Sunday, October 26, 2008

LIBOR Re-Freezes For Second Session

SUMMARY:
- Global gloom threatens a real selloff, but when the bell rang it was just another down day in the bear market.
- LIBOR re-freezes for second session.
- A watched bottom never forms.
- Sellers appear out of ammo, unable to finish off the prior lows, indicating market is still working on the first bottom, not the second.
- US path set to follow the same policies that led to the prolonged 1970's malaise.
- If market doesn't break the lows Monday, looking for a bounce to precede another bottom finding attempt.

The gloom was there but not the capitulation selloff.

It looked as if salvation was at hand. The world markets were crushed, down 9% and more. US futures were locked limit down from the wee hours of the morning. The bad news abounded. For a second day the credit thaw suffered an unseasonal frost and failed to decline (LIBOR 3 month was 3.52%; 3.53% Thursday). The UK reported its first negative GDP quarter in 16 years. Not quite keeping the British end up. GE was borrowing from the Fed's commercial paper window. AIG was borrowing too much from the Fed's bailout window ($90.3B versus the $85B originally planned). OPEC cut its production by 1.5M bbl/day. Plenty of negatives and an extremely negative air. Many veterans and newcomers alike were certain judgment day had come, i.e. the big blowout to the downside to clean out the pipes.

Then the opening bell rang, and as expected the market opened lower. We were looking at the DIA pre-market given the futures were locked & no one knew where they were trading. DIA indicated an open near 8050, almost 700 points lower but still well over the October intraday low. The open was not that bad. DJ30 hit 8187 in the first few minutes, down around 500 points for an instant.

That was it for the morning. We posited the market may sell after the initial bounce or even in the last part of the afternoon. A look at the early volume showed it was nowhere near the heavy levels that would take the market down and indicate a real burn off to the downside. It looked as if any real selloff would have to come late in the session. We took some of the SPY and DIA downside gain. Stocks continued to the upside, weakened after lunch, but then rebounded toward the bell. The indices closed near session highs, and though still sporting 3% losses, volume was lighter after no real test of the low on DJ30. Friday was not judgment day, just another down day in the bear market.

TECHNICAL. Low to high action on the indices and the in general means more bullish action, but frankly it varies with the wind of the market each session. Some days the bulls are in charge the next the bears. There was a streak there where the bullish action was winning out, i.e. the market was rising even when the market was noncommittal, but that has given up to the return of the back and forth action. The fact that the NYSE large caps have held their prior lows, however, suggests there is a bit of upside overhang still present.

INTERNALS. Once more the internals climbed. You would expect them to with 3% moves on the indices. Breadth was in the -4:1 range. New lows topped 1100 on NYSE, 840 on NASDAQ. Volume was still above average, but it did back down. Thus even if the selling had been deeper the volume was not really there to clean out the plumbing.

CHARTS. No new lows for the year by DJ30 and SP500 but NASDAQ did make its second straight 2008 low and its third straight closing low. While DJ30 and SP500 did not move below the early October intraday lows they did close below the bottom of their two-week range, joining the other indices in that dubious position. They are still holding above the intraday lows so the chance for a bottom of some sort here is still alive, but the solid floor that was forming has cracked. Precarious, but as discussed below there are reasons to believe a bounce is going to emerge from this particular action.

LEADERSHIP. Leadership bases remain a rare commodity. Right now most of what you can find with respect to strength is stocks holding their 2 week lateral consolidations. Steel and energy stocks held tough through the session and through the week. Quality stocks such as AAPL held up just fine as well. Does that mean they are ready to bottom here? As with the indices they could definitely bounce out of these lateral consolidations, but this is not likely their ultimate bottom as discussed below.


Investors outsmart themselves by waiting on the bottom to form.

I said Thursday that the market cannot form a bottom when everyone expects one. Everyone, us included, watches the action each day and sizes up if there is a bottom and what it will take for a bottom to form. After all sentiment indicators are at very extreme levels, internals hit very extreme levels, and the losses are steep enough to conclude a bottom is at hand.

On the other hand, while the losses are definitely deep enough compared to past bear markets, is this selling deep enough to account for the truly historic problems confronting the entire world with respect to the mortgage and subsequent credit collapses? The largest bailout in the history of the world is underway. While the market started selling a year ago, the selling did not really explode until the past two months when the market logged the lion's share of the losses. If the bailouts don't work the losses could be another 2500 points on the Dow. That will also extend the length of the bear market. If the bailouts do work the market bleeding will stop, but that does not mean the recovery will be quicker.

More to the point, as noted above, with everyone looking for a capitulation bottom on a daily basis there is no 'throw in the towel' mentality. They are hanging on, waiting for the bottom, and without the cathartic selloff or slow motion grind out where even the pros say 'forget it,' then the bottom does not come. The market is not to the point yet where the pros and even a lot of retail players are at the 'fer get it' stage (from 'Urban Cowboy'), and thus the pain lingers.


What will it take to get there? Another rise and then another fall.

All of the pieces looked to be in place Friday for a cathartic bottom, but the market could not follow through on the negatives and take out the prior lows. There just were not enough sellers left to drive the knife home. The NYSE large cap indices once again tested lower but easily held and reversed above the 2008 intraday lows. The sellers tried but they simply didn't have the strength.

That action suggests a bottom is indeed here, but it is not THE bottom. If the bailout plans are indeed going to work, this current action is likely the 2008 equivalent of the 'July' leg of the 2002 bottom, i.e., the first bottom in that double bottom process. It takes a bounce and then a second bottom, the equivalent of the 'October' leg of that 2002 double bottom, to complete the process.

Recall that volatility spikes on the first leg of a major bottom. It fades as the market rebounds from that initial pummeling, preferably a bounce that lasts 4 to 6 weeks to the peak before it starts to turn down again. Then the market starts to fall and volatility starts to climb again. It may or may not hit the prior highs; usually doesn't. On that second leg down, however, the fear rises sharply even if VIX doesn't match the prior highs. Veterans start to question if the market can hold this time as that leg is usually pretty ugly and violent to the downside. When they panic and cough up their shares, THAT is the bottom.

That is how it happened in 2002 when we heard that even the pros on the floor of the NYSE were saying that the old tried and true market indicators just were not working anymore. We saw EBAY, TSCO, AMZN and others finishing up good bases that were not ready by any stretch at the July lows, the first leg down. With good stocks in good bases and the pros throwing in the towel we knew the bottom was in.

The failure to capitulate this week and particularly Friday is thus in keeping with historical bottoms. There are hardly any great stocks in good bases ready to move upside just as there were not any in July 2002. There was still work to do with a rebound and them some more selling to get those bases set up. There are still investors that need to get shaken out of the market when they give up on trying to wait out the bottom. October is a month many look for the market to bottom. That is keeping this market from actually making a bottom. They are looking for THE bottom in October, but it is very likely not going to occur in October this year. An interim bottom could very well start to the upside this coming week, but in all likelihood it won't be THE bottom unless there is a big shakeout to the downside Monday or Tuesday in the nature of 1000 points or so on DJ30. That would likely result in a big massive turn, but it would STILL be better to have that blood curdling, screaming, hair on fire drop to come on the second leg lower to really set the true bottom in cement.


THE ECONOMY

Ignoring history and taking the low road to economic mediocrity.

Now all of this talk of the bottom may be moot if the economy heads into a 1970's-like malaise, the worst economic times since the Great Depression. Not necessarily the worst times for the market in terms of absolute losses, but it was a long, 4 year period of nothing after the surge off the bear market low. The economic times were bad, however, and if we follow that path now that means a lot more economic slowing, a longer, drawn out decline, and thus lower earnings and lower stock prices.

Back in the 1970's the US was pretty much a joke for the rest of the world. Our economic malaise left others talking about the 'failed experiment' of a capitalist economy. The irony is, it was not a failure of capitalism but the incessant tinkering with it by injecting big government controls that led to the near demise of our system. Interest rates hit over 20%, inflation ran almost 10%, unemployment topped 11%. New York almost went broke. It was a nation of stagnation.

The parallels of the 1970's problems and those of today and what is planned are frighteningly similar. The 1970's saw oil spike in price with the oil embargos. The Fed flooded the economy with liquidity, fearing a shutdown due to the high prices. The economy shut down anyway due to the high prices and the massive increase in regulation brought about as a result of the social programs of the 1960's and the new initiatives for cleaning up the environment, conserving energy, education, etc. It simply became too costly to do business compared to the rest of the world. That is when the demise of the US auto industry started as they made cheap, throw away cars compared to their foreign competition because the regulatory costs here were so high. Same with the steel industry, electronics, energy (Windfall Profits Tax)- - just about every industry fell behind the world trying to cope with the new regulations and with the cost of new social programs. The cost was not only to industry but for the taxpayer as well as the programs of the 1960's and 1930's were massively expanded as taxes were raised in the hope of capturing more tax revenue.

The Fed didn't flood the economy with liquidity with respect to the oil price surge; it wanted to avoid doing that. Problem is, it has had to flood the economy with liquidity for other reasons, the most recent the mortgage and credit crisis. There is a backlash against deregulation and a push for massive new regulation in housing, banks (the US is actually taking them over) and, business (Rep Frank and Senator Biden are talking of limiting CEO compensation). Increased income taxes, despite the promises of both candidates, are going to happen (Rep Rangel wants a 45% top bracket rate; Frank is talking about taxing 401k's), and increased taxes on capital (capital gains tax is going to increase).

What happens when you employ these changes? If there is a shift to tax the wealthier as well as businesses including the small business category (10 to 500 employees where 100% of the private sector jobs came from in 2004) so that the revenue can be given to or spent on programs benefitting those not paying federal tax initially the tax revenues will rise. The money is distributed and the recipients spend the money and give it back to the companies that were taxed to produce the revenue. What do they do with it? With higher taxes reducing the risk/reward they start looking for ways to shelter the gain. As in the 1970's they look for tax shelters to protect the gains and wait for a better economic environment when the risk/reward ratio is better to expand their business with that money. That takes that capital out of the economy. That further slows the economy and after that initial jump in tax revenues, they fall below the pre-tax increase levels despite the increased rates.

That is what Congress always fails to understand: if you tax more, money will be removed from the areas that result in additional tax assessment and it won't be put into endeavors that generate taxable income or revenue. Thus tax revenues fall even with the higher tax rates and we get the 1970's stagnation: capital is locked away until the day a new direction is taken that rewards risk taking and capital creation once more. The 1970's set up the Reagan tax cuts and economic recovery incentives and the Volcker interest rate hikes (even in a weak economy) that lead to the massive 'invest in America' boom that we rode for 20+ years.

