Gold and bonds continue to recover as global events spark gains

SUMMARY:
- No relief ahead of weekend but NASDAQ third leg lower is already long in the tooth.
- Friday shows more mixed economic signals, confusing some as to Fed's course. There should not be any confusion.
- Gold and bonds continue to recover as global events spark gains, but trend is still same & Fed will take note.
- After triggering further weakness, earnings set to trigger a rebound that was delayed last week.

More selling, not much covering ahead of weekend.

Investors had even more data to worry about Friday with further aggression in the Middle East, more warnings about the future (Borders, D.R. Horton, GE), and mediocre retail sales and sentiment. Basically more worries about the economy given the Fed, energy prices, world tensions, and a potentially weaker consumer.

Stocks started lower in a continuation of the prior selling but then tried a rebound into midday. We expected a rebound attempt ahead of the weekend, but this one never got any strength, just wandering up off the lows into the close. Not a lot of covering given expectations of more violence this weekend as Israel made it clear it would not let up while it soldiers were still captive.

Technically it was just more selling in the current leg lower with the normal summer attributes, i.e. lower volume. Breadth was lighter to the downside but still a negative 2:1. NASDAQ fell further past its June low, landing at the October 2005 lows where it bottomed and started a solid rally through April 2006. It has dropped 150 points on this leg, getting close to the 200 points or so on the prior two legs lower. In addition, SOX continues to act as if it is sold out with INTC, TXN, CYMI and other chips posting modest gains. Recall that SOX was positive mid-Thursday before the Middle East escalation. The rubber band is stretched and ready to snapback for a rebound move. The quality of the move remains to be seen.

SP500 and the NYSE indices may have something to say about that. They fell close to the June lows, still in position to set up a nice double bottom at those levels, though it will have to prove it as NASDAQ blew right on through on its attempt. With NASDAQ ready to rebound after another 50 points or so, the NYSE indices could continue lower to test the June lows and then be in position to actually form that double bottom.

There are still a lot of major issues ahead, and earnings are just getting underway. The harsh selling to this point decreases the likelihood of a lot more downside from here unless some really nasty news hits. Most likely the news turns out to be not as bad as feared with respect to earnings and stocks mount a decent relief move. If we get through the weekend without any further escalation of the war and get some halfway decent earnings news stocks will likely pop up. Of course, Bernanke speaks to Congress this week in his semiannual son of Humphrey-Hawkins testimony and the CPI is out as well. The market is ready to bounce in relief, but it still has to deal with harsh reality as well.


THE ECONOMY

Retail sales and sentiment lighter, but business sales sold. What is a Fed to do?

June sales fell 0.1% versus a 0.1% gain in May and well off the 0.4% expected. That was the first drop in four months. Ex-autos sales rose 0.3%, and that was as expected. Autos were the drag as gasoline sales rose 1.1%, reflecting a rise in prices and not a lot of drop off in usage. Take out autos and gas and sales rose 0.1%. Year over year sales rose 5.9%, not bad, but the slowest in four months. More money was diverted to gasoline as opposed to other areas.

Michigan preliminary sentiment for July fell to 83.0 versus the 85.5 expected and the 84.9 final in June. Usually there is not much correlation between sales and sentiment at these levels; it takes much lower sentiment to stall consumer spending.

There is, however, some worry in the business land, and that along with the consumer is a very necessary component of economic expansions. The NABE survey reports just 39% of businesses say demand is rising, down from 54% in January. Profit margin expansions, planned price hikes, and capital investment plans all hit multiyear lows. This is the first real sign of change in the business climate even as shows such as Kudlow & Company tout the strong expansion still to come. We have a lot of respect for Art Laffer, but the rosy view of the economy he and Kudlow are putting out is a bit overdone.

The economy is not falling apart, it just is not expanding as it was. There is still data that is moving higher, but there is more and more data that is stalling and some is heading down. That is not the recipe of an economy ready for a new expansion. Indeed, investors are concerned about both sides of the ledger. The S&P Retail Index hit a 14 month low Friday as restaurants, discounters (WMT, COST, TGT), home improvement, etc. all headed lower.

And the Fed should . . .

