Coal in the Stocking for Retailers

Retailers who were betting on strong holiday sales are not happy with the way 2007 is ending. Target (TGT) warned this week that same-store sales for December may actually decline from a year ago. Other reports show growth that is sluggish at best. There is some hope that shoppers who received gift cards will redeem them in the next few days, but if so it will likely be at steeply discounted sale prices.

Other signs of economic weakness continue to add up. Today's government reports on durable goods orders and employment were disappointing, and investors seem to be losing confidence in the Federal Reserve to engineer a "soft landing" and avoid recession. We should begin to see the real impact of the housing bust as 4Q corporate earnings are reported in the first half of January.

Meanwhile, crude oil prices were already jumping even before today's news of the assassination of former Pakistani prime minister Benazir Bhutto. Instability in the Middle East is obviously nothing new. What is new is the possibility that radicals could take advantage of Pakistan's political chaos to seize control of its nuclear weapons arsenal. Much will depend on how this situation develops. Even in the best case scenarios, the fear-factor will probably keep a floor under crude oil prices - and a cap on global economic growth.

Due to the New Year's Day holiday, our next update will be on Thursday, January 3rd. By then we will know how the markets opened in 2008. It will be interesting to watch. Happy New Year!

Ebbs & Flows

Market Commentary: Equity markets around the globe rallied strongly this past week. The end-of-the-year is now just three trading days away, and all major indexes have a good chance of finishing the year in the plus column. Such a finish was far from certain many times during the year. All major indexes were in negative territory in early March after sporting healthy returns the prior week. A correction in late July and early August caused these same indexes to give up their double-digit year-to-date gains and become dangerously close to slipping into negative territory again. One more correction started to take hold in October, resulting in a test of the August lows. For now, those lows have held, and the market seems determined to end the year on a positive note.

The equity market’s gains of the past week have been the bond market’s loss. The 10-year Treasury yield closed today at 4.28% after dipping below 4.0% for a brief period last week. Much of the equity market woes of 2007 are tied to losses in the subprime credit markets. However, government issued notes and bonds were a different story. For high-quality Treasury securities, the yields dropped and prices rose every time the equity markets weakened this year. This made Treasury securities one of the best diversifying asset classes of 2007.

Sectors: Energy, Materials, and Utilities were the leading sectors for most of calendar year 2007 and are now finishing the year in that position. It was by no means a smooth ride. Energy had five pullbacks of -6% or more, Materials had two double-digit corrections including a nearly -16% mid-year decline, and the often placid Utilities sector had a mid-year correction of nearly -12%. Of course, the real problem area was the Financial sector, which experienced its own bear market by dropping more than -24% at one point. The Consumer Discretionary sector narrowly missed having its own bear market by holding its decline to just under -19%.

Styles: Mid Cap Growth turned in the best performance for 2007 thanks to a strong showing in the first half of the year. The Large Cap Growth style took over the leadership reins starting in July and was one investment segment that managed to avoid having a double-digit correction during the year. On the other end of the style spectrum are the Micro-Caps, which lagged the market for most of the year and appear destined to finish in negative territory.

International: International markets also underwent a series of declines similar to the US, although the superior strength of the international markets generally meant that their pullbacks were also of greater magnitude. Latin America is finishing at the top of our rankings for 2007 even though it underwent four separate corrections of more than 10%, one of which turned into a -22% mid-year bear market. China spent more time atop our rankings than any other global region this year and will likely finish the year with the best returns. However, China’s stellar performance was punctuated with two separate bear market intervals where it posted declines of -21% and -25%. Japan will likely end the year with a loss and at the bottom of our rankings where it stayed for most of 2007.

Recession In Sight?

The Index of Leading Economic Indicators came out today at its lowest level in more than two years, suggesting that the economy remains weak and recession is not out of the question. The housing slump continues to hurt employment and consumer spending. Credit is still very tight. Recession may not be inevitable, but we are still getting a reminder of what it looks like.

What will a recession mean to the stock market? History tells us that the markets can be weak in a strong economy and strong in a weak economy. This is because the stock market does not reflect the present; it discounts the future. Investors buy now based on what they expect will happen later. These expectations can be wrong, of course. Nevertheless, it is often the case that stocks begin rising when people conclude that the end is in sight. Moreover, "the market" is not monolithic. Some companies can perform well even in a recession, while others will not. This means that as the economy bottoms out, certain sectors will rotate into favor while others will lose their momentum. What keeps things interesting is that the cycle repeats itself a little differently each time.

