Sunday, August 20, 2006

Momentum kicks in and drives stocks to a positive close to round out the week.

- Market closes out the week with gains in a tame expiration Friday.
- Sentiment takes a tumble on gas prices, Middle East.
- Another week of mixed economic data while ECRI leading indicators hit a 2 year low.
- A key, 'interesting' week: will the big money return to buy?

Momentum kicks in and drives stocks to a positive close to round out the week.

Stocks were a bit weaker Thursday and Friday they started down. Futures, however, were improving into the open and looked to be ready to turn up once the action started. Not quite. Stocks instead turned back down at the open and thumped lower. NASDAQ lost 20 points as the technology bid dried up. Looked as if the old expiration week volatility was kicking in; strong moves up on some short covering midweek and now some giveback as positions were shuffled some more.

A half hour into the session NASDAQ bottomed. That started a solid, steady rebound that held on into the close. Seems nothing could keep stocks down last week even when the leading stocks for the week (techs) lagged the rest of the market Friday. Indeed, when tech lagged energy stepped in as we thought it might. With the bullish tape last week, whether short covering, long buying, or both, the market had the momentum to finish out an up week with a come from behind gain. The fact that the energy stocks stepped in when tech slowed (semiconductors were even down on the day) a bit is even a sign of some almost bullish rotation.

Technically there was no real change in the market position. Sure the indices closed higher (except SOX), but all they did was push marginally higher with no significant moves; those were made earlier in the week when SP500 broke out and NASDAQ broke its downtrend. Friday SP500 pushed a bit further into the next range of resistance while NASDAQ didn't come close to challenging the July high. Volume fell way off pace as well, not nearly enough to push the indices toward resistance, and certainly not enough to get them through. Of course we did not expect much of a move given the strong gains earlier in the week shot a lot of the ammunition. Seems the market got all of the volume out of its system early on, something much more common over the past year.

Despite Friday showing no technical change, it showed that bullish intraday high to low action to cap off a strong week of gains. There was actually some accumulation on NASDAQ though a lot of the action was also short covering after the move started, feeding on itself given that expiration loomed. Of course all rallies start with short covering, and as we discussed Thursday night, there is some NASDAQ accumulation as shown by the patterns of more and more tech stocks. Again, NASDAQ broke its downtrend with a gap reversal; quite bullish. SP500 broke out from its double bottom with handle.

Good action to close the week, but that solid move in itself along with some slowing action Thursday and Friday indicate the market needs a bit of a breather. That can mean a pullback to some near support or it can mean the market just pauses in place for a few days and then starts higher. Tired and in need of a pause that refreshes, so we were not too eager to jump into a lot of new positions. If it holds the line (i.e. gives up little ground) and starts back up we can participate in that move when it begins. There was some good action last week but leadership remains scattered, and that is always a problem for a sustained move no matter how good the index moves look. Unless leadership comes along much better we still feel we are looking at another 2 to 3 weeks upside and then a serious challenge starting in the first half of September.


Sentiment tumbles, purportedly on gas prices and Middle East issues, but politics is there as well.

Michigan preliminary sentiment dropped sharply to 78.7 from July's 84.7 reading (83.6 expected). Now you have to take Michigan sentiment with a few grains of salt to begin with and given this was the preliminary reading it is even more problematical. The data pool is so thin it is hardly an accurate sample. One wonders why they would put out a preliminary in the first place. Well, we all know; it gets the name out there twice, hypes up the product, etc. Marketing.

If it holds it was the lowest reading since just after Katrina. The worries focused on continued gasoline prices and the Middle East turmoil with consumers (all 200 of them) actually voicing concerns about inflation as a result. As of yet this concern has not shown up in retail sales, but of course the monthly retail reports lag real time events. Thus retail sales could be falling as we write.

Could be. Retail sales and consumer activity usually do not track sentiment until it gets to very low levels, i.e. in the mid-sixties to the fifties. At that point the consumer is concerned enough to start leaving the wallet on the hip, the purse on the shoulder, the checkbook in the desk drawer. Of course, there are always credit cards, right? In short, the preliminary reading may be way off. Unfortunately, we don't get any corroboration from the Conference Board's sentiment reading until August 29. Further, the decrease to this level, while not the trend you want to see, is not at the point to cause enough consumption slowdown to threaten recession.

Two of the best leading indicators continue to soften, however.

Sentiment is not really a leading indicator, at least not a LEADING leading indicator. In other words, other indicators give you a better heads up than trying to gauge whether the consumer has had enough. Two of the best, however, are not as positive as we would like, but they are also not flashing critical mass just yet.

ECRI's annualized growth rate toppled to a near two year low this week, falling to -1.4. That follows the prior week's -0.8 reading. As ECRI put it, "with the leading index growth now at a 93-week low, the US economic growth prospects continue to dim." Continue to dim. That means, as we have reported, that the ECRI indicators, very accurate indicators at that, have been trending lower. Last weeks decline did not suggest a recession, and this week's decline does not either. It is, however, showing a continued trend of slowing, and the recent data suggests it is picking up some speed. If it continues then the risk starts growing fast. Very accurate leading indicator.