Unfortunately we are not on the cusp of renewing the Reagan/Volcker combination. Instead we are on the cusp of starting the regulation, tax, and inflation cycle of the 1970's and if we go that route many very smart economists and historians fear we are going to have to live through similar times. I was a teenager in the 1970's. It was really a bad time for the US. There was not a lot of hope for the future as we muddled through bad economic and foreign policy decisions. We need to stay on our Congressmen no matter who is elected because either one of these candidates can go that route as both are populists even though the media tries to contrast them.


THE MARKET

MARKET SENTIMENT

VIX: 79.13; +11.33. VIX hit a new high on this cycle, spiking to 89.53 right out of the box as the opening bell rang. As noted in the earlier discussion, VIX hits its peak on the first leg. It is still moving higher but this might very well be the peak as the indices held their prior lows as it made this spike and in the midst of the morning gloom.
VXN: 78.82; +8.98
VXO: 79.36; +10.8

Put/Call Ratio (CBOE): 1.24; 0. A week above 1.0 on the close as the downside speculators and protection buying hits highs again.


Bulls versus Bears:

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: 22.2%. Just a modest drop from 22.4%. Down from an already very low 25.3% that was the largest single week drop we have ever seen, down from 33.7% and 37.5% the week before. Well below the 35% threshold considered bullish. Down from 40.7% on the high during the rally off the July 208 lows. Surpassing the 27.8% on the low this round. 30.9% was the March low. In March the indicator did its job with the dive below 35% and the crossover with the bears. 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: 54.4%. Very respectable rise from 52.9% after pausing at that 53%ish level for a couple of weeks. Surging from 47.2% and 40.9% the week before. Surpassing 50.0%, the high on this move. Well above the 35% threshold so still a bullish indication. This move over 50 takes it to the highest since 1995. Extreme negative sentiment. 35% is the level that historically indicates excessive pessimism. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March. 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: -51.88 points (-3.23%) to close at 1552.03
Volume: 2.684B (-15.02%). Lower trade though it was still above average as volume picked up Wednesday to Friday after below average showings to start the week. Some late week distribution in techs.

Up Volume: 478.313M (-352.454M)
Down Volume: 2.191B (-126.71M)

A/D and Hi/Lo: Decliners led 3.84 to 1
Previous Session: Decliners led 2.54 to 1

New Highs: 3 (+3)
New Lows: 842 (+293). Getting up toward those early October levels (1709) but still not there even with the new low on NASDAQ Friday. That is, again, a positive as it shows there are not as many stocks in NASDAQ selling off.

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

Another new low for 2008 with the gap lower and then another comeback. Not quite as good as Thursday, but the buyers did pick up a few tech stocks. It is still in a downtrend having broken out the bottom of its attempted October lateral consolidation. It is heading toward the 2001 low (1460) and the December 2002 peak after rallying out of the October 2002 bottom (1485). Got close on Friday and then reversed. That should act as some support and if the rest of the market rallies from this level, NASDAQ is ready to do so as well.

Similar to NASDAQ, NASDAQ 100 (-2.98%) gapped lower and out of its lateral consolidation attempt. It recovered to the two earlier intraday lows in October on the close but that still leaves it outside of its closing range as with NASDAQ overall. This is nothing more than a downtrend right now in need of something to pull it back up.

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

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


SP500/NYSE

Stats: -31.34 points (-3.45%) to close at 876.77
NYSE Volume: 1.594B (-5.53%). Volume fell back close to average as the NYSE indices sold off, breaking below the lateral consolidation the prior two weeks. Still higher volume overall as the NYSE indices sold lower on the week. There was renewed distribution. Needs something to reverse them off the intraday lows.

Up Volume: 236.995M (-509.902M)
Down Volume: 1.354B (+426.105M)

A/D and Hi/Lo: Decliners led 4.43 to 1
Previous Session: Decliners led 1.67 to 1

New Highs: 17 (+7)
New Lows: 1148 (+322). Up as on NASDAQ but also below the highs hit on that first spike lower in October (2631). Fewer stocks hitting new lows as the old lows were tested. More are holding their ground and that is a silver lining.

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

Undercut the second and third intraday lows of the month, coming within 14 points of the prior intraday low. Bounced up off that level to recover not quite half of the losses. Yes it broke out of the range of closing lows but it has held the intraday lows and is in a good position to make a rebound. Good position but with the renewed distribution last week it will have to prove it. We kept some of the SPY downside positions alive because while it is laying the groundwork for a rebound it has to find some buyers.

SP600 (-3.81%) is in full-fledged selling with four straight sessions lower after failing at the 10 day EMA Tuesday. No double bottom here, just a continuing downtrend. It is oversold and ready to rebound, but it is just a rebound in a continuing downtrend. That is not good news for the economy as small caps are economically sensitive.

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

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


DJ30

DJ30 again tested lower, and though it undercut the second October intraday low (8199), it has held well above the early October low at 7882, a good 105 points above that level. DJ30 and SP500 are in position to bounce off of this level. The question is whether they do it. The ability to repeatedly hold over those lows and recover indicates the two large cap NYSE indices are sold out on this leg and are going to try and bounce.

Stats: -312.3 points (-3.59%) to close at 8378.95
VOLUME: 335M shares Friday versus 340M shares Thursday. As with the other indices, volume picked up midweek as the selling picked up. Some distribution as it headed lower Wednesday, but it started backing off as the week ended.

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


MONDAY

Earnings will continue at a torrid pace, LIBOR will be watched for a renewed thaw, and no one admits it, but many will watch oil as well. Sure the decline is a result of a lack of demand, but lower prices aren't going to hurt the world economies. All important, but the market is in technical gear now after a week of shots at the lows on SP500 and DJ30.

While NASDAQ and the small and mid-caps hit new lows on the week, SP500 and DJ30, despite the best attempts of the sellers, held above the prior lows. As noted, there was the perfect storm Friday to send them careening lower but instead it was just another day of 'normal' selling. The sellers appear to have shot up their ammunition for now, and if they cannot push SP500 and DJ30 to new lows to start next week they likely will not do it on this leg.

Thus we see how the first of next week plays out. We could very easily get another test lower Monday or Tuesday that still holds the prior lows and sends the market back up. If we get that push lower we take the rest of the DIA, SPY and NSC positions off the table and then flip to the upside with some more DIA and SPY and even some other indices and stocks that can move for us. As noted, steel and energy held up to end the week; they are in position to rally as well as DIA and SPY bounce back, and as seen, at this price they can peel off large percentage gains as the do.

Friday we opened a couple of upside positions already with AAPL and NUE, both in position to move higher in a market bounce. This is still in our view not the bottom but just a set up to bounce to take SP500 and DJ30 higher so they can test and try to put in the real bottom. Nonetheless, we really like how these two performed on the week. They may come back to test some after a bounce, but this might be as low as they go. We will look for more of these all week ahead.


Support and Resistance

NASDAQ: Closed at 1552.03
Resistance:
1565 is the second low in October 2008
1620 from the early 2001 low
1644 from August 2003
The 10 day EMA is 1679
1752 from 2004
The 18 day EMA at 1764
1782 from August 2004
1882 from October 2003
1900 is the gap down point in October; from August 2004
1912 from April 2005
1947 is the point where the market gapped down from in October 2008
1984 is the lat September low
The 50 day EMA at 1993
2070 from September 2008
2099 is the mid-September closing low
2155 is the March 2008 low
2167 is the July 2008 low

Support:
1542 is the early October 2008 low
1521 is the late 2002 peak following the bounce off the bear market low
1387 is the 2001 low
1253 is the March 2003 low on the test of the rally off the 2002 bear market low
1108 is the 2002 low


S&P 500: Closed at 876.77
Resistance:
889 is an interim 2002 peak
The 10 day EMA at 939
965 is the 2003 consolidation low
The 18 day EMA at 983
995 from June 2003 consolidation peak
1065 is the Q4 2003 level that SP500 started the run to 2007 after the first run in the recovery.
1075 from August 2004.
The 50 day EMA at 1102
1106 is the late September low
1133.50 is the mid-September 2008 low
1200 is the July 2008 intraday low
The 90 day SMA at 1203
1244 is an August 2005 peak
1245 is the 2002/2003 up trendline
1257 is the March low
1270 is the January low
1285 is the recent July peak
The 200 day SMA at 1290

Support:
866 is the second October 2008 low
853 is the July 2002 low
839 is the early October 2008 low
800 is the March 2003 post bottom low
768 is the 2002 bear market low

Dow: Closed at 8378.95
Resistance:
The 10 day EMA at 8885
8985 is the closing low in the mid-2003 consolidation
9200 is the July peak in the 2003 consolidation
The 18 day EMA at 9247
9323 From June 2003 peak
9575 from September 2003, May 2001
9814 from August 2004
9852 is 25% off of the October 2008 intraday low
9937 from May 2004 low
10,100 to 10,000
10,127 is an April 2005 low
The 50 day EMA at 10,187
10,215 from Q4 2005
10,365 is the new 2008 low
10,459 is a September 2008 low
10,827 is the July 2008 intraday low
The 90 day SMA at 10,939
10,962 is the July closing low
11,061 from February 2006
11,317 from March 2006
11,388 is the prior August low

Support:
8626 from December 2002
8521 is an interim high in March 2003 after the March 2003 low
8197 is the second October 2008 low
7882 is the early October 2008 low
7702 is the July 2002 low
7524 is the March 2002 low to test the move off the October 2002 low
7282 is the October 2002 low

Economic Calendar

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

October 27 - Monday
September New Home Sales (10:00): Expected 445K, prior 450K

October 28 - Tuesday
October Consumer Confidence (10:00): Expected 52.0, prior 59.8

October 29 - Wednesday
September Durable Orders (8:30): Expected -1.0%, prior -4.5%
10/25 Crude Inventories (10:35): 3.2M prior
FOMC Policy Statement (2:15): Fed Funds futures indicate a 50BP rate cut to 1.0%

October 30 - Thursday
Q3 Chain Deflator-Adv. (8:30): Expected 4.0%, prior 1.1%
GDP-Adv., Q3 (8:30): Expected -0.5%, prior 2.8%
Initial Jobless Claims, 10/25 (8:30): Expected 473K, prior 478K

October 31 - Friday
Q3 Employment Cost Index (8:30): Expected 0.7%, prior 0.7%
Personal Income, September (8:30): Expected 0.1%, prior 0.5%
Personal Spending, September (8:30): Expected -0.2%, prior 0.0%
Chicago PMI, October (9:45): Expected 48.0, prior 56.7
Michigan Sentiment-Rev., October (10:00): Expected 57.5, prior 57.5

By: Jon Johnson, Editor
Copyright 2008 | All Rights Reserved

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

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Sunday, October 19, 2008

Quiet Session Closes Historic Week

SUMMARY:
- A relatively quiet session to close a historic week.
- LIBOR continues a slow thaw. Here's to a warm fall and winter.
- After summer improvement, economic data tumbles on the credit freeze. Did the economy go into deep freeze or just catch cold?
- Earnings along with LIBOR are the focus this week, and thus far earnings have done no harm.

