Sunday, July 30, 2006

Stocks Rally on Views of Soft Landing

- Stocks rally on views of a pause and soft landing, but volume continues to lag.
- Q2 GDP helps spark a market rally, but the numbers are not that pleasant.
- Showing momentum ahead of Fed pause, but thus far lacking strong buying heading into another week heavy on earnings, economic data.

Look, up in the sky, it’s the Fed ending its rate hikes.

Certainly that was the idea Friday with Q2 GDP coming in at 2.5%, much less than expected. More to the point, there were many statements that a soft landing was taking place. Bonds had rallied all week, pushing the yields closer and closer to 5%. The GDP data basically sealed the deal Friday with the 2 year closing at 4.97% and the 10 year at 4.99%. The curve reverted to positive by a hair, a good sign, but as noted Thursday, rates are overall very low when compared to a 5.25% Fed Funds rate. That is telling you two things. First, the Fed is indeed done as the Fed Funds futures contract estimates less than a 30% chance of a rate hike on August 8. Second, its telling you that money is too tight given the deteriorating economic conditions and some economic slowing is ahead if the current pace holds. If the Fed backs off perhaps some confidence is restored and the economic investment can continue and thus a resumption in growth.

That is what bulls were talking about Friday with their ‘soft landing’ predictions. At 2.5% they figured if the Fed halted its hikes then things should pick back up a la 1995 and everyone is happy at Christmas. To that end stocks started higher on the bell. A good early surge was followed by a test as the leading DJ30 and SP500 climbed near the July highs and started to waffle. Volume was running lower and that looked as if it could be a problem for a continued move. Stocks caught their second wind, however, rallying into the afternoon with SP500 and DJ30 closing right at the July highs. Even NASDAQ and SOX helped out, moving through near resistance for the first time in two months. After earnings guidance failed to spark a rally and indeed led to selling, it took the idea the Fed would stop rate hikes to get the market back into recovery mode.

To keep it going, however, economic growth will need to pick up. As noted, earnings guidance has been tepid despite 14.5% earnings growth year/year and 70% beating estimates. The market is not being kind to companies in the current economic environment either; if you guide lower you are slaughtered. IBD reports that 39 $10+ stocks suffered a 20+% one day loss the past three weeks. Seventy-six fell 15%, and 185 dropped 10% in one day. That is brutal. In addition, stocks have sold off, bonds have rallied to ridiculous levels versus the Fed Funds rate, and transports, always a leading indicator, have been clocked. They just managed to recover the 200 day SMA on the Friday rally. As if that were not enough, inflation is still showing signs of life with a jumping PCE, and business investment is lower.

Technical action not strong but doing what needs to be done.

Technically it was nice price day. The NYSE indices finally made it to where we said a couple of weeks ago we would like to see them, i.e. the July highs. They acted as if they didn’t want to do it, but the past week picked up some headway. That complements the price pattern on SP500 and DJ30 as they are now at the ‘hump’ in the double bottom patterns that formed with their bottoms in June and July. They even had some help from NASDAQ and SOX as both broke through the 18 day EMA, finally trying to give that long awaited higher bounce in their downtrends.

That last party kind of sums up the move for the week, however. Though prices rose, volume was not kind. Monday’s strong price move was on low volume. Tuesday trade was up but still below average. Wednesday the market churned and lost some ground on above average volume. Thursday they sold on higher volume. Friday’s nice move started the week as it finished: up but disappointing trade levels. In sum, simply not much volume support, indeed some distribution. The buyers were in control, but there were not that many slinging money back into the market.

Leadership tells a lot of the story. There has not been much. Friday there was definitely positive movement in some leadership caliber stocks that are not in too bad of shape. Many, however, still need more work before they are ready to sustain a rally, but they are working on it. While the buying strength has not been what you would want, the fact that the leaders are forming up, massing at the borders so to speak, indicates there is some positive build ongoing

The likely outcome.

The market typically factors in the end of a Fed rate hiking campaign before the actual event. With bonds rallying all week the stock market started factoring in the end as well. NASDAQ and SOX were due for a bounce as well, and they look to be finally making that move, adding some support to the SP500 and DJ30 moves.

Of course, what is factored in ahead of the event is typically taken out some after the fact. After all, Fed rate hikes can take a year to impact the economy, and simply saying ‘we are done’ has some immediate impact, but after that there are still rate hikes out there on their way down to land on the economy. Stopping the hikes won’t change the immediate course of the economy.

