Monday, November 03, 2008

Small Caps Surge, Lead Market Higher

- Market heads home positive, holding gains that changed the outlook, not for October, but for November.
- Incomes rise but spending declines for the first time in 5 years.
- Regional manufacturing continues its skid as Chicago turns in a failing report card.
- Worst economic news of the cycle, but the small caps surge, lead the market higher.
- Looking for continued upside as the market bounce stretches out, but still has to break free from current resistance.

Market closes out a bad month with some positives.

No doubt October was a bad month for the market as it inflicted the lion's share of the damage to this point in the bear market (going with an animal theme this weekend). There were a couple of positives to the month, however. First, the indices hit a new low for the year, a low deep enough to be considered the extent of a bear market selloff, and the indices reversed immediately off of that level. On that dive lower they held in the middle to top of the 2002 bear market bottoming patterns, a logical place for a subsequent bear market to find its bottom. Second, after bouncing up off of those levels the indices fell back again, but SP500 and DJ30 did not undercut that low, instead all indices reversed sharply this past Tuesday on strong volume. New lows held below the prior levels even as NASDAQ, SP600 and SP400 hit new lows for the year.

That shows the indices were pretty much sold out on this leg, not surprising given the 20+% declines in October, and the reversal on volume shows buyers stepping back in. The market is game for a move higher to work on a larger bottom and let stocks build some bases. It may or may not ultimately work, but this confluence of indications tell us there is a tradable rally that we have a good stake in already as we bought into the upside ahead of that big Tuesday surge and have already banked some nice gain on several positions. We even picked up some more positions Friday as DJ30 sets up for the next break higher.

Friday there was mixed news early yet again (seems we say that every day of late). Personal spending fell negative for the first time in almost 5 years (-0.3%) and a bit more than expected. The Bank of Japan lowered interest rates but less than hoped. Chicago manufacturing was terrible (37.8) and Michigan sentiment was weak (poor football performance perhaps). On the other hand, incomes gained again (+0.2%). Importantly, LIBOR once more continued its more rapid thaw: overnight 0.41% (0.73% prior); 1 month 2.58% (2.85% prior); 3 month 3.03% (3.19% prior).

Despite the preponderance of negatives, the credit improvement is helping more than it is currently being discussed. Futures were negative but bouncing toward the open. Stocks started negative but turned positive in a steady climb from losses to gains in the last hour. The sellers took their shot ahead of the weekend and the indices peeled back significantly from their highs. A last minute bounce made it look a bit better but they held their gains nicely. This action continues the consolidation after that big Tuesday surge, and we are looking for that move to continue once this pause or rest period is over and the market moves into the new month.

TECHNICAL. Intraday there were steady gains from negative to positive by more than 2% on most indices. The last hour drop pared those back but the action was good enough: the indices held the 18 day EMA, continued to consolidate the Tuesday surge, and kept themselves in position to continue the move.

INTRADAY. Once more solid breadth as the small and mid-caps surged 4.4% and 2.8% respectively. Volume was down on NASDAQ, not bad given techs lagged the market, particularly large cap techs. NYSE trade improved by 13%; given that the small and mid-caps surged, that rise in volume shows some buying in these beaten up but surging economically sensitive stocks.

CHARTS. The indices moved through the 18 day EMA, but the last hour selling and the somewhat light-ish overall volume said the move was nothing definitive. With respect to the large cap indices the action shows more of a continued consolidation despite the gains. There is some accumulation on NYSE in the small and mid-caps as they posted gains on that rising trade. The smaller caps didn't even slow down from Tuesday, the start of the current leg, rallying 4+% Thursday and Friday. They may need a rest soon but the large caps will be ready to pick up the torch when the small caps do rest as the large caps have put in something of a pause after their big surge. Indeed, DJ30 is working on the handle to its short three week double bottom.

LEADERSHIP. As noted this week there are more stocks and sectors forming good bases. Airlines have decent patterns and were up Friday. Retail is forming bases right now in an environment where personal spending just fell for the first time in 5 years. Energy was strong again as those sectors bounce off of good short term bottoms even with fears of a worldwide economic slowdown. Steel is still improving. Stocks are in the process of building their patterns and that is what the overall market needs to put in a real bottom. The upside move that started last week is buying the time for the needed accumulation that builds a foundation for significant and more sustained upside moves. Still a lot of work to do before that is set up because there are simply not that many of those great bases out there that were relatively plentiful at the October 2002 low and market bottom.


A week of poor economic data capped by personal spending turning negative and Chicago producing not a heck of a lot.

