FLAT CORE PPI HELPS MARKET RECOVER MOST OF THURSDAY'S LOSSES -- BUT RETAILERS CONTINUE TO SHOW RELATIVE WEAKNESS -- INSURANCE GROUP IS STARTING TO SHOW NEW UPSIDE LEADERSHIP -- AMERICAN INTERNATIONAL GROUP ON VERGE OF MAJOR BULLISH BREAKOUT

RETAILERS LAG MARKET ... On Saturday April 14, I ended a weekly wrapup with advice to "follow the leaders". The leaders at that time were materials, energy, utilities, telecom, healthcare, and consumer staples. One group not on that list was retailers. The next two charts show why. In a market uptrend, I generally favor stock groups that are showing relative strength. Since the start of the year, one of the groups that has underperformed the S&P 500 has been retail. That's an example of relative weakness. The daily bars in Chart 1 show three negative problems. One is simply the inability of the S&P Retail Index to reach a new high (while the S&P 500 has). The second is the sharp drop in the RLX/S&P 500 ratio since the end of February. The third is the fact that the RLX is threatening its 50-day moving average. That makes this a good group to avoid.

Chart 1

RETAILERS ARE GETTING MARKED DOWN ... Actually, retailers have been underperforming the market for almost two years. Chart 2 compares a weekly chart of the Retail Index (red bars) to a ratio of the RLX divided by the S&P 500 (a relative strength line). Notice that retailers led the market during its 2003 upturn, and continued to do so until the middle of 2005 (first arrow). The retailers have been market laggards since then. The group started to do better from last summer to this February. The 2007 downturn the the RS line, however, is a bad sign for the group (second arrow). In the late stages of a mature bull market, it's generally a good idea to avoid market laggards. That includes retailers.

Chart 2

TAKING OUT INSURANCE... One group that's starting to show new upside leadership is insurance. Earlier in the week I showed two insurance stocks -- AIG and Travelers -- that were starting to show new leadership within the financial sector. Fidelity also lists its insurance fund as one of the top performers for the week. Let's start there. Chart 3 shows Fidelity Select Insurance (FSPCX) hitting a new high. What caught my eye, however, was its relative strength (solid) line. The FSPCX/SPX ratio peaked in late 2005 and has been weak since then. In other words, insurance has been a market laggard for about eighteen months. To the bottom right, however, the ratio has started to jump. Chart 4 gives a closer look at the ratio itself. If the ratio can break through its 2006-2007 highs, that would be a good sign for the insurance group. Part of the reason for that may have to do with interest rates.

Chart 3

Chart 4

INSURANCE STOCKS TIED TO INTEREST RATES... The red line in Chart 5 is a ratio of the S&P Insurance Index (GSPINSC) divided by the S&P 500. The green line is the yield on the 10-year T-note. There seems to be a negative correlation between the two lines. Like most financials, insurance is considered to be interest-rate sensitive. That means they do best when rates are falling. The chart seems to bear that out. The plunge in rates from 2000 through 2002 produced strong insurance results. The group hasn't done as well since rates started rising in 2003. It's possible that the new interest in insurance stocks in 2007 may be predicated on ideas that a slowing economy will keep long-term rates down and may even encourage the Fed to lower rates later this year. Financial stocks like insurance usually do better in a slowing economy.

Chart 5

AIG NEARS MAJOR BREAKOUT... A lot of the recent interest in insurance may be tied to the performance of American International Group, which is the biggest holding in the Fidelity Insurance Fund. Chart 6 shows AIG surging 10% since the start of April on rising volume. The big insurer appears to be on the verge of a new 52-week high. Friday's buying is on especially heavy volume. Notice the upturn in the stock's relative strength line (top of chart) over the last month. The monthly bars in Chart 7 also paint a pretty picture. They show the stock on the verge of a new three-year high, which would put it in position to challenge its 2005 peak at 75.75. Its RS ratio (solid line) is just starting to rise after several years of weak performance. Because of its size, new buying in AIG is giving a nice boost to the entire insurance group.

Chart 6

Chart 7

FLAT PPI BOOSTS MARKET ... Friday's news that the core PPI for April was flat allowed the market to recover most of Thursday's losses. Some of our shorter-term indicators like MACD did turned negative on Thursday and remain so at week's end. The good news is that the 20-day moving average (which defines the market's short-term trend) held. That's true of both the S&P 500 (Chart 9) and the Nasdaq Composite (Chart 10). The Nasdaq also remained above its February peak at 2531. That means that little or no damage was done this week. That doesn't change the fact that the market is dangerously extended. Nor does it erase the negative divergence in the new highs list that I wrote about earlier in the week. We'll have to wait until next week to determine if Thursday's selloff was just one-day flop or the start of a market pause.

Chart 8

Chart 9