Things must be interesting when a 563 point swing is anticlimactic.

The economic data was again ugly with new home starts falling 6.3% and Michigan sentiment falling 13 points. On the other hand, LIBOR rates and the TED spread continue to improve bit by bit and Warren Buffet said in the WSJ that we should be buying US stocks.

The news may have tipped toward the negative or not, but the market did open lower. After a big intraday reversal and rally Thursday, however, being a bit off your feed is nothing unusual for stocks. Indeed it did not take long for stocks to bounce from that early weakness and turned positive midmorning, rallying through lunch to early afternoon. That was it for the day, however. Stocks could not hold on and started a slow bleed downside all afternoon. Even with that pullback the indices were bouncing up and down, and until the last 15 minutes it was not a clear cut deal that they would close lower.

It was expiration so you would expect some volatility. Even with that 563 point swing, however, it was the least volatile session of the week. As Ben Stein would say, 'Wow.' Friday trade was lower and as strange as it may seem, 563 points was overall pretty quiet.

The week was amazing in other ways than Friday. The week encompassed the worst single day in the market since 1987. On the other hand, it was the best week in the market since 2003. 966 point swing Monday in a huge upside rush followed a 1019 point reversal the prior Friday. 733 points to the downside on Wednesday, then a 782 point reversal to the upside Thursday. It seems hard to fathom a week that saw a 733 point downside session would close positive. Interesting times indeed.

TECHNICAL. The day itself did not mean a lot. The low to high move was good for the upside, the high to low close was not. All of this was cleanup for the week as the range was less, volume was lower, and the losses were by comparison, very light.

INTERNALS. Friday was a flat day for breadth, volume was lower, new lows were nothing special. A review of the week is more instructive. Breadth was strong on the upside. New lows did not explode higher as the indices reached toward the prior Friday lows on the Thursday intraday low. Price/volume action was good (low on the down days, stronger on the up days): big volume on the Monday gain, lower on the Tuesday stall, lower again on the Wednesday selling, then big again on the Friday reversal and rally to positive. Not only that, but volume was high all week long as the market tested, rebounded, etc. Strong volume tends to go with tops and bottoms. Good internal action after a very weak week the prior week.

CHARTS. The week saw a continuation of the Friday reversal off a new 2008 and bear market low two Fridays back. Monday was a big move but as noted during the week, the Tuesday and Wednesday selling was too early for a really solid, stable base to support a big rise that you stake a new bull run off of. Now the Dow did come within a percentage point of the 25% move it made off the initial low in the 2002 bottom. That means the stage can be set for a sustained move off this test, but everything is bigger and more volatile this time around so we are not banking on that. There was lower volume on the decline off the Monday surge that turned into a higher volume rebound after a test near that prior low. We played both of those bounces for some nice gain on index plays. Now this shorter double bottom may not sustain a big move in most cases, but it can give a nice run higher and accomplish what we wanted the first bounce to do, i.e. set the stage for a test a few weeks down the road and thus form a better overall base. Again, this may be it, it may be the bottom, but history suggests that is unlikely. Overall we liked the action for the week and Friday was not a concern, just cleanup as noted.

LEADERSHIP. There is still not a lot to hang your hat on from the perspective of good traditional bases to lead the market out of a bear market and onto a new rally. At this stage the market is trying to put in an interim bottom and there are stocks in patterns similar to those that surged off the first and second bottoms in the 2002 low, i.e. those lateral consolidations such as MA. They don't need big bases to make that initial move off the first low or off the second low for that matter, just some relative strength and those box consolidations. After the surge we look for more traditional bases to form that lead to breakouts and big runs higher. Right now we are still at the stage where stocks are trying to get off their bottoms so to speak.


THE ECONOMY

The credit thaw continues at a trickle, but it does continue.

Bernanke said last week that the credit thaw would 'take some time.' He was not kidding. The chain was completed over last weekend with the US and Europe agreeing to guarantee interbank loans as well as providing liquidity for the commercial paper markets. Nonetheless, Tuesday (the US bond market opened that day after a Monday holiday) the credit markets didn't show much of a change for the better. After the big upside party Monday in anticipation of this action having a solid impact, Tuesday and Wednesday the market sold.

By Thursday, however, the results started to show up. LIBOR rates started lower with the overnight breaking below 2% to 1.95%. The TED spread (difference between US 3 month treasury and the 3 month LIBOR) fell 27BP to 4.07%. The stock market sold early and then reversed sharply. Friday yields improved a bit more. LIBOR overnight fell to 1.67%. The 3 month fell to 4.18% from 4.28%. The TED spread fell to 3.667%. This is down from 4.34% pre-Paulson.

Picking up a bit of speed, but still a long way to go. Recall from last week when we reported that in 2006 the average TED spread was 0.36%. 0.36% versus 3.667%. Still quite a ways to go, but at this rate it will take about ten more days to get there. Moreover, as it starts to fall more it will likely pick up speed.

That is what we are looking for but there is a scuffle between the US and Europe that broke out Friday over Europe's desire for a quick meeting to set new regulations with respect to oversight of financial activities, something the US, rightly so, views with skepticism. Yes the US dropped the ball across the board with respect to this mortgage mess, but we don't want to exacerbate the problem and risk our future economic strength by letting Europe have a say in how we oversee and regulate our financial institutions. Some coordination is fine but in this day of government intervention around the globe, this is not the time to start hammering out new regulations. We need to work through the crisis, get things settled down, and then approach the situation with calm, cool, clear heads.


A sharp downturn in economic data but will it bury the market further?

Thursday I reviewed the economic data to date and posed the question whether the current downturn was of the 1991 and 2001 type and thus relatively shallow or something worse given the massive implications of the mortgage crisis and credit freeze. Friday some more data came out and it was not good. But is it the death of the economy?

New home starts hit a 17 year low. They should. Recall in the summer of 2005 how the homebuilders paraded across the sets of CNBC, Bloomberg and other news station that would listen and answered questions about the longevity of the housing market. They cited their '10 year demographic' that would keep things rocking right along. Their enthusiasm was justified if the Fed kept rates at 1% and the wheels remained greased. They did not, however, and as noted last week, seeing that we knew it was the top.

Michigan sentiment tanked to 57.5 from 70.3 in September. It was expected to fall, but 65.0 as expected would have been a bit more palatable. The rest of the week was not good. The New York PMI fell to -24.6. Retail sales fall 1.2%, the fifth straight decline. Industrial production fell to 76.4 from 78.7. The Philly Fed PMI fell to -37.5 from positive.

Bad news all around. This was brought about by the credit freeze that worsened in August and September and the panic that was sparked in the mind of the public. That shut down a lot of business activity and then the consumers were shocked to see the Treasury Secretary and Bernanke put forth such a massive plan. We had traders in CDS (credit default swaps) suggesting withdrawing cash and putting it into safety deposit boxes. The news was bad but the people involved thought things were really bad. When Bernanke went up to the Hill along with Paulson, that really put the fear into the public. And the market. It dove lower.

It is, however, a quick fall. The economic reports that are down tend to be the leading ones. They are impacted first. Many deal with the sentiment of the consumer and businesses. The credit freeze has frozen parts of the economy, but the question is how deep? Just some chapped hands and a cold or are we talking cryogenic?

A quick fall is better than a slow bleeding. It was caused by locked up credit. Credit is starting to move. Commercial paper markets are moving after going bone dry. Interbank lending rates are falling. If the recovery in credit, the lifeblood of the economy, quickly returns to more normal levels the patient can recover quickly or at least quicker, and that is always good for the market.

Back in the 1970's oil shocks hit the economy along with incredibly high interest rates, inflation rates, and unemployment rates. The market dove lower starting with a peak in January 1973 and bottoming in, of course, October 1974. That was a steep 53% drop on SP500 taking 22 months. The market bottomed after that and ran higher quickly. It then wandered for 4 years until 1980 and the election that year.

The current drop is 53% and it has taken just 13 months. A quick fall riding down in front of a fast economic decline that is more like a sentiment led panic decline than just your run of the mill fall into an economic slowdown and recession. Restore credit and the panic dies down and the economy can function once more and start healing itself (provided we don't overreact and over-regulate, etc., something that is not a sure thing). The market? It would jump higher well ahead of the economy just as it did in 1974. Thus this bottom attempt here, while not complete, could set the stage for a rapid rise over the next several months. It is, after all, October.


THE MARKET

MARKET SENTIMENT

VIX: 70.33; +2.72. Big week for VIX hitting a new post-1987 high at 81.17 Thursday during the early selling. Now remember, VIX is not THE turning point for any bottom. Volatility spikes once, and it can spike again on a second low or test of an initial dive lower. The turn comes several weeks AFTER volatility hits its peak. Now in 2001 it spiked, but that was when the market re-opened after 9-11. In the bottom it surged on the July low to the high in the process and then spiked again as the second bottom was hit. The big spike on the first leg, the next spike on the second leg and it can be and often is lower. So, we need the indices to build a base. The bounce in 2002 was 10 weeks, bottom to bottom. Again, more needs to be done here.
VXN: 71.26; -1.13
VXO: 71.06; +0.72

Put/Call Ratio (CBOE): 0.97; -0.18


Bulls versus Bears:

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: 22.4%. Down from an already very low 25.3%. That prior week was the largest single week drop we have ever seen, down from 33.7% and 37.5% the week before. Well below the 35% threshold considered bullish. Down from 40.7% on the high during the rally off the July 208 lows. Surpassing the 27.8% on the low this round. 30.9% was the March low. In March the indicator did its job with the dive below 35% and the crossover with the bears. 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: 52.9%. Modest decline from an already high 53.0%. Surging from 47.2% and 40.9% the week before. Surpassing 50.0%, the high on this move. Well above the 35% threshold so still a bullish indication. This move over 50 takes it to the highest since 1995. Extreme negative sentiment. 35% is the level that historically indicates excessive pessimism. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March. 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: -6.42 points (-0.37%) to close at 1711.29
Volume: 2.765B (-18.89%)

Up Volume: 1.323B (-1.586B)
Down Volume: 1.417B (+959.974M)

A/D and Hi/Lo: Decliners led 1.29 to 1
Previous Session: Advancers led 1.21 to 1

New Highs: 2 (0)
New Lows: 127 (-274)

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

Good recovery off the early weakness but then could not close the deal for the day, but that did not ruin the week. Rallied up to the 10 day EMA and then faded back to basically flat. Reminiscent of Tuesday, but like the Thursday reach lower to test toward the prior low and a big reversal on strong volume. A short term double bottom that can send NASDAQ up closer to 2000, maybe even 2100 on this move.