September spending fell 0.3% and that was just shy of the June 2004 0.4% decline. In the Thursday GDP report Q3 consumer spending fell 3.1% annually, the first drop in spending since 1991 and the largest since 1980. Many predict a 2% personal spending decline in October, but there is that sharp decline in oil and thus gasoline thanks to a falling world economy and a surging dollar (closed at 1.2730 Friday, not the low of the week, that was 1.2448). Saw gasoline at $2.09 Friday. That is giving consumers a much needed shot in the arm. Problem is, thus far consumers are not spending the extra coin just in case . . . credit doesn't loosen, the policies the next administration puts in place don't work, jobs become a bit more threatened, etc.

Manufacturing sentiment continues to swirl in the toilet as Chicago, usually the more staid of the regional reports, fell to 37.8 from 56.7. Not only did it fall below 50, the threshold that defines expansion and contraction, it collapsed. After several months skirting around 50 and then moving sharply over that level in August and September, sentiment for manufacturers fell as hard as that for consumers. The credit freeze, the inability to conduct business as usual, and the worries about the ramifications down the road has purchasing managers quite gloomy. This, after all, a sentiment reading not a report based on hard data as some seem to imply. Thus it is subject to the most fallible of all factors going into economic reports, i.e. human emotion.

So while the decline is important, what is more important is whether it stays down or rebounds. Solid reading up to this point, then a plunge as the credit market locked up money. If it continues to thaw quickly, sentiment can change quickly. Thus we are not, as you can tell, overly sweating this report that matched Philly's weakness but which can turn quickly.

Michigan sentiment holds up.

Speaking of sentiment, Michigan was not hideous, coming in at 57.6 versus the 57.5 expected and posted before. It is still at recession levels, good thing given Q3 GDP was negative - hate to get the economic indicators all mixed up and at odds with one another. Overall the consumer is depressed given the intrigue the past month with the market crash, the government takeover, the election, etc. Again, gasoline was $2.09 on Friday, and that means it is not long until we could see, believe it or not, sub-$2 gasoline. That alone and the countdown to $1.9-something gasoline could keep consumers feeling better. Seems bizarre, but that amber fluid plays a huge role in US citizen outlook.

Okay so the economic data stinks so why are small caps rallying?

SP600 rose 17.4% last week. SP500 gained 13.9%, DJ30 13.7%, NASDAQ 10.8%. Small caps were all the rage last week even as economic data hit the worst levels in one and even two recessions. Economically sensitive stocks surging as economic data dives. As is often the case, the market moves contra to what the current data show because the market discounts the future not the past or present.

The stock market dove lower in October on credit issues and uncertainty as to the future economic and tax policies coming out of the November election. It hates the uncertainty of how damaging the credit crunch might be as well as what uncertain policies will actually be. Some of the proposals match what was done in the past that pushed a recession into a depression both here in the 1920's and 1930's and more recently in Japan.

There is this belief that we have to prop everything up in order to save the economy. Sometimes it is best to let things just fail because keeping them propped up only builds additional problems or just puts off the ultimate day of reckoning. Friday we heard talk about bailing out the US automakers. The idea is they employ a small nation of workers and make up a large part of the economy. True, but they also have become health care companies that make vehicles on the side. They cannot compete with international makers. So do we take more taxpayer money and prop up fundamentally flawed (to use some buzzwords in the news of late) business models, basically subsidizing poor business decisions for the foreseeable future or is it better in the long run to let them fail and then let others fill the void with new business models that stress building better vehicles than operating as health care companies? If you were deciding what to invest in would it be the former or the latter? You know the market's answer.

Getting back to the small caps, however, they exploded higher and led the rebound after a hard and sharp plunge. They held out the longest, but when they gave in they gave in big time as the credit issues directly impacted their greatest influence, i.e. the economy. Now that they are rebounding they suggest the economic prognosis midway into 2009 may not be that bad. This is the initial run so it is not definitive, but it is something that we have to watch as the overall market bottoming process continues. If the small caps test and set up good bases, things from the economic perspective look a bit more promising.



VIX: 59.89; -3.01. Hit a new closing high at 80.06 though that was not the high. That was hit the previous Friday and was the highest level since 1987. Definitely strong enough to set a market turn. Remember, the highs on VIX are typically hit several weeks before the bottom and in this case that means a bounce here and then a subsequent test of the early October lows still to come.
VXN: 60.3; -2.89
VXO: 61.38; -3.93

Put/Call Ratio (CBOE): 0.96; +0.16. Third day below 1.0 on the close after three weeks closing above that level. As stated before, this did its job, showing high anxiety about the downside prospects as the market sold off.

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: 21.3%. Fading from 22.2% as the market could not move up last week. Still decline but now in dribs and drabs (22.4% the week before). 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: 52.7%. Slipped from a high of 54.4% on this move, up from 52.9% before that 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.


