Sunday, July 20, 2008

Inflation and Recession Have Silver Lining

SUMMARY:
- Expiration Friday leaves the building quietly but its work was already done.
- Oil cracks through its lower 2008 trendline, but it won't all be straight down from here.
- Inflation and recession have a silver lining: as both get worse, pay off debts, pick up bargains.
- After a pause, looking for some more upside to release some more oversold pressure.

Market takes a pause after the upside blast.

After partying hard midweek, very hard, the market eased into the weekend to nurse the hangover and look for a bit more fun early next week. The oversold bounce finally unleashed itself with impressive fury. Oversold, over-shorted markets finally do unload, and when they do the moves are stronger than anything you see in an upside bull run. By Friday the chamber was empty, and now we see if the market can reload over the weekend and make a second charge up to first real key resistance.

Stocks faced some Friday morning headwinds from techs after disappointing GOOG and MSFT results. There was a little more M&A, this time in drug sector with TEVA buying BRL. Citigroup reported losses of 'only' $2.2B and gapped higher. You know things are bad in the financials when a $2B loss is viewed as a positive. Oil was flat all day (finished at 128.69, -0.60). Gold was down all day (out at 950,00, -15.20). The dollar was flat after bouncing back up from the slaughter that started the prior week, but it is not looking good here as it stalls at the 10 day EMA, possibly making a lower high. The Fed threw it under the bus last week, and it doesn't look promising ahead. Hello more inflation, but as discussed below, there are some silver linings. Bond yields continued to rise, recovering some of the lost ground but still well off the highs hit not so long ago (2.65% 2 year, up 8BP on the session; 4.09% 10 yr, up 4BP on the day) as investors back out a bit more from the run to safety in US treasuries.

Even with more data hitting, it was a week full of data and investors had their fill. Moreover, it is a technical move at this point: if you wind up a kids propeller airplane with a big rubber band, once it slips your grip and starts unwinding, it tends to go ahead and unwind, and those sticking their hands in the way to stop that propeller get hacked up pretty bad. Thus the oversold bounce started, and the data, outside of oil's decline, did not impact it much. Friday the move paused and the indices meandered up and down all session around the opening price. This week they are likely to resume the move.

TECHNICAL. Intraday it was up and down around the opening price, and that was higher for DJ30, lower for NASDAQ, and flattish for SP500. No direction, no impetus either way. The market was exhausted to end the week after huge surges ahead of expiration and indeed fanned by expiration as the oversold market sparked a reversal.

INTERNALS: The internals matched the price action: flat. Even volume was lower on expiration Friday, further evidence the market used up all of its energy in the sprint stages on Wednesday and Thursday. Just a pause, no big deal.

CHARTS: The indices didn't make any headway, but they also held up well with even the loss leading NASDAQ holding its 10 day EMA on the low and bouncing off of that level. Nice easy rest day at near support after the run. Just making a pause on the way up to the 50% retracement or the 50 day EMA as may be the case, the first serious test of resistance on this bounce.

LEADERSHIP: Most every stock, sector, commodity, etc. that moved sharply in one direction or the other on Wednesday and Thursday (and that was pretty much everything), paused or reversed field a bit on Friday. No major moves, just a bit of normal pushback after those very strong moves. Again, typical action after a strong charge, and the result was no changes in leadership. It is still too thin with basically only health services/medical sector stocks in good patterns and showing good moves: still safety oriented even with the snapback rally. We will see how the market acts next week in part two of the rally attempt, i.e. will it post a follow through session (another strong upside move on breadth and volume that shows buyers picking up the torch) and try to set up some base building to bring some more stocks into the leadership level. Lots of work to get there and we are not holding our breath, but if we stick with strong stocks in good bases and stocks moving up from support and forming new bases, then if there is a continued rally that just won't stop we will be in very good shape in that event.


THE ECONOMY

Oil falls below $130 on the week, starting to crack its trendline.

We enjoyed a nice drop in oil, banking gain with some DUG options, the ultrashort ETF that plays a decline in oil with an upside gain (the new inverse ETF's for those adverse to playing the downside like the downside). The quick reversal back toward the trendline after just visiting the trendline the prior week indicated oil had spent its last drop on the near term rally.

It tumbled down to that first trendline Tuesday, then broke it Wednesday and continued lower to the second trendline Thursday with more sharp selling. Friday, even with energy stocks rebounding from their similar pounding, oil slipped a bit lower and through that second and lower trendline formed here in 2008 when that last, 45 degree run higher began.