Currently the economy appears to be in the early stages of recession, but a substantial number of investors still think there may be a "soft landing." Opinions change daily as more data comes in, which is why we are seeing substantial short-term volatility. This may be amplified for the rest of the month by seasonally low trading volume. The first week of January will give us a much better sense of what 2008 holds in store.

Due to the Christmas holiday, we will have only one update next week, on Thursday December 27th.

Emerging Markets Slammed!

Market Commentary: The action in the equity markets has been predominately to the downside since the FOMC meeting of December 11. On an intra-day basis, the S&P 500 has pulled back more than 5%, the MSCI EAFE iShares (EFA) more than 7%, and the MSCI Emerging Markets iShares (EEM) more than 10%. Bright spots have been hard to find as negative sentiment appears to be taking the upper hand. Investor expectations are clearly lower, leaving some potential for upside surprises.

Credit markets are still a mess. The ECB injected an unprecedented $585 billion (more than half a trillion) of cash into the banking system to help bring this crisis to an end and ensure that banks have enough cash for year-end needs. Treasury yields are back in the same neighborhood they were prior to the Fed’s interest rate reductions last week. The 10-year Treasury yield closed today at 4.07% while traversing a range of 3.99% to 4.26% this past week.

Sectors: Utilities, Energy, and Consumer Staples held up the best this past week amid the global equity market pullback. The Materials sector did not escape the selling, getting bumped out of our top spot. The Financial and Consumer Discretionary sectors were knocked down hard once again with Financials dropping nearly 11% on an intra-day basis this past week.

Styles: The style rankings have been fairly consistent for the past few months. The domestic market continues to favor Large Caps over Small Caps and Growth over Value.

International: Strength in the US dollar and weakness in the international equity markets teamed up for a one-two punch for international holdings of US based investors. This has caused a high degree of movement within our relative rankings over the past week. We will need some additional time to determine if this is just a short-term event or the beginnings of a more significant shift.

Stagflation Lives

Those old enough to remember the 1970s may remember "stagflation." It describes an economy that features the worst of both worlds: low or negative growth and rising prices. Such times are decidedly unpleasant. In a depression, your income falls but the things you need to buy get cheaper at the same time. With inflation, everything costs more but your income is probably rising, too. Stagflation doesn't have a silver lining. It's bad no matter how you look at it.

Thus it was rather shocking to hear retired Fed Chairman Alan Greenspan tell ABC News over the weekend that he now sees the "early symptoms" of stagflation. Others concur; economists at JPMorgan Chase are forecasting the slowest global growth in four years this quarter, along with the highest inflation in a decade. The ongoing credit crunch is not easing despite the best efforts of the Fed and other central banks. Rapid growth in China and other emerging markets is driving up food and energy prices. It is beginning to look like the perfect storm may be coming.

Lipstick on a Pig

That is how one analysts describes the coordinated effort by the Federal Reserve and several other central banks to drive down interest rates by injecting new liquidity into the bond market. William O'Donnell at UBS Securities said "What the program will not do is cure the cancer that got us here in the first place - the housing bust, the collapse in credit conditions, etc. We view this new program as palliative, and not a cure. Much more time is needed and much more pain is up ahead."

The way this plan emerged is puzzling. On Tuesday the Fed disappointed the markets with a quarter-point interest rate cut and the Dow promptly plunged. More important, key lending rates did not budge, showing that banks were still unwilling to extend credit. Then Wednesday morning the broader plan was announced. It would have made much more sense and saved everyone a lot of grief had they announced both at the same time. It is unclear why this was not done. Confidence in the Fed is waning, and it couldn't come at a worse time. For this reason we continue to favor defensive equity sectors such as health care, utilities and consumer staples.

International funds had a nice run in recent weeks as the dollar lost ground against other major currencies. That trend appears to have slowed.

