FED LEAVES RATES ALONE AS EXPECTED -- RECENT COMMODITY DROP SHOULD ALLEVIATE INFLATION CONCERNS -- FIRM DOLLAR HURTS GOLD -- FINANCIALS, RETAILERS, AND AIRLINES LEAD MARKET BOUNCE -- DESPITE SHORT-TERM IMPROVEMENT, NO CONVINCING SIGNS OF A BOTTOM YET

COMMODITY DROP SHOULD EASE INFLATION ... The Fed left the short-term rate unchanged at 2% today as expected. It did, however, cite growing inflation concerns along with a weakening economy. That's a bad combination. Most of the inflation increases, however, have come from rising commodities. With commodity markets in retreat (especially food and energy), it seems reasonable to expect that inflation pressures may ease somewhat in the months ahead. That's what usually happens after an economy enters a recession. Economic slowing in big commodity importers like China is also contributing to a drop in global demand for raw materials. Chart 1 shows the CRB Index falling more than 15% since the start of July. At the same time, the U.S. Dollar is gaining. Chart 2 shows the Power Shares Dollar Bullish Fund (UUP) trading at a two-month high today. The dollar rally over the last month has coincided with the commodity drop. Both indexes are heading for tests of their 200-day moving averages. What both markets do around that important trendline will help determine if the commodity downturn (and dollar rebound) represent major turning points. The market most impacted by a rising dollar is gold. Chart 3 shows the streetTracks Gold ETF (GLD) falling below its 200-day average today (as did silver). An index of gold stocks fell to a new six-month low yesterday.

Chart 1

Chart 2

Chart 3

FINANCIALS BOUNCE OFF LONG-TERM SUPPORT... On July 3, I wrote an article on the sector rotation sequence. In that and other articles since then, I've explained that peaks in basic material and energy stocks mean that the leadership baton is passing on to other groups. I explained that defensive money first moves to consumer staples, healthcare, and utilities. That process has been going on for sometime. With the exception of utilities (which have fallen sharply of late), staples and healthcare continue to attract money. One way to tell when that the cycle has moved into the next stage is when money starts flowing into consumer discretionary and financial shares. That's what we've been seeing lately, and what we saw again today. While that's not a convincing sign of a market bottom, it is an encouraging sign. It's no secret that financials have been the market's weakest group over the last year. One positive sign is the fact that the Financials SPDR (XLF) is bouncing off potential chart support at its 2002 low (Chart 4). Monthly RSI and stochastic lines also show the financials to be in the most oversold condition in years. Needless to say, any strength in financials would be a big plus for the market as a whole. The daily bars in Chart 5 show the XLF closing over its 50-day average today for the first time in three months. Its relative strength line (below chart) has also bounced since mid-July. That will certainly be helpful it it continues. Chart 6 also shows, however, that the XLF is still well below its 200-day average which defines its major trend.

Chart 4

Chart 5

RETAIL STOCKS REBOUND ... Retail stocks have suffered from rising oil prices. It's no surprise then to see them rallying sharply on falling oil prices. Retailers were among today's strongest stocks. Chart 6 shows the S&P Retail SPDR (XRT) closing over its 50-day line today as well. Even more impressive is its relative strength line (below chart) which bottomed in January and is now trading at a four-month high. That's another sign of improvement. Upside leadership by retailers (which are part of the consumer discretionary sector) is a prime ingredient in any market upturn. Radioshack was one of today's retail leaders. Chart 7 shows the stock having cleared its 200-day line. Airlines, which we've highlighted recently, had another strong day today. Chart 8 shows the AMEX Airline Index hitting a new three-month high. Its relative strength line bottomed a month ago when oil prices started to drop.

Chart 6

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Chart 8

STILL NO MAJOR UPTURN ... Despite the signs of improvement mentioned above, the market still has a long way to go to signal that a major bottom is in place. Most short-term indicators (like MACD) have turned positive. As is usually the case, however, the first tangible sign of an upturn is a close over a 50-day moving average. None of the major market market indexes have accomplished that yet. Of the three indexes shown below, the best bet for a potential bottom is the Nasdaq Composite Index. Chart 11 shows it the closest to its moving average line. It's also the only major index that has bounced off its March low. At a market bottom, Nasdaq leadership is usually a necessary ingredient. Another ingredient in a market bottom is small cap leadership. Chart 12 shows the Russell 2000 Small Cap Index right up against its 200-day line. We'll be keeping a close on that test.

Chart 9

Chart 10

Chart 11

Chart 12