UNEMPLOYMENT NUMBERS CONFIRM WHAT MARKETS ALREADY KNEW -- SECTOR ROTATIONS REMAIN NEGATIVE -- WEAKNESS IN RETAILERS, HOMEBUILDERS, REITS , AND TECHNOLOGY ISN'T ENCOURAGING -- DAILY EMA LINES STILL NEGATIVE

ECONOMISTS ARE ALWAYS THE LAST TO KNOW... Friday's report that the unemployment rate jumped to a fourteen year high of 6.5% has finally convinced the economic community that the U.S. economy is in a recession and a deep one at that. As a result, we're now being treated to a parade of economists telling us how bad things really are. Judging from their sudden gloom, one would think that things just started to turn bad during October and that they're telling us something we didn't already know. Those of us who follow the markets knew that things started going bad a year ago when the stock market peaked. On Halloween, I explained why we can't use economic news to predict the direction of the market. That's because the economy changes direction anywhere from six to nine months after the stock market. The two lines in Chart 1 plot the turns in the stock market (red line) and the U.S. economy (green line) during a business cycle. Notice that the stock market changes direction before the economy at tops and bottoms. The legend along the bottom shows that the market usually peaks while the economy is still in recovery. You may recall hearing the economic community during the fourth quarter of last year and the first quarter of 2008 explaining to us that the market drop was nothing more than "fear versus fundamentals". It's the same old story of the market peaking well before the economic news turns bad. The bottom legend also shows that the market bottoms while the market is still in recession. That means that the market will bottom while the economic news is still bad. My advice is to ignore the economists and take your cues from the market itself. You can't drive a car looking out the rear window.

Chart 1

SECTOR ROTATIONS ARE STILL NEGATIVE ... Chart 1 also shows the normal sector rotation that takes during the business cycle. Basic material and energy stocks are usually the last to peak as the economy enters a recession. That happened at midyear when commodity prices tumbled. Another sign of a weakening economy is when leadership comes from defensive groups like consumer staples, healthcare, and utilities. Chart 2 shows those three defensive groups being the strongest sector performers during 2008. We're talking here about relative performance. All market sectors are in the red for the year. Financials have been the weakest 2008 performers. One sign of a potential market bottom to look for is upside leadership from the financial sector.

Chart 2

NO CHANGE YET ... Chart 3 shows the sector situation over the past week not showing any improvement. On a relative basis, the three top sectors were still consumer staples, healthcare, and utilities. By contrast, the weakest were technology, consumer discretionary, and financials. That's not a bullish recipe. In addition to requiring new leadership from financials, Chart 1 shows that two other groups that normally lead at market bottoms are consumer cyclicals (discretionary) and technology.

Chart 3

NO SIGNS OF A BOTTOM ... Retails stocks are one of the main driving forces in consumer discretionary stocks and tell us something about the strength of retail spending. Chart 4 shows the S&P Retail SPDR still in a downtrend. Its relative strength line turned back down in mid-September. Chart 5 shows a similar downtrend in the PHLX Housing Index. Since that's where most of the economic problems came from, the absence of a bottom (both in absolute and relative terms) is another negative. REITs aren't doing any better. Chart 6 shows the Dow Jones REIT Index still in a downtrend. That's weighing on the financial sector. None of those three key groups is offering much encouragement at the moment.

Chart 4

Chart 5

Chart 6

NASDAQ 100 DOESN'T SHOW MUCH BOUNCE ... Technology stocks also have a history of leading the market higher at bottoms. Unfortunately, that hasn't happened so far. Chart 7 shows the Power Shares QQQ Trust still in a downtrend. Its relative strength line has been falling since mid-August. The market will need more help from technology stocks to pull it out of its current slump. When a market bottom does occur, we'll probably see some improvement in these key groups. When that happens, it will be long before the economic news gets better.

Chart 7

DAILY CHARTS ALWAYS TURN UP FIRST ... One of our readers asked if there was a quicker way to spot market turns than by using weekly moving averages. There is, but there's also a tradeoff. Moving average signals on "weekly" charts are slower to appear, but they carry much more significance. Signals on "daily" charts are faster but don't necessarily signal a major turn. Chart 8 plots the 13 and 34 day EMA combination for the S&P 500. The last sell signal took place at the start of September (see arrow). The daily EMA lines are still negative. When a bottom finally does occur, one of the first signs will be a positive crossing by the daily lines. A daily buy signal, however, won't mean much until the weekly EMA lines start to show some improvement as well. So far they haven't.

Chart 8