The bond market is also a key leading indicator. For months we were told that the bond market was no longer valid given foreign buying of US treasuries pushing rates artificially lower. That was Greenspan's conundrum and he attributed it to that foreign buying (petrodollars, Chinese boom). That melted away over the past several months as the new Bernanke Fed took over. Oh for sure Bernanke still followed the Greenspan line, but the bond market changed. Yields rallied on talk of a pause with the curve reverting to normalcy, then fell as economic data started to weaken. That is traditional bond market action, looking at the economic future and adjusting accordingly.

Bond yields started to recover after the Fed pause, indicating the market believed the Fed got it right, but this past week they waffled. Rates fell and yields inverted once more (4.90% on the 2 year, 4.86% on the 10 year). We want to see yields move back over 5% and on toward 5.25% (the current Fed Funds rate) to show the bond market has confidence money will be in demand down the road. After some promise they are now indicating less demand, particularly for the longer term. That is never good. If the inversion holds for several weeks that does not forebode well for the economy.

Thus we have the two accurate indicators for economic activity in a weakening state. Not at a recession state, but at a 'the economy is going to slow' state. Of course, even the Fed says the economy is going to slow. The problem is, there is a difference between thinking it will and then putting a quantity to it, i.e. how much it will slow. ECRI is not showing recession yet, and was not showing a significant slowdown. If this recent trend holds a few more weeks it is something to start worrying about.



VIX: 11.64; -0.6. Volatility is diving as the market rallies. It is rapidly approaching the July and December 2005 lows. In December the market just kept on rising. In July it made an interim top when volatility hit this level. What does this tell us? Be cautious, but low volatility does not always correlate to market tops.
VXN: 18.45; -0.51
VXO: 11; -0.57

Put/Call Ratio (CBOE): 0.89; +0.02

Bulls versus Bears: High readings helped trigger the rally seen the past few weeks, but topping out a bit for now.

Bulls: 40.9%. Ticked higher from 40.2% but still down from 41.5% the week before, continuing the retreat toward 38.7% five weeks back. It remains 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: 36.6%. Bears became more scarce, falling from the jump to 37.1%, but holding well above the 36.2% and 34.5% hit in the preceding weeks. The 37.1% was the highest level in this entire cycle, easily clearing the 34.4% hit in late June back when bulls and bears kissed, just missing a crossover. Hit a new post-2002 high in that late June move, eclipsing the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005).


Stats: +6.34 points (+0.29%) to close at 2163.95
Volume: 1.743B (-11.4%). Volume tanked Friday, falling below average in a different twist for expiration. Stocks moved on pure momentum and a definite lack of intervention from sellers that had to cover a lot ahead of the expiration.

Up Volume: 983M (-215M)
Down Volume: 731M (+27M)

A/D and Hi/Lo: Advancers led 1.12 to 1. Weak, bespeaking of the lack of conviction on the day.
Previous Session: Advancers led 1.44 to 1

New Highs: 68 (-42)
New Lows: 61 (-17)

The Chart:^ixic.html

Volatile session on low, below average volume and modest breadth. Dipped first then rebounded in a long, steady rally to the close. Thursday NASDAQ closed off its high on lower trade, and Friday it was all over the map on below average volume. It is showing some wear and tear after the move, needing a breather before it can take on the July high (2191). Two to three days of rest and it is ready to try the July high.

SOX (-0.05%) was down and up similar to NASDAQ, reaching down to 435 on the low, still easily above the 50 day EMA (429) it broke through Wednesday. Thursday it also closed well off its high; as with NASDAQ that indicates the move is getting a bit tired and needs a blow. Still solid reversal of the trend, and it just needs to regroup and build for the next move to take on some resistance at 450.


Stats: +4.82 points (+0.37%) to close at 1302.3
NYSE Volume: 1.342B (-14.58%). Very low volume as the NYSE indices pushed their gains to varying degrees. No accumulation but also no sellers daring to come in yet.

A/D and Hi/Lo: Advancers led 1.37 to 1. Mediocre, but better than the Thursday read. The breadth coupled with the stronger upside moves in the large cap indices tells us this is more of a large cap story. Not hard to see that over the past six months.
Previous Session: Advancers led 1.18 to 1

New Highs: 91 (-31)
New Lows: 23 (-16)

The Chart:^gspc.html

SP500 showed solid intraday action, starting with a fade and then that same steady rebound to close at the session high. Same type of action as on NASDAQ and SOX the past two sessions, i.e. off the high to close on Thursday and then a more volatile Friday session. It pushed through resistance at 1300 but did not make significant inroads. Basically a probing session given the very low volume. Same story as with NASDAQ: looking for some type of pause to start the week then a move up from there.

