STOCK INDEXES STABILIZE BUT LOSE MORE GROUND -- DROP IN RETAILERS AND HOME IMPROVEMENT STOCKS MAKE CONSUMER CYCLICALS MARKET'S WEAKEST SECTOR -- WALMART, MACY'S AND HOME DEPOT FALL ON STRONG EARNINGS -- CONSUMER STAPLES CONTINUE TO OUTPERFORM

DESPITE LATE REBOUND, STOCK INDEXES LOSE GROUND... Despite a rebound on Thursday and Friday, all major U.S. stock indexes lost ground this week. But very little changed on their respective chart patterns. Chart 1 shows an upside reversal on Thursday keeping the Dow Industrials above its 200-day average. But it remains well below its early November peak and its 50-day line. Chart 2 shows the S&P 500 rebounding as well but still trading below its 200-day average. Chart 3 shows the Nasdaq Composite Index being the only one of the three to close lower on Friday, and the furthest below its 200-day line. All three indexes found support in the underlying gap areas formed a couple of weeks ago which is another short-term positive. Beneath the surface, however, investors continued to favor defensive parts of the market over stocks tied to growth. The Nasdaq continues to be weighed down by technology stocks which were the second weakest sector of the week (-2.3%). The only sector that did worse was consumer discretionary (-3.3%). By comparison, defensive sectors like consumer staples, utilities, and REITs continued to show relative strength. That's not exactly a vote of confidence in the direction of stock prices.

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Chart 1

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Chart 2

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Chart 3

RETAILERS SLIDE DESPITE STRONG EARNINGS ... The daily bars in Chart 4 show the Consumer Discretionary SPDR (XLY) falling below its 200-day moving average (red line) and in heavier trading. It was the market's weakest sector on the week. The red line in the upper box shows the relative strength ratio of the XLY divided by the S&P 500 (XLY:SPX) peaking in early September and in decline since then. It fell especially hard this week. And therein may lie a bigger message for them and the stock market. The above headline is taken from a Thursday article in the Wall Street Journal which pointed out that "retailers are sliding despite third-quarter results that suggest consumer spending is strong...Walmart, Macy's, and Home Depot have suffered steep share price losses this week, even after posting relatively robust results." The article goes on to point out that Walmart not only posted strong quarterly results but boosted its profit outlook for the year. It lost more than -7% for the week. Walmart is actually not in the XLY. It's one of the biggest stocks in the XLP. But it is still the biggest retailer in the world (more on that shortly). Macy's lost 11% during the week after posting strong earnings and upbeat guidance. Home Depot (HD) lost ground after also reporting upbeat results. Retailers and home improvement stocks were the biggest XLY losers this past week. What's especially disturbing is to see them falling on good earnings and strong forward guidance. That suggests that investors are becoming more skeptical about future results.

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Chart 4

HOME DEPOT, MACY'S, AND AMAZON LOOK WEAK... Chart 5 shows the price of Home Depot (HD) trading near its lowest level of the year and below its 200-day average. Home Depot is closely tied the housing industry which is having a especially bad year. Homebuilders have lost -28% so far this year. Department store stocks are falling for other reasons. Chart 6 shows Macy's (M) falling hard this week before stabilizing. As the Journal pointed out, both stocks fell after reporting strong earnings. We've been told that weakness in brick and mortar retail stocks isn't a sign that consumer spending is slowing; but simply a sign that consumers are doing more shopping online. But that explanation is starting to look pretty weak. Our next chart shows why. Chart 7 shows Amazon.com trading below its 200-day average and having lost -21% since the start of September. That puts the world's biggest online retailer in bear market territory. Amazon happens to be the biggest holding in the XLY (20%). Yet they keep telling us that consumer spending, which accounts for two-thirds of the American economy, is strong. Recent price drops suggest otherwise.

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Chart 5

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Chart 6

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Chart 7

WALMART HAS A BAD WEEK ... The daily bars in Chart 8 show Walmart (WMT) having a bad week (after reporting strong earnings). And it did so in heavier trading. So far, the damage has been relatively limited as it tests is 50-day average (blue line). One thing that does concern me is the On Balance Volume (OBV) line in the upper box which has not kept pace with this year's price advance. The OBV line is a running cumulative total of upside versus downside volume. It should rise along with prices in an uptrend. It hasn't done that this year by a wide margin. Which may suggest that the uptrend in the stock isn't as strong as it looks. For reasons that I don't understand, the world's biggest retailer is included in the Consumer Staples SPDR (XLP). It's actually one of its top five holdings (8.3%). Despite this week's big drop in WMT, the XLP held up relatively well.

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Chart 8

CONSUMER STAPLES STILL LOOK STRONG ... The daily bars in Chart 9 show the Consumer Staples SPDR (XLP) still in a strong uptrend. It was one of Friday's strongest sectors, despite a modest seback during the week (-1.3%). Walmart's loss of -7.5% had something to do with that. Of equal importance is that fact that the XLP/SPX relative strength ratio (top box) is still rising. It started rising in early October as the market started to weaken and investors rotated in safer parts of the market like staples, utilities, and REITS. Staples were the second best performers over the last month just behind REITS. And they were the market's top sector over the last three and six month periods. Utilities and REITs were right behind. That's a sign that investors have turned a lot more defensive. That can also be seen in the lower box in Chart 9 which plots a ratio of consumer staples (XLP) divided by consumer cyclicals (XLY). That rising ratio carries a dual message. Not only are investors seeking more defense; they're also rotating out of economically-sensitive growth stocks that don't do as well in a weaker stock market. Or a weaker global economy.

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Chart 9

HOW DO THEY KNOW THAT THE FUNDAMENTALS ARE STILL BULLISH? ... Financial analysts keep telling us that the fundamentals remain bullish despite stock market weakness. What puzzles me is how they know that? Think about it. Earnings are being reported for the previous quarter that ended in September. They tell us nothing about the future, or even present conditions. They only tell us about conditions a couple of months ago. They won't get this quarter's results until the first quarter of next year. So they don't actually know the fundamentals for this quarter. Yet they keeping saying with such confidence that those fundamentals remain bullish. Same thing with the economy. We got GDP results for the previous quarter which looked pretty good. But that's the past. What about this quarter? We won't know that until next quarter. In the meantime, we're pretty much in the dark. But they keep assuring us that the economy shows no signs of slowing (despite the fact that the rest of the world is weakening). Again, how do they know that? Where's the current data to support that confidence? Imagine trading stocks using price data from the previous quarter.

WHY WE USE CHARTS
Chart 10 shows the S&P Composite 1500 Index reaching a new record during September. [That index includes large, midcap, and smaller stocks and is good barometer of the entire U.S. stock market]. That September high completed a strong third quarter for stocks. No one would make current trading decisions based on that old technical data while ignoring the fourth quarter weakness. But that's what we're being asked to do with old fundamental data. Financial analysts are asking us to make fourth quarter financial decisions based on third quarter results. In other words, they're assuming the current fundamentals are still strong because they were strong a couple of months ago. That's a lot to ask. By the time we find out if they are weakening, it may be too late to do anything about it. And that's why we look at charts. They provide the most up-do-date information on the state of the stock market. They may also be telling us something about the fundamental reports we won't be getting until early next year. Charts track forward-looking markets, while fundamental data is backward looking. It's always safer to look out of the front window of your car while driving to see where you're going. Not the back window that shows you where you've already been. And you'll have fewer accidents.

Chart 10