Stats: +22.43 points (+1.32%) to close at 1720.95
Volume: 2.488B (-1.95%). Solid volume on the Tuesday surge, then declining trade the rest of the week as NASDAQ continued to rally. Good turn, weaker as it coasted higher. May need to test back just a bit, but view this as a good turn and still in position to move higher.

Up Volume: 1.451B (-466.722M)
Down Volume: 1.011B (+356.449M)

A/D and Hi/Lo: Advancers led 2.99 to 1
Previous Session: Advancers led 2.67 to 1

New Highs: 7 (+2)
New Lows: 99 (-54)


Undercut the prior 2008 low the previous Friday and made a new closing low for the year Monday. Then the surge higher Tuesday that started the move and the coast on up to the 18 day EMA where NASDAQ closed Friday. This is the second level of near resistance for the index as it tries to break higher once more. NASDAQ is in a downtrend. The action the past three weeks is trying to set up a break higher, but it has to make the break. NASDAQ is lagging this move but it too is in position to make the break higher still, though it could use some consolidation before it continues.

NASDAQ 100 (+0.06%) was flat Friday, and that was not really bad action given the lighter overall trade. NASDAQ 100 is similar to SP500 and DJ30, i.e. working laterally a bit after the initial surge higher, and that is setting up a consolidation handle to lay the ground work for the next break higher.

SOX (+1.88%), despite the improving look of the large cap indices, has the look of an index in a continuing downtrend. It has rebounded past the near resistance at the 10 day EMA on up to the next level in a downtrend, the 18 day EMA. It tried that level Friday and then faded back. It looks like a classic downtrend bounce that is ready to turn back and resume the move lower. That shows tension in the market between some tentative upside moves in the other indices. As seen last week when the market reversed from positive to sharply negative in the last few minutes on reports regarding GE's 2009 outlook, the market is still fragile.




Stats: +14.66 points (+1.54%) to close at 968.75
NYSE Volume: 1.563B (+13.68%). Volume moved up close to average Friday after falling below average on the Thursday gain. Volume fell Monday as the NYSE indices faded. It jumped to the highest level of the week on the Tuesday surge. Then it faded the rest of the week though it showed good price/volume action nonetheless, i.e. stronger volume on upside price days and lower volume on downside days. The upside volume Friday was not bad given the small and mid-cap stocks surged.

Up Volume: 1.16B (+17.856M)
Down Volume: 399.02M (+174.456M)

A/D and Hi/Lo: Advancers led 2.68 to 1
Previous Session: Advancers led 4.11 to 1

New Highs: 11 (+4)
New Lows: 99 (-4). New lows did not surge on the Monday new closing low for the year. As noted at the time, that suggests the market is sold out for now.


SP500 coasted into the weekend as well, angling up toward and just through the 18 day EMA (962) on Friday. Not a lateral move for sure as you would see in a typical handle, but moving up the 10 day EMA (938), using that as support. This is something of a handle for the three week double bottom though it could test back a session or two and set up better. Overall it still looks ready to move higher; the question is simply when it makes the move.

SP600 (+4.46%) ripped higher once more posting its second back to back 4+% gain. The move represents a knifepoint turn off a new low for October, and SP600 bolted through the 18 day EMA on the Friday close. Knifepoint turns rarely work to the extent they never come back to test again, but the small caps strapped on the rocket last week just as the economic news turned in its worst performance of they year. If they can continue to set up and move higher, that bodes well for the market and the economy. Still early in the move but it is making the moves it needs to make.

SP600 Chart:



The Dow was the main indicator on this test of the early October low. It easily held above that early low on the test and then reversed sharply on Tuesday with the best volume of any index. As with the other indices it started to test Wednesday, but then drifted higher again Thursday and Friday. Volume returned Friday, however, moving up to average as on NSYE. That shows some real buying interest continued. This resumed rally on higher volume on the forth session after the rally started is a follow through to that Tuesday rally. Positives are piling up on the Dow and thus we anticipate more upside on this move with the 50 day EMA (9966) on up to 10K looking reachable.

Stats: +144.32 points (+1.57%) to close at 9325.01
VOLUME: 311M shares Friday versus 267M shares Thursday.



Earnings continue to play out with the likes of DELL and CSCO along with a boat full of economic data: ISM, auto sales, Factory orders, and the jobs report. No more Fed meetings until December, and with rates at 1% we likely won't hear much from them outside of more assistance clarifications, tweaks, etc. to their facilities. In other words, we will hear from them all the time, just not about rates. There is also this election thing on Tuesday. A surprise result could lead to a vigorous rally. A senate with less than 60 democrats will be a positive as well to the market because a split in power is viewed as good. That will have to play out on its own. A bigger immediate concern is that there is no answer on Tuesday if things do continue to tighten and/or there are voting irregularities or something of that nature. That means uncertainty again, and we all know the market hates uncertainty.

