Sunday, February 25, 2007

Economic worries rise as the market fades, and though slowing some, the data does not support worries of collapse.

- Market ends the week on a cautious note as last move is tested.
- Economic worries rise as the market fades, and though slowing some, the data does not support worries of collapse.
- Can the Fed reduce healthcare costs by raising rates?
- Worries of a correction continue even as indices hold their trends in an orderly pullback.
- Pullback trying to again set up new buy points for market leaders.

Market tests back to close a week that saw some breakouts and a large cap pullback.

Friday started with more of the same the market has seen for several weeks: some earnings (LOW, RRGB posted solid guidance), some analyst calls (KO upgraded), and some intrigue (MSFT hit with a $1.5B patent infringement judgment). There was even more M&A activity though it came after hours (KKR buying TXU).

Futures were lower, however, as the Thursday decline in the NYSE large caps spilled over to Friday morning. Not much of a decline, and if the buyers wanted an opening, the modestly lower start would provide it.

In addition to the same old news there was a twist, something that was growing since the Wednesday release of the CPI. The traders and brokers we talked to before the open complained about inflation, rising mortgage defaults, and rising oil prices. Financial stations were talking correction. With the market (defined as DJ30 and to some extent SP500 by the financial stations) fading the 'market people' were playing pin the tail on the reason for the selling. Each time the market starts to struggle and the players are nervous, they play this game.

Many believe the market is overextended, and with earnings growth likely to slow they are pondering just when the correction will come. It inevitably will, but it won't come along just because the players get heartburn wondering about when. It will come when it is ready, when it simply gets too much baggage to push higher. It has shown some stress with the distribution sessions following strong upside moves, indicating sellers are taking control from time to time, but it has also responded to those by regrouping and making new highs. Even NASDAQ joined in with its own post-2002 high this past week.

Though the selling was blamed on inflation, oil, etc., could it possibly be that DJ30 and SP500, after again hitting the top of their uptrend channels, are once more making the test back down? Indices and stocks rise on buying, then fade as the buying pressure declines. If sellers don't run in and overpower the buyers, after a pullback the buyers will be ready again, moving in as their favorite stocks sell back some and become better 'values.' If the selling volume jumps and the sellers stay in more than a session, a fade can become a correction.

This past week could lead to a correction, but as of Friday it was not. This past week the NYSE large caps were fading, but money moved into techs, and that precipitated a NASDAQ breakout to a new post-2002 high and pushed SP600 to a new all-time high. Money left the large caps and moved into other areas, awaiting the large caps to finish their pullback and set up another potential move higher. No real mystery here, no deep, hard to grasp logic. The key, as we have said all week, is whether the selling gets out of hand, i.e. the price drops and downside volume spike and take out supports. Thus far that is not the case as the pullback is orderly and most leadership is holding up in nice pullbacks. There were some issues during the week as retail took some hits and Friday quite a few financials got boxed around.

Technically speaking.

The week saw some breakouts as money moved toward technology and the small caps (aided by the rise in oil) after SP500 and DJ30 hit their trendline/channel resistance and started their fade back toward their lower trendlines. As said in 'The Matrix Reloaded,' cause and effect. This is the same pattern shown for the past three months.

Thus far the fade is mostly positive. Volume is lower on the pullback after running higher as NASDAQ broke to that new post-2002 high. Breadth was solid on the upside and has backed off to quite modest levels as the large cap NYSE indices fade. Leadership is holding up for the most part, but again, the financials were distributing some Friday and that has to stop. SOX is even trying to come around, clearing some key resistance and setting it sights on the next as well, showing relative strength to end the week. Thus far it is not showing signs of runaway selling, but we have to remain diligent as always as it makes this test.


Q1 economic data not living up to Q4.

