HOMEBUILDING CHARTS SUGGESTS HOUSING SITUATION IS GOING TO GET A LOT WORSE -- DR HORTON AND LENNAR BREAK NECKLINES IN MAJOR HEAD AND SHOULDER TOPS -- VIX HITS NEW 2007 HIGH -- RISING YEN THREATENS GLOBAL RALLY

HOUSING SECTOR CONTINUES TO WEAKEN ... I've suggested for some time that those calling for a housing bottom look at the long-term chart of homebuilders. If they had, they wouldn't be as surprised as they seem to be. [That includes the heads of the Fed and the Treasury]. Homebuilders were down 5% at one point today and pulled the rest of the market down with them. If the chart of the PHLX Housing Index (HGX) is any guide, things could get a whole lot worse. That's because the HGX is threatening to break its mid-2006 low near 186. A drop below that level would put the homebuilder index at the lowest level in three years. The chart shows that homebuilders peaked exactly two years ago. The actual bear signal, however, took place in the spring of 2006 when the HGX broke its major support line (see arrow). It's been all downhill since then -- both on an absolute and a relative basis. While the HGX is testing its 2006 low, its relative strength line (top of chart) is well below it. The charts of several individual homebuilders look even worse.

Chart 1

HOMEBUILDERS BREAK NECKLINES ... The charts of two homebuilders plotted below show the same chart pattern. And it's a bearish one. The pattern is a "head and shoulders" top that started with a pullback in early 2004. The H&S topping pattern is marked by three successive peaks in which the middle peak is the highest of the three (called the "head"). The two surrounding peaks (called the "shoulders") often peak at about the same level (but below the head). The "neckline" is a trendline drawn below the two lows formed by the shoulders. The "neckline" is often flat or shows a slight upward slope. The break below the neckline is a bearish sign that the major topping pattern has been completed and lower prices are in store. Charts 3 and 4 show DR Horton and Lennar trading well below their necklines (as are other builders). Those charts tell us that the housing situation is going to get a lot worse.

Chart 2

Chart 3

BULLISH PERCENT INDEX GIVES SELL SIGNAL ... Last Friday, I wrote about weakness appearing in the NYSE Bullish Percent Index (BPNYA). Since then, it's gotten a lot weaker. The BPNYA is the percentage of stocks that are in point & figure uptrends. As I explained before, readings over 70 suggest an overbought market. Problems start, however, when the line falls back below the 70 level as it did last week. I suggested, however, that it would take a drop below its March low near 62 to give a bona fide sell signal. Chart 4 shows that the BPNYA did just that yesterday. The point & figure in Chart 5 shows the sell signal more clearly. The zero column to the right shows the recent downside reversal. The fact that the last zero has fallen to 62 (one box below its previous low at 64) constitutes the first sell signal for the NYSE in more than a year.

Chart 4

Chart 5

SO DO S&P 500 AND NYSE INDEXES ... I've written before that one of the benefits of point & figure charts is their simplicity. They give precise buy and sell signals. Today's downturn has triggered p&f sell signals in the NYSE Composite Index and the S&P 500. Each box in Charts 6 and 7 is worth one percent of the value of each index. That makes for much easier comparisons. It also eliminates short-term whipsaws that often occur on more sensitive charts. Chart 6 shows the last zero column for the NYSE falling below two previous zero columns. [Red boxes show today's action]. That's the first sell signal since June of last year. Chart 7 shows a similar breakdown in the S&P 500. The p&f signals coincide with both market indexes breaking their June reaction lows today.

Chart 6

Chart 7

VIX HITS NEW 2007 HIGH ... Last Friday's Market Message also included a warning from the CBOE Volatility (VIX) Index which has been forming a pattern of "higher lows" since February, which is usually the first stage of an emerging uptrend. I noted, however, that a close over its March peak was necessary to put the VIX into a new uptrend, which would be bearish for stocks. Chart 8 shows the VIX registering its highest close in a year today. The reason that's a problem is that a rising VIX is usually associated with falling stock prices. Chart 9 shows that the last two upward spikes in the VIX (May 2006 and February 2007) was accompanied by a market pullback in the S&P 500 (green line). Chart 9 also shows that the VIX has one last hurdle to overcome, which is the 23.81 level reached during the last market downturn in the spring of 2006. The VIX downturn from that level last June helped launch the past year's market rally. A close over 23.81 would put the VIX at the highest level since the bull market started in the spring of 2003. That would be a more serious bearish warning for the stock market.

Chart 8

Chart 9

RISING YEN THREATENS CARRY TRADE ... I also noted last Friday that the Japanese yen was starting to rebound for the first time since February, which threatened to weaken the "yen carry trade" which has propelled global stock markets higher. That being the case, I don't think it's a coincidence that the yen hit a new three high today s global stocks fell sharply. Chart 10 compares the yen (orange line) to the EAFE iShares (EFA) over the last year. You can see the negative correlation between the two. The last two spikes in the yen in May 2006 and February 2007 accompanied market selloffs (matching a similar performance in the VIX). A rising yen forces traders to cover their yen shorts and take profits elsewhere. It sure looks like that's what's happening.

Chart 10

BAD DAY FOR EVERYTHING BUT BONDS... It was a bad market day all around. Major stock indexes lost 2% on average as did a lot of global stock markets. Once again, volume was very heavy and breadth figures were terrible (ten to one negative on the NYSE). All sectors and industry groups fell, with some of the biggest losses in energy and materials as well as airlines, brokers, and homebuilders. A drop in the dollar didn't stop gold from losing more ground. The only winner was bonds which surged on a huge flight to safety (Chart 11). Stocks suffered short-term chart damage with a number of support levels and moving averages broken. [My earlier message reviewed some of those breakdowns]. Let's survey the technical damage.

Chart 11

NYSE COMPOSITE INDEX FALLS THE HARDEST... What caught my eye in particular today was the unusually weak action in the NYSE Composite Index. It's drop of 2.78% was day's worst of the major market averages -- even worse than small caps. I suspect part of the reason is the sharp drop in energy and metals which are heavily represented in the NYSE. Nonetheless, this is the first time in a long time that the NYSE has shown relative weakness. Chart 12 puts today's downturn in some perspective. It shows the NYA closing below its June low on huge volume. That's not good. A late day rebound helped a little, but not much. While a short-term rebound wouldn't surprise anyone, chances are now pretty good for the NYA to drop down to the vicinity of its 200-day moving average and/or its late February peak at 9463. Another way to gauge whether a downturn is just a pullback or something more serious is to compare its percentage loss to the previous downturn. The last downturn in late February/early March lost 6.6%. A similar loss would put the NYA at 9582. It hit that point today on an intra-day basis. That's a normal expectation in a market correction. A loss of much more than that (accompanied by a break of the 200-day line) would be more serious.

Chart 12