INVESTMENT GRADE CORPORATE BONDS ARE GAINING SOME GROUND ON TREASURIES -- BOUNCING DOLLAR KEEPS GOLD IN CHECK -- THE VIX HAS REACHED A POTENTIAL SUPPORT LEVEL WHICH MAY REMOVE BULLISH PROP FROM STOCKS -- MARKET FAILS FIRST WEEK OF JANUARY TEST

CORPORATE BONDS ARE STARTING TO RECOVER... During the second half of 2008, Treasury Bonds were the top performing fixed income group as investors fled to safety. Other bond categories actually lost ground including corporate bonds. There are signs that some bond money is starting to flow into that other bond category. Chart 1 shows the 20 Treasury Bond Fund (TLT) turning up at midyear and soaring during the fourth quarter. Chart 2 shows the Investment Grade Bond iShares (LQD) falling from July through October before rebounding during the fourth quarter. The LQD has just exceeded its 200-day moving average (red line) in Chart 2. Chart 3 is a relative strength ratio of corporate bonds (LQD) divided by Treasuries (TLT). Corporate bonds started underperforming Treasuries during July and continued to do so for most of the second half of the year. The ratio of corporate bonds to Treasurie , however, has been rising since mid-December. It's too early to call that a new uptrend, but the rising ratio does suggest that investment grade corporates are starting to gain some ground on Treasuries. CORRECTION: [Chart 9 in Tuesday's message read the 3-month T-bill rate at 1.3%. The actual number was .13%. My mistake.]

Chart 1

Chart 2

Chart 3

DOLLAR BOUNCE KEEPS GOLD IN CHECK ... A rebound in the U.S. Dollar today was negative for commodity markets. Chart 4 shows the Power Shares US Dollar Bullish Fund (UUP) climbing today after recently bouncing off chart support near its 200-day moving average. The dollar bounce kept streetTracks Gold Shares (GLD) stalled near its 200-day average and a resistance line drawn over its July/Sepember highs.

Chart 4

Chart 5

VIX REACHES POTENTIAL CHART SUPPORT ... One of the factors supporting the stock rebound from late November has been a decline in the CBOE Volatility (VIX) Index. Chart 6 shows, however, that the VIX has declined to potential chart support near its 200-day moving average and the previous peak reached in January of last year near 37. [Price pullbacks often find support near previous peaks]. The horizontal line in Chart 6 makes that a potential support line for the VIX. The solid line shows that the late November bounce in the S&P 500 coincided with a second peak in the VIX that same month. The fact that the VIX has reached a potential support zone may remove one of the factors that has supported the rally attempt in stocks and may put that rally in jeopardy. That will be especially true if the VIX starts bouncing again.

Chart 6

MARKET FAILS EARLY JANUARY WARNING TEST... All the major market indexes lost ground this week. As a result, the market failed its first test of the year which holds that market direction during the year's first week often determines the direction for the rest of the year. A more important test is the market's direction for the whole month of January. The lack of upside volume earlier in the week was an early warning that last Friday's upside breakout was suspect. Then things got worse. Chart 7 shows the Dow Industrials closing back below the 50-day moving average. Chart 8 shows the S&P 500 closing right on that line. I've also drawn in the potentially bearish "rising wedge" pattern that Arthur Hill wrote about at midweek. [A rising wedge is identified by two rising trendines that are converging. It's normally a bearish pattern]. I've drawn the same lines on the hourly bars for the S&P 500 in Chart 9. While a decisive break of the lower line is a negative sign, I'd place more importance on the late December intra-day low at 857. A close below that level would mark the end of the rally attempt and wouldn't bode well for the rest of the month.

Chart 7

Chart 8

Chart 9