The Q4 3.5% GDP growth was a surprise. It buoyed economists and you hear a lot about Goldilocks again. Q4 was an aberration as Q1 is not following through with the same strength. Since that Q4 GDP report the numbers are slowing. Key regional and national manufacturing reports slipped into contraction. Housing has deteriorated further as the delinquency report released late last week shows (+15.6% in Q4 versus 5.2% in Q3; 90 day delinquencies +$3.1B versus $974M). Sure it is the sub-prime that is hardest hit (a very small percentage of the overall mortgage market), but this is where it always starts. In addition oil has topped $60/bbl, one of the Fed's worries about inflation pressures sparking back up, and the core CPI was hotter than expected.

As my father would have said, looks as if things are going to hell in a hand basket. They are not. As we reported to start the year, the long-leading economic indicators such as ECRI showed a slowdown to start this year, but out into the year an economic recovery. Now ECRI has shown some slowing the past month, but they are still showing growth rates increasing out into the year. Thus the slowing right now is not that unanticipated if you look at the real leading indicators.

What about the inflation worries? Oil is up and as noted, the Fed is worried that could rekindle the inflation it fears. With the core CPI hotter than expected this past month, higher oil gives Fed hawks more to worry with respect to 'bleed-over' into the core.

But why was the core higher? It was not due to any oil bleed over or creep of general costs. Thanks to rising medical costs year/year core inflation rose 2.7%. Take out those costs and since late 2006 the yearly increase is under 2%, well off the 10 year average at 2.51%.

Medical costs pushing core inflation.

You cannot really take it out of the equation, but you can learn from it and realize that our system is building in a lot of costs that are unnecessary, costs the Fed cannot control by jacking interest rates up or down. First, our system is backwards similar for dissimilar reasons to nationalized healthcare systems because the consumer of the services has no idea what costs are and has no incentive to learn about treatment and associated costs. The 'insurance will pay for it' mindset is predominant among patients and doctors. Lots of wasted money is spent on unnecessary procedures because the parties involved in much of the decision process know someone else in the form of the insurance company and the employer paying the premiums will pay for it. Also, there is the threat of getting sued, and doctors will over-test and over-treat to avoid even the chance of being accused of not doing enough. HSA plans are putting control backing the patient's hands, and thus the cost of this insurance is less as it helps keep costs down. The recent changes pushed by Bush and passed in Congress nicely enhance these plans and will help their spread and thus help rein in health care costs.

Second, we have to stop subsidizing the rest of the world's low cost drugs. Each new drug averages $802M to develop. Companies need the incentive to produce the drugs, i.e. the ability to make their money back and a profit as well. Some say the answer to our cost problems is nationalization of the healthcare system including capping what companies can sell their drugs for as well as limiting doctors to performing only procedures that are authorized. Even if you could pay for it you could not get it without risking sanction for both patient and doctor.

The problem with that is you remove the incentive to produce great drugs. Canada invented medically usable insulin back when it had a private healthcare system. After nationalizing healthcare Canada has not produced one new drug. Instead it forces foreign drug companies to sell to it at lower cost in order to keep its healthcare system somewhat viable. The incentive to develop new drugs is just not there given the price controls. We pay a lot for our drugs in the US not necessarily because of the high cost of development, but because we have to pay for what the rest of the world does not. If our companies want to see their drugs sold in Europe or Canada they have to meet the price those countries' socialized healthcare systems will pay or simply not sell there. In order to get a reasonable return on investment those companies charge more for those countries that do not have such controls. Again, we are subsidizing the rest of the world's low cost drugs.

The answer is not just nationalizing our system and demanding the same treatment. That would curtail new discoveries because research incentives would be greatly reduced. It also really fouls up healthcare decisions, even more so than the current US system. My brother was a dual citizen in the US and Australia. He contracted a rare blood disease that was a form of cancer while living in Australia and opted to be treated there. At first the socialized system was not going to treat him because he was too old and not a good risk. When a suitable donor was found that no one else needed, however, they reluctantly decided to allow it. I have now experienced treatment of cancer in my family in both Australia and the US. There is no comparison. None. Australia, and I mean no disrespect, was decades behind in treatment procedures and technology. I am convinced that if my brother had come back to Houston for treatment at M.D. Anderson he would be alive today.