Is it going to tumble further? Very likely. From the Friday close? Not so likely. A 12% drop in less than a week typically cannot sustain itself without an interim bounce. The second trendline of 2008 is a logical point for a bounce. After that bounce and a move up toward the 10 day EMA, however, it will likely be done and heading lower once more, this time to the low 120's. Then a bounce, then a slice through the 120's . . . IF there are no shocks to the system. Interestingly, renewed violence in Nigeria Friday didn't bounce oil. Militants will be militants the market figured.

Lower oil prices because it killed world economies can then be the savior of the economy.

If there is a slice through 120, and I am getting slightly way ahead of the game here, that could be the move that salvages the economy. In the strange world of supply and demand, it was demand and perceived limited supply that drove prices into the 140's that killed demand and started to undermine world economies. As a result of that overshot in price, prices are now falling.

Too much of a good thing for the oil producing countries just as in the 1970's: they made a ton of money, but they didn't learn their lesson of 35 years back and blamed speculators for high prices, doing nothing to slow them down, not even try to talk them down. Greed got in the way and now there are many world economies heading lower. The US, much of Europe, and when the Asian countries finish lifting their petroleum and gasoline subsidies, they will face slowing as well as demand will plummet. Indeed, China has already said that after the Olympics it is prepared for slowing. Kind of like getting ready for a party for months, then when it is over you don't spend a nickel.

If prices drop far enough and fast enough, however, there is hope. Prices reached levels where they did not truly reflect demand, just fear of loss of demand. China and India were buying up reserves as fast as possible in a kind of 1970's US fear of running out that caused consumers to wait in line for hours just to keep their tanks topped off for fear of running out. This fear buying was not on a nationwide level but a global level by countries with burgeoning economies and lots of money as a result. They bought everything 'just in case.'

This last spike likely quenched the need to for these countries to feel they need to keep the 'tanks topped off,' and thus that pervasive underlying upside pressure is going to abate as well. Oil could finally shake off that $20 to $30 of fear premium, and that puts it near $100.

At $100 things suddenly look much rosier. Hard to imagine saying that level would help the economy, but indeed it would be the thing that might, just might, pull the US out of its recession. Many things are accomplished with oil almost 50 clicks off its high. Consumer confidence immediately jumps as oil prices decline and anticipation of lower gasoline prices jumps. Indeed anticipate a 20 cent drop in pump prices in the coming week based on this past week's decline. Plans that were put off are suddenly viable both on a consumer and a business level. Prices would have to stay down as consumers will be skeptical at first, but after this kind of spike, the tumble typically takes the wind out of the sails for quite some time.

Thus the move that killed the economies in the end helps revive them as the cycle of supply and demand continues to work. The worst thing we can do if prices collapse below 120? Forget all of the initiatives that were planned and/or started to help combat the rise. Well, there is one to forget: ethanol. Don't need our food prices rising anymore. We should still push for some more near term drilling, wind, hydrogen, nuclear, geothermal. It is only through a combination or 'cocktail' of solutions will we buy enough time to come up with the real solution that gets our vehicle fleet off the internal combustion engine. When we get there, we have won. No more transfer of wealth to countries that hate us, immediately raising our standard of living and giving us all of the appurtenant benefits. Have to like that.


The modest positives of higher inflation and recession.

The Phillips Curve pundits say it doesn't happen: they say you cannot have a slowing economy and jumping inflation. Once again, hard facts prove otherwise. Even as the economy slows faster and faster, inflation rises faster and faster. Those understanding money supply and supply and demand know that slowing economies produce less supply of goods and services, and that causes an immediate jump in inflation. Add on to that the impact of a recession and the usual attempts to combat it with interest rate cuts and easy money, and you have a falling dollar and thus even more growth in inflation. Now if you fall into depression you may at some point deep, deep down in the bottom of the trough see inflation slow simply because demand falls to zero. So the one time the Phillips Curve works is at the bottom of Depression. Given that we typically avoid depression in our economy, that makes the Phillips Curve about as, as they say in the south, tits on a boar.

Given that we likely will see inflation continue to rise even as the economy slips further, what good can we get from it. Not a whole lot as a country, but as individuals you can use it to your advantage. First, when we go into recession and even as we head that way you will see a lot of goods go on sale. You will see very aggressive auto promotions (and likely more federal incentives to buy autos to come), farm equipment and other machinery on sale, etc.