NASDAQ 100 (-0.10%) was trying to lead Friday with the earnings from GOOG, AMD, and IBM sparking some excitement in technology. It was the relative strength leader on the session, and as with NASDAQ you have to like the short double bottom. Still looking at the AAPL, RIMM and similarly situated techs as potential upside plays on a continued NASDAQ rebound.

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

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


SP500/NYSE

Stats: -5.88 points (-0.62%) to close at 940.55
NYSE Volume: 1.74B (-12.88%)

Up Volume: 818.794M (-738.405M)
Down Volume: 913.803M (+502.715M)

A/D and Hi/Lo: Advancers led 1.23 to 1
Previous Session: Decliners led 4.54 to 1

New Highs: 47 (-2)
New Lows: 211 (-340)

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

Rallied to the 10 day EMA (980.50) on the Friday high and faded to flat on lower though still above average volume. Similar to the other indices the large caps are trying to advance off of a short double bottom, but they have to get through the 10 day EMA first and then 1000 to 1050, the range it stalled out early last week.

SP600 (-1.57%) was the market laggard Friday. Led the Thursday romp, lagged Friday. Go figure. It rallied up to the 10 day EMA as well then reversed to negative. Still the same action as the other indices: they all seem to want to do this together. What a co-dependent market.

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

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


DJ30

Basically a carbon of the other indices with the action on the week and on Friday. It more matched the small caps as DJ30 was a laggard. Still, the same pattern and if the others go the Dow will more than likely follow.

Stats: -127.04 points (-1.41%) to close at 8852.22
VOLUME: 360M shares Friday versus 422M shares Thursday.

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


FRIDAY

Earnings and LIBOR, earnings and LIBOR. Last week the earnings started to come in, and while they were not blowing the market away, they were not sending it down the drain either. It is expected earnings will turn in their fifth straight quarter of declines, and they likely will. The initial big names last week (JNJ, GOOG, IBM), however, did no harm. Right now that may be the best that we can look for. If credit continues to improve and earnings continue this kind of showing, the market may be quite encouraged. The action last week in the midst of all of the turmoil has put in place the foundation for at least a tradable run to set up a better bottoming attempt.

The sentiment and internal indicators, as reported the past week, are at levels that support a bottom in the market or at least the bottoming process. The loss is equivalent to prior bear markets; it has just piled up very quickly this time, understandable given the nature of the beast causing the decline.

At this juncture, however, the market is still in the process of putting in that initial low in a bottom, and that makes the plays we are looking, whether upside or downside, more short term in horizon, capturing a surge, taking some gain, seeing how the move holds, then looking for more. Thus the index plays that capture the runs off the reversals. Other plays are a bit different as they form up nicely for a solid surge (those lateral consolidations) if this market gets serious about the upside off of this short double bottom, and that is why we are hanging around in those positions. There are some others, mostly financials but some others as well, that are actually in good current bases. Again, once this market gets serious about this move higher off the short double bottom we expect those to start breaking higher.

Thus it is still early in the process as this is the first leg of a potential bottom and there are not a lot of stocks with long term leadership patterns. We will continue to look for those patterns to develop, and if we see them with good stocks we will put them on when they look ready. For now we are still expecting more from the likes of MA, AAPL, RIMM, CME and some new stocks setting up in energy and metals. It is the combination of extreme sentiment, solid market internals, good action in the indices, and the improvement in the credit markets that makes this current action more positive than just another bounce in a downtrend.


Support and Resistance

NASDAQ: Closed at 1711.29
Resistance:
1752 from 2004
The 10 day EMA is 1768
1782 from August 2004
The 18 day EMA at 1859
1882 from October 2003
1900 is the gap down point in October; from August 2004
1912 from April 2005
1947 is the point where the market gapped down from in October 2008
1984 is the lat September low
2070 from September 2008
The 50 day EMA at 2070
2099 is the mid-September closing low
2155 is the March 2008 low
2167 is the July 2008 low
2202 is the January 2008 low
2261 is a March 2008 interim low
2286 is the first April 2008 gap up point.
2300 is some resistance
The 200 day SMA at 2312
2340 from the March 2007 low

Support:
1644 from August 2003
1620 from the early 2001 low
1565 is the second low in October 2008
1542 is the early October 2008 low
1521 is the late 2002 peak following the bounce off the bear market low
1387 is the 2001 low
1253 is the March 2003 low on the test of the rally off the 2002 bear market low
1108 is the 2002 low


S&P 500: Closed at 940.55
Resistance:
965 is the 2003 consolidation low
The 10 day EMA at 981
995 from June 2003 consolidation peak
The 18 day EMA at 1031
1065 is the Q4 2003 level that SP500 started the run to 2007 after the first run in the recovery.
1075 from August 2004.
1106 is the late September low
1133.50 is the mid-September 2008 low
The 50 day EMA at 1142
1200 is the July 2008 intraday low
The 90 day SMA at 1226
1243 is the 2002/2003 up trendline
1244 is an August 2005 peak
1257 is the March low
1270 is the January low
1285 is the recent July peak
The 200 day SMA at 1302
1313.15 is the August 2008 peak
1317 from the February low
1324 is the April low
1348 is an ancient trendline

Support:
889 is an interim 2002 peak
866 is the second October 2008 low
853 is the July 2002 low
839 is the early October 2008 low
800 is the March 2003 post bottom low
768 is the 2002 bear market low

Dow: Closed at 8852.22
Resistance:
8985 is the closing low in the mid-2003 consolidation
9200 is the July peak in the 2003 consolidation
The 10 day EMA at 9211
9323 From June 2003 peak
9575 from September 2003, May 2001
The 18 day EMA at 9631
9814 from August 2004
9852 is 25% off of the October 2008 intraday low
9937 from May 2004 low
10,100 to 10,000
10,127 is an April 2005 low
10,215 from Q4 2005
10,365 is the new 2008 low
10,459 is a September 2008 low
The 50 day EMA at 10,503
10,827 is the July 2008 intraday low
10,962 is the July closing low
11,061 from February 2006
The 90 day SMA at 11,127
11,317 from March 2006
11,388 is the prior August low

Support:
8626 from December 2002
8521 is an interim high in March 2003 after the March 2003 low
8197 is the second October 2008 low
7882 is the early October 2008 low
7702 is the July 2002 low
7524 is the March 2002 low to test the move off the October 2002 low
7282 is the October 2002 low

Economic Calendar

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

October 20 - Monday
Leading Economic Indicators, September (10:00): -0.3% expected, prior -0.5%

October 22 - Wednesday
10/18 Crude oil inventories (10:35): 5.61M prior

October 23 - Thursday
Initial Jobless Claims (8:30): 461K prior

October 24 - Friday
Existing Home Sales, September (10:00): 4.93M expected, prior 4.91M

By: Jon Johnson, Editor
Copyright 2008 | All Rights Reserved

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

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Sunday, October 12, 2008

Hedge Fund Unwinding Continues

SUMMARY:
- Massive selling, a reversal, the reversal reverses, then fights back to close out the week.
- Hedge fund unwinding continues, now including Treasuries.
- Treasury Department announces intention to buy equity in financial firms.
- This could be the weekend the various fixes to the world credit chain get linked up.
- Re-entering the market with some buys to play the rebound, the start of a new bottoming attempt.

It's another selloff. No, it's a reversal. No it's a selloff. How about an almost reversal?

There was nothing new and major Friday, but the 'same old, same old' was bad news enough. Foreign markets sported 7% to 10% losses, interbank lending rates spiked again indicating all of the drastic measures by federal governments have yet to break credit free. Hedge funds were liquidating again across the board as the massively overcrowded trades of late 2007 are still unwinding. Oil was clobbered on the weaker world economic assessments and the hedge funds' need for capital, breaking $80/bbl with ease and in doing so blowing out support at $85 (closed at 77.70, -8.90/bbl). Commodities, agriculture as usual, now joined by all other sectors as well. Again, more of the 'same old, same old.'

Stocks gapped much lower than futures suggested and within 10 minutes the Dow fell 697 points, NASDAQ 102, and SP500 70. Hey, they had to keep up with those overseas 7+% losses. They immediately rebounded, however, turning positive within the first 40 minutes of trade. Then the sellers took their shot, selling into a rally as hedge funds used the recovery to once more liquidate and raise capital to cover redemptions and margin calls. That put the kybosh on the upside and the session wandered lower and lower into mid-afternoon, threatening the early lows.

Then the rebound. There is a G7 meeting this weekend (leaders of the largest western economies, though it includes Russia and the judo-video, tiger taming Vladimir Putin so go figure) and even though the participants played down the chance of blanket insurance for interbank loans (what the markets really want and the last link in the chain for credit markets and of course the government takeover of same), the possibility of that brought in the shorts to cover ahead of the weekend meeting. It was quite a rush higher, driving the indices positive with 25 minutes before the bell. The Dow moved positive almost 300 points. It shot its ammunition a bit too early, however, and the Dow fell 430 points off of that late high to close negative though well, well off the lows. Unreal volatility fed by hedge funds that were all into those crowded trades and are still in the process of unwinding. There is some buying by long term players, but it is not enough right now to overcome the massive moves brought about when the hedge funds stampede the market.

TECHNICAL. Unreal volatility even intraday. The massive volatility in the market shows a change trying to move in, and the now intraday volatility underscores that. Early on there was that palpable, sick feeling once more. The reach lower in continuation of the Thursday selling, the bad day on top of a bad day, had that climax air to it. It was Friday, however, and those often cascade into weak Mondays as well. The afternoon recovery may have altered that some though it was driven by short covering ahead of the G7 and possible good news. Of course all rallies start with short covering. Thus if the G7 guys and gals take the final step the late reversal by the shorts to cover could be warranted.