If you want the kind of treatment options we have today where people come from around the world to be treated here (ever hear of someone in the US going to Canada or Australia to be treated for cancer?) you cannot nationalize. You can nationalize, but the standard cannot be the gold standard we want, and, despite what we believe here, the rest of the world knows we do have the gold standard of healthcare (that is why they come here for treatment). We have to alter the 'insurance pays for it mindset' and figure out how we stop subsidizing the creation of miracle drugs for the rest of the world to buy on the cheap.

The issue: What inflation the Fed can and cannot control

The point of this is not that inflation is not an issue, but to highlight what so-called inflation we are tasking the Fed to control. Just as the Fed cannot cause OPEC to lower the price of oil by raising interest rates, it cannot control the cost of healthcare by toying with monetary policy. Raising interest rates is not going to make drug companies charge less. It is not going to change the cavalier mindset that insurance will pay for any procedure so why not do them all.

These are policy decisions that need realistic approaches and not the class warfare approach we are seeing now. We all want everyone to have access to healthcare but as we should have learned over the past 47 years, if you attempt to have the government deliver better living conditions through welfare payments, housing allotments, etc., you only worsen the conditions overall. We can 'dummy down' the healthcare system or we can take the actions that will allow it to work the same way our other successful systems work, i.e. letting the US citizens take control of their lives and futures and demand quality care at a reasonable price. That entails breaking the current mindset and HSA's are a good start in doing that.

Having the Fed raise interest rates to slow inflation that is rising because of medical costs is not going to mitigate healthcare inflation, just slow the economy and lessen our ability to pay for the increasing costs of healthcare. This shows that the current discussions regarding inflation are simply ridiculous. We have built in a certain amount of inflation by the policies we pursue and that won't change until we recognize the policies are distorting the market and creating pricing issues.


You have to like the run up in negative sentiment even as stocks fade modestly. The reason there is such concern is the length of the run and thus anticipation of a correction. The put/call ratio jumped over 1.0 three times the past week (just four trading sessions). Housing worries are rising again with the sub-prime mortgage issues. Bulls fell while bears rose. Things are moving in the right direction even with a modest pullback.

Sure the indices are overextended and have shown some distribution. Sellers are trying to assert some force but not overwhelming. Thus each time they show up there is new money filling in the pullbacks. The latest example is this week's move into techs as the large cap NYSE stocks started to fade. It did the same in late 2006 and early 2007 when the large caps struggled as well.

There has been something of a character change as the uptrends have flattened the past three months, accompanied by that outcropping of distribution after the big gains. That keeps you on your toes given how far the indices have run, but the market has not turned into a juvenile delinquent as of last week. Good kids can go bad, however, so we keep watch on the pullback for signs of trouble, but we also look for opportunity in the event the same old trend holds once more.


VIX: 10.58; +0.4
VXN: 15.32; +0.02
VXO: 10.6; +0.49

Put/Call Ratio (CBOE): 1.43; +0.4. Third close above 1.0 for the week and the fourth in the past two weeks. A real jump in activity as the NYSE large caps continued their fade though still well within their up channels.

Bulls versus Bears:

Bulls: 50.0%, down from 51.1% last week and 53.3% four weeks back. Starting to head in the right direction after grazing past 55% (the 55.4%) in early January. Still quite a bit of bullishness though backing down from the 55% threshold hit to end 2006 and considered bearish as it signals pretty much everyone is in the market.

Bears: 22.2%, up from 21.1% last week though still hanging in this low twenties range (was 22.2% three weeks back). Still too close at this juncture as it indicates not enough pessimism. When bears are low it is the same as high bulls: everyone is in. Hit a new post-2002 high in that late June 2006 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: -9.84 points (-0.39%) to close at 2515.1
Volume: 2.055B (+0.71%). A most modest climb in volume, coming just above average again for the session. Slight distribution, but hardly enough to get too sensitive about, particularly when the prior distribution after breakouts was rather massive.