The sales are already hitting fast. We can use this slowdown to pick up big ticket items that are aggressively priced and then use the tax incentives already in place ($250K of section 179 expensing for small businesses) or to come to give us a solid 1-2 savings punch. In the last recession we picked up some farm equipment at lower prices and 0% financing (free money, why not take it?). Boats were also at fire-sale prices. If you saved your money as you made it you will be rewarded with tremendous bargains on long-lasting goods. As Jimmy Stewart said in "It's a Wonderful Life" when the run on the banks began in the depression: 'Everyone is selling. You know what old man Potter is doing? Buying!' You may not have liked Potter, but he knew when to strike. Stocks will show that kind of bargain time, but we want to buy them as they are ready to surge back up and not just for the sake of moving in and sitting around. When the time is right we load the boat as we did in the fall of 2002 and again in March of 2003.

As inflation runs higher start considering paying off debt. Inflation makes dollars worth less and less. Your household mortgage, however, is not going to cost more dollars just because the dollars you owe are worth less. When inflation stats to peak (we will let you know when), it is a good time to pay off debts with dollars that are worth less. The dollars you make after that will increase in value after you eliminated the same dollar amount of debt but with dollars worth less than the ones you are earning as inflation declines.


THE MARKET

MARKET SENTIMENT

VIX: 24.05; -0.96. The week saw VIX rise to 30.81 on the Tuesday high just as NASDAQ turned off the bottom and closed positive. That helped launch the upside surge on the week. Original CBOE data was incorrect, showing a spike to 38 intraday midweek. Not the case as it turns out. That means VIX never hit a level commensurate with a serious reversal. That move up into the 40's remains elusive on this selling, and that indicates there is still plenty more work to get done here and that this move is indeed a relief move.
VXN: 30.49; +0.62
VXO: 25.46; -0.46

Put/Call Ratio (CBOE): 0.92; +0.06. Three straight sessions below 1.0 on the close after 13 straight above 1.0. Plenty of backlog to drive a bounce, and indeed, one started.


Bulls versus Bears:

For the second time this year bears are crossing above bulls, doing so basically where they did in March on their way to much more extreme readings just about the time the market made the March low and started the last rally. Positive for the market and if SP500 is going to hold the long term trendline is the place to do it.

This is a reading of the number of bullish investment advisors versus bearish advisors. The reason you look at this is that it gives you an idea of how bullish investors are. If they are too bullish then everyone is in the market and it is heading for a top: if everyone wants to be in the market then all the money is in and there is no more new cash to drive it higher. On the other side of the spectrum if there are a lot of bears then there is a lot of cash on the sideline, and as the market rallies it drags that cash in as the bears give in. That cash provides the market the fuel to move higher. If bears are low it is the same as a lot of bulls: everyone is in and the market doesn't have the cash to drive it higher.

Bulls: 27.8%. Scratched back up last week, but basically no gain, up just 0.4% from 27.4%. I guess it just got about as bad as it could get as the market was not showing any signs of improvement at that point. A sharp plunge from 31.9% the prior week, blowing past the 30.9% low hit in March and well below the 35% level considered bullish for stocks (gets so low there is plenty of money lying around to fund a rally if things turn). Steep drop from a rebound high at close to 50% on the run through May. In March the indicator did its job with the dive below 35% and the crossover with the bears. Now it is going above and beyond. Bulls and bears have crossed over again, doing so even before the prior lows are hit. The bulls and bears were eye to eye in mid-February and have crossed. A move into the lower 40's is a decline of significance. A move to 35% is a bullish indicator. This is smashing that. For reference it bottomed in the summer 2006, the last major round of selling ahead of this 2007 top, near 36%, and 35% is considered bullish.

Bears: 48.9%. While the bulls may have managed a paltry optimism gain, the bears swelled their ranges, rising from 47.3%. Not as strong a move as before with a gain from 44.7% and 39.3% in the preceding weeks. Well above the bullish level and the highest since 1995. Again, that is one of the best indications that sentiment is getting extreme on the negative side. It is again past 35%, the level that historically indicates too much pessimism. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March that was up from an already freakishly strong 43.3% the week before. Up sharply from a low of 19.6% on the last rally. Bearishness peaked at 37.4% in September 2007. It topped the June 2006 peak (36%) on that run. That June peak eclipsed the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005). This is a huge turn, unlike any seen in recent history.


NASDAQ

Stats: -29.52 points (-1.23%) to close at 2282.78
Volume: 2.269B (-14.5%). Sharp decline in volume, not what you usually expect for expiration, but with all of the midweek trade it was all used up.

