Sunday, December 17, 2006

CPI gives investors an early Christmas present

- CPI gives investors an early Christmas present, but they almost act as if they want to return it.
- Transition in progress, trying to beat the Christmas rush?
- Soft landing approaching? CPI growth slowing for second month even as retail sales solid.
- Stocks still set to move higher into Christmas despite lukewarm response to CPI.

CPI shows promise, market plays coy.

The big news of the day was the CPI, showing a flat growth rate overall and at the core level. That helped push the core year/year down to 2.6% from the 10 year high hit in August. Time to celebrate and have a good time. Indeed, that news trumped all other in the morning, including some warnings from BDK and ITW (sure seems like a lot for so early in the season), higher oil (attacks on Shell in Nigeria, continued OPEC blustering), and lower capacity readings. Stocks gapped higher, continuing the Thursday breakaway move after a lateral move in December.

What looked to be 'the' news the market needed to really extend its gains, however, was trumped itself. Not by any news story, but by a monthly event, expiration Friday (and maybe, just maybe, a bit of top-heaviness). NASDAQ gapped to the November high while SP500 and DJ30 moved to new post-2002 and all-time highs respectively. Nonetheless, it was over in an hour. The early gains were solid, but hardly impressive (69 points on DJ30, 16 points on NASDAQ, 6 points on SP500). Maybe they shot their ammunition on the Thursday jump. The indices are well into their run and they have had a hard time making upside moves stick.

That could explain the fade after the morning surge, but there was also expiration at work. It tends to keep the market on edge and volatile at some point during expiration week. After the move higher Thursday, expiration was prime time to give some back. Looking at the big volume surges on both NASDAQ and NYSE that was the main influence in the pullback. It was no reversal; the indices mostly finished positive and holding the Thursday move. It was expiration Friday following a relatively quiet expiration week and a big move Thursday.

The expiration action makes a technical read rather murky but you have to look at these sessions in context with the overall market picture. There was the big volume related to expiration and narrow breadth with the large cap indices the only ones holding gains. Lots of stocks were moving, but they were moving all over the place. All of this is typical of expiration and thus we don't want to read something into the tea leaves that is not there. That is an urge you always have to fight; let the market speak and don't see shadows or sunny skies that are not there. The Fed did that in the late 1990's just as it did in the 1920's when it saw stock gains and interpreted them as inevitably leading to inflation. It acted on an incorrect assumption and the results are indexed in history books under 'P'; not for prosperity but for poverty.

Friday did nothing to change what the market is doing: rising in an uptrend that is aging and is thus showing some signs of age. That does not mean the rally from July is terminal nor the overall rise ready to fall. It may be middle aged and showing some related signs, but middle aged is not on the deathbed.

Some dormant large caps coming to life.

Indeed, the 4 year bull run spurred by renewed economic growth is by comparison fairly old. The leading indicators that matter are starting to show some renewed growth down the road, and that is one reason grow indices such as NASDAQ and SP600 have recovered with the small caps indeed hitting a new all-time high in the past month. The age of the run suggests that the large caps will take over similar to what was seen when this latest rally started, when the small caps stumbled while SP500 and DJ30 led the way higher.

Thursday and Friday saw some of the large cap leadership returning while the small caps lagged the move. Stocks such as C and GE, dormant for years, have suddenly jumped higher. That is an indication that the big money that moves the market is allocating money into large caps of all kinds (leaders and laggards) in preparation for the new year. It could also mean that the world liquidity is looking for anywhere to go, and is now looking to laggards.

That could spell trouble as it suggests things might be getting a bit overcooked as money seeks anything that could turn a profit. It could also represent storm clouds for other areas of the market such as when this current rally started and the small caps took a back seat. They did not breakdown, however, they just moved from leader to follower. Moreover, they recovered and moved to a new high, and as noted above, that indicates good economic action to come as they are growth oriented stocks.

Thus, with liquidity in the world still very high with China, OPEC, and others needing to find homes for that money, perhaps what we are starting to see is simply a further spreading out of the advance. A survey of investment in US equities last week showed more foreign buyers of US stocks than US buyers. Further, the net foreign purchases of US debt and equities released Friday surged to $82.3B, blowing past the consensus of $69.5B and September's $70.2B (revised higher from $65.1B). Part of the low bond yields is the foreign appetite for US treasuries as a place to park oil money (of course no one has a definitive answer as to how much that is driving lower rates, but it is not the major force as even Greenspan admits).