Thus after the pause or stop or whatever you want to call it the market will have to get over the excitement of the Fed getting off its back and then deal with the reality of where the economy really is. That will lead to a test where those patterns that started to build during the pre-Fed run will test back. That is likely where the bottom will be set unless it turns out the Fed just went too far given all of the other economic factors (e.g., energy, housing, war). After all, we had an inverted to flat bond curve for over a month, and that was AFTER the inversion in 2005 and early 2006 that was argued to be caused by foreign buying of treasuries.

There is an economic slowdown in progress, and it is likely to continue through Q3. If the Fed is done, however, the economy will likely recover and the market will start pricing that in ahead of the event. Thus the timing of another test after a pre-pause run is just about right for a ‘typical’ year of a bottom in Q3. Of course we have to watch the price/volume action as it unfolds, and very importantly, how leadership continues to develop during that period.


GDP drop rounds out a week of definitely mixed economic data.

From surging durable goods orders to a lower than expected GDP gain in Q2, the week was again all over the map regarding economic data. Of course GPD received the headlines to end the week, particularly given that it showed a lower 2.5% reading than expected (3.0%). That prompted the ‘soft landing’ commentary noted above, even getting the IMF to chime in that the US could have a soft landing if it stayed on top of inflation. Well gee whiz, if the IMF says its so then it must be 180 degrees from reality.

GDP breakdown shows the quarter was not that great.

Despite the hope of a Fed cessation resulting from the lower GDP growth number, the GDP numbers were not very positive, and indeed, one would almost wonder why the market would rally based on the results. Specifically, inflation concerns were compounded with a much higher than expected PCE (personal consumption expenditures), coming in at 4.1%, an all-time high. Even the core was smoking, coming in at 2.9% versus 2.0% before. That is the highest level since 1994 when the Fed was also in a tightening cycle. Further, the Employment Cost Index rose 0.9%, the highest in five quarters. Instead of dwelling on the Fed’s favorite indicator (PCE) or the labor market, stock investors focused on the bond market rally as reason for a Fed halt.

Business investment, the missing ingredient in the 2001 recession, helped lead the economy back after solid investment incentives in the second round of tax cuts restarted business spending. Since then it has been a mainstay of the economy, and indeed many pundits are saying that when the consumer slows, as he has started to do (2.5% growth in Q2 versus 4.8% in Q1), it will be business spending that keeps the economy going. After all, corporate balance sheets are loaded with cash as we hear every day on the financial stations, so they should spend, spend, spend and keep us all happy. Well, they were not spending as much in Q2 with capital spending falling to 2.7%, the smallest gain since early 2004 and far behind the 13.7% registered in Q1. While overall business buying slowed, spending on equipment and software actually declined.

Thus we are starting to see not only slowing growth rates but declines in some areas as the GDP growth rate was almost cut in half from Q1 to Q2. Meanwhile the Fed’s inflation indicators continue to rise, but as we have discussed in the past, those are lagging. As the economy slows, inflation will climb, peaking after the economy. Thus while the readings were higher, they don’t necessarily suggest any big change in the lay of the land: the economy is slowing as we have noted, and inflation that was allowed to jump up due to easy liquidity, is still climbing based on some reports. As we have noted, however, ECRI says that inflation peaked in October 2005 and pressures are actually declining despite the bump higher in the Q2 GDP report.

The market may have gotten ahead of itself with this rally on the likelihood of a Fed pause given the slowing economic data, but as usual there are underlying fundamentals for the rally. It senses the Fed is almost done and it also realizes that very accurate economic forecasting models such as ECRI still suggest just a slowdown and no recession in the economy. After two years of Fed rate hiking, the market is more than happy to come away with economic slowing as opposed to a recession. All things considered, that was reason to rally.



VIX: 14.33; -0.61
VXN: 19.26; -1.53
VXO: 13.44; -1

Put/Call Ratio (CBOE): 0.88; -0.17. After a series of closes above 1.0 the put/call ratio eased back during the Friday rally.

Bulls versus Bears:

Bulls: 42.2%. Bumped back up to the level two weeks back as bulls are in a lateral holding pattern. (42.1% last wee, 42.2% the week before). There was a big spike higher from 38.7% two weeks back, but we hoped for more here. At this level we note it is below the levels hit on the last market sell offs. On the last pullback bulls hit the lows for this rally, i.e. since 2003. That put it below the 42.3% hit on the last low and the May and October 2005 readings that preceded new upside runs.

Bears: 34.5%. Bears are moving higher the market sold off and then rebounded. Up from 33.7% last week and 33.3% the week before. Still lower than the 34.4% hit three weeks back, but on the climb again. Kissed the bulls to end June, just missing crossing over with the bulls, but that in itself is not a bad indication for the upside. Hit a new post-2002 high in that late June move, eclipsing the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005).


