Stocks slumber through post-Fed hangover, avoid any immediate selling.

SUMMARY:
- Stocks slumber through post-Fed hangover, avoid any immediate selling.
- Jobless claims remain in very good shape.
- Leading indicators sag for second month, continuing the trend lower.
- A rest before resuming the move would do the rally good.

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VIDEO NEWSLETTER & TRANSCRIPT
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This weekend we have another installment of the video newsletter. We also have a transcript available for following along, reading on its own, or other use as you may see fit.

To view the Video Market Summary please browse to the following links. There are two this week to accommodate some additional information:

http://investmenthouse.com/ihmedia/3232007marketsummaryvideo.wmv

http://investmenthouse.com/ihmedia/3232007marketsummaryvideotag.wmv

TRANSCRIPT:

Well everyone the market did what we thought it couldn't: it followed through on the reversal two Wednesdays ago. Kind of poetic justice that the follow through was on Wednesday a week later. There was a Fed-assist on the follow through. What happened was the Fed dropped the language that rates may need additional firming in the future. And even though it had a lot of other language we and many others consider hawkish in its statement, the market took it as a positive that the Fed was on its way to changing from a bias towards tightening to a neutral bias.

Thus the big move up on Wednesday. It was not unanimous. The NASDAQ was the clear leader: it gave the 2% gain on rising volume, had great breath, and solid leadership. S&P 500 was up as well, but its volume didn't even crack average. That's always a warning sign when a big move is made, that volume doesn't follow. All it takes is one index to have a follow-through, however, so despite the lagging in the other indices, we did in fact have a follow-through. We need to keep watching how S&P 500 and the other NYSE stocks tagalong. Are they going to go with the NASDAQ or are they just going to tag along. NASDAQ has leadership and that can handle it the task, but as the market moves up towards the prior highs and the old trendline channels it has to have more cylinders hitting than just NASDAQ to make a break and continue on a new and sustained rally.

There was some other good news this week as well. After the Fed changed its bias, the bond yield curve almost immediately reverted to positive. It was not a big move and finished the week with the two year bond at 4.60% and the 10 year treasury at 4.61%. A little bit of a positive reversion, but it's more flat than anything. A flat curve suggests slow economic times ahead. But we also have consider also that were moving from an inverted curve to flat and hopefully onto a good positive sloping curve, which will be a good sign for economic times down the road.

Now, what we've had thus far is the slowing economy and the curve was inverted in conjunction with that. Now if the yield curve starts to revert to positive perhaps will see economic readings picking up. ECRI has forecasted a return to expansion later on after the summer. Things seem to be falling into place along those lines. More about that later.

Now technically there was that follow through that set the stage for a further rally following the break from the late 2006 uptrend. After the strong uptrend that was in place since August and July of 2006 broke, the market entered into the correction. It formed a short double bottom with that reversal two Wednesdays back and now the follow through. That indicates it can continue the recovery move and go on up and challenge those old highs and the uptrend channels. There was great volume on NASDAQ, good breadth, and solid volume in leadership. As for leadership, energy stocks are performing very well, particularly the drillers and refiners, the metals, and some chip stocks rallied well with others preparing to make a break as well. That is new leadership coming in with the old leadership has been shown by energy and metals. Even the financial group, after they imploded in the selling, are recovering, and if they can come around the S&P 500 might actually move up with NASDAQ, and maybe they can share leadership up to the old highs.

After the Wednesday surge the market put in a couple lateral moves, although Friday stocks moved higher though volume was lower and breadth lagged. Many lamented this action, but the sideways meander to close the week is really good action. What would like to see as we talked about in the reports this week is for a couple more sessions laterally. That would build a nice handle to the double bottom and give a launching pad to jump up and take on those old highs late in February and the uptrend channels.

The problem is the double bottom is very short, only 4 to 5 weeks long. Historically those have a hard time holding up and sustaining long rallies. Sure that is enough to take us up toward the old highs, but then the question becomes is there enough strength or enough consolidation to continue a rally beyond those levels and sustain a rally. After all that is what you are looking for. We can play these up and down rallies, but you like these 5 to 6 month rallies as in 2006. Next week is going to start the big test as to whether we can move up from this little lull after the big Wednesday move higher that provided the rally follow through.

Follow through is important and we want to review this some because what happens is there is the cessation of the selling where shorts cover and drive prices up along with some bottom fishing buyers trying to pick the bottom and buy stocks while they are lower. The important feature of follow through is that after that initial surge you have 4, 5, 6, 7 days where the buyers and sellers fight it out, and then the buyers surge back in in a big way, and they want back in at a higher price and still buy stocks. That shows it is not just a one day wonder. The buyers moved back in, the sellers try to sell it off but fail, and then the buyers come back in and say 'we want more stocks' and they come in with force. That gives it the power, shows it has the strength to drive higher and sustain a rally. That is why we are always looking for a follow through as it sets the stage for a rally. It does not guarantee a rally will be successful, but every successful rally has a follow through session.

There are some reasons we like this one (and some we don't). We like this one because there is leadership that was not all taken out in the selling. They have set up bases and are ready to run. The market is not overrun with leaders from every sector; it is not a huge swath of the market with good bases. But there are several sectors that have good, longer bases such as in energy, metals, medical, and some technology, particularly chips. Others still have work to do. That is the neat thing about a follow through, however. At the time of the follow through there are stocks that surge higher. As the move progresses, other sectors continue to work on their bases and they then break higher in waves as the rally continues, giving it continued strength. First one group breaks out while another forms up, then another forms up and breaks out, giving you waves of breakouts that sustain a rally as back in 2006.

Economy

A lot of the issues swirling around the market correction relate to the economy. Economic issues were big again this past week. Housing starts and existing home sales on Friday were highlights given the concern surrounding housing. Friday we got some pretty decent news with respect to housing with existing sales rising 3.9% versus the expected decline. Once again there is not a cataclysmic disaster in the housing market as being predicted. It is not occurring just yet, at least in existing home sales that make up 80% of the housing market. Now there may be more problems than appear because some people are pulling their homes off the market because they are not going to get the price they want, and that is masking some weakness in the existing home sales. We will find out more about that as the summer moves on. But we can take some comfort in that the market is not falling off a cliff just yet despite predictions it is doing that.

This looks like a classis mid-cycle slowdown in the economy. It has everyone scare because they are used to an expanding economy since late 2002 or early 2003. Many maligned the economic gains, but there is no denying the gains coming out of the recession were strong as they rivaled growth rates not seen since the early 1980's when the economy blasted out of the 1970's malaise. Just as a market rally runs out of steam as it gets further along with the gains getting smaller and smaller, it corrects back, then resumes the rally, the economy does the same thing as the gains