Up Volume: 933.089M (-1.025B)
Down Volume: 1.305B (+582.477M)

A/D and Hi/Lo: Decliners led 1.22 to 1
Previous Session: Advancers led 2.16 to 1

New Highs: 54 (-4)
New Lows: 113 (-13)

NASDAQ CHART: http://investmenthouse.com/ihmedia/NASDAQ.jpeg

NASDAQ gapped lower, sold some more down to the 10 day EMA, then rebounded to hold support and cut its losses. Lower trade so no real selling. Held up pretty well given the earnings disappointments from GOOG and MSFT, and it is in good position to bounce higher this coming week toward the 50 day EMA at 2355.

SOX (-0.68%) sold Friday, but it too managed a rebound off the 10 day EMA to close with just a modest loss. Still in shape to make a continued run toward next serious resistance at 380, another 14 points higher.

NASDAQ 100 CHART: http://investmenthouse.com/ihmedia/NASDAQ100.jpeg

SOX CHART: http://investmenthouse.com/ihmedia/SOX.jpeg


SP500/NYSE

Stats: +0.36 points (+0.03%) to close at 1260.68
NYSE Volume: 1.729B (-12.24%). Lower trade but not a major drop off from levels hit midweek.

Up Volume: 978.468M (-407.994M)
Down Volume: 707.817M (+160.511M)

A/D and Hi/Lo: Advancers led 1.16 to 1
Previous Session: Advancers led 2.7 to 1

New Highs: 31 (0)
New Lows: 135 (-10). Hit over 1100 new lows Tuesday just as the market turned. It was extreme and that pushed it over the edge.

SP500 CHART: http://investmenthouse.com/ihmedia/SP500.jpeg

After two strong sessions, SP500 was out of gas as well and it tested the 10 day EMA on the intraday low as well, then rebounded to flat. Nice and orderly test lower after a massive run, setting it up in great position to continue the run this week up toward the 50 day EMA at 1314, right at the 50% retracement level from the losses incurred from the May peak.

SP600 (-0.29%) finished the week in good shape with a small test. It formed a short double bottom over the past two weeks at the March lows and shot higher off the Thursday reversal that just slightly undercut that level. Great action off the prior low and as with SP500, the small caps are set up nicely to continue the move next week on up to the 372 level (closed at 363.49)

SP600 Chart: http://investmenthouse.com/ihmedia/SP600.jpeg

SP400 CHART: http://investmenthouse.com/ihmedia/SP400.jpeg


DJ30

The blue chips continued their upside movement, aided Friday by the Citigroup losses that were in the billions, but not as many billions as expected. Find your catalyst and hang onto it baby. The Dow put in the best move on Friday, but even after three upside sessions it is still below the prior 2008 lows, the closest the January intraday low at 11,635. Will move with the rest of the market and move up to that prior low and the 11,750 resistance level. Things will get tougher from there.

Stats: +49.91 points (+0.44%) to close at 11496.57
VOLUME: 378M shares Friday versus 335M shares Thursday. Volume kept rising all week, capping it with the strongest trade on Friday. Good upside trade, but again, it was expiration driven and exacerbated by the reversal that caused even more short covering than usual.

DJ30 CHART: http://www.investmenthouse.com/ihmedia/DJ30.jpeg


MONDAY

All eyes will be on oil and how it responds off its second trendline from 2008. It could bounce a bit more and thus pressure stocks a bit to start the week, but as with Friday, that will likely just set up a better point to rally from for the next leg. Earnings will also hit full stride; thus far there have been very solid results followed by the Thursday clinkers from a couple of big name techs. Even those did not sink NASDAQ and simply left it in a good position to continue the oversold rally after this pause.

Barring any damning news over the weekend we still anticipate another run higher in this leg. The indices just cleared the 10 day EMA on this move, something they could not do on the entire selling cycle from May, and after such a pernicious downtrend there is typically more upside than just a run to that first resistance. After a breather Friday and another Monday it will be in position to continue the move.

While many of the contrary indicators hit extreme levels (put/call ratio, new lows, bulls/bears) and are lining up, they did not all line up. VIX is still low, and with the Fed no longer the put behind the interest rate market (though it is moving again in that direction somewhat), VIX is no longer under the governor it was back in January through May. Thus it needs to really spike higher over 40 for the market to really consider putting in a bottom, and note as discussed in the spring, after the VIX spikes it takes several weeks for the actual bottom to find itself.

The market's fate also rests with oil, and this first move lower is a good one; after a modest bounce we want to see it collapse lower yet again to the next rung down at low 120's. That will help set up a market recovery even better, and if it really collapses, perhaps it jumps right past the next part of the bottoming process and takes off from here. Maybe; that is still a stretch given all of the financial stress still to work through. Plunging oil and the bottoming in the housing market, however, is a strong 1-2 punch.