Stats: +39.67 points (+1.93%) to close at 2094.14
Volume: 1.877B (-14.08%). Substantial volume decline dropped volume back to below average on what many said was an important move. Without the volume it as not that important, however. Sure it was a summertime Friday, but what about all of the other days NASDAQ moved higher on lower volume? One day can be an exception. Several days start making the rule. Last week volume was basically down when it needed to be up, and up when it needed to be down (i.e., on the down days).

Up Volume: 1.54B (+778M). Those that were in the market were buyers.
Down Volume: 326M (-1.079B)

A/D and Hi/Lo: Advancers led 2.32 to 1. Solid advancing breadth as NASDAQ actually recovered through its 18 day EMA and brought more covering into play.
Previous Session: Decliners led 1.66 to 1

New Highs: 83 (+10)
New Lows: 101 (-28)

The Chart: (Click to view the chart)

NASDAQ made its first push through the 18 day EMA (2080) since early July before the earnings tumble lower. That clears near resistance in its downtrend, and when it did not hold and confirm a more severe downtrend, the shorts started to cover, and that helped push NASDAQ even higher. Looks as if 2100 is going to be tested, and if the pre-FOMC pause rally continues, the 50 day EMA (2131) is definitely in play. That would be the lick log for NASDAQ. It stalled at the 50 day on its last rebound attempt, and if it fails there again it will have established a rather well-defined downtrend. That would really keep us on alert for a longer market decline as a leading growth area would have confirmed its downtrend. For now, more of a bump higher appears appropriate ahead of the Fed.

SOX (+3.04%) surged through the 18 day EMA (410.72), clearing it on the close for the first time since early May when the selling really started to get ugly. After that long decline it finally looks ready to make its higher bounce in its downtrend to test higher resistance near the 50 day EMA (436.61).


Stats: +15.35 points (+1.22%) to close at 1278.55
NYSE Volume: 1.689B (-7.2%). Volume could not match the price action as SP500 in particular enjoyed a nice price day. Trade declined but managed to hold average, much better showing than on NASDAQ. NYSE suffered some distribution last week, but not as much as NASDAQ. Pretty much in line with the differences in performance of the two indices the past couple of months.

A/D and Hi/Lo: Advancers led 4.05 to 1. Another very impressive breadth session as stocks were bought across the board. Volume did not match, and it has not matched, the upside breadth figures. They appear too volatile to us, too extreme whether to the upside or the downside, and that suggests the market is still in for more of a struggle.
Previous Session: Decliners led 1.31 to 1

New Highs: 120 (-1)
New Lows: 66 (-26)

The Chart: (Click to view the chart)

Came back from a mid-session wobble to close near the highs and just off the July high at 1280. After volume churned Wednesday and showed some distribution Friday, it was lower as SP500 made its grand move. It tapped right at 1280, but could not punch through without the volume. This is where we figured SP500 should get on this bounce and then do some more work laterally to build a handle and then try to move on. It sort of built the handle Wednesday and Thursday; not much of one, and of course volume was not low as you want in a handle. Thus the move remains a bit under a cloud, but with the FOMC meeting coming and an anticipated ‘no action’ vote, SP500 could push higher to 1290 and even 1300 ahead of the meeting before forming that handle. If that occurs over a 2 week period and then forms the handle, that would just be about perfect timing for a low in September and then a recovery and break higher that month or in October. A test higher will also put in the test of the crossover of the 50 day EMA over the 200 day SMA. Typically an index will make the break and then rebound; the 50 day EMA lags the move back up and thus we can see SP500 continue to rise but still see the crossover hold. That is another important point we are watching as the rebound continues.

SP600 (+1.96%) was stellar in its session gain, but with respect to its pattern it is still in the doghouse. Its pattern here more resembles a head and shoulders than a double bottom, and that is unfortunately in line with a slowing economy and a growth area in the market. That said, with the market bouncing its first test is the 50 day EMA (367) and the 200 day SMA (368), and there it is likely to find some serious resistance. How it reacts at that level will be something of a canary or leading indicator to the rest of the market.


Similar to SP500, the blue chips rallied up to the July high (11,228), closing just off that mark. Lower, below average volume on the move; still not a lot of buyers pushing things higher, just more of them than sellers. A solid week for DJ30, the best move since 2004 or something like that. Nice double bottom pattern has set up and as with the other indices it can still run higher here with next resistance from 11,275 to 11,335 and then take time to form the handle.