INTERNALS. Impressive once more though by the close the incredibly negative breadth was basically flat. New lows surged to over 2600 on NYSE and 1700 on NASDAQ. Volume exploded to the third highest ever on NYSE (2.9B) and the highest ever on NASDAQ (4.2B). After all of the other indicators (sentiment, internal, technical) hit extremes, this volume is finally the kind of volume you associate with a reversal. Massive trade levels.

CHARTS. The dive lower early Friday pushed the indices lower toward the 2002 lows, the bottom of the prior bear market. DJ30 came within 740 points of that low; with these declines that is just a day's selling. SP500 a mere 80 points. If they hold here, if Friday was the crescendo selloff that starts a new bottom, that is a real positive for the market and the economy. Even if it goes lower to start next week and tests these levels further, that is okay as well. The small cap SP600 undercut the 2004 double bottom in that index and held the Q4 2003 lows, bouncing with fury the other indices did not possess. It covered over 30 points in the session, and 11% move, finishing up 4%. We bought into some IWM positions as it rebounded in what looks to be a very strong, market leading reversal. This is a very important move by the small cap index.

LEADERSHIP. The leader of the day? The dollar. It closed at 1.3410 euros versus 1.3603 euros Thursday. Huge move and it even faded some from an intraday move lower (1.3376). The small caps were popping off of their hard selloff of the past week, providing a lot of upside momentum. Hard to call them leaders just yet, however. There was not much change from Thursday because of that early dump lower. The base metals and large cap techs are still setting up for a turn. We will see if they can make it.


THE ECONOMY

Paulson after hours: US will buy equity in financial institutions.

The $700B socialist program empowers Treasury to give money to financial institutions . . . in exchange for equity. This is a very dangerous provision. US federal government owning equity and potentially calling the shots in financial institutions. Just look at what it does to local schools: they are slaves to the money the state, via federal spending, puts into the system. The result is absurdly bloated administration employees and facilities that are often physically larger in terms of employees and budgets than the actual schools they oversee. Instead of going to the teachers and kids, the money has created a sub-bureaucracy that seeks to grow itself as do all bureaucracies.

Fortunately Paulson still has some living roots to free enterprise and capitalism left. He will use the power to buy non-voting preferred stock. That will give the companies capital in the companies without direct voting control by the feds. It dilutes all shareholders, but it is explained away as benefitting us all through the preferred stock ownership, though we know any gains will go to Treasury to be spent by the feds. What a sweet deal for the government. All we get out of it is, at best, maintaining the status quo with the exception of a hugely expanded federal government. What a deal. It will help solve the current crisis, but down the road it only adds to the problem we will some day be faced with and what our founding fathers said was a good thing: a little revolution now and then never hurt any country. Not necessarily the armed type, just social disobedience and the like. The true test will be how the vastly expanded federal government responds.


G7 set to meet again this weekend to hammer out some details.

Friday the G7 countries met preliminarily ahead of more meetings this weekend. The group issued a 1-page statement, something of a rarity in its brevity. It indicated they would work to secure the system but tended to lean toward individual, case by case fixes versus the blanket proposal to insure all of the interbank loans. Some really smart people, however, say it is going to do otherwise.

Why this move is needed. There is plenty of liquidity in the world. The central banks are pushing money into the system and citizens, thanks to governments guaranteeing their deposits and even before that showing a good sense of calm, keeping their money in the bank. Problem is, because banks cannot be sure which fellow banks are loaded with the crap to the extent they are about to implode they are very reluctant to lend to each other as they typically do freely every day. These loans are not guaranteed and the banks are on their own or have to seek some kind of insurance from collateral default swaps. As discussed three weeks back, the premiums on those policies have shot up ($10M was $14K but rose to over $400K in just a few weeks) and as we have seen may be just worthless paper anyway.

Thus in order to try and protect themselves they charge more for the loans. This is the 'TED' spread you hear about every day. It is the difference between the yield on the 3 month LIBOR (London Interbank Offer Rage) and the yield on the 3 month US Treasury. On Friday that difference was 4.34%. It has bounced between 2% and 6% for more than three weeks. For a reference point, in 2006 (before it started to rise in 2007 as the market started to sense the crisis) it averaged 0.36%. It costs 12 times to borrow funds as it did in 2006 just to do business. Banks cannot afford it.

That creates liquidity squeezes as institutions cannot meet their required ratios of deposits to obligations because they cannot get the cash needed. It sets up a vicious cycle: those institutions struggling and needing liquidity in order to make some money and work things out cannot get funds and their financial condition deteriorates further and further. They will eventually fail and one by one (2 by 2, and 3 by 3, etc. as time goes on) the financial institutions go down.

Thus the call to insure the interbank loans so banks will lend to one another. All other links in the chain are there: commercial paper is backed, depositors are insured, swap facilities are in place around the world, the US is going to (eventually) buy the bad assets and take them off the financial world's balance sheets. That completes the chain of liquidity flow and federal intervention. That provides the needed liquidity so the money can circulate through the system, going where it needs to go and thus avoiding the spiral lower that unnecessarily took down BSC and LEH.

As noted, some very smart economics minds say this will work to fix the system near term. Of course they are not Constitutional scholars and they put the caveat out that it fixes things 'near term.' No one knows specifically what all of this government intervention into historically private areas will cause, but there is general concern that after the crisis is averted for now just how and whether the government will extricate itself and whether this level of intrusion will chill economic risk taking and thus economic output in the future. If Big Brother is involved, potential is rarely met.


THE MARKET

MARKET SENTIMENT

VIX: 69.95; +6.03. Hit new 20 year closing high and intraday spike at 76.94, surpassed only by the meltdown in 1987.
VXN: 71.58; +1.92
VXO: 85.99; +10.03

Put/Call Ratio (CBOE): 1.22; -0.13. Three weeks in excess of 1.0 and it spiked intraday. As noted, this indicates plenty of downside speculation and when everyone thinks things are going lower they usually don't.


Bulls versus Bears:

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: 25.3%. Largest single week drop we have ever seen, down from 33.7% and 37.5% the week before. Well below the 35% threshold considered bullish. Down from 40.7% on the high during the rally off the July 208 lows. Surpassing the 27.8% on the low this round. 30.9% was the March ow. In March the indicator did its job with the dive below 35% and the crossover with the bears. 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: 53.0%. Surging from 47.2% and 40.9% the week before. Surpassing 50.0%, the high on this move. Well above the 35% threshold so still a bullish indication. This move over 50 takes it to the highest since 1995. Extreme negative sentiment. 35% is the level that historically indicates excessive pessimism. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March. 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: +4.39 points (+0.27%) to close at 1649.51
Volume: 4.204B (+40.79%). The highest NASDAQ volume ever. This is the type of volume that you look for to accompany a reversal.

Up Volume: 1.632B (+1.432B)
Down Volume: 2.533B (-243.652M)

A/D and Hi/Lo: Decliners led 1.09 to 1
Previous Session: Decliners led 5.34 to 1

New Highs: 6 (-1)
New Lows: 1709 (+651)

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

Gapped lower, undercut the mid-2003 consolidation, bottoming just over the late 2002 (1521, 1542 on the Friday low), followed by a big surge back up that made it to positive. Huge intraday volatility but also a huge recovery on tremendous volume that held support on the close. That is reversal quality action. Now it will need to follow through starting Wednesday, looking for a move accompanied by strong breadth as well as volume. Then we look for bases to form on the ensuing bounce and test of the prior low. You have heard it before. The market will go through this until it gets a base of leaders in position along with a base in the indices.

NASDAQ 100 (-0.42%) could not hold the move back to positive. Strong volume, good reversal. Looking for large cap techs to pull some weight on a move this week.

SOX (-0.93%) sold as well, coming within spitting distance of the 2002 low and then reversed, just missing positive on the close. Nice deep doji with tail shows the momentum trying so shift.

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

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


SP500/NYSE

Stats: -10.7 points (-1.18%) to close at 899.22
NYSE Volume: 2.929B (+45.46%). As with NASDAQ, this is the kind of volume you look for when the market reverses. Third highest volume of all time.

Up Volume: 1.071B (+976.124M)
Down Volume: 1.854B (-61.647M)

A/D and Hi/Lo: Decliners led 1.95 to 1
Previous Session: Decliners led 10.73 to 1

New Highs: 16 (+10)
New Lows: 2631 (+827). Impressive. And extreme.

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

Big reach lower, coming close to the March 2003 low that tested the late 2002 double bottom bottom, and then rebounding. Turned positive late but as with DJ30, could not quite hold positive on the close. New lows surged, volume surged, index reversed after massive selling. Short covering yes, but still looking for more upside after this selloff.

SP600 (+3.99%) undercut the 2004 double bottom lows, tapped the bottom of the 2003 Q4 consolidation, and then furiously reversed to lead the market higher. This kind of furious recovery by the economically sensitive stocks suggests the rest of the market will show strength as well if the upside trigger hits over the weekend in the form of a significant G7 agreement.

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

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


DJ30

Same action as SP500, just more points involved. Reached down toward the May 2003 low and then reversed course. Surged positive by 300 points less than a half hour ahead of the close, then just couldn't hold onto it. The moves were huge with 100 point increments reeling off in seconds. Huge volume here as well. By the close it missed the big reach lower and reversal to positive, but with NASDAQ and the SP600 making the reversal they can carry DJ30 and SP500 along with them.

Stats: -128 points (-1.49%) to close at 8451.19
VOLUME: 674M shares Friday versus 436M shares Thursday. Big volume all week as DJ30 sold. Distribution for sure but that is how it gets sold out.

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


MONDAY

Got another selloff and then a big intraday bounce, but it was not all just huge reversal off the lows. The sellers still took a second bite of the apple before covering late in the session. Thus while there was a big recovery into the close, it was not a clear run by the buyers when the sellers are exhausted. That makes this weekend G7 meeting extremely important as the market wants that last link in the chain forged, yet many of the European nations are against insuring the interbank loans for fear of a failure. Okay; that is what insurance is for. Can't say you want to insure unless you are willing to make it pay. Moreover, what if they do fail if the governments don't step in? They think that won't burden their taxpayers in other ways such as lost jobs, folding businesses, etc.?

The market closed with the rebound both out of fear by the shorts and hope by the longs that the G7 will do the right thing. At this point they have done everything but this last step in completing the 'circle of life' for financials to operate their businesses and fund the world economies. It would be foolish, yea verily stupid, to not go ahead and finish the job. Worries of too much intervention at this point is similar to halting construction of the last mile of a 100 mile road through pristine forest because it will knock down a few more trees. The damage is done. Steve Forbes thinks the G7 will do the right thing, so there you go.