Up Volume: 706.934M (-558.187M)
Down Volume: 1.266B (+519.607M)

A/D and Hi/Lo: Decliners led 1.3 to 1. Well under control once more versus the solid 2:1 breadth as NASDAQ broke to a new post-2002 high Tuesday and Wednesday.
Previous Session: Advancers led 1.23 to 1

New Highs: 84 (-79)
New Lows: 19 (+4)

The Chart:^ixic.html

Thursday NASDAQ tapped toward the upper channel line connecting the November and January highs, showed a doji, and started to fade Friday. It broke below the January high on the low but rebounded to hold above that level. Good rebound from that level. Likely not done testing, however, because it is testing as SP500 and DJ30 fade back in their channels as well. Want it to hold near 2500 and deliver another strong upside mover, something it has failed to do since it started bumping up at a new post-2002 high in late 2006.

SOX (+0.48%) came to life late last week, clearing 475 resistance and tapping at the November and December highs (493.25) on the Friday high (491.68). It faded well off that peak, not ready to take it on just yet. A modest test along with the other indices next week, and then it needs to make a run at the breakout and make a serious higher high.


Stats: -5.19 points (-0.36%) to close at 1451.19
NYSE Volume: 1.449B (-1.36%). Volume remained below average (as it did for the entire week) and lower on Friday as the NYSE indices faded. No distribution; just the kind of action you want to see on this pullback.

Up Volume: 592.942M (-64.721M)
Down Volume: 832.609M (+52.294M)

A/D and Hi/Lo: Decliners led 1.07 to 1. Very lean, very modest, just as on NASDAQ.
Previous Session: Decliners led 1.16 to 1

New Highs: 134 (-94)
New Lows: 9 (+4)^gspc.html

SP500 continued lower after tapping at the upper channel line all week. It tapped down near the 18 day EMA (1447) on the low and recouped some losses. It is holding up much more than DJ30 in this pullback; whereas DJ30 is already close to the bottom channel trendline, SP500 is still in the upper half of the channel. Surprising given that the financials were really struggling Friday. The lower channel line is near 1438.

SP600 (-0.29%) tested some as well Friday, but very little. It broke to a new all-time high on Tuesday and is refusing to give up much ground, aided by the climb in oil and thus the energy stocks.


DJ30 faded for the third straight session, almost finding its lower channel trendline on the low (12,628 on the low; trendline at 12,615) before a modest rebound. Volume was up on the industrials, but still below average. It will hit the trendline early this coming week and we will see how it responds and how SP500 responds with it.

Stats: -38.54 points (-0.3%) to close at 12647.48
Volume: 215M shares Friday versus 207M shares Thursday. Volume was up some but still below average as the blue chips continued their selling. A whiff of distribution last week but it was a flat out close, tight volume range. Now we see how it fares when it makes the test of the trendline.

The chart:^dji.html


Entering the week in decent shape though more pullback likely to come.

Earnings are mostly over but the week is heavy on the economic data with confidence, home sales, regional and manufacturing reports, and income and spending to name a few.

Anything can happen over the weekend, but the market comes into the week in a testing mode, coming off of new highs on all the indices last week. SP500 and DJ30 are extended but still keeping their trend in tact; they have another time to prove it this week as DJ30 is almost there as the week starts. NASDAQ has its own critical test ahead as it comes back after breaking to a new post-2002 high as it did in January. It made a super breakout in January and started a nice orderly pullback only to have it cave in on some high volume selling.

Thus far the selling has been orderly with modest price losses on modest volume. That shows no real interest in selling. A lot of investors fear a correction, but at this juncture the market action in terms of price, volume, and leadership is not showing it. Some fluff needed to be removed and tested after the breakouts last week, but that is currently happening with some decent action.