A Market Displeased

Market Commentary: At yesterday’s widely anticipated FOMC meeting, the Fed decided to lower the fed funds target rate to 4.25% and the discount rate to 4.75%, a reduction of 25 basis points for both. The typical market reaction to a Fed interest rate change is an immediate increase in volatility with a couple of directional reversals thrown in, all within the first hour of post-announcement trading. Yesterday was different. Volatility picked up, but all the action was to the downside. The market was apparently signaling its displeasure with the magnitude of the cut. Overnight, the Fed joined forces with the European Central Bank, Bank of England, Bank of Canada, and the Swiss National Bank to inject billions of dollars (and other currencies) into the banking system. The markets applauded this move by gapping up at today’s open and recapturing the better part of yesterday’s sell-off. The euphoria quickly faded with stocks drifting lower until the final hour when they briskly sold off and then turned around to rally into the close.

Treasury yields climbed most of this past week. The 10-year Treasury yield was hovering around 4.1% prior to the Fed announcement and then plunged to finish the day below 4.0%. Today, following a path similar to the stock market, the yield surged back up to 4.18% shortly after the open and then drifted lower to close at 4.08%.

Sectors: Energy climbed back into the #4 spot in our sector rankings this week, and crude oil moved back above $90. There is a noticeable disjuncture when viewing the absolute strength graphs of the major sectors. The chart depicts a typical smooth decline in strength as we move down the list from Materials to Industrials. At that point, there is a sharp break in graphical display before the poorly performing sectors of Consumer Discretionary, Financials, and Telecom show up. It almost looks as if there are a handful of sectors missing from the chart that should be inserted between Industrials and Consumer Discretionary, but that is not the case.

Styles: Once again we have very little change in the relative rankings among the various styles even though the absolute strength improved across the board. The domestic market is clearly favoring Large Caps over Small Caps and Growth over Value.

International: Latin America led the global charge this past week and moved into our top position. The Russian market also performed quite well, helping to improve the standing of Diversified Emerging Markets. Canada is at the bottom of our list again, with the US performing only slightly better.

Pushing On A String

We come once again to Federal Reserve time. The futures markets suggest a high probability that the Fed will cut short-term rates by 25 basis points to 4.00% on Tuesday. The bigger question is what sort of statement will accompany the announcement. The Wall Street honchos want reassurance that the Fed will take aggressive action to stabilize their bonus checks, oops, we mean stabilize the economy. We have no doubt the Fed will do what Wall Street wants. Whether they will succeed in stabilizing anything is another question.

The problem is this: whatever generous loan terms the Fed offers to the banks will not necessarily inspire those same banks to be any more flexible in granting credit to businesses and consumers. Economists call this phenomenon "pushing on a string." It is an evocative image; no matter how hard you push on string, all it does is pile up around your feet. Lenders are in no hurry to take on any additional risks after being stung so badly this year. Until that attitude changes, Fed policy will have little lasting impact. Perhaps Ben Bernanke has an unexpected rabbit in his hat, but so far we see no evidence of one. Tighter credit leads ineluctably to economic slowdown.

This outlook is consistent with the recent patterns in sector relative strength. The strongest intermediate-term momentum is found in defensive stocks like utilities, consumer staples and health care. Dollar weakness is allowing materials and energy to also move up, but those sectors face heavy overhead resistance. Our best guess is their momentum will fade shortly.

Just What We Need

Investors relaxed as media reports of a government bail-out plan for subprime mortgage holders seemed to be taking shape. The idea is to freeze interest rates for homeowners whose mortgages are scheduled to balloon to higher rates that would push them into default. We are wary that any such plan will ever see the light of day, and that it will have the desired effect even if it reaches fruition.

The first problem is that the troubled mortgages have been sliced and diced into a plethora of derivative securities owned by many different parties who may have wildly different goals. The legal and practical complexities of implementing a bail-out plan cannot be overstated. Think about all those papers you signed when buying your home, then multiply it by several million and you will get the idea. Second and perhaps more important, it is far from clear that freezing mortgage rates for some borrowers will solve their problems. It may just delay the inevitable. Lenders have been selectively doing this sort of thing for a long time, and reports show that the borrowers often end up defaulting anyway in another year or two. The best solution will almost certainly be to let nature run its course. As people default, more homes go up for sale and prices fall, the economy will naturally restore the balance that was lost over the last few years. The pain this will cause for many people is sad but there really are no better options.