It takes money to drive economies and markets, and with record US profits and high world liquidity there is money available. We will have to see if this turn toward laggard large caps occurs at the expense of the smaller cap and mid-cap growth indices or if it lifts all boats once more. On Friday the smaller cap indices definitely lagged, turning in negative performances. Overall, however, they are not lagging anymore having both put in new all-time highs this month. In that sense they are leading the SP500 and of course are well ahead of NASDAQ and SOX.


CPI slowing, making Bernanke look like a genius compared to Greenspan's first year.

We thought CPI would come in less than expected, and it indeed did. Overall consumer price growth has slowed the past four months, even declining in September and October before the November flat reading (+0.2% expected). Lower energy prices drove most of that decline as the core (ex food and energy) stubbornly held its ground. In October, however, the series of 0.2% gains slipped to 0.1%. November fell to flat. That dropped the year over year rise in core inflation to 2.6% from the 10 year high at 2.9% in August. That is still above the 2% cap the Fed wants, but it is getting substantial, and these trends tend to pick up speed as they progress. Indeed, over the past three months core CPI growth rose 2.2% versus 3.5% in July. In three or four months we could see yearly core CPI skipping along the 2% range.

Of course that does not mean a rate cut is imminent. The slowing growth in core inflation merely affirms the Fed's decision to pause. With the core year/year still well above 2% the Fed is not about to cut rates. Indeed, the bond market seemed to finally get that on Friday. With each indication inflation and the economy were cooling at a 'soft landing' pace, bonds have rallied, pushing yields lower and raising the expectations of a rate cut in March. That expectation peaked at 82% just a couple of weeks back. Since then economic data in the service side as well as in jobs reduced that expectation to just 12%. When the news hit Friday bonds rallied and pushed the 10 year back close to 4.50% (4.51%) but bonds then reversed and by the close the 10 year was where it started the day at 4.60%. Even with the core inflation rate finally following what the leading inflation indicators have been saying, bond traders realized all this means is the Fed is going to hold steady well into 2007.

Economic activity set to pick up in second half 2007.

ECRI's leading indicators continue to rise, hitting yet another yearly high. This long leading indicator looks well down the road, measuring forces that combine to generate growth just as its inflation indicator measures forces that combine to generate inflation 6 months or more down the road. This continued rise still does not eliminate some interim slowing, but it bodes well longer term.

The wildcard is the Fed and how it reads any indications of economic strength. It has so engendered the public over the years with the idea that economic growth leads to inflation that it has hard time doing what is right for fear of confusing everyone with its actions given the economic indicators it claims to use. Former Fed president McTeer summed it up a couple of months back when he noted that growth actually helps REDUCE inflationary pressures. Unfortunately McTeer is no longer on the Fed and his replacement, after sounding good at the start, is basically a wing nut.



VIX: 10.05; +0.08. Volatility spent another week declining, and as noted the past couple of weeks, the volatility geeks are out warning the sky is falling because volatility is approaching the late 1993, early 1994 lows. Lions and tigers and bears, oh my. Volatility can indeed suggest tops and bottoms in runs, but it is a fickle indicator. Sometimes the correlation sets up and works, sometimes it does not. This is a cycle where it does not. Just as in the early to mid-nineties, the market embarked on a long run even as volatility touched near record lows. When volatility rose dramatically . . . in late 1999 and early 2000 . . . the run was over. The point: low volatility in and of itself does not necessarily mean anything. In this case it has been low, well below the historical range that indicates complacency that can indicate market tops. It has not moved in sync with the market's ups and down, just hugging the bottom. A correlation can always set up, but it has not done so yet on this cycle.
VXN: 15.15; +1.06
VXO: 9.97; +0.39

Put/Call Ratio (CBOE): 0.74; +0.1

Bulls versus Bears: Bulls eased a bit but remained well above the key 55% level. Bears fell this week, coming closer to 20% considered bearish. Not a great development but as of yet there is still enough money coming in to feed the bulls. That is really the import of this reading: if you get too many bulls, there is no ammunition on the sidelines to keep shooting the market higher. With all of the liquidity in the world (OPEC nations making billions a day), it has to go somewhere. Markets around the world are benefiting from that money, and the US, despite the naysayers, is still a favored destination because of our rule of law, stability, and of course, year in and year out economic growth.

