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

LAST WEEK'S HEADLINES STILL APPLY... As I survey the damage done to the stock market this week, I reviewed what I wrote last Thursday. The preceding headline is taken from last Thursday's Market Message and describes today's market action quite well. Except that things have gotten worse since then. We've been writing about all of the "negative divergences" being formed by various market breadth figures -- with special emphasis on weak financials, consumer discretionary stocks (including retailers), small caps and transports. Those weak groups have led the rest of the market lower this week. Defensive groups like consumer staples and utilities have held up relatively well. Bond prices have continued to rally as U.S. rates have fallen to two-year lows (Chart 1). That has weakened the dollar and pushed commodity prices sharply higher. None of those trends should come as big surprise to anyone. What has been a surprise is the tumble in technology shares.

Chart 1

CISCO AND ORACLE TUMBLE ... Just a couple of days ago Cisco was being hailed as a Nasdaq leader. The tech bellwether hit a seven-year high on Tuesday. Cisco tumbled 9% today on huge volume (Chart 2). Oracle was almost as bad. Chart 3 shows that stock falling 8% in heavy trading. Both former leaders now appear headed for a test of their 200-day moving averages. That helped make the Nasdaq the weakest part of the market today. Chart 5 shows the Nasdaq 100 (QQQQ) falling 2.3% on heavy volume. It made back part of its early losses, however, to close just above its 50-day average and initial chart support at 52.

Chart 2

Chart 3

Chart 4

DEFENSIVE STOCKS HOLD UP BETTER ... Last Thursday's message showed an earlier version of Chart 8 in which utilities (blue line), bond prices (red line) and consumer staples (green line) were starting to outperform the market. Chart 8 shows that's still the case. Those relative performances are plotted against the S&P 500 which is the flat black line. Not surprisingly, the weakest sectors over the last week have been financials and consumer discretionary stocks. Gold and energy stocks have been market leaders thanks to a plunging dollar. Even there, however, some caution is advised as gold nears its all-time high at $850 and oil approaches $100. Both look over-extended.

Chart 5

LATE BOUNCE PREVENTS SERIOUS DAMAGE ... An afternoon bounce in financial stocks prevented what could have been a very bad chart day. For one thing, the late bounce prevented the Dow Industrials from closing below its 200-day moving average (Chart 6). The S&P 500 has traded below that long-term support line for two days in a row, but by a slight margin. When it comes to moving average crossings, I place a lot of importance on the Friday close. A Friday close below a moving average line is more important than an intra-week crossing. A Friday bounce can erase an earlier breakdown. I'd rather give the market another day to see if it can regain its footing. Chart 8 shows part of the reason why I'm reserving judgment on today's market action. It shows the NYSE Composite Index bouncing off its 200-day line to close higher -- and on strong volume. That's an encouraging chart day.

Chart 6

Chart 7

Chart 8