SP600 (+0.12%) was down and up as well, tapping the 50 day EMA (364.32) on the low and rebounding for a modest gain. Still trapped below the 200 day SMA (370) for now. The fact it is below the 200 day when SP500 is above that level tells the story of how the small caps have turned from leader to laggard.


The blue chips continued higher as well, approaching the late April lateral range before the spurt higher into May that ended the rally. That is the next resistance point for the Dow before a run at the May high (11,670). Volume jumped higher as it made the move, the first above average showing in a month. Some movement into the industrials at expiration.

The transports rebounded Tuesday and Wednesday, coming back to the 200 day SMA. Thursday and Friday they tested modestly. Important juncture for the transports. A failure here is dangerous for the Dow.

Stats: +46.51 points (+0.41%) to close at 11381.47
Volume: 282M shares Friday, versus 243M shares Thursday. Best volume in a month, but it was on expiration.

The chart:^dji.html


Now that expiration is in the bank and the rally showed a bit of age to end the week (just a bit) the issue is whether the action last week was just an overheated short covering run ahead of expiration or if there is some sustainable buying taking place. The move started in July with a bounce, then a three week test, then last week's surge. There was something stirring before last week; it's just that last week made it very clear.

There is definite improvement in leadership, though from basically none to better is not a quantum leap. It will have to continue to build to make this rally stick beyond August. During the 2000 bear market we saw many rallies that held out promise ultimately fail due to lack of leadership. The selling paused and stocks rebounded, but no groups would form up accumulation patterns and break higher after the initial rebound move. Consequently the rally attempts failed. There is leadership appearing; the report has many. It is not at the point, however, where stocks are ready to take off en masse.

Short covering and some buying drove techs last week. Energy perked up Friday, rebounding from the recent slump. We will have to see if they pick up the slack again this week after what we expect to be an early week pause. It will be interesting to see if the two can rally together.

This move definitely has some upside strength but we have to see if it can continue past the expiration week jump. A pause to reload and we think it can run on into September. After that we still anticipate a dip if the ECRI readings and the bond market continue their present course. If they do that would mean more significant economic slowing ahead than many anticipate, and the market would start factoring that in. September and early October are good times to do that, i.e. historically months the market suffers through weakness.

Given this scenario we will have to do what we always do, i.e. take what the market gives us. We are focusing on solid stocks in solid patterns that will be testing back from solid moves or preparing to make the breakout after forming up good bases. Oil rebounded Friday and energy stocks did as well. Some remain in solid patterns while others are fighting back. We like the action we saw in several on Friday, coming back from selling. We will again be looking at them as well to see if they can muster strength after some vigorous takedowns last week. We will ride any of our plays as far as they will take us; we still have to be cautious of a late summer fade after another run, so we still want to take interim gains as our plays make good moves, banking some profit and letting the remainder move higher as long as they will.

Support and Resistance

NASDAQ: Closed at 2163.95
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
The 200 day SMA at 2225
2230 is the June 2006 peak

2158 from the May 2005 low.
The 50 day EMA at 2115
2100 from the early and mid-2005 peaks
2072 is the June closing low
2050 from the summer 2005 lateral range lows. It has held the past three weeks.
2045-47 from June and October 2005 lows and June 2004 highs
2037 at the October 2005 closing low
2020 is the July closing low
2019 is the April 2005 interim high

S&P 500: Closed at 1303.30
1315 is the May and May 2001 peaks
1311 is the April closing high.
1324 to 1329 from the October 2000 lows.

1294 is the January 2006 high and 1297.57 is the February 2006 high.
The early June high at 1288
The late January peak at 1285
1280.37 is the recent July peak.
The 200 day EMA at 1273
The 50 day EMA at 1271
1259 is an old trendline from the August 2003/August 2004/October 2005 lows.
1239 from the late June consolidation range.
1225 from the March 2005 high
1223 is the June 2006 closing low.

Dow: Closed at 11,381.47
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
11,642 is the May 2006 closing high
11,670 is the May intraday high

11,279 is the late May high
11,243 is the August closing high.
The 10 day EMA at 11,239
11,228 is the July closing high.
11,097 to 11,137 is the last peak from the February top.
The 50 day EMA at 11,127
11,044 is the January high.
The 200 day SMA at 11,030
10,965 from Q4 2000
10,931 is the November 2005 high
10,890 is the December 2005 closing high.
10,737 to 10,730 from December and February lows
10,706 is the June 2006 closing low
10,705 - 10,965 from July/August 2005 range top to bottom

Economic Calendar

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

August 23
Existing home sales, July (10:00): 6.58M expected, 6.62M prior
Crude oil inventories (10:30)

August 24
Durable goods orders, July (8:30): 0.0% expected, 2.9% prior
Initial jobless claims (8:30): 312K prior
New home sales, July (10:00): 1.1M expected, 1.131M prior

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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