Bulls: 59.6%. Slipped fractionally from the prior jump to 59.8%. It has been a steady move higher from 58.5% and 56.4% the week before. Fourth straight week the bullish advisors topped 55%, the level where the market is viewed as overdone and some corrective activity can enter. A sharp jump from 52.1% the week before and closing in on the January peak at just above 60%.

Bears: 21.3%. Big drop in bears, down from 23.9% after a bounce higher just before that. It is now coming close to that 20% level considered bearish. This is well off the 37.1% hit in July (the highest level in this entire cycle), now so far in the distance you can barely see it. 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: +3.35 points (+0.14%) to close at 2457.2
Volume: 2.147B (+10.74%). Explosive volume, the highest in over a month, as NASDAQ closed out expiration. Lots of movement and thus lots of volume. Not calling it accumulation, not calling it distribution. Just expiration. Bigger picture NASDAQ has suffered some distribution and churning bouts the past month, though obviously not enough to sink it.

Up Volume: 1.521B (+91.806M)
Down Volume: 827.673M (+410.294M)

A/D and Hi/Lo: Decliners led 1.1 to 1. Large cap techs led as the index posted a gain while breadth was negative.
Previous Session: Advancers led 1.47 to 1

New Highs: 78 (-29)
New Lows: 11 (-15)

The Chart:^ixic.html

Gapped higher on the CPI news, clearing the November high (2469) but unable to hold it, starting the selling within the first hour of trading. NASDAQ lost ground all session but managed to close with a modest gain, hanging on to the Friday break higher from its lateral consolidation. NASDAQ needs to hold the breakout and then continue from there. Clearing that November high will be key for a run on into Christmas.

SOX (+0.03%) scratched out the bare minimum gain, still trying to get off the 50 day EMA it sold to the past week. Modest double top over the past month sent it down to near support. Still some important chip stocks performing well (e.g. WFR, NVLS), and we will see if they can lead the nation of chips to breakout land.


Stats: +1.6 points (+0.11%) to close at 1427.09
NYSE Volume: 2.102B (+34.1%). Volume hit a 2.5 month high Friday as the last expiration before year end ran its course. As with NASDAQ, no real distribution or accumulation, i.e. no reversal session even though SP500 closed off its high.

Up Volume: 977.771M (-200.422M)
Down Volume: 1.066B (+691.625M)

A/D and Hi/Lo: Decliners led 1.15 to 1. A large cap day at the NYSE as well as the large cap indices were up but breadth was negative.
Previous Session: Advancers led 1.76 to 1

New Highs: 152 (-162)
New Lows: 5 (+1)

The Chart:^gspc.html

SP500 rallied higher early as well, managing to continue rallying even after NASDAQ already peaked out in the first half hour. The writing was on the wall, however, and SP500 slid back all afternoon, failing a mid-afternoon rebound attempt. It managed to hold a modest gain and of course Thursday's strong break higher. The large caps are getting attention again and that could be very good for them on into Christmas and into 2007.

SP600 (-0.24%) struggled as the small and mid-caps did not attract the money the large caps enjoyed. There was no lump of coal in the stocking, however, just a pullback from the new high hit to start the month. Still in solid shape and still looking for a continued break higher.


Volume shot off the scale, posting the highest trade in 7 months. With stocks such as GE, C, JPM and friends jumping higher on strong trade, this was not all expiration volume but some real buying in the large caps. DJ30 is still as extended as a college student at the end of the month before the parents' check comes, but just as the college student, it keeps finding ways to keep going.

Stats: +28.76 points (+0.23%) to close at 12445.52
Volume: 417M shares Friday versus 253M shares Thursday. As noted, the strongest volume in 7 months as expiration and some real buying in some large caps pushed trade higher.

The chart:^dji.html


CPI was big last week along with retail sales and the FOMC meeting, and the data barrage doesn't slow much this week with housing starts, PPI, final GDP, personal income and spending, and final Michigan sentiment being the highlights. In addition, earnings from some well known stocks such as MS, ORCL, NKE, FDX are on tap, and 'tis the season for earnings warnings as well with January just two weeks away.

Is the news as good as it is going to get?

There is a confluence of positives hitting the market of late. The economic data has a positive turn despite the sub-50 ISM, the Fed gave a nod at that slower manufacturing rate and noted the housing slowdown was 'substantial,' leading indicators are pointing toward more growth, and at the same time consumer inflation is finally starting to turn. As noted in one of our alerts Friday, the news is getting about as good as it can. With earnings season coming and a dozen quarters of growth, the likelihood of some disappointment is higher. Already we are seeing warnings from chips (NSM and others), and Friday saw more from other sectors as BDK and ITW warned.