All of this weakness leads many to wonder what the Fed is going to do at the August meeting. Bernanke is going to update the Congress on monetary policy this week just as the new CPI figures come out. The Fed wants to quit hiking rates. The data are starting to scream it needs to quit hiking and sell some treasuries to sop up the remaining liquidity and then call it a day.

Again, however, the rest of the world is the problem. Inflation in the US peaked last October according to ECRI's forecasts, and they tend to be quite accurate. The Bank of Japan raised its rates 25BP Thursday, the first rise in six years after its economy fell into depression over 10 years ago. Japan had a habit of raising rates just as it tried to pull out of depression, and that kept its economy in the miso soup too long. That hike follows the BOJ's withdrawal of trillions of yen from the market in the last four months. Europe is drying up some of the liquidity, but it is still behind the curve as its inflation rate jumps and is at a 5.5 year high.

Foreign banks are working on the excess liquidity, and it has had an impact as seen in the decline in emerging markets. Many have lost their luster as easy money dried up and commodities prices fell. The 'financial tourism' so popular the past year has turned into a run for cover, and some of these countries that enjoyed the influx of foreign money are going to be hurt, particularly those with large deficits such as Turkey and Hungary.

The US has a high deficit, but recent action shows it is still the world's safe haven when times are troubled and friends just can't be found. We have watched gold and bonds, and both are rising as the world struggles with the new war in the Middle East, North Korean nukes, and Iranian ambitions. Gold is up as usual when war erupts, and bond yields are down as money seeks safety in US treasuries. The 2 year yield is down to 5.09% while the 10 year is at 5.06%. It looked as if it was just another economy related sell-off, but the drop in yields the past couple of days is also tied to the uncertainty the Middle East flare up. Of course, the curve is still inverted, and that is still an indication of economic weakening ahead; the action before this flight to safety this week showed that, and the economic data and earnings guidance is bearing that out to some extent.

With the mixed economic data and inverted curve, the Fed should take the heat off the US markets. We don't need to fall on the sword for the rest of the world, but if the Fed stops, other central banks will take its lead. Tough situation for the Fed to be in when the other world central banks are not fully cooperating or are just well behind the curve. Regardless, the Fed cannot afford to send us into recession; best to stop and at least wait awhile to see just how things pan out.


THE MARKET

MARKET SENTIMENT

VIX: 18.05; +0.26. Pretty tame move, and indeed, disappointing. Wanted to see another spike that really got the volatility rise jumping.
VXN: 24.62; -0.04
VXO: 18; +0.08

Put/Call Ratio (CBOE): 1.23; +0.1. Fourth session above 1.0 on the close as plenty of downside betting is ongoing. Overall it is a bit late in this leg to be starting a lot of downside positions. The fact that there is a lot of activity after 150 points on NASDAQ's downside move is a pretty good indication the rubber band is stretched about as far as it will go on this leg.

Bulls versus Bears:

Bulls: 42.2%. Big spike higher from 38.7% the week before, but that is going to get washed away after the results from the current week. Even at this level we note it is below the levels hit on the last market sell offs. On the last pullback bulls hit the lows for this rally, i.e. since 2003. That put it below the 42.3% hit on the last low and the May and October 2005 readings that preceded new upside runs.

Bears: 33.3%, down from 34.4%. Lower, meaning fewer bears. As with bulls, that will likely change after this week. Kissed the bulls three weeks back, just missing crossing over with the bulls, but that in itself is not a bad indication for the upside. Two weeks back Bears hit a new post-2002 high, eclipsing the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005).

NASDAQ

Stats: -16.76 points (-0.82%) to close at 2037.35
Volume: 1.842B (-12.24%). Volume backed off to end the week after the Thursday distribution. Most of the selling has occurred on light volume so this is nothing new. The market suffered from a chronic lack of bids last week with some distribution sprinkled in.

Up Volume: 598M (+334M)
Down Volume: 1.202B (-617M)

A/D and Hi/Lo: Decliners led 2.13 to 1. Breadth was sharply negative all week and on the Tuesday bounce upside breadth was modest.
Previous Session: Decliners led 4.04 to 1

New Highs: 35 (0)
New Lows: 239 (+28). Not popping off enough lows.

