STOCKS TUMBLE ON FED MOVE -- FINANCIALS LEAD DECLINE -- BONDS RISE ON FLIGHT TO SAFETY

FED CUTS TWO RATES BY A QUARTER POINT ... The market was more than a little disappointed by the two modest rate cuts by the Fed and its accompanying statement. It lowered both the Fed fund and discount rates by a quarter of a point. Apparently, the market was hoping for more. The Fed's statement also showed a continuing concern about inflation. Judging from today's heavy selling, market participants appear to be of the belief that the Fed has fallen behind the curve and is underestimating the threat to the economy from subprime and housing problems. At least that's the message the markets sent today. Stock fell heavily while bond prices rose sharply in a flight to safety. All market sectors and industry groups fell. The hardest hit were financials, homebuilders, and retailers all of whom are directly impacted by interest rates. Small caps and transports also fell sharply. Just yesterday I warned that lack of upside confirmation by those three groups threatened the viability of any yearend rally. Charts 1 and 2 show the Financials SPDR and the Russell 2000 iShares failing challenges of their mid-November peak and 50-day moving averages. Today's sharp drop took place on rising volume which is a negative sign. Chart 3 shows the Dow Transports failing a test of its 200-day moving average. The inability of those three groups to gain more ground could undermine chances for a yearend rally.

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MARKET INDEXES FALL IN HEAVY TRADING ... Today's combination of falling prices and rising volume was decidedly negative. One of readers expressed concern this week about the lack of upside volume in stock index ETFs during the recent rebound. The Dow Diamonds (Chart 4), the S&P 500 SPDRs (Chart 5) and the Nasdaq 100 Power Shares (Chart 6) have shown a marked decline in trading activity over the last month. Notice how the green volume bars (up volume) have been getting smaller and smaller as prices have advanced. That's a sign that the rally is on weak technical footing. To make matters worse, today's selloff of more than 2% came on noticeably heavy volume. All three indexes fell back below their 50-day averages, while the S&P 500 SPDR is threatening its 200-day line. Unless the Fed does something more dramatic before its next meeting, prospects for a continuing rally appear greatly diminished after today's heavy selling. Stay defensive.

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