FINANCIAL DROP PULLS MARKET LOWER -- THE FACT THAT OVERSOLD TREASURY BOND PRICES ARE STARTING TO BOUNCE OFF CHART SUPPORT MAY ALSO SUGGEST THAT STOCKS ARE DUE FOR A PULLBACK

GOLDMAN SACHS PLUNGES NEARLY 13%... The SEC sued Goldman Sachs on Friday for fraud in the mortage market. That shocking news caused the stock to plunge nearly 13% on huge trading volume. Chart 1 shows the chart damage. GS hasn't exactly been a market leader over the has year and remains well below the highs of last October. Even so, the plunge in the stock unnerved the financial sector and the stock market as well. The plunge in stocks, combined with a bounce in the U.S. Dollar, pushed commodity prices lower. Treasury bonds attracted safe haven buying as stocks and commodities dropped.

Chart 1

FINANCIALS FALL HEAVILY... Financial stocks are considered to be leading indicators for the rest of the market. Over the last year, the group has led the market higher. Yesterday, they led it lower. Chart 2 shows the Financial SPDR (XLF) falling 3.6% on huge volume. The big volume is more serious than the price drop. With the group (and the market) having rallied two months without a pullback, one certaintly seems overdue. And it may have started yesterday. If this just a short-term pullback, the XLF should find support along its January high. The green lines show that would also be a 38% retracement of the February/April rally. The ability of the XLF to stay above that initial support level will help determine if this is just a short-term pullback or something more serious.

Chart 2

S&P 500 MAY BE ENTERING CORRECTION AS WELL ... Everyone has been complaining about the lack of volume during the market's recent rally. We got big volume yesterday, but it was in the wrong direction. Friday's volume for the S&P 500 was in fact the biggest of the year (although options expiration added to the volume total). That's not an encouraging sign. It may also be significant that the S&P 500 has fallen back below the 1200 mark after moving briefly above it at earlier in the week. The market certainly looks due for a correction and one may have started yesterday. Chart 3 shows the first level of significant support to be at the January high near 1150 which also happens to be a 38% pullback of the February/April rally. A pullback to that area would also bring it closer to its 50-day moving average. What it does from that lower level (if it actually gets there) will be very important in gauging the market's strength. There are reasons to be cautious at current levels. The market appears to be in the fifth wave of a five-wave advance. Market indexes are dangerously close to overhead resistance levels not far above 1200 in the S&P and 11000 in the Dow. Seasonal patterns turn less positive after this month. Another factor that may work against stocks in the short-term is that Treasury bonds are bouncing.

Chart 3

WHY A BOUNCE IN TREASURIES MAY COINCIDE WITH A PULLBACK IN STOCKS... One of the more reliable intermarket relationships that has existed for the last decade has been the inverse correlation between Treasury bond prices and stocks. Their tendency to trend in opposite directions over the last three years is seen quite clearly in Chart 4. Bonds peaked in late 2008 a few months before stocks bottomed. Since then, the two trends have mostly diverged. Chart 5 shows the trend of the 20-Year T-bond iShares (TLT) over the last year. Bond prices rallied with stocks from last June to October. After that, bonds fell as stocks rose (as investors became more optimistic on the end of the recent recession). The green bars in Chart 5, however, show the 20-Year T-bond iShares (TLT) starting to bounce off potential chart support formed last summer. The black line shows the bond yields backing off from its June high near 4%. [Bond prices and yields move in opposite directions]. That simply suggests that bond yields are starting to weaken from resistance as Treasury prices are starting to bounce from support. Any rally in Treasuries (or drop in bond yields) would most likely coincide with a pullback in stocks.

Chart 4

Chart 5