STOCKS ARE HEADED FOR A TEST OF MARCH LOWS -- THE FED'S IN A BOX -- IT CAN'T LOWER RATES OR RAISE THEM -- STAGFLATION IS THE REASON WHY

MARCH LOWS IN SIGHT... The stock market keeps going from bad to worse. Arthur Hill wrote on Wednesday that the market appeared to have begun another downleg. It sure looks that way. At the very least, we can say with some degree of confidence that the March lows are going to be retested. Chart 1 shows that the Dow isn't too far from doing that. Chart 2 shows the S&P 500 undercutting its mid-April low and trading at a three-month low. The Nasdaq had the weakest day of all. That's a bit unusual since the Nasdaq had been doing better than the rest of the market since March. Chart 3 shows the Nasdaq Composite closing back below its 50-day moving average today. Part of the reason for that was selling in Internet and semiconductor stocks.

Chart 1

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WHERE THE TECH SELLING IS ... The next two charts where most of the technology selling is located. Chart 4 shows the Interactive Internet Index falling below its 50-day and 200-day moving averages. Chart 5 shows the Semiconductor (SOX) Index falling nearly 3% and also breaking its 50-day line. It certainly looks like the March rally has ended for both of these key technology groups.

Chart 4

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THE SAME PROBLEMS ... The same markets that have been leading the market lower did so again today. Although all sectors lost ground, the two biggest losers were consumer discretionary stocks and financials. There's nothing new there. Chart 6 shows the Consumer Discretionary SPDR having broken its five-month up trendline. Its relative strength line (bottom of chart) is also turning back down. Chart 7 shows the Financials Select SPDR trading below its March low. Its RS line has been falling all year. The monthly bars in Chart 8 show this to be the lowest level for the XLF in five years. That puts it on track to retest its 2002 lows. As financials go, so goes the market.

Chart 6

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BEAR FUNDS ARE RISING ... Outside of bonds, the only other markets that gained ground today were bear funds. We've shown these two bear funds before, but here they are again. Chart 9 shows the Short S&P 500 ProShares Fund (SH) reaching a three-month high. Chart 10 shows the ProShares Ultra Short Dow 30 (DXD) acting even stronger.

Chart 9

Chart 10

THE FED'S IN A BOX ... I've written recently about the Fed turning its attention away from the economy and back to inflation. Unfortunately, this week's market downturn is going to make its job a lot harder. The Fed apparently concluded that its easing program since last September would be enough to stabilize the stock market and the economy. This week's stock drubbing calls that analysis into question. How can the Fed raise rates to fight inflation with stocks tumbling? It can't. That should keep the dollar from rallying much further and could give a boost to gold. Money moving out of stocks and into bonds is also keeping long-term rates from moving up any further. Here's the problem. The market can't expect anymore help from the Fed. To lower rates again would give inflation another leg up which is a big part of the problem. Rising inflation and a weak economy make for stagflation which we haven't seen since the 1970s. One of our readers asked if "cash was trash" in an inflationary environment. Right now, cash looks better than stocks.