MORTGAGE CONCERNS HURT FINANCIALS BUT BOOST BONDS AND UTILITIES -- COMMODITY PRICES ARE RISING AGAIN -- WHY RISING GOLD IS GOOD FOR JAPAN -- KLA TENCOR NEARS BULLISH BREAKOUT

MORTGAGE CONCERNS WEAKEN HOUSING SECTOR ... On February 12, I showed a chart of Countrywide Financial starting to break down on rising volume. It's fallen even further since then and is now threatening its 200 day moving average (Chart 1). I took its earlier weakness as a sign that it was being hurt by growing concerns about sub-prime mortgage defaults. Those concerns are effecting the entire housing and real estate sectors. Chart 2 shows the Homebuilder SPDR (XHB) falling below its 50-day moving average today. The homebuilding ETF has been falling on heavy volume for the entire week. Its relative strength ratio (top of chart) is rolling over as well. I also suggested on February 12 that it might be time to start "lightening up" on REITS. Chart 3 shows why. Real Estate iShares (IYR) had started to drop on rising volume. That's not a good sign in a continuing uptrend. Although no serious damage has been done to its uptrend, I continue to believe that the overbought REIT is vulnerable to more profit-taking. Mortage concerns are spilling over to the entire financial sector today. As a result, banks and brokers are among the day's weakest groups.

Chart 1

Chart 2

Chart 3

BROKERS LEAD FINANCIAL DECLINE... Brokerage stocks led the day's decline in financial shares and are suffering some chart damage in the process. Chart 4 shows Lehman Brothers falling below its 50-day average for the first time in three months. And it's doing so on rising volume. Merrill Lynch has fallen to the lowest level in 2007 in heavier trading. It's well below its 50-day line. The stock is heading toward its early December low at 85. This is of some concern to the broader market. That's because the relative strength ratio (top of Chart 5) is also falling. Brokerage stocks (which are viewed as market leaders) had been leading the market advance since last summer. Any serious weakness in that group could lead to a market correction. At the same time that financial stocks are falling, bond prices and utilities are rising.

Chart 4

Chart 5

BONDS AND UTILITIES BENEFIT FROM STOCK SELLING ... It may seem strange that financial shares are dropping along with bond yields, which means that bond prices are rising. [Bond prices and yields move in opposite directions]. The reason for that apparent divergence is that falling financial shares are worrying stock investors who are buying bonds as a defensive maneuver. Chart 6 shows the 7-10 Year Treasury Bond fund (IEF) trading at a two month high and back over its 50-day average. At the same time, utility stocks (Chart 7) are rising in a falling market. That's because utilities are often viewed as stock proxies for bonds. Utilities (some of which have natural gas exposure ) may also be benefiting from recent strength in energy prices and shares. Falling bond yields are also weakening the U.S. Dollar which is causing more buying of precious metals and commodity markets in general.

Chart 6

Chart 7

COMMODITY PRICES ARE RISING AGAIN ... Just when it seemed like inflation was on the wane, another rally in commodity markets suggests just the opposite. [This week's unexpected jump in the core CPI also caught the market's attention]. Chart 8 shows the DB Commodities Tracking Fund (DBC) challenging its late November peak at 25.33. A close above that chart barrier would signal even higher commodity prices. Most commodity indexes benefitted from crude oil closing back over $60 and strong gains in precious metals, copper, and agricultural markets. [Corn hit a new 10-year high]. Since most commodity indexes have a heavy energy weight, they've been held down by energy prices since the start of the year. Chart 9 gives a better idea of how commodity markets are doing outside of energy. The CRB Continuous Index (CCI) has a smaller energy weighting than most other commodity indexes (including the CRB Reuters/Jefferies Index) and a heavier agricultural weighting. Chart 9 shows the CCI breaking out to a new record high on Thursday. The commodity bull market is alive and well. The Fed recently cited the drop in commodity prices as evidence that inflation was slowing. This week's upturn may cause some rethinking of that view.

Chart 8

Chart 9

WHY NIKKEI BENEFITS FROM RISING GOLD... Since I've been focused on the rising tide in Japan and the gold market recently, this is a good time to revisit a theme that I wrote about last year having to do with the link between rising gold prices and the Japanese stock market. I don't think it's a coincidence that in the same week that gold prices surged to a nine-month high, the Japanese market rose above 18K for the first time in seven years, and was the world's strongest stock market. First a word about relative strength. The monthly bars in Chart 10 show the Nikkei bottoming at the start of 2003 below 8K and closing over 18K this week. The orange line in Chart 10 is the more important line. It's a relative strength ratio of the Nikkei divided by the S&P 500. That line also bottomed in 2003 and is starting to rise again after a weak 2006. That means that Japan turned into a global leader in 2003 after a decade of underperformance. I've suggested before that rising gold (and other commodities) over the last five years has helped Japan, because it suggested a global shift away from deflation (which was Japan's main problem) to global inflation. Chart 11 shows a remarkably close correlation between the two markets. Japan underperformed other global markets last year as gold corrected (see Nikkei:S&P ratio at bottom of chart]. It's now outperforming again as gold is breaking out to the upside.

Chart 10

Chart 11

KLA TENCOR IS STOCK STANDOUT ... Semiconductors had a standout performance in a generally flat market week. While Analog Devices (and a few others I showed yesterday) had bigger percentage gains, KLA Tencor appears to have one of the most promising chart patterns. The stock still had a pretty good week. A 3.9% gain on Friday pushed it up 6.7% for the week. Friday's 52-week high also came on very strong volume. It's the stock's monthly chart, however, that caught my attention. The monthly bars in Chart 12 show KLAC in a triangular shaped pattern since 2000. In fact, the stock has been a very poor performer since then. That may be about to change. This week's advance broke a seven-year down trendline, and put the stock very close to breaking through chart resistance formed at the start of 2006. A close above that resistance barrier would be the first bullish breakout in seven years. The point & figure boxes in Chart 13 shows KLAC already on a buy signal at 53. A close at 55 or higher, however, would push it through its early 2006 highs and would represent a major buy signal.

Chart 12

Chart 13

DOW UPTREND STILL INTACT ... The Dow lost some ground this week, but not enough to disturb its p&f uptrend. A 38 point Friday loss pushed the Dow to a weekly close of 12647. The Dow would have to drop to 12600 to cause a three-box reversal to the downside. More importantly, it would have to close at 12500 or lower to trigger the first sell signal since last August. A close below that level would also violate the mid-February low on its daily bar chart and its 50-day moving average. Despite overbought readings, and the flattening out of various momentum indicators, the price uptrend has yet to turn down. That's the most mportant market indicator of them all.

Chart 14