While the rally may not have been of the purest with respect to a turn to long buying, after such an onslaught of selling the market often turns with a spell of massive short covering. Whether it continues depends upon a couple of issues. First, the hedge funds will have to get sold out, i.e. cover the redemptions and margin calls. Second, the credit market has to get the links of the chain forged with a complete bailout package so it can finally function and allow the institutions to conduct business and provide the money the world economies need.

If the latter is accomplished then the hedge funds will be less pressured to liquidate. The economy can start to operate, and while just a functioning credit market won't heal the economy, it will allow it to operate and get on the road to recovery. We have heard predictions that if the credit chain is completed the economies could be back and starting to recover in 6 months.

That would allow the market to start discounting a recovery almost immediately, meaning the reversal Friday could continue with a nice relief bounce from here and go about setting up a bottom, either a less typical 'V' bottom or more likely the usual 'W' bottom with a test of the Friday low.

In that vein we will continue to look for vehicles to ride a recovery bounce higher as we also watch for bases to form in growth stocks so that they can lead the subsequent move higher after the initial rebounding stocks carry the market off the lows. That is how it worked in 2002. The first leg of the bottom had little in the way of leadership bases, but bases formed as the market tested back following the initial surge higher. Those stocks in bases then broke out as the market bounced off the second bottom, leading the way higher through December. Then as the market tested back from January to March, dozens and dozens of growth stocks formed bases and broke out in late March.

We may still be a bit early, but late last week we started buying into stocks in position to bounce that were showing some relative strength along with some index positions with the intention to ride them higher on the first leg of a rebound. We are still looking to do that and add positions as the opportunity presents. Monday will tell much more of the tale as it could be another down session given the history of bottoms. With the massive early selloff and bounce on Friday, however, we felt it worth venturing some buys.

Again, we will continue to do so as the opportunity presents to start the week, adding to current positions and looking at some new plays as well. For now while we wait for bases to form in growth stocks we keep it simple, sticking to strong stocks showing relative strength and in position to bounce as well as indices as they bounce higher.


Support and Resistance

NASDAQ: Closed at 1649.51
Resistance:
1752 from 2004
1782 from August 2004
The 10 day EMA is 1844
1882 from October 2003
1900 is the gap down point in October; from August 2004
1912 from April 2005
1947 is the point where the market gapped down from in October
The 18 day EMA at 1956
2070 from September 2008
2099 is the mid-September closing low
The 50 day EMA at 2144
2155 is the March 2008 low
2167 is the July 2008 low
2202 is the January 2008 low
2261 is a March 2008 interim low
2286 is the first April 2008 gap up point.
2300 is some resistance
The 200 day SMA at 2335
2340 from the March 2007 low

Support:
1644 from August 2003
1620 from the early 2001 low
1521 is the late 2002 peak following the bounce off the bear market low
1387 is the 2001 low
1253 is the March 2003 low on the test of the rally off the 2002 bear market low
1108 is the 2002 low


S&P 500: Closed at 899.22
Resistance:
965 is the 2003 consolidation low
995 from June 2003 consolidation peak. Below this level on the Wednesday close.
The 10 day EMA at 1028
1065 is the Q4 2003 level that SP500 started the run to 2007 after the first run in the recovery.
1075 from August 2004.
The 18 day EMA at 1088
1133.50 is the September 2008 low
The 50 day EMA at 1183
1200 is the July 2008 intraday low
1242 is the 2002/2003 up trendline
1244 is an August 2005 peak
The 90 day SMA at 1249
1257 is the March low
1270 is the January low
1285 is the recent July peak
1313.15 is the August 2008 peak
1317 from the February low
The 200 day SMA at 1315
1324 is the April low
1335 is an ancient trendline

Support:
889 is an interim 2002 peak
853 is the July 2002 low
800 is the March 2003 post bottom low
768 is the 2002 bear market low

Dow: Closed at 8451.19
Resistance:
8521 is an interim high in March 2003 after the March 2003 low
8626 from December 2002
8985 is the closing low in the mid-2003 consolidation
9200 is the July peak in the 2003 consolidation
9323 From June 2003 peak
9575 from September 2003, May 2001
The 10 day EMA at 9627
9814 from August 2004
9937 from May 2004 low
10,100 to 10,000
The 18 day EMA at 10,106
10,127 is an April 2005 low
10,215 from Q4 2005
10,365 is the new 2008 low
10,459 is a September 2008 low
10,827 is the July 2008 intraday low
The 50 day EMA at 10,834
10,962 is the July closing low
11,061 from February 2006
The 90 day SMA at 11,309
11,317 from March 2006
11,388 is the prior August low

Support:
7702 is the July 2002 low
7524 is the March 2002 low to test the move off the October 2002 low
7282 is the October 2002 low

Economic Calendar

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

October 13 - Monday
September Treasury Budget (2:00)

October 15 - Wednesday
September Core PPI, (8:30): 0.2% expected, 0.2% prior
NY Empire State Index, October (8:30): -10.0% expected, -7.4% prior
PPI, September (8:30): -0.3% expected, -0.9% prior
Retail Sales, September (8:30): -0.4% expected, -0.3% prior
Retail Sales ex-auto, September (8:30): 0.1% expected, -0.7% prior
Business Inventories, August (10:00): 0.4% expected, 1.1% prior
Crude Oil Inventories, 10/11 (10:35): +8.1M prior

October 16 - Thursday
September Core CPI (8:30): 0.2% expected, 0.2% prior
CPI, September (8:30): 0.1% expected, -0.1% prior
Initial Jobless Claims, 10/11 (8:30): 478K prior
Net Foreign Purchases, August (9:00)
Capacity Utilization, September (9:15): 78.0% expected, 78.7% prior
Industrial Production, September (9:15): -0.8% expected, -1.1% prior
Philadelphia Fed, October (10:00): -5.0 expected, 3.8 expected

October 17 - Friday
September Building Permits (8:30): 845K expected, 895K prior
Housing Starts, September (8:30): 880K expected, 895K prior
Michigan Sentiment-Prel., October (10:00): 69.0 expected, 70.3 prior

By: Jon Johnson, Editor
Copyright 2008 | All Rights Reserved

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

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Sunday, October 05, 2008

After $700B, What Can be Done

SUMMARY:
- Stocks rally to House vote despite jobs report, then hedge funds sell the rally.
- Is there a panic in the house? Panic talk sends economy sharply lower. Long term damage or just temporary?
- The economy needs loose credit and more. After $700B, however, what can be done?
- Sentiment, internals hit extremes so watching for leaders and a market turn.
- After new lows Friday, history says watch out for Monday and Tuesday.

Once more market finds no solace in the bailout package.

There are three themes attacking the market. First there are hedge funds still in the liquidation process of those massively one-sided trades in commodities, energy, and agriculture. As the market has sold off further that has morphed into liquidation of most of their positions in other sectors as well as they have to raise cash to meet current and anticipated liquidations this month as investors panic and pull out of the market. Second, the bailout passed wont rescue the economy; it is simply a measure to free up credit, i.e. get the markets working the way they should. It does not provide incentive to invest in the economy. The market realizes this and is looking for something else to help stimulate it. Third, some panic from our leaders in selling the $700B bailout package that panicked the populace, causing many to pull in their buying drastically.

It was not the jobs report. The -159K was worse than expected, but the market didn't sell on it, instead rallying the futures after the number. The early optimism got a boost from WFC swooping in to buy Wachovia at a premium versus the FDIC-forced Citigroup purchase of WB. If WFC can find value at something other than federally induced rock bottom, there is hope for the market. Sure it had an IRS rule change aid, but unlike the vote on the bailout, the market liked the WFC/WB deal even if Citi got burned by the deal.

The market rallied through the morning and up to the House vote. The bailout passed. The market, as after the Senate passage, sold off. The news was out, the hedge funds had a rally, hedge funds needed money, the trigger was there. Didn't hurt that the bailout won't fix the problem. It is like a drowning person in the middle of the ocean finding a life preserver. It keeps them from drowning but the situation is still grim with not much hope in sight.

TECHNICAL. It was an ugly week starting with an ugly Monday, a rebound, an ugly Thursday that really got sentiment down given the Senate passage and then the rollover. Friday another passage, another rollover. Everyone is feeling trampled.

INTRADAY. Nice start and rally but SP500 and DJ30 only made it up to the closest resistance before they stalled and rolled over. Bulls never like to see the happy starts then long faces on the close. It shows that the sellers are still on top, as if the action all week didn't suggest just that.

INTERNALS. The week showed some massively negative internal readings with Monday the leader of the pack with new lows at 1392 on NYSE. The NYSE advance/decline ratio was almost -17:1. As extreme as we have seen it. Back in October 2002 -10:1 was pretty much the height of extremism. Thursday as SP500 hit new 2008 lows the A/D ratio was 'just' -5.3:1; new lows topped out at 629 even as SP600 and SP400 broke to new 2008 lows. Friday new lows were roughly even at 642 even as the indices struck out to new 2008 and selloff lows again. Less then half the new lows as the indices hit new lows. So you have extremes on selling and then on further selling the extremes normalize somewhat, though anything over 500 new lows and you start looking for a bottom. Got to that point. Now as the selling continues the lower number of new lows indicates less selling intensity. It is an issue of gradation, but after massively negative sentiment and internals it is another insight that shows the environment is right for the market to bottom.

CHARTS. New lows Monday for all indices but the small caps. Not to be left out, they cratered to a new closing low Thursday and then a new 2008 low Friday along with every other index. Before the Friday new lows the indices tapped at near resistance at the 10 day EMA ahead of the vote. Failing at the lowest rung of resistance is not a sign of inner strength. But this is nothing new. As I said on Thursday in relation to sentiment, we have been here before, this time in a technical sense. Back in 2002 the Dow bottomed, along with the other indices, forming a double bottom where the right leg undercut the left leg. The question we have here is - has it undercut too much and thus require a test of the new low?

You see, there is this technical analysis concept, some would say rule, that new lows have to be tested before a bottom can form. Some say if you violate the old low you have made a new low and thus you have to have a test, and if that test violates that new low then you have to have another test and see if it was violated, etc. Who knew technical analysis was so violent? Who knew there were tests involved? Some who say this are old salts and you would assume if an old salt was around long enough to become an old salt that he or she would be right and thus after breaking to new lows this week the indices would have to bounce and then test again, this time without breaking the lows in order for the selling to finally come to an end.