SOX is an indication that the market is still nowhere near out of the woods. It has all the look of a typical bear market bounce in a continuing downtrend. The other indices are improved but are not clearly on the mend. As seen on the GE news just before the close midweek, the market is fragile and subject to upset even with the improvement in the action. It is due a bounce after the massive October liquidation, and it started that bounce this past week. It is set up to do so given the LIBOR improvement even with the weakening economic data: if credit loosens quickly then the economy will have the ability to function and start to recover. That does not mean it won't get challenged.

Nonetheless the market is in position to continue higher. Might take two or three days off as it continued to climb into Friday, forming a better consolidation to break higher from, but what we saw last week says to us the upside will continue from here. The indices are still not definitively above the 18 day EMA, but the resurgence of the small caps is a potentially important new element looking ahead for the economy and thus the market. The market looks ahead, not back at the last GDP report.

Those are positives but for now we are looking for a move higher that is more of a rebound to set up a bigger, scarier test of the prior October lows, but that rebound is definitely one we can buy and make money off of. As noted earlier, we are already doing that and will continue to buy positions that give us good opportunity to capture the moves higher.

Again we are looking in the neighborhood of Dow 10,000. At that point many will feel good about the rally and posit that the bottom is in, load up, etc. That will be the tipping point for an October 2002-like dive lower and test of the prior lows. That will likely be what sets the bottom on this market move and leads to the more sustained run higher. As always there is the caveat that the market may not look back at all. If it doesn't then we have some positions in great stocks and stand to make even more on such a move. We could definitely admit we were wrong and live with that.

Either way we want to be ready with some plays in hand to take advantage of the direction the market takes, realizing that it could stumble given the look of some sectors and indices such as SOX. It is not easy right now to find stocks that are still ready to move yet are not too extended, yet the large cap indices are setting up for a new break higher and some sectors such as parts of retail are setting up in very interesting patterns. As noted above, if this market action continues to set up or work on a larger bottom, there should be more and more stocks setting up in bases. If not, this bounce attempt will ultimately be just that, a bounce attempt in a continuing bear market. Thus for now, given the action in the indices, we look to play the current action, taking what the market gives.

Support and Resistance

NASDAQ: Closed at 1720.95
The 18 day EMA at 1718 is bending
1752 from 2004
1782 from August 2004
1882 from October 2003
1900 is the gap down point in October; from August 2004
1912 from April 2005
The 50 day EMA at 1931
1947 is the point where the market gapped down from in October 2008
1984 is the lat September low
2070 from September 2008
2099 is the mid-September closing low
2155 is the March 2008 low
2167 is the July 2008 low

The 10 day EMA is 1669
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 968.75
The 18 day EMA at 962
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.
The 50 day EMA at 1071
1075 from August 2004.
1106 is the late September low
1133.50 is the mid-September 2008 low
The 90 day SMA at 1181
1200 is the July 2008 intraday low
1244 is an August 2005 peak
1245 is the 2002/2003 up trendline
1257 is the March low
1270 is the January low
The 200 day SMA at 1279
1285 is the recent July peak

965 is the 2003 consolidation low
The 10 day EMA at 938
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 9325.01
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
The 50 day EMA at 9966
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 90 day SMA at 10,776
10,827 is the July 2008 intraday low
10,962 is the July closing low
11,061 from February 2006
11,317 from March 2006
11,388 is the prior August low

9200 is the July peak in the 2003 consolidation
The 18 day EMA at 9141
The 10 day EMA at 8982
8985 is the closing low in the mid-2003 consolidation
8626 from December 2002
8521 is an interim high in March 2003 after the March 2003 low
8197 was 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.

November 3 - Monday
September Construction Spending (10:00): expected -0.8%, prior 0.0%
ISM Index, October (10:00): expected 42.0, prior 43.5

November 4 - Tuesday
October Auto Sales: 4.3M prior
Truck Sales, October: 5.3M prior
Factory Orders, September (10:00): expected -1.5%, prior -4.0%

November 5 - Wednesday
October ADP Employment (8:15): expected -80K, prior -8K
ISM Services, October (10:00): expected 48.5, prior 50.2
Oil inventories (10:30): 493K prior

November 6 - Thursday
11/01 Initial Claims (8:30):
Productivity Q3 Preliminary (8:30): expected 1.0%, prior 4.3%

November 7 - Friday
October Average Workweek (8:30): prior 33.6
Hourly Earnings, October (8:30): prior 0.2%
Nonfarm Payrolls, October (8:30): prior -159K
Unemployment Rate, October (8:30): prior 6.1%
Pending Home Sales, September (10:00): prior 7.4%
Wholesale Inventories, September (10:00): prior 0.8%
Consumer Credit, September (3:00): prior -$7.9B

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

Jon Johnson is the Editor of The Daily at

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