As we have said, the stage of the market, at least in terms of SP500 and DJ30, requires some vigilance as it makes this pullback, particularly given the financial sector's performance to end the week. NASDAQ has suffered some distribution sessions and has given back a breakout this year already, so it also requires watching as it makes this test. Don't want volume jumping significantly and NASDAQ giving up its breakout on that strong volume. You don't want to see DJ30 crashing through the bottom of its channel on volume either. Same for SP500, though it is still I the upper reaches of its channel even with its fade to end the week.

If this pullback holds the current trend it will set up some more entry points for strong stocks. As noted this past week, the early leaders are already testing their support, and some have started moving up even as the overall market comes back some. If we see more of those popping as the rest of the market pulls back we know there is some good likelihood that the overall market is going to hold its test and then follow them as well. If they start breaking back through support that is something to really focus our attention for the potential of a deeper correction.

For now, given the action seen through Friday, we have to view this as setting up new buy points. Yes we don't like how far the SP500 and DJ30 have extended themselves on this run but if we see strong stocks continue to set up good patterns as the market continues an orderly, contained pullback and then make moves back upside, we have to go with what the market is telling us and not what our gut feels.

We want to be patient and let them set up and show us the move. At the same time we watch the overall market, leaders, and tend to our current positions such that if things start eroding or otherwise deteriorating we get out of Dodge and see how it shakes out. We can always get back in.

Support and Resistance

NASDAQ: Closed at 2515.10
2523 is price resistance November 2000
2533 is the upper channel from the November and January highs.
2573 - 2852 from peaks in April and May 1999

2509 is the January 2007 high
The 18 day EMA at 2487
2471 is the December 2006 high
2468.42 is the November 2006 high
The 50 day EMA at 2457
2450 is minor support
2412 from June 1999 low
2384 is an interim peak from January 1999
2379 is the October high.
2376 is the April high, the former post-2002 high
2368 is the early October handle high.

S&P 500: Closed at 1451.19
1463 is the upper band of the current channel
1475 from peaks in December 1999 and January 2000

The 18 day EMA at 1447
1444 from February 2000
1440 is the mid-January high
1439 is the late November to February up trendline
1432 is the December 2006 high
The 50 day EMA at 1430
1425 is an interim high from November 1999
1408 is the November high

Dow: Closed at 12,647.48
12,808 is the upper channel line marking the November to date uptrend channel.
About 8.6% above the 200 day SMA. Still going strong, overcoming the chop as it pushes to a series of new highs once more.

12,615 is the up trendline connecting the November and January intraday lows.
The 50 day EMA at 12,526
12,499 is the December intraday high.
12,361 is the November 2006 high
October high is 12,167
11,986 is price support from mid-October and the early November low.
11,865 from the early October consolidation
11,750.28 is the pre-2000 all-time high

Economic Calendar

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

February 27
Durable goods orders, January (8:30): 02.0% expected, 2.9% prior
Consumer confidence, February (10:00): 109.0 expected, 110.3 prior
Existing home sales, January (10:00): 6.24M expected, 6.22M prior

February 28
Q4 GDP 2nd iteration (8:30): 2.3% expected, 3.5% prior
Deflator, Q4 (8:30): 1.5% expected, 1.5% prior
Chicago PMI, February (9:45): 50.0 expected, 48.8 prior
New home sales, January (10:00): 1.09M expected, 1.12M prior
Crude oil inventories (10:30): 3.694M bbl prior

March 1
Personal income, January (8:30): 0.3% expected, 0.5% prior
Personal spending, January (8:30): 0.4% expected, 0.7% prior
Initial jobless claims (8:30): 332K prior
Construction spending, January (10:00): -0.4% expected, -0.4% prior
ISM Index, February (10:00): 50.0 expected, 49.3 prior

March 2
Michigan sentiment (final), February (10:00): 94.0 expected, 93.3 prior

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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