How do you answer that theory? 'Not true' comes to mind. As with the extremely negative new lows readings, it is yet again a gradation thing. It is also a historical thing. In late 2002 the Dow bottomed with a double bottom where the second low viol . . . er, breached the prior low. The Dow rallied off that second low. It never tested that second low. The 'test' theory must be false, right? Wrong. There was a test. The second low tested the first low. The key is how low can it go? In 2002 the second leg undercut the first by 4.5%. On the Friday low DJ30 undercut its July low by 4.6%. It is pretty much at the lick log point with respect to undercutting the prior low. It can head down more but on the close it needs to get back up in this range.

The pattern is interesting but it is not great. It is in a third leg lower in this selling and the current leg is about half the size of the prior leg. Legs tend to be the same size so if DJ30 is going to hold it needs to do so here or it is going to get well past that 5% grace level for undercutting a prior low and still forming a bottom.

LEADERSHIP. The Dow's chart is still in position to bottom as indicated above. Each technically feasible bottom, however, needs a leader. Actually, it needs a lot of leaders. Thursday we discussed financials shaping up nicely. They sold some Friday though are still holding up well. They are being supported by the ban on shorting though the bailout bill should help them. They sold some Friday as some profits were booked in case the SEC does not re-up its ban. We think it likely will give it another few weeks and thus we can look for them to rebound from this pullback. Homebuilders were solidly setting up bases; until Friday when they broke lower. Food is still good, but that is defensive. Healthcare is good and it can be defensive as well as growth oriented. We are looking around to see if anything else is out there. If leadership, particularly growth oriented leadership, does not develop during the next few weeks then any bounce has a low chance of succeeding.


THE ECONOMY

Everyone on television is panicked so there must be a panic.

All week you heard the comments and they really ratcheted up after the House voted down the $700B behemoth Monday. The President talked about losing our cars and televisions or something along those lines. Senate majority leader Reid launched a selloff of insurance stocks as he tried to sell the new deal, saying a committee member told him a major insurer we all knew the name of could go bankrupt. Not a smooth move. Of course he did the old Potomac two-step (watched "Clear and Present Danger" recently) and had his office say he had no specific knowledge of any insurance company in such a situation, but of course that doesn't mean what he said was not true but he just didn't know the name himself. You have to love it when our leaders make these idiotic blunders. It underscores just how little they really do know and understand about the financial markets. Heck, that statement is worthy of SEC investigation by itself.

In addition the financial stations are reporting on cases of credit impingement. Auto Nation's CEO was on CNBC listing statistics of loan approvals with just 60% of prime borrowers getting loans versus 91% normally. One current car lessor wanted a new lease but couldn't get it. He offered to pay 4 years of payments up from and still couldn't get it. The problem: banks have no money to lend, or at least had no money to lend before the $700B baby. There were stories about college funds ready to disappear, 401k's turning into 201k's, college students without money, car dealers unable to get credit to buy inventory, dogs sleeping with cats, plague, satanic worship, etc.

If your leaders panic then the people panic. When your Senate leader comes out and talks about big insurance going down that worries people, especially when you have had Midwest floods, Atlantic coast hurricanes, Gulf coast hurricanes, western fires - - you want to know your insurance company is at least solvent when Rome is burning.

This was a panic and it has notably curtailed economic activity the past two weeks. Brian Westbury, a very good economist though he was a bit too optimistic with respect to the mortgage meltdown, says this panic talk helped push the US into a sharp downturn since the Paulson proposal was pitched to Congress two weeks back. As noted there are many anecdotes of problems. An interesting statistic that shows the fear induced consumption shutdown is the disaster relief donations for Hurricane Ike. It is now believed that the death toll will top 400 because a lot of people that have been in the 'missing' category are presumed to have been washed out to sea in the communities east of Galveston where homes on pilings were washed away . . . along with the pilings as well. The devastation is as complete as with Katriana east of New Orleans and into Mississippi. Donations for Ike disaster relief are at $20M. For Katrina where far fewer died, donations were $400M. Money is tight, and with the feds spending $700B for bad mortgages, money is not going to be flowing from Washington for other matters.

Comparisons to the 1907 panic-led recession.

Westbury believes that the panic will subside quickly and believes consumption will rebound quickly as well. In the history of the US, the only time a recession resulted from a panic was in 1908 on the heels of the Bank Panic of 1907. J. P. Morgan himself was at the center of that panic, adding stability in a famous afternoon meeting with all of the New York bankers where he raised $25M in a matter of minutes to stave off panic at the NYSE due to a lack of liquidity. He told the panicked head of the NYSE who ran to his office saying the exchange had to close early that it would not close early and then called the bankers together, raised the money, and saved the day. After that day he left his office at about 7PM to see a group of reporters outside. He said slowly 'If people will keep their money in the banks, everything will be all right.' After that day when he went to his office in his coach the street would clear ahead of him to shouts of 'there goes the Big Chief!' Morgan ultimately could not defeat the market failure but it is not without a note of irony that we watched JPM bank as the first big bank to get the nod from the Fed to rescue other banks in this current credit panic.

The 1907 panic followed the 1906 recession and immediately preceded the 1908 recession. Interesting. We said we had a recession in the last half of 2007 and early 2008 despite some pumped up GDP numbers strewn around in the mix. Inventories and exports kept us positive while most of the country fell from lofty levels to just scraping along. The pre-panic recession. The problems snowballed into the current panic just as the economic data starting in the spring started to turn back up as we chronicled all summer. The panic has shut down more than just big business. Now we are going to likely see a new downturn to recession as the more recent data have taken a sharp turn lower.

Westbury says that such a recession will be short-lived as was the 1908 recession, the only other 'go by' we have with respect to panic recessions. Maybe. While there is no doubt that the economy seized up the past two weeks when the credit freeze manifested itself, there was slowing taking place before the panic hit Main street. Auto sales tanked. The ISM fell well off the breakeven point. Factory orders tanked. Spending fell to flat. Retail sales turned negative. It was not just that past two weeks and that means as the credit freeze worsened the impact on the economy worsened. Thus the worst is yet to come because even with passage of the $700 Billion Dollar Baby credit spreads are still huge and it takes time to get the process underway just to get the bailout apparatus on line and thus credit flowing.

Thus we could face a couple of ugly quarters before things break positive. Much has to do with what the federal government can do in addition to the bailout. As for the market, we have to see how it discounts this recession and how far out it expects it to last based upon the market action. As noted above, more leaders are needed because even if the market bottoms right now it doesn't have enough growth companies in position to sustain the move.


The Next Step.

The dog catches the car. Then what? Congress passed the 700 Billion Dollar Baby to get credit flowing. As all of our leaders were saying today, it stopped the bleeding. Okay, now how about the transfusions, surgery, medication, etc.?

That is the unspoken part of the equation. Everyone seems to know something is needed but no leader is yet voicing it because the timing is terrible, i.e. just 34 days ahead of a presidential election. Something needs to be done immediately but logistics suggest it will take at least 6 months to get some form of stimulus passed if it can be passed after this budget busting bill. By that time the recession will be entrenched, not likely the quick snapback Westbury calls for.

Stimulus package. As discussed Thursday, the economy needs a Kennedy, Reagan, and Bush 2 stimulus package #2 stimulus package. That means better marginal rates, lower corporate rates, and 'use it or lose it' tax stimulus such as tax credits for investing in US business, research, home improvement, etc. I have to laugh when I hear some democrats talk about bringing back 'Reagan tax policies' yet say they want the top marginal bracket at 39.6%. By 1986 in the Tax Reform Act of 1986 the top bracket was lowered to 29%. When Reagan took office the top rate was 70%, reduced in 1965 from 94%.

But I digress though just slightly. Credit may be available, but that does not mean people in a recession will use it. The problem with recessions is no one spends money even if it is available. That is why investment tax credits work so well: if you spend the money you get something of value rather than shipping it off to Washington to, as Ronald Reagan put it, "feed the fat man." Unlike the so-called 'rebates' that are sent out and often just saved because consumers are worried about their jobs and thus their income stream, you don't get the benefit of a tax credit unless you spend the money up front. That is the 'use it or lose it' aspect. No wonder the economy did not recover after the 2000 crash with the first 'stimulus' package that was all rebates. It took the second one with its tax incentives that jumped the market forward almost to THE DAY the package was passed as the market bet, correctly, that this package would bring about prosperity. The 7.3% GDP growth in Q3 2003 was the proof. Once again history shows that these tax incentives work.

Problem is, who is going to take the lead on this and fight for it over the next two months? The 'blue dog' democrats would not vote for the $700B bailout because it had tax cuts that were not offset by spending cuts. Nothing wrong with spending cuts but what this means to the blue dogs is no tax cuts because they offset them by eliminating tax cuts elsewhere as their 'spending.' Tax cuts are not spending; it is not taking the taxpayers' money. With a weak, lame duck President and a new administration coming that will want to take credit for any stimulus, nothing will happen. Of course, there are many that like to take no chances, and if they can pass something now and it doesn't work they can always blame the last administration. . . Washington, as we all know, is a strange place that tends to suspend reality.

There is talk of a plan to insure or otherwise back up commercial credit paper. That market helps companies and their liquidity as they sell paper to buyers. That market is in virtual lockdown as no paper is trading hands. It is vital to companies, and there is serious discussion of providing some kind of federal backstop to get that market moving as well. Hey, in for an ounce, in for a pound. The federal government is on a roll so why stop now?

The private mortgage insurance the House republicans put in the bill as an option though one disdained by Treasury's Paulson, may prove to be very useful. It could be the surprise in the bill as a market based solution outperforms the heavy handed federal buy out methodology of the RTC in the past. The Wells Fargo/Wachovia deal shows there is a market out there that does not require the government to buy. FDIC was going to put tend of billions of taxpayer dollars at risk on the Citi/Wachovia deal even if Citi had to take the first $42B risk. Wells said it would do it without the feds at all, aided by a smart and timely IRS rule change allowing acquiring companies sensible tax breaks if it bought a company with distressed assets and wrote them down immediately. That gets companies into the game again and uses a private mechanism to bail out distressed companies. The House plan works very much the same way and hand in hand these two approaches could solve much of the problem without touching much of that $700B boondoggle.

Finally there is the talk of Fed rate cuts. Some are saying the Fed was waiting for passage of the bailout bomb to cut rates so Congress could not use the cut as an excuse not to pass the bill. There could be a cut this weekend or Monday according to a couple of sources we have. Big mistake. Huge mistake. Yes lets put rates back down to where they were that sewed the seeds for this current disaster (1% Fed Funds rate). Let's follow the Japan Plan from the 1980's and 1990's that helped it land that 12 year depression following a similar banking crisis. Japan lowered rates to less than 0% in real terms for 10 years. It did not help at all, but once down it could not raise them or so it feared. Japan has planted the inflation seeds for years to come.

