STOCKS FALL SHARPLY - FLIGHT TO SAFETY TRADE RESUMES -- BONDS GAP HIGHER - VOLUME SURGES ON NYSE AS PRICE DECLINE ACCELLERATES

STOCKS FALL IN BROAD DECLINE... Today's Market Message was written by Arthur Hill. - Editor

It was a sea of red on Wall Street. All nine sectors were lower with financials leading the way. Just when you thought they could not go any lower, chart 1 shows the Financials SPDR (XLF) recording another new low by declining over 9%. Financials were not the only ones to blame today. The total number of declining issues swamped the number of advancing issues in a truly broad-based decline. Chart 2 shows the Russell 2000 ETF (IWM) recording a new 52-week low by declining over 5% today. The ETF is down around 25% in the last four weeks. While it may be oversold and ripe for a bounce, there is simply no sign of support yet.

Chart 1

Chart 2

GOLD AND THE DOLLAR SURGE... With stocks moving sharply lower, the flight-to-safety trade carried the day. Gold and the dollar have been the main stay of this flight-to-safety trade. Chart 3 shows the Gold SPDR (GLD) surging off support around 88. This support level stems from the rising 50-day moving average, broken resistance and the November trend line. The bottom indicator window shows the relative strength comparative, which compares GLD to SPY. GLD has been outperforming SPY the last six months. Notice that the relative strength comparative is close to a new high today. Chart 4 shows the US Dollar Index Bullish ETF (UUP) closing in on its Oct-Nov high with a gain today. The relative strength comparative shows UUP outperforming SPY over the last six months as well.

Chart 3

Chart 4

BONDS SURGE WITH BIG GAP... Bonds were part of the flight-to-safety group in 2008, but fell out of grace in 2009 as both stocks and bonds declined sharply this year. Recently, the iShares 20+Yr T-Bond ETF (TLT) broke pennant support and appeared to be headed lower. Chart 5 shows the situation changing today with a gap up and break above the blue trend line. I am not sure if this is flight-to-safety renewed or merely speculation on the next Fed move. Consider these four items. First, Gordon Brown was just here on a visit with Obama. Second, the Bank of England cut its benchmark rate today and announced a new plan to purchase sovereign and corporate debt. Third, the Fed is running out of options. Four, there has been speculation before that the Fed might purchase Treasuries. In fact, Bernanke himself even mentioned this on 1 Dec and this sparked a huge rally in TLT the next few weeks. Putting two and two together, the bond market appears to be speculating that the Fed may follow the Bank of England's lead. Whatever the reason, buying or selling will show up on the charts. Right now, the gap up and trend line break are positive. Resistance from the February highs remains and a break above this level would be bullish.

Chart 5

SIGNS OF CAPITULATION EMERGING... Charts 1 and 2 show the Nasdaq and the NY Composite with volume and the 4-week Rate-of-Change indicator. Signs of capitulation are starting to emerge as the decline accelerates and volume increases. The blue dotted lines show when the decline accelerated (Rate-of-Change) and volume expanded. These are the ingredients for capitulation. The last two capitulations occurred in January 2008 and October 2008. After a high volume decline in January 2008, the market tested the January low and bottomed in March. After a high volume capitulation in October, the market moved to new lows in November before bottoming. Notice that the actual capitulations foreshadowed the lows. They did not mark the actual low. These two capitulations were a few weeks ahead of the actual bottom.

Chart 6

Chart 7

Now let's look at current conditions. Except for a one week gain in early February, the stock market has been moving lower the entire year. This decline turned into free fall the last four weeks. As the 4-week Rate-of-Change shows, the NY Composite is down over 20% in the last four weeks, while the Nasdaq is down over 17%. NYSE Volume surged three of the last four weeks, but we have yet to see it reach the levels of the last two capitulations. Nasdaq volume has been running above average, but it too is below the volume spike seen on the last two capitulations. It looks like we have evidence of capitulation based on the price decline, but volume is still lacking. A true capitulation should witness a huge spike in volume.