The Chart: http://www.investmenthouse.com/cd/^ixic.html

NASDAQ was in the tank from the bell, slicing through some potential support at 2050 and on down to the October 2005 lows (2037 closing) where it bottomed. D j vu all over again? That was a 2.5 month sell off, and that is what we have here, though this one is nastier in terms of point loss. It bottomed then as earnings season got really underway, just as the market now (at least in terms of where we are in the earnings season). That makes this test a bit more interesting, and given that NASDAQ has dropped on this leg just about as much as the prior two legs and the last part of the drop has been straight down, we are going to see a rebound. Whether that is the bottom we will see.

SOX (-0.49%) was not ready to lead the charge, but its losses were minimal and on Thursday it was positive and ready to move before the war escalation hit the wire. Some big names notched modest gains Friday as well. It is poised to rebound and help bring NASDAQ along with it. It is still in that pernicious downtrend below the 18 day EMA (431), ready for a bigger rebound this time. NASDAQ and SOX will pull each other along.

SP500/NYSE

Stats: -6.1 points (-0.49%) to close at 1236.19
NYSE Volume: 1.717B (-3.51%). Volume was lower but still above average on NYSE, showing some more distribution action. It helped that the indices rebounded much better than NASDAQ; maybe some nibbling there, particularly when you look at the banks, energy, and some healthcare.

A/D and Hi/Lo: Decliners led 2.07 to 1. Bad but not horrid.
Previous Session: Decliners led 3.15 to 1

New Highs: 24 (-9)
New Lows: 220 (+38)

The Chart: http://investmenthouse.com/cd/^gspc.html

SP500 sold off to 1230 on the low, still holding above the June lows (1223 closing) on the dip. 1225 is the March 2005 high; reaching back a bit but there is something there. SP500 held on longer than NASDAQ in its pattern, and is playing catch up on this selling. Another dip lower by NASDAQ takes SP500 down to the June low as well, and that leaves both of them working together at a point ready to bounce higher.

The small cap SP600 (-0.91%) still took a beating, but it found support intraday just above its June 2006 and December 2005 lows and September and October 2005 interim highs at 352 to 350. A lot of support at this level, and SP600 bounced smartly off that support Friday. SP600 is a bit ahead of SP500 in getting to the point it can form a double bottom. This is roughly where it needs to hold to make its attempt at a double bottom.

DJ30

Similar to SP600, DJ30 hit the June lows intraday and bounced back some. A full test of that low as well as the lows from December 2005 and February 2006. This is where it tries a double bottom of its own. Some big names were getting smacked around Friday (e.g. UTX, BA, WMT, HON), however, not exactly an indication the index is ready to hold the line just yet.

Stats: -106.94 points (-0.99%) to close at 10739.35
Volume: 312M shares Friday versus 328M shares Thursday. Selling volume remained fairly strong given the light trade up to Thursday.

The chart: http://www.investmenthouse.com/cd/^dji.html

MONDAY

Lots of bad news last week with respect to earnings, the new war, the economy. This week there is earnings, the new war, and the economy. Bernanke speaks not once but twice to Congress re the economy and monetary policy. The CPI comes out Wednesday just as Bernanke speaks. Earnings will really hit the fan.

The potential is there for more of the same. Israel says it is going to step it up over the weekend. Earnings have yet to prove themselves though the season is hardly started. Economic reports are mixed at best, and at this point bad news really is bad news with respect to the economy.

On the other hand, the market has sold hard over the past two weeks and really hard to end last week. It was ready to bounce Thursday but was thwarted by the escalation in the war. If there is basically no change in that situation and we get some better earnings news the market is primed to rebound and rebound rather sharply. It is also in position to try and put in a bottom given the positioning of the indices. There are still issues about the economy in the future given the mature expansion hit by high energy prices and tighter money, but a bounce will deserve some scrutiny to see how strong it is. The question remains whether this is just a mid-run correction or the selling that marks the end of the post-2002 run higher. With the Fed action and historically high energy prices there is quite a bit of merit to the latter.

There is also a problem with leadership; a lot of it got hit, especially at the end of the week. There is still leadership, but it is defensive in nature, e.g. energy and healthcare. Yes some chips are trying to bounce along with some techs, but they are looking to bounce from a slaughter and not from good patterns.