The stock market is less concerned about borrowers and more concerned about the losses faced by banks and other lenders. Investors seem to welcome the bail-out talk since financial stocks are up sharply the last few days. Here again, we are concerned that the optimism is misplaced. Intermediate-term momentum still favors the economically defensive sectors like utilities, consumer staples and health care.

Follow-Through Day!

Market Commentary: The market kicked-off a new rally last week and established a strong follow-through today. For widely followed equity benchmarks such as the S&P 500 and the Dow Jones Industrial Average, it appears that the lows of last week constitute a successful retest of the August lows. It should be noted however, that it has been the Nasdaq and the international markets that have been providing the leadership for much of 2007, and the November pullback did not approach their August lows.

Investors are banking on another interest rate cut from the FOMC next week. Additionally, a word we haven’t heard in a couple of years – deflation – is now popping up in economic discussions. As a result, the 10-year Treasury yield finds itself back below 4% again, closing today at 3.91%.

Sectors: This past week produced an across-the-board improvement in our sector rankings, which now show half of the major sectors in positive intermediate-term trends. Relative strength is similar to last week and is exhibiting a definite bias toward defensive sectors such as Utilities, Consumer Staples, and Health Care.

Styles: The global equity rally that kicked off a week ago improved the absolute strength of all style categories while producing little change in the relative rankings. The domestic market is clearly favoring Large Caps over Small Caps and Growth over Value.

International: China has bounced back into our top spot in the global rankings, signaling once again that it may be premature to declare the bursting of the China bubble. US-based investors with large positions in Canada are learning that currency translations work in both directions. For the first 10+ months of this year, Canadian equity investments were boosted by a 31% appreciation of the Canadian Dollar (often called the Loonie) versus the US Dollar. However, in the past four weeks, the Loonie has plunged more than 9% against the greenback, pushing Canada to the bottom of our global rankings in the process.

Home Stretch

December is here and 2007 is turning out to be a year many investors would prefer to forget. It is, of course, still possible that a Santa Claus rally will help the record books record an "average" year. Stranger things have happened. Yet the evidence suggests that whatever December brings, the longer-term picture is less than positive.

The stock market is driven by many factors but in the end they all boil down to one: corporate profits. When companies are making money - or when investors at least antipate that the will make money in the near future - you can expect to see stable or rising equity prices. When business is not growing and profitable, stocks are less valuable. This is why some recent reports are more than a little disturbing. Despite record earnings from foreign sales, per-share profits for the S&P 500 companies fell almost 25% in the 3Q. Some analysts expect the 4Q to be even worse.

Of course, profitability is not evenly dispersed. There are substantial differences between the various industry sectors and even between companies of the same sector. The bulk of this year's losses are in the financial services sector thanks to the meltdown in subprime mortgage securities. Unfortunately this happens to be a very big sector, and its problems threaten to spread into technology, retail and construction spending. Softness in the economy is also part of the reason that energy prices are in retreat. So far, oil company profits are still strong, but if the economy moves into recession even this powerful sector could lose its long-term momentum.

The safe havens continue to be the defensive sectors: utilities, consumer staples, and health care, along with selected foreign markets and Treasury bonds.

Crunchy Credit

If humility is a virtue, then the leaders of Citigroup may be some of the more virtuous people in New York. This week they agreed to sell $7.5 billion in convertible stock to an investment fund controlled by the government of Abu Dhabi, one of the United Arab Emirates. The terms of the transaction are complex and it is not entirely clear who gets the best end of the deal. Nonetheless. it is hard to portray as anything other than a bailout. Citigroup is, in effect, borrowing money at an 11% interest rate and giving up a 4.9% equity stake. A Wall Street Journal editorial summed it up well, saying "it strikes us as unfortunate, if not a tragedy, that America's largest bank had to go hat in hand to Arab sheiks because of bad management and blundering U.S. monetary policy."

Having been reduced to nothing less than a subprime borrower itself, Citi and its peers are increasingly selective about lending money to anyone else. The resulting "credit crunch" threatens to push the economy into recession. The fact that year-end is approaching exacerbates this situation, as lenders are reluctant to acquire new loans that will have to appear on their December 31 balance sheets. This suggests the situation may ease in January; whether it will be enough to matter is impossible to say at this point. Consumers who face a softening job market, rising fuel and food costs, falling home prices and tighter interest rates can hardly be blamed if they decline to stimulate the economy with exorbitant holiday spending.

