ANOTHER DROP IN CONSUMER CONFIDENCE WEAKENS STOCKS AS BROKEN SUPPORT BECOMES NEW RESISTANCE -- TREASURIES RALLY AS STOCKS AND COMMODITIES DROP -- A RIGHT SHOULDER RALLY IN THE DOLLAR COULD COINCIDE WITH A RIGHT SHOULDER BOTTOM IN STOCKS
STOCK INDEXES CONTINUE TO SLIP ... Today's report of another drop in consumer confidence is contributing to more stock selling. Charts 1 through 3 show the downward drift in all three major stock indexes. Another negative sign for the market is that former support levels that have been broken are now acting as overhead resistance barriers. Chart 1, for example, shows the Nasdaq Composite breaking its 50-day moving average (blue line) on Tuesday. That previous support line is now acting as resistance above the Nasdaq. Chart 2 shows the Dow Industrials continuing to trade below the May low at 8221. This week's modest bounce has been unable to better that new resistance level. Chart 3 shows the S&P 500 slipping further below its May low at 878. Overhead resistance for the SPX now resides at its late June low at 888 (and its neckline). With stocks on the defensive, money continues to flow back into Treasury bonds.

Chart 1

Chart 2

Chart 3
FALLING STOCKS BOOST TREASURIES ... As usually happens when stocks fall, traders switch into Treasury Bonds. Chart 4 shows the 7-10 Year Treasury Note (IEF) climbing back over its 200-day average today and trading at the highest level since late May. The green solid line is the S&P 500. It's clear that the bottom in Treasuries coincided with the June stock peak. Treasuries are also getting a big boost from the continuing drop in commodity prices. Bond prices are very sensitive to any inflation threat from rising commodities as was the case from to March to June. Chart 5 shows Treasury Notes falling in price during the second quarter as commodity prices rose. The commodity peak a month ago coincided with a bond bottom. The commodity peak coincided with a bounce in the U.S. Dollar. Chart 6 shows the DB Commodities Tracking Index Fund (DBC) tumbling well below its 200-day average. Part of the reason for that is the bounce in the U.S. Dollar Index (green line) over the same time period. The dollar may be on the verge of an rally within a major topping pattern.

Chart 4

Chart 5

Chart 6
DOLLAR MAY BE FORMING RIGHT SHOULDER ... You've been reading a lot about "head and shoulder" patterns recently. I've written that the recent short-term H&S top in the S&P 500 could be a "right shoulder" in a major H&S bottom. Here's another one. The green bars in Chart 7 show the Dollar Index bouncing off chart support near its December low. The price pattern for the USD has the look of a possible head and shoulders top with the "left shoulder" forming last November and the "head" in March. That makes the trendline drawn under its December/June lows a possible "neckline". And that would make a dollar rally from current levels a possible "right shoulder" in a topping pattern. That would fit in nicely with the idea of right shoulder bottom in stocks. If you compare the two markets in Chart 7, you'll see that the USD and the SPX (below chart) have been a mirror image of each other. That makes chart and intermarket sense.

Chart 7
YEN RALLY IS BAD SIGN ... I wrote on Tuesday that money flowing into the Japanese yen was a sign that global traders were turning more defensive. While the yen hit a five-month high against the dollar this week, the more telling yen upturn may have come against the Euro (which has been much stronger than the dollar all year). The orange line in Chart 8 is a ratio of the yen divided by the Euro. The blue line is the Dow Jones World Stock Index. You can see them trending in the opposite direction over the last eighteen months. The yen rally last summer coincided with a big downturn in global stocks. The second quarter drop in the yen this year coincided with a stock rally. The week's strong jump in the yen comes just as global stocks have started to weaken. As I wrote earlier in the week, the yen has become a global barometer of risk tolerance. A falling yen shows more risk tolerance (willingness to buy stocks and commodities), while a rising yen shows risk aversion and selling of stocks and commodities. If you're looking for a good time to start buying stocks and commodities again, it might be a good idea to wait for the yen to start dropping again.

Chart 8
EMA LINES TURN DOWN ... A number of readers have pointed out this week's downward crossing of the 13- and 34-day EMA lines as shown in Chart 9. As you know, I'm a big fan of that EMA combination to generate trading signals. Chart 9 shows a short-term buy signal in mid-March as the the 13 day EMA (blue line) crossed over the 34-day (red line). A short-term sell signal was triggered by this week's EMA crossing to the downside. Although that's a relatively late signal, there's an earlier way to spot a market top with the two EMA lines. On June 5, I warned that spread between the two EMA lines was starting to narrow and was forming a "negative divergence" with the S&P 500. That's the black line in Chart 10. By inserting 13,34,1 into the daily MACD indicator, you can plot the spread between the two EMA lines. Actual buy and sell signals take place when that line crosses above and below the zero line (which correspond with EMA crossings). You can see, however, that the black line changes direction well before an actual trading signal is given. Its early March bottom was a couple of weeks before its late March buy signal. The declining tops in early June were an early warning that the SPX uptrend was losing momentum. That was a month before this week's bearish crosssing. Please keep in mind that EMA crossings on the daily chart represent "short-term" signals, but do serve to confirm the deterioration that we've seen on the daily charts over the last week. Chart 11 shows that the weekly EMA lines, which turned negative at the end of 2007, have not yet given a major buy signal.

Chart 9

Chart 10

Chart 11
JUDGE FOR YOURSELF IF THESE TWO LINES ARE CONNECTED... Every time I write about the CBOE Volatility (VIX) Index, I get messages questioning its value.. This week was no exception. I warned on Monday that an upturn in the VIX could spell trouble for stocks. That's because a rising VIX is usually associated with falling stock prices because they usually trend in opposite directions. One reader informed me that a couple of academic researchers could find no correlation between the VIX and the stock market. Given what I've seen of most academic market research, that doesn't surprise me. I wonder how they would explain Chart 12 which compares the VIX (red line) to the S&P 500 (blue line) over eight years. They sure seem to move in opposite directions. The VIX peak in 2002 coincided with a major market bottom (see arrows). After falling throughout the bull market, the VIX turned up in 2007 and correctly signaled a major top in stocks. The VIX dropped throughout the spring stock rally, and bounced this week as stock indexes broke support levels. Judge for yourself if you see any connection between the two lines. Yogi Berra once said you can see a lot by looking. I bet Yogi would see a connection. And I trust Yogi more than most academicians.

Chart 12