If we go back down to 1% in an even greater attempt at liquidity flooding we build in the same problems as before. This is the band aid approach I discussed last week that doesn't solve the problem but instead keeps us running like a hamster on a wheel from one liquidity/inflation/panic crisis to the next without ever solving the problems of bad debt, a debased currency, and declining foreign confidence. Bad idea. Very bad idea.

What should be done? If we want to try and save the system and keep the bad debt around by shifting it from mortgages to other areas of the economy we will need the first three steps above. As we passed the $700B baby that is the route we are going to take so we need to get the economy going with some stimulus or it is all for naught. Otherwise the Fed should raise rates a bit at a time and the Congress pass stimulus to encourage real investment in solid US businesses and new businesses and ventures while letting the terminal financial institutions go under. That takes the bad debt off the books forever while we build new, strong, viable businesses with the new investment. Out with the old and failed and corrupt, in with new and entrepreneurial companies just as we have done for centuries. Of course we would like to get the government new and improved versus the socialist mess it is in now, but we have to keep things somewhat tethered to reality.


THE MARKET

MARKET SENTIMENT

Market sentiment hit levels high enough to indicate a turn in the market. The gloom hit Main street in fear over a total meltdown. The only thing I didn't hear, though I am sure it manifested itself at some point, was the 'it is different this time.' Maybe comparing things to something that occurred 100 years ago before the advent of the Fed is enough.

VIX: 45.14; -0.12. Hit 48.40 on the high and posted the highest closing price in 20 years. Closed the week high as well. After the peak is hit it takes several weeks for the market to make its break higher.
VXN: 49.76; +0.23
VXO: 51.76; -2.4

Put/Call Ratio (CBOE): 1.11; -0.26. Impressive series of closes above 1.0, showing plenty of expectation to the downside.


Bulls versus Bears:

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: 33.7%. Big drop from 37.5% and below the 35% threshold considered bullish. Now with the bulls down and the bears up big there is plenty of pessimism here. Down from 40.7% on the high during the rally off the July lows. Heading back toward the 27.8% on the low this round. Hit 30.9% low hit in March. In March the indicator did its job with the dive below 35% and the crossover with the bears. 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: 47.2%. Surging from 40.9%. Closer toward 50.0%, the high on this move, but a long way off. As the NYSE indices test the lows you would want it higher. Still above the 35% threshold so still a bullish indication. A move over 50 takes it to the highest since 1995. Extreme negative sentiment. 35% is 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. 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: -29.33 points (-1.48%) to close at 1947.39
Volume: 2.549B (+18.96%)

Up Volume: 649.453M (+550.722M)
Down Volume: 1.87B (-239.098M)

A/D and Hi/Lo: Decliners led 2.53 to 1
Previous Session: Decliners led 4.33 to 1

New Highs: 6 (0)
New Lows: 461 (+59)

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

Unlike DJ30's second low, NASDAQ has gone too far. Its leaders are in the tank in dives straight down with no semblance of accumulation patterns. If the market is going to find leadership it won't be from NASDAQ unless things change dramatically in the next few weeks.

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

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


SP500/NYSE

Stats: -15.05 points (-1.35%) to close at 1099.23
NYSE Volume: 1.42B (-2.98%). above average volume but at least a bit lower to end a week marked by higher volume selling, i.e. distribution or dumping of stocks.

Up Volume: 434.836M (+274.873M)
Down Volume: 976.109M (-318.913M)

A/D and Hi/Lo: Decliners led 1.87 to 1
Previous Session: Decliners led 5.35 to 1

New Highs: 17 (+6)
New Lows: 642 (+13)

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

Rallied to the 10 day EMA on the high, the lowest level of resistance, and then turned back down to close at a new low for 2008 and in this selling. SP500, despite improvement in many financials given the bailout plan that was coming (and is now here) and the no-short rule on the financials, is in a serious downtrend. This looks to be the third downside leg in the selling. If it matches the other legs (and they often do), SP500 has about 50 to 100 points more to the downside.

SP600 (-2.63%) broke its 9 month trading range to the downside, posting a new closing low on this selling since the July peaks. Not a good sign for the economy as the economically sensitive small caps should lead upside.

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

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


DJ30

As discussed above, DJ30 broke to a new bear market low as it, similar to SP500, sells in its third leg lower. If it cannot hold the line here and form a double bottom then it is going down to 9500 or so.

Stats: -157.47 points (-1.5%) to close at 10325.38
VOLUME: 299M shares Friday versus 395M shares Thursday. Still strong volume.

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


MONDAY

Now that the bailout has passed the market has a lot of sizing up to do. Perhaps it started that Friday when it reversed gains and hit new lows for the year. It has to figure in the possibility of stimulus anytime soon (slim), the success of the bailout and perhaps the private solution, and compare that to the expected damage the credit freeze and recent panic did to the economy. That will take some time and that may help, if DJ30 can hold up, the formation of bases by new leaders.

As for the market action associated with this mulling over process, history says that in a bear market, when new lows are hit on Thursday or Friday, you need to watch out for deeper lows on Monday and Tuesday. While that will break up any bottom attempt in DJ30 it would match up historically with other bottoming processes where sentiment and internals hit these extreme levels and then there was a big flush out to start the next week. Then the market works through a few weeks of movement where bases are built, a new test is made, and then if there are some leaders emerging, a new break higher attempt.

You look for what drivers are out there for the market right now, and outside of the bailout bill that is aimed at credit, the list is thin. Europe is in the crapper. That is helping the dollar and thus making exports less helpful to the US economy. Oil is lower on demand issues. We are expecting a move to 85 soon and if things are as dire as the initial readings from Europe appear to be then it could fall to the fifties as amazing as that seems.

In a way the lack of external forces is good. Now the market can go about getting the pipes cleaned out and discounting the future economic activity.

During this time we do what we said Thursday. First, we look at what stocks are setting up in bases. Hopefully some will do so as the ranks thinned more Friday with the homebuilders flaring out. Second, we look to take what the market gives in the interim. That means downside as it sets up and presents itself, some quick bounce plays on stocks that have fallen straight down, and some rolling ranges as the move up and down. It is not a time for investing per se outside of buying just pieces of solid stocks as they move from solid bases, seeing if they hold up. If they test, hold and bounce we add some more incrementally. If more stocks form nice bases over the next few weeks after the Dow holds in this range or dumps lower but then tries to bottom again, we prepare for more buys.

The sentiment indications and internal indications are at levels associated with bottoms. The Dow has an outside chance at holding here and forming a 2002 like double bottom. At the 2002 bottom the chips were leaders but not all of them were in bases. Some were in straight dives lower such as AAPL and other big techs are right now, and turned on the knifepoint. Others double bottomed. Ebay was set up well as was TSCO. AMZN for instance was forming a base and when ahead and completed its pattern while the chips rallied. Financials were in patterns similar to the AAPL's right now, i.e. in dives and then rallying with a V bottom.

The point: with the sentiment indicators this high the market can bottom despite the apparent odds against it, but that means some of these diving stocks will have to find sudden buyers as with chips and financials in 2002, and other growth stocks will need to be in some decent patterns already. There are key stocks in similar patterns, e.g. MSFT, MU, but while they are at bottoms and are setting up bases of sorts, there is still a lack of really good bases on some quality growth stocks. The market needs more of these to form up over the next 2 to 3 weeks as this is usually the Achille's heel in bottom attempts.


Support and Resistance

NASDAQ: Closed at 1947.39
Resistance:
2070 from September 2008
The 10 day EMA is 2074
2099 is the mid-September closing low
The 18 day EMA at 2131
2155 is the March 2008 low
2167 is the July 2008 low
2202 is the January 2008 low
The 50 day EMA at 2237
2261 is a March 2008 interim low
2286 is the first April 2008 gap up point.
2300 is some resistance
2340 from the March 2007 low
The 200 day SMA at 2358

Support:
1912 from April 2005
1900 from August 2004
1882 from October 2003
1782 from August 2004


S&P 500: Closed at 1099.23
Resistance:
1133.50 is the September 2008 low
The 10 day EMA at 11.57
The 18 day EMA at 1182
1200 is the July 2008 intraday low
The 50 day EMA at 1231
1240 is the 2002/2003 up trendline
1244 is an August 2005 peak
1257 is the March low
1270 is the January low
The 90 day SMA at 1272
1285 is the recent July peak
1313.15 is the August 2008 peak
1317 from the February low
1324 is the April low
1331 is the June low
The 200 day SMA at 1328
1365 is an ancient trendline

Support:
1075 from August 2004.
1065 is the Q4 2003 level that SP500 started the run to 2007 after the first run in the recovery.
995 from June 2003 peak

Dow: Closed at 10,325.38
Resistance:
10,215 from Q4 2005
10,365 is the new 2008 low
10,459 is a September 2008 low
The 10 day EMA at 10,734
10,827 is the July 2008 intraday low
The 18 day EMA at 10,890
10,962 is the July closing low
11,061 from February 2006
The 50 day EMA at 11,216
11,317 from March 2006
11,388 is the prior August low
The 90 day SMA at 11,497
11,635 is the January intraday low
11,670 is the May 2006 intraday high; 11,642 closing
11,710 is the 2004/2005 up trendline
11,731 is the March 2008 low
11,867 is the August 2008 peak
12,050 from the March 2007
12,070 from the early February 2008 lows
The 200 day SMA at 12,098

Support:
10,127 is an April 2005 low
10,100 to 10,000
9937 from May 2004 low
9814 from August 2004


Economic Calendar

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

October 7 - Tuesday
FOMC Minutes, September 16 (2:00)
Consumer Credit, August (3:00): $5.5B expected, $4.6B prior

October 8 - Wednesday
Pending home sales, August, (10:00): -1.0% expected, -3.2% prior
Crude oil inventories (10:35): +4.2M prior

October 9 - Thursday
Initial jobless claims (8:30): 497K prior
Wholesale Inventories, August (10:00): 0.4% expected, 1.4% prior

October 10 - Friday
Export price ex-ag, September (8:30)
Import prices ex oil, September (8:30)
Trade Balance, August (8:30): -$60.0B expected, -$62.2B prior

By: Jon Johnson, Editor
Copyright 2008 | All Rights Reserved

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

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