With all this going on, why did the stock market stage a major rally on Tuesday and Wednesday, then hold on to its gains today? The market is back in "Bad news equals good news" mode. Traders are betting that economic weakness will allow the Fed to keep dropping interest rates, and Fed officials are dropping plenty of hints to support this notion. Meanwhile, a pullback in oil prices suggested inflation pressure could ease. This week's equity gains can easily be characterized as nothing but an "oversold bounce," and unless there is more follow-through soon it will become difficult to argue otherwise.

Taking a step back, intermediate-term relative strength is largely unchanged despite all the fireworks. The defensive trio of utilities, consumer staples and health care is still the place to be for equity investors. Selected foreign markets remain in uptrends but show signs of weakening.

Vroom Vroom

Market Commentary: If you listen closely, that sound you hear is the collective sigh of relief emanating from Wall Street. Yesterday’s upward move was widely welcomed. Today’s upward move was a happy turn of events. However, that does not mean it is time to throw caution to the wind. After all, it has only been two days, and with most market benchmarks still below their 200-day moving averages, there remains much damage to repair.

The 10-year Treasury yield plunged this past week, hitting a low of 3.85% before moving back up to close at 4.02% today. The 3.85% level was its lowest in nearly two and half years and was a reflection of recession fears. Analysts are crediting today’s upside move in equities, as well as Treasury yields, to comments from Fed Governor Kohn that indicate further interest rate cuts are indeed a possibility.

Sectors: Our sector rankings do not take into account today’s upside action, which was led by the Financial sector’s impressive +5.8% gains. Unfortunately for Financials, that only recovers the action of the previous six market days. Today’s action will likely be referred to as a short-covering rally for the Financial sector, but there is also evidence that some opportunistic value managers were starting to buy. Today’s rally also lifted the defensive sectors of Consumer Staples and Utilities, indicating that a major sector rotation is not taking hold just yet.

Styles: Today’s rally also helped every style grouping. Mid Cap Growth was one of the laggards today, if you can call a +2.8% gain a laggard. Small Cap Blend received the largest bounce of the day with the Russell 2000 Index jumping +3.6%, while its tracking ETF gained +3.9%.

International: The global market correction took its toll on our global rankings this past week. Every category except the European Union has now flipped over to negative intermediate trend status, and the EU is dangerously close. Today’s US stock market rally boosted the prices of all international ETFs traded in the US. We will see how much of those gains are translated back into the international markets during the overnight trading sessions.

Freddie Mac Loses His Friends

With year-end rapidly approaching, the U.S. stock market is back roughly to the level at which it began 2007. Bearish news abounded this week. The quasi-governmental mortgage bank affectionately known as Freddie Mac reported heavy losses in its loan portfolio and may need a multi-billion dollar bailout soon. We won't be surprised if taxpayers are left holding the bag; Wall Street seems to have little interest in taking on even more risk at this point, especially after a new economic forecast from the Federal Reserve suggested more economic weakness is probably ahead. Corporate news shows no hints of recovery, either.

All the bad news is causing another wave of near-panic buying of Treasury securities. This has the effect of driving down the effective yield. The U.S. 10-year bond yield dropped below 4% for the first time since 2005. Two-year notes dipped below 3% as well. The yield curve is steepening in anticipation of further interest rate cuts by the Fed. Rising crude oil prices did little to help energy or any other sector. Today even the defensive equity sectors that had been market leaders retreated amid the flight to quality. This may have something to do with holiday trading schedules, but we won't know until next week.

Our indicators continue to suggest that stocks are at a critical juncture. A great deal of technical damage has been done in the last few days, and if it is not repaired soon then further losses seem likely. On the other hand, the market benchmarks are clearly approaching oversold conditions and due for at least a short-term bounce. We should know more next week when normal trading resumes. Happy Thanksgiving.