Stats: +119.27 points (+1.07%) to close at 11219.7
Volume: 270M shares Friday versus 286M shares Thursday. Below average trade all week as DJ30 made its run. As with the other indices, upside volume was the obvious missing element.

The Chart: (Click to view the chart)


No Fed meeting until the following Tuesday. That means just more earnings and another boatload of economic data (Chicago PMI, personal income and spending, ISM, factory orders, and the jobs report.

The market has a lot to chew on once more as the leading indices, SP500 and DJ30 test the July highs. The market has some momentum after its best Dow week since the fall 2004, but the move lacked any volume. A Fed pause is a big incentive to rally further, but even with that idea starting to permeate the market, volume was still missing last week. Thus we can see the indices move higher to next resistance but unless more trade comes in the NYSE large caps start working on a handle to their double bottoms. At the same time we will watch how NASDAQ, SOX and the small caps react to next resistance in their continuing downtrends.

Thus despite the other factors this week the market has some momentum on the Fed anticipation. How long that lasts against lack of real volume on the move, continued earnings guidance, and leadership that still needs more recovery remains to be seen. Scanning several thousand charts this weekend we see some leadership caliber stocks moving into position to put together sustained rallies. We see many more still needing more time to set up, similar to the overall market. We also see a lot of chip and tech stocks that have rebounded, but remain in downtrends. On balance there is improvement, but we have to remain defensive in the sense we stay with well positioned stocks versus jumping into rebounds from downtrodden patterns. The market has rebounded but has not shown a lot of strength on the move, and that keeps it susceptible to another turn lower after this rebound stalls. Even if it does, that is part of the rebuilding process for the next sustained run higher.

Support and Resistance

NASDAQ: Closed at 2094.14
2100 from the early and mid-2005 peaks (and the 18 day EMA as well).
The 50 day EMA at 2131
2177 is the December 2004 high.
2185 to 2182 is the September 2005 peak and interim high from November 2005.
2190 is the July 2006 high

2072 is the June closing low
2050 from the summer 2005 lateral range lows.
2045-47 from June and October 2005 lows and June 2004 highs
2037 at the October 2005 closing low
2019 is the April 2005 interim high
2008 is the January 2005 low
1971 from an October 2005 peak and 1973 from a March 2005 low.

S&P 500: Closed at 1278.55
1272 to 1268 is the November and December 2005 closing highs and March 2006 closing low
1280 is the recent July peak.
The late January peak at 1285
The early June high at 1288
1297.57 is the recent February high.
1315 is the May and May 2001 peaks
1317, the recent intraday highs from April.
1324 to 1329 from the October 2000 lows.

The 200 day EMA at 1266
The 50 day EMA at 1263
1252 is an old trendline from the August 2003/August 2004/October 2005 lows.
1239 from the late June consolidation range.
1225 from the March 2005 high
1223 is the June 2006 closing low.
1213 from December 2004 high to 1215
1205 from the August lows

Dow: Closed at 11,219.70
11,228 is the July closing high.
11,279 is the late May high
The March 2006 highs at 11,329 to 11,335
11,350 from the May 2001 peak
11,401 from the September 2000 peak and April 2001 highs

11,097 to 11,137 is the last peak from the February top.
The 50 day SMA at 11,059
11,044 is the January high.
10,965 from Q4 2000
The 200 day SMA at 10,964
10,931 is the November 2005 high
10,890 is the December 2005 closing high.
10,737 to 10,730 from December and February lows
10,706 is the June 2006 closing low
10,705 – 10,965 from July/August 2005 range top to bottom
10,678 to 10,665

Economic Calendar

These are consensus expectations. Our expectations will vary and are discussed in the ‘Economy’ section.

July 31
- Chicago PMI, July (10:00): 56.0 expected, 56.5 prior

August 1
- Personal Income, June (8:30): 0.7% expected, 0.4% prior
- Personal Spending, June (8:30): 0.4% expected, 0.4% prior
- Construction spending, June (10:00): 0.3% expected, -0.4% prior
- ISM Index, July (10:00): 53.5 expected, 53.8 prior

August 2
- Crude oil inventories

August 3
- Initial jobless claims 298K prior
- Factory Orders, June (10:00): 1.1%, 0.7% prior
- ISM services, July (10:00): 56.5 expected, 57.0 prior

August 4
- Non-farm payrolls, July (8:30): 145K expected, 121K prior
- Unemployment rate, July: 4.6% expected, 4.6% prior
- Hourly earnings, July (8:30): 0.3% expected, 0.5% prior
- Average workweek, July (8:30): 33.9 expected, 33.9 prior

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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