's usually good news for bond prices which do better in a slowing economy. Technically, this is a logical spot for bond prices to start doing better and bond yields (which move in the opposite direction) to start dropping. Chart 1 is a monthly bar chart of the 10-year Treasury Note yield. The chart shows the 10-year yield testing a a major down trendline connecting the highs of 1994, 2000, and 2006. The last time I showed this chart I pointed out that this would be a logical spot for bond yields to start to weaken. And that's what they've been doing. The daily bars in Chart 2 show the reaction to today's weak news. The 10-year yield has fallen below its June low to the lowest level in four months. Besides pushing bond prices higher, falling bond yields have also given a boost to market sectors sensitive to interest rates -- like banks, utilities, and REITs and to defensive stocks in general -- and to safer large cap stocks (especially dividend-paying ones) at the expense of riskier smaller stocks. Falling rates are hurting the dollar which is giving a boost to gold.

Chart 1

Chart 2

EUROPEAN RATE HIKES BOOST CURRENCIES... Rate hikes by the British and Europeans this week have given a big boost to their currencies at the expense of the U.S. dollar which continues to weaken. Chart 3 shows the British Pound hitting a new 52-week high today. Chart 4 shows the Euro not far behind. The Euro has reached a two month high and is nearing a challenge of its June high at 129.74. Although the Japanese yen has been much weaker than the European currencies, it's beginning to bounce as well. Chart 5 shows the yen trading over its 50-day average for the first time in two months. [The Australian Dollar is also rising after a rate hike down under]. The dollar is also being hurt by increasing signs of economic weakness (like today's employment report) and growing expectation for the Fed to stop raising rates next week. Futures traders rated the likelihood of another rate hike next week as low as 16% after today's job report. Rising foreign rates -- and flat or falling U.S. rates -- hurt the dollar. But that's usually good for gold.

Chart 3

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Chart 5

GOLD ETF NEARS WEEKLY BUY SIGNAL ... On Wednesday, I showed the Gold ETF (GLD) giving a Parabolic SAR buy signal on its daily chart. I pointed out, however, that it still needed to give a buy signal on the weekly chart. The weekly bars in Chart 6 shows that the GLD needs to hit 65.75 to give a weekly SAR buy signal. It also needs to clear its July peak at 66.42. The weekly bars in Chart 7 show a similar pattern for the PHLX Gold & Silver (XAU) Index. It needs to reach 151 to exceed its July high and trigger a weekly SAR buy signal. With the dollar under pressure, I think there's a very good chance of that happening. Silver has already reached a two-month high.

Chart 6

Chart 7

LARGE CAP VALUE IS TOP GROUP SINCE MAY... Since May, the market has undergone a shift from small caps to large caps. But there's more to it than that. Investors are also favoring "value" over "growth". Since the start of May, the S&P 500 Large Cap Index has lost 2.3%. Large cap value is the only group to do better (-1.3%). Chart 8 is a relative strength ratio of the S&P 500 Large Cap Value Index (SVX) divided by the S&P 500. The RS has been rising since May. That doesn't mean that it made money. But it lost less than the S&P 500. Large cap growth lost 3.3% to come in second. The two worst groups were small cap categories. Small cap value lost 6.8%. The worst category was small cap growth (-8%). Chart 8 is a ratio of the S&P 600 Small Cap Growth Index (CKG) divided by the S&P 500. Its RS line has been dropping since the start of May. That all makes sense. In a defensive market with a slowing economy, investors usually gravitate toward large cap value. One vehicle for doing that is S&P 500 Value iShares (IVE). It's not hard to see why. Its heaviest weighting is in financials (36%) -- banks in particular -- which stand to benefit from falling rates. Some of its big stock holdings are in defensive stocks like Pfizer and Verizon as well as energy (Chevron Texaco). Large value stocks also pay dividends.

Chart 8

Chart 9

A MIXED MESSAGE FOR STOCKS ... Stocks rose initially on today's weak jobs report based on the view that more economic slowing would give the Fed reason to stop raising rates next week. That tells us a lot about the precarious state of the market when Wall Street is reduced to cheering bad economic news. That seems more like desperation than conviction. If you check out "John's Latest Performance Chart", you'll see that investors are taking a more skeptical view of things. The top performing groups over the last month are gold, natural gas, telecom, pharmaceuticals, utilities, and consumer staples. All are defensive in nature. Two of the weakest groups are transportation and retailers. That's not a sign of a confident stock market. Neither is the recent action in the S&P 500 SPDRS. After rising to to a three-month high in the morning, the SPY fell back in the afternoon to record a downside reversal day. That put it back below its early July peak at 128. And it did so on rising volume. That's not a bullish sign. I recently complained about the lack of upside volume in the market to support its July price advance. The On Balance Volume (OBV) line at the bottom of Chart 10 shows it better. The OBV is a running cumulative total of volume on up days minus down days. The OBV line should be rising with the price. In fact, it's stayed flat throughout the July rally. That type of negative divergence doesn't inspire confidence in a long-running summer rally. It's hard to predict what the Fed will do next week or how the market will react to it. At this point, technical indicators are mixed. All we can do is wait and watch and react accordingly. It's not a time to be aggressive either way. Having said that, I'd continue to stick with an overall defensive strategy until market action dictates otherwise.

Chart 10