FINANCIALS PULL MARKET LOWER -- TOO MANY NEGATIVE DIVERGENCES EXIST FOR A HEALTHY MARKET -- SECTOR ROTATIONS FAVOR CONSUMER STAPLES, HEALTHCARE, UTILITIES -- AND BONDS

CITIGROUP PLUNGES 7% ... It's the same story over and over again. More bad news in financial stocks pulls the rest of the market lower. The day's biggest financial casualty is Citigroup which plunged more than 7% on huge volume. Chart 1 shows the nation's biggest bank tumbling to the lowest level in four years. Banks, brokers, and insurance stocks are tumbling as well and making financials the day's weakest sector. Consumer discretionary stocks (including homebuilders and retailers) are the day's second worst group. Sound familiar? I've suggested in several past messages that these market laggards should be avoided. Today's sharp downturns in both groups demonstrate why.

Chart 1

BANKS ARE THE HARDEST HIT ... Banks are the weakest part of the financial sector. Chart 2 shows the PHLX Bank Index tumbling 4% and nearing a new 52-week low. Its relative strenth line has been plunging all year. The Financials Sector (SPDR) looks almost as bad. Chart 3 shows the XLF falling more than 3% today and nearing a test of its summer low. Its relative strength line has been tumbling as well. Note that the October rally attempt failed at a falling 200-day moving average (red arrow). It's tough for the market to withstand that kind of bearish action.

Chart 2

Chart 3

Chart 4

RETAILERS AND HOMBUILDERS CONTINUE TO LAG ... Problems in housing continues to weigh on consumer discretionary stocks. Chart 5 shows that the chart of the Consumer Discretionary SPDR (XLY) doesn't look much different from the financial SPDR. It too remains below its moving average lines and in a chart downtrend (both absolutely and relatively). One of the reasons for that is retail stocks. Chart 6 shows Retail Holders in a downtrend as well. The main reason for all that selling can be seen in Chart 7. Homebuilders are down another 3% today and near another multi-year low.

Chart 5

Chart 6

Chart 7

TOO MANY DIVERGENCES ... On October 9, I wrote about the large number of negative divergences that existed during the market's recent rally and showed a version of the next chart to make that point. If anything, the situation has gotten worse since then. One of the problems with the recent market rally has been those groups not participating. That creates "negative divergences" as reflected in various market breadth measures. Chart 8 shows several groups closer to their yearly lows than highs. The group includes transports (black line), small caps (blue line), consumer discretionary (red line) and financial stocks (green line).

Chart 8

DEFENSIVE GROUPS DO BETTER -- INCLUDING BONDS... On Tuesday, I showed a sector rotation model that suggested which groups should start to do better as the market (and economy) starts to enter an "early contraction" phase. Those three defensive groups include utilities, consumer staples, and healthchare. All three groups have done better than the S&P 500 since mid-year. That's where money would be expected to move in a slowing economy. And it is. Bond prices should also do better than stocks in a slowing economy. And they are. Chart 9 nine is a ratio of the 20-Year T-Bond Fund (TLT) to the S&P 500 since the start of the year. [The S&P is the flat black line]. Although the S&P is still slightly ahead of bond prices since January, bonds have been doing better since July. Bond prices usually rise when stocks fall. In fact, the TLT is the day's strongest ETF in the face of falling stock prices. Although the stronger performance by bond prices since July isn't enough to reverse four years of stronger stock performance, the process of rotating back into bonds may have already started. That would be consistent with rotation into more defensive stocks like utilities and consumer staples. Chart 10 shows a similar jump in both groups' relative performance since July.

Chart 9

Chart 10