It is also an unusual time for the market to find the bottom for the year, but the climate out there is also quite unusual what with the pummeling the market is taking from all sides. Indeed, Mark Haynes on CNBC said he could not recall a time when the market was confronted by so many different events. Must be the case. He is a lawyer, after all. Bottoms are often born in the midst of the worst imaginable times. North Korea, Iran, the new war, the Fed, high energy prices, bird flu, earnings scares, Barry Bonds crying, doping scandal at the star of Le Tour de France. The list goes on.

In sum we anticipate a rebound attempt this week; the one we expected last week got started just to get bumped in favor of a new war. Things are bad enough to actually make this last test, the third leg lower in the selling, the bottom of this downside move. Deep down we don't think that will be the case, instead taking another dip in late summer, early fall. The rebound from here, however, could be quite sharp and indeed tradable. With the damage to many stocks this past week there will need to be time to set back up. A rebound from here is likely to be an oversold short covering bounce and then that next pullback to set up the bottom. That lets stocks rally back, test, and thus ready to make a more sustained move higher from bases as opposed to rebounding from downtrends. We are looking to play that upside move, taking what the market gives.

Support and Resistance

NASDAQ: Closed at 2037.35
Resistance:
2045-47 from June and October 2005 lows and June 2004 highs
2050 from the summer 2005 lateral range lows.
2072 is the June closing low
2100 from the early and mid-2005 peaks
The 50 day EMA at 2166
2170 is the August 2004/April 2005 up trendline.
2177 is the December 2004 high.
2185 to 2182 is the September 2005 peak and interim high from November 2005.
2190 is the July 2006 high

Support:
2037 at the October 2005 closing low
2019 is the April 2005 interim high
2008 is the January 2005 low
1971 from an October 2005 peak and 1973 from a March 2005 low.

S&P 500: Closed at 1236.20
Resistance:
1249 is an old trendline from the August 2003/August 2004/October 2005 lows.
The 18 day EMA at 1257
The 200 day EMA at 1264
1272 to 1268 is the November and December 2005 closing highs and March 2006 closing low
1280 is the recent July peak.
The late January peak at 1285
The early June high at 1288
1297.57 is the recent February high.
1315 is the May and May 2001 peaks
1317, the recent intraday highs from April.
1324 to 1329 from the October 2000 lows.

Support:
1239 from the late June consolidation range.
1225 from the March 2005 high
1213 from December 2004 high to 1215
1205 from the August lows

Dow: Closed at 10,739.35
Resistance:
10,890 is the December 2005 closing high.
10,931 is the November 2005 high
The 200 day SMA at 10,934
10,965 from Q4 2000
The 18 day EMA at 11,025
11,044 is the January high.
The 50 day EMA at 11,084
11,097 to 11,137 is the last peak from the February top.
The 50 day SMA at 11,133
11,279 is the late May high
The March 2006 highs at 11,329 to 11,335
11,350 from the May 2001 peak
11,401 from the September 2000 peak and April 2001 highs

Support:
10, 737 to 10,730 from December and February lows
10,705 - 10,965 from July/August 2005 range top to bottom
10,678 to 10,665

Economic Calendar

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

July 17
New York Empire State Index, July (8:30): 21.8 expected, 29.0 prior
Capacity Utilization, June (9:15): 81.9% expected, 81.7% prior
Industrial production, June (9:15): 0.4% expected, -0.1% prior

July 18
PPI, June (8:30): 0.3% expected, 0.2% prior
Core PPI, June (8:30): 0.2% expected, 0.3% prior
Net foreign purchases, May: $46.7B prior

July 19
CPI, June (8:30): 0.2% expected, 0.4% prior
Core CPI, June (8:30): 0.2% expected, 0.3% prior
Housing starts, June (8:30): 1.915M expected, 1.957M prior
Building permits, June (8:30): 1.920M expected, 1.946M prior
Bernanke testimony to Congress
Crude oil inventories (10:30): -5.985M prior

July 20
Initial jobless claims (8:30): 332K prior
Leading Economic Indicators, Jun (10:00): 0.1% expected, -0.6% prior
Philly Fed, July (12:00): 12.5 expected, 13.1 prior
FOMC minutes, June 29 (2:00)

By: Jon Johnson, Editor

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

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