MORTGAGE CONCERNS CONTINUE TO PLAGUE MARKET -- BROKERS AND REITS LEAD DECLINE -- RISING YEN HELPS EXPLAIN GOLD DROP -- DOW AND S&P 500 ARE HEADED TOWARD 200-DAY AVERAGES

MORTAGE SITUATION WORSENS... Since the market meltdown started last week, the economic community (aided by a willing TV media) keeps telling us that the subprime mortage problems are relatively limited and shouldn't impact on the economy or the stock market. And each day everything tied to housing and real estate continues to lead the market lower. Take a look at the first four charts. A nearly 5% loss has pushed Countrywide Financial further below its 200-day moving average (Chart 1). Further proof that mortgage problems are spreading is seen in Chart 2 with the Broker/Dealer Index closing below its 200-day line. The XBD/SPX ratio has fallen to the lowest level in six months. [As I explained last Monday, brokerage stocks are leading indicators for the rest of the market]. REITs continue to tumble on heavy volume (Chart 3). So are homebuilding stocks. Chart 4 shows Pulte Homes trading at a four-month low. Those same economists who keep telling us that nothing has changed in their positive economic outlook got news today that the U.S. service sector rose at the slowest pace in four years in January, which was well below their expectations. By the time they figure out what else has changed, it will be too late to do anything about it. Please remember that the stock market is a leading indicator of the economy. Not the other way around. Asking economists to analyze the stock market drop is like driving a car by looking out the rear window.

Chart 1

Chart 2

Chart 3

Chart 4

RISING YEN HELPS EXPLAIN GOLD DROP ... I keep getting asked to explain the drop in gold. There are several possible explanations. One is simply that a lot of traders were forced to dump their winning gold positions to help pay off margin calls from a plunging stock market. Another reason may be tied to the sudden surge in the yen. Chart 5 shows the Japanese yen surging to a new three-month high over the last week. Chart 6 shows gold denominated in yen (GLD:$XJY) plunging heavily. [A market quoted in a rising currency like the yen will fall faster than one quoted in a falling currency like the dollar]. The Japanese are big gold traders. The surging yen exaggerated drop in the price of bullion and probably contributed to Japanese bullion selling. Chart 7 shows that the drop in the Gold Trust Shares (GLD), which is quoted in dollars, hasn't been nearly as bad as in Japan. Even so, GLD has been falling on heavy volume and is nearing a test of its October/January up trendline.

Chart 5

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VOLATILITY KEEPS RISING ... Last Tuesday, I showed the CBOE Volatility (VIX) Index surging more than 60% to a new eight-month high. I warned that rising volatility was bad for the market. [A rising VIX is associated with falling stock prices]. Chart 8 shows the VIX reaching a new high again today. I suspect it's headed toward the highs of last May. Chart 9 shows the Nasdaq Volatility Index (VXN) surging as well. That's not good for the Nasdaq market. One way to protect against (or profit from) a falling Nasdaq market is to buy a short Nasdaq fund. Over the weekend, I showed the ProShares Ultra Short ETF (QID) giving a buy signal. One of our readers objected to my showing an "ultra" fund which has twice the leverage of a normal fund. [Ultra funds move twice as fast as their benchmark index]. Chart 10 shows the ProShares Short QQQ Fund, which trades in the opposite direction of the Nasdaq market. It's also designed to rise the same amount as the Nasdaq falls.

Chart 8

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Chart 10

ETFS FOR BONDS AND THE YEN ... I was asked if there were any ETFs that allowed purchases of Treasury notes (or bonds) and the Japanese yen. The answer is yes. Chart 11 shows the 7-10 Year Treasury Bond Fund (LEH) which is moving above its early December high. Chart 12 shows the relatively new CurrencyShares Japanese yen Trust (FXY) which is traded on the NYSE. It too is rising.

Chart 11

Chart 12

MARKET INDEXES HIT NEW LOWS ... The stock market continues to erode. The next two charts show the Dow and the S&P 500 closing at new 2007 lows today. Both indexes appear headed toward their (red) 200-day moving averages. The horizontal lines how where overhead resistance lies if the market were to attempt a short-term rally before that happens. An eventual drop to the 200-day line would put both indexes 8% below their recent highs. That's about in line with a couple of other downside corrections over the last four years (including last May). What the indexes do when they get to those 200-day lines will determine if this is just another 8% correction, or something more serious.

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Chart 14