The market finally broke higher once again last week after working laterally all month even as the good news hit. The inability to rally on the good news was a concern, and the Thursday break higher was good to see. Now it needs to extend that break with a move higher this week. With large caps getting some new money ahead of the new year the momentum is there to carry stocks on into Christmas.

We still have to be wary of any shifts in the various market sectors. For the most part they are all rising together (though chips are struggling). We don't want to see the small and mid-caps deteriorate as that calls into question the growth prospects for 2007. Want to see that money continue to move into all areas of the market, large and small caps, indicating this overall rally out of the bear market still has significant legs to carry it higher.

Even in that event, there will still likely be a correction of some sort near the first of the year if stocks can continue this move. There will be some redistribution of capital for the new year and a 5% or more correction would not be out of the question. That is an educated assessment of current market condition and historical trends; it is not anything written in stone. As always the market will tell us the direction it is going to take.

We are going with the same game plan: look where the money is flowing and getting in on those stocks starting moves or stocks that are testing good moves and giving us new buying opportunities. That way we will ride the current move as far as possible. As for current positions, we are letting them move as high as they will on this run higher. Positions that have been lagging and not moving with the market are getting closed; if they did not break higher with the market and cannot do so on any further upside moves, we will take the money off the table and use it to focus on those that are getting the money and are moving.

Support and Resistance

NASDAQ: Closed at 2457.20
2468.42 is the November 2006 high
2477 from January 1999
2493 is an interim peak from February 1999

2438 is the July up trendline
The 18 day EMA at 2435
2412 from June 1999 low
The 50 day EMA at 2385
2384 is an interim peak from January 1999
2379 is the October high.
2376 is the April high, the former post-2002 high
2368 is the early October handle high.
2333 is the top of the Q1 2006 trading range (the January and mid-March 2006 highs)
2316 from interim tops in January and March 2006 trading range
2300 represents some price support

S&P 500: Closed at 1427.09
1444 from February 2000
1475 from peaks in December 1999 and January 2000

1425 is an interim high from November 1999
The 10 day EMA at 1414
1408 is the November high
The 18 day EMA at 1408
1401 is a low from April 2000
1397 is the July up trendline.
1390 is the October high.
1389 is a low from November 1999
The 50 day EMA at 1385
1378 is a low from May 2000
1371 to 1373 is the December 2000 peak and the January 2001 peak
1358 to 1362 mark a series of peaks from April 1999 to August 1999 high and the February
2002 low at 1360.

Dow: Closed at 12,445.52
At a new all-time high. Back to 8.5% above the 200 day SMA, about the point where DJ30 started to struggle in late October.

12,361 is the November 2006 high
The 10 day EMA at 12,339
The 18 day EMA at 12,297
October high is 12,167
The 50 day EMA at 12,118
11,986 is price support from mid-October and the early November low.
11,865 from the early October consolidation
11,750.28 is the prior all-time high
11,723 is the January 2000 closing high
11,670 is the May intraday high
11,642 is the May 2006 closing high
11,488 is the early September high.

Economic Calendar

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

December 18
Current account, Q3 (8:30): -$225.0B expected, -$218.4B prior

December 19
Housing starts, November (8:30): 1.55M expected, 1.486M prior
Building permits, November (8:30): 1.540M expected, 1.553M prior
PPI, November (8:30): 1.2% expected, -1.6% prior
Core PPI, November (8:30): 0.2% expected, -0.9% prior

December 20
Crude oil inventories (10:30): -4.295M prior

December 21
GDP, final Q3 (8:30): 2.2% expected, 2.2% prior
Chain deflator, Q3 (8:30): 1.8% expected, 1.8% prior
Initial jobless claims (8:30): 315K expected, 304K prior
Leading economic indicators, November (10:00): 0.0% expected, 0.2% prior
Philly Fed, December (12:00): 3.0 expected, 5.1 prior

December 22
Durable goods orders, November (8:30): 1.0% expected, -8.2% prior
Personal income, November (8:30): 0.4% expected, 0.4% prior
Personal spending, November (8:30): 0.7% expected, 0.2% prior
Michigan sentiment, December revised (10:00): 90.2 expected, 90.2 prior

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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