If all goes to plan and basic market history, then we get another pause to start the week as oil tests its dive lower, then the market makes another leg in this run, this one up toward the 50% retracement level. That is the key initial level of serious resistance to test it hard. As an aside, in discussing market history, we talked last weekend about how a market attempts to bottom on Tuesday after a tough prior week. Sure enough the market was weak Monday, but then was awful Tuesday, only to reverse off the low. Again, if no external forces bear down on the market, history says we get a run up to cut half the losses. From there we see what kind of strength there is: a turn back down to test again , or a continued summertime rally.

With more upside anticipated we are still looking at playing the good stocks that can take us up there and make us some nice gain. We are not looking for long term romance, just stocks that can take advantage of a further move to next resistance, and then if things continue in a longer summer rally, on up from there. At the same time we watch oil and energy's relief bounce and look for more opportunity to play the downside. Many were talking about how this current decline is an opportunity to load up. After the gain leading up to this plunge, that is likely too early as oil needs to work off more of the excesses. Thus a bounce will suck some in only to turn on them. Thus we will be spying on oil stocks as they rebound, picking some juicy ones for the downside as they set up over the week.

As for other downside, if the indices run up to the 50 day EMA or the 50% retracement level (and on most indices they are currently coincident) and reverse we want to play the downside move. Thus as the market bounces we will watch closely for stocks that run out of gas at resistance and start to reverse (along with some index plays); if they start looking top-heavy we will get ready, and if they do flip we will move into them and shut down the upside that was in bounce mode with the overall market.


Support and Resistance

NASDAQ: Closed at 2282.78
Resistance:
2286 is the first April 2008 gap up point.
2339 is the trendline from the summer 2004/July 2006 lows, Q4 2005 consolidation
2340 from the March 2007 low
2358 is a 50% retracement of the June to July selloff.
The 50 day EMA at 2356
2370 from the April 2006 peak
The 90 day SMA at 2378
2378 is the mid-February peak; 2379 from the October 2006 peak
2386 is the August 2007 intraday low
2388 is the June 2008 low
2392 is the April 2008 peak
2419 is the January 2008 peak and the early February peak
2451 is the August closing low
The 200 day SMA at 2473
2500 from interim August lows.

Support:
2261 is a March 2008 interim low
2202 is the January 2008 low
2155 is the March 2008 low


S&P 500: Closed at 1260.68
Resistance:
1270 is the January low
The 18 day EMA at 1268
1317 from the February low
The 50 day EMA at 1315
1320 is a 50% retracement of the May to July selloff
1324 is the April low
1331 is the June low
1343 is an ancient trendline
1370 is the August 2007 intraday low
1374 is the March 2007 closing low
1387 is the April 2008 intraday high
1396 is the February 2008 peak
The 200 day SMA at 1396
1406 is the August and November 2007 closing low

Support:
1257 is the March low
1244 is an August 2005 peak
1240 to 1221 are September 2005 peaks1234 is the July 2006 low
1224 is the June 2006 low
1176 from the Q4 2005 lows
1167 is the January 2005 low
1154 from the May 2005 lows
1142 is the 2005 closing low

Dow: Closed at 11,496.57
Resistance:
11,634 is the January intraday low
11,670 is the May 2006 intraday high; 11,642 closing
11,731 is the March 2008 low
The 50 day EMA at 11,863
11,982 is a 50% retracement of the May to July selloff
12,050 from the March 2007
12,070 from the early February 2008 lows
12,250 from late March 2007 lows
The 90 day SMA at 12,291
12,518 is the August intraday low
12,573 is the mid-February high
The 200 day SMA at 12,697
12,743 is the November low
12,750 to 12,768 is the February 2008 peak and a series of lows and highs from August 2007
12,786 is the February 2007 peak
12,845 is the August closing low
13,092 is the December 2007 intraday low
13,133 is the May 2008 high

Support:
11,317 from March 2006
11,061 from February 2006
10,912 peak from March 2005
10,854 from December 2004
10,701-10,705 from July 2006, July 2005


Economic Calendar

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

July 21 - Monday
Leading Economic Indicators, June (10:00): -0.1% expected, +0.1% prior.

July 23 - Wednesday
Crude oil inventories (10:35): +2.95M prior

July 24 - Thursday
Initial jobless claims (8:30): 366K prior

July 25 - Friday

Durable goods orders, June (8:30): 0.1% expected, 0.0% prior
Michigan sentiment, July revision (10:00):
New home sales, June (10:00: 505K expected, 512K prior

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at InvestmentHouse.com

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