WHIPSAW

Market Commentary: The market continues to struggle with volatile day-to-day and intra-day swings being the norm. The major question surrounding all of this uncertainty remains unanswered – will the subprime slime drag the US economy into a recession, or will global growth save the day? Weighing in on the issue today, the Fed released its first set of forecasts under its new disclosure policy. Fed officials now anticipate a soft-landing, moderate economic growth, stable inflation, and low unemployment through 2010. However, they admitted that their forecasts are surrounded by uncertainty.

The 10-year Treasury yield continues its march toward a 3% handle by closing today at 4.05%, down from last Wednesday’s intra-day peak above 4.3%. This is its lowest yield in more than two years and suggests that bond investors currently fear recession more than inflation.

Sectors: Our sector rankings are displaying a typical “weak market” picture. The classic defensive sectors of Consumer Staples, Utilities, and Health Care are at the top of our rankings and remain in positive trends, while the other sectors are exhibiting negative intermediate-term trends. The Financials continue to be knocked down on bad news. Today, the Federal Home Loan Mortgage Corp (FRE), better known as Freddie Mac, announced a $2 billion loss. It closed today at a price that was nearly 25% lower than yesterday and about 60% lower for the year. Fannie Mae, the Federal National Mortgage Association (FNM), has experienced a similar fate.

Styles: Many of the style categories are now in full-fledged corrections, and some are approaching bear-market territory. Small Cap Value is showing a -15% decline from its mid-year peak, is at a 52-week low, and has wiped out all its gains of the past 20 months. Large Cap Growth and Mid Cap Growth have also experienced pullbacks the past few weeks, but so far, they remain well above their 52-week lows and are in much better “relative” shape than their Value counterparts.

International: Global equity markets continued their retreat this past week. On a relative strength basis, the theme of the past year remains the same – Emerging Markets continue to outperform the Developed Markets of the world.

Record Year on Wall Street

As the stock market continued to sell off, news reports today estimated that the top Wall Street firms will pay out record bonuses at year-end. The five leaders - Goldman Sachs (GS), Morgan Stanley (MS), Merrill Lynch (MER), Lehman Brothers (LEH) and Bear Stearns (BSC), collectively employ 186,000 workers who are expected to split bonuses of about $38 billion. This is in addition to normal salary and benefits, and works out to an average of $201,500 per person.

Of course, many employees will receive far less than average because a small number of top producers will keep most of the money. The one group that seems destined to receive nothing is shareholders, who have lost some $74 billion in the market value of their shares this year. The companies will argue that competition for top traders is fierce and they must pay for talent. It remains unclear how many shareholders will agree with this logic.

Stocks tumbled today to open the holiday-shortened week. Financial stocks were again the downside leaders, with sector benchmarks dopping to test their early November low points. One analyst estimated that Citigroup (C) will have to write down another $15 billion in subprime loan losses. The classic defensive sectors are beginning to assert clearer market leadership in our momentum rankings. Utilities, consumer staples, and health care funds are the main islands of stability right now, while the uptrends in technology, energy and materials seem to have broken down. Gold funds still dominate the top of our lists but are falling fast.

Due to the Thanksgiving holiday, our next update will come to you on Wednesday, November 21.

More Things Change

Signs of change continue to grow in markets around the globe. The exact nature of the change is still unclear. Nervousness has returned to the credit markets, with no less than General Electric (GE) posting a 4% capital loss in an "enhanced cash" fund that was supposed to remain as stable as a rock. Other companies like Bank of America (BAC) have avoided similar fates for their money market funds only by injecting large amounts of company cash to reimburse the funds for losses in mortgage derivatives. As yet, no money market funds have "broken the buck" but it may be only a matter of time.

In any case, the recovery of the financial services sector now appears to have been nothing more than an oversold bounce. Another test of the lows seems likely. Crude oil prices are backing off, to the detriment of energy and energy service sector funds. Capital appears to be flowing toward the traditionally defensive corners of the stock market: utilities, consumer staples, and health care. Financial services, consumer discretionary, and real estate are the most bearish sectors for now, but technology is looking increasingly vulnerable. Further complicating the situation is dollar weakness. From a U.S. perspective, this means better results can be found in foreign stocks, even if those stocks are actually performing no better than their U.S. counterparts. Investment maven Jim Rogers made news today with bearish comments about the dollar and re-stated his intent to be out of dollar-denominated assets in the near future. We find it hard to disagree.

