BONDS OUTPERFORMING STOCKS -- YIELD CURVE POINTS TO LOWER RATES -- WEAK DOLLAR LIFTS GOLD -- SURGING OIL SINKS TRANSPORTS -- QQQQ REMAINS STUBBORN

BONDS CONTINUE TO ATTRACT MONEY... Today's Market Message was written by Arthur Hill. - Editor

Money continues to flow into the bond market as the economic outlook deteriorates. John Murphy pointed to the sharp decline in the Cyclicals Index ($CYC) on Monday and noted that this was a "vote of no-confidence in the economy." Yesterday, the Fed confirmed this price action by reducing its expectations for economic growth. Stocks started the day strong on Tuesday, but abruptly reversed course after the Fed report. Today, Consumer Sentiment from the University of Michigan fell to its lowest level in two years. This negative economic news is putting downward pressure on interest rates. The Fed is more likely to lower interest rates when the economy sputters. In addition to bad economic news, Treasury bonds continue to attract money as a safe haven during the current credit crunch. On chart 1, the iShares 20+ Year Bond ETF (TLT) broke resistance at 89.5 in October and surged above 93 this week. Chart 2 shows a clear inverse relationship between stocks (SPY) and bonds (TLT) since mid October (blue line). Money is still moving away from stocks and into bonds.

Chart 1

Chart 2

YIELD CURVE POINTS TO LOWER RATES... Chart 3 shows the Rate-of-Change for the 10-Year Treasury Yield ($TNX) and the 2-year Treasury Yield ($UST2Y). The shorter maturity (2 year) has fallen a lot more than the longer maturity (10 year). The sharper drop in short rates shows that investors expect a rate cut from the Fed. Charts 4 and 5 show static snapshots taken from the Dynamic Yield Curve. The first static snapshot was taken on 13 July when the S&P 500 was trading near 1552. Notice that the yield curve was flat at the time. The credit crisis had yet to hit and there were relatively few concerns over the economy then. Flash forward four months and the yield curve has changed dramatically. The credit crunch is full-blown and the economic news has been quite negative. As a result, the yield curve is now much steeper. Short rates have dropped sharply and are now much lower than long rates. The 10-Year Note Yield ($TNX) now yields 4.02% while the 2-year Treasury Yield ($UST2Y) yields 3.14%. A steep yield curve also points to lower rates from the Fed.

Chart 3

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LOWER RATES SINK THE GREENBACK... Among other things, the prospect of lower interest rates in the U.S. is weighing on the U.S. Dollar. Chart 6 shows both the U.S. Dollar Index ($USD) and the 10-Year Note Yield ($TNX) over the last six months. Both are clearly headed downhill. Even though the moves look quite extended, there are no signs of firmness in either. Lower interest rates in the U.S. make dollar-denominated investments (bonds) less attractive to foreign investors.

Chart 6

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GOLD MOVING OPPOSITE THE DOLLAR... What's bad for the U.S. Dollar Index ($USD) has been good for Gold ($GOLD). Chart 8 shows Gold and the U.S. Dollar Index over the last 18 months. The black line (Gold) is pretty much a mirror image of the green line (U.S. Dollar Index). Gold moved from the lower left to the upper right while the U.S. Dollar Index moved from the upper left to the lower right. The decline in the dollar accelerated over the last three months and this corresponded with an upward acceleration in gold.

Chart 8

SURGING OIL SINKS THE TRANSPORTS... Moving back to stocks, the Dow Transports ($TRAN) declined over 4% this week and hit a 52-week low. Many of the stocks in the Dow Transports are part of the Consumer Discretionary sector and this is the most economically sensitive sector. The decline in the Dow Transports is another "no-confidence vote" for the economy. Weakness also stems from the relentless rise in oil prices. West Texas Intermediate Crude ($WTIC) bounced off support around 90 and surged above 97.5 this week. Companies in the Dow Transports are now dealing with a double whammy. A weakening economy reduces demand while rising prices increase costs. The Dow Transports is leading the way. Lower and relative weakness in this key average is not a good sign for the broader market.

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BIG TECHS REMAIN STUBBORN... Even though the broader market remains weak, big techs are making a stand and holding up better. Over the last three days, the Dow Industrials ETF (DIA) declined 2.84%, the S&P 500 ETF (SPY) lost 2.85% and the Russell 2000 ETF (IWM) declined 3.51%. One would expect equally large losses in the Nasdaq 100 ETF (QQQQ), but this big tech ETF held up relatively well by losing 1.93%. Less absolute weakness translates into relative strength. Should the market turn around, those that held up the best on the way down should lead on the way up. Chart 12 shows the performance of DIA, IWM, SPY and QQQQ since late September. QQQQ is the only one that remains above its 12 November low.

Chart 12

On chart 13, QQQQ broke down with the rest of the market in early November and found support around 49-50. The ETF stalled the last five trading days. What happens after this stall holds the next key. A surge above 51 would break consolidation resistance and this would be quite positive for big techs. This is something to look out for next week. In the meantime, I wish all of you a happy and safe Thanksgiving.

Chart 13