Waterfall

Market Commentary: A swift and volatile downside move was the primary action in the equity markets for the better part of the past week. The high-momentum segments of the market, those that have been exhibiting most of the recent strength, were hit the hardest. The Nasdaq 100, the domestic market leader, dropped -10.9% in just four market days. On the international front, iShares MSCI Emerging Markets (EEM) shed -10.2% and iShares FTSE/Xinhua 25 (FXI) plunged -14.5% in those same four days. Whether this marks an abrupt change in market leadership or just a temporary correction for the existing leadership remains to be seen. By the same token, the strength in the Financial Select Sector SPDR (XLF) this past week does not guarantee its woes are over.

The 10-year Treasury yield closed today at 4.27%, just slightly lower than a week ago. Meanwhile, yields continue to climb in the high-yield segment, suggesting that investors believe the odds of a recession are increasing.

Sectors: The big drop in high-momentum sectors this past week caused Technology and Energy to drop in our rankings. The defensive sectors of Utilities and Consumer Staples have now risen to the top while Telecom has replaced Financials at the bottom of our rankings. The Telecom sector is currently displaying extremely divergent results on a global basis. The US Telecom sector, as indicated in our chart, is extremely weak thanks to dismal performance from Verizon (VZ) and Sprint (S). However, the international telecom sector is behaving quite well thanks to strong showings by Vodaphone Group PLC (VOD), Vimpel Communications (VIP), and Telefonica SA (TEF).

Styles: The sell-off showed little mercy as all domestic style categories suffered this past week. There was not much change in the relative rankings, but absolute strength took a hit across the board, flipping the last five style categories to negative intermediate-trend readings.

International: More air was let out of the China market this past week, allowing us to drop the frothy label. Canada also took a big hit thanks to pullbacks in both the energy markets and the Canadian dollar. Latin America takes over the top spot in our global rankings for now, but with volatility remaining quite high, our rankings could dramatically change again. The bottom of the list has not undergone much change, with Japan and the USA continuing to occupy the bottom two slots.

Momentum Shift

"Everything people were buying they're now selling, and everything they were selling they're now buying." That is how one currency trader, quoted by the Wall Street Journal, described the turnaround in global markets. It's not quite a perfect description but is close enough. A lot can change in three days - and it did.

Prior to last Thursday, the technology sector was the place to be for U.S. equity investors, while financial services and consumer discretionary stocks were in solid downtrends. They're still in solid downtrends, but they've been joined by technology, industrials, and to a lesser degree health care, materials and energy. The remaining islands of stability are utilities and consumer staples. These are traditionally defensive sectors, the kind you would expect to be strongest in a period of economic weakness. It is no surprise, then, that they are rising in relative strength just as more signs of a recession for the U.S. economy become apparent. Meanwhile global strength seems to be shifting from Asia to Europe.

Bottoms Up

Trying to pick key market turning points is tricky business. Downtrends usually end with something traders call "capitulation." You could also call it "surrender." When the last bearish investor sells his shares and heads to the sidelines, then stocks have nowhere to go but up. Did the last bear sell today? We don't know yet. There was a fairly substantial turnaround in the afternoon after a very weak morning. This suggests that many of the "weak hands" may now be out of the picture. If so, we may look back on November 8th as a day of capitulation, much like August 16th and March 14th. Unfortunately we do not yet have the benefit of hindsight to be sure.

There is a key difference in the past week's action that we are watching closely. Technology has been the strongest sector for several months now with only a few short periods of underperformance. At the same time, financials have been the weakest sector. Tech stocks, the thinking goes, have little or no exposure to subprime mortgage derivatives. This explains the relative strength of both technology sector funds and Nasdaq-based style funds, which tend to have a heavy weighting in technology and only minimal exposure to financials. In the last few days technology and financials dropped together. Financials were still weaker, but the difference shrank considerably. What does this mean? Maybe nothing, but it is a significant change.

Today's technology sell-off was sparked by news from Cisco Systems (CSCO), which said that a decline in sales to automotive and financial companies is curbing growth. So maybe the tech sector is exposed to subprime mortgage losses - but indirectly as its customers in that sector are forced to cut spending. One day and one company does not make a general trend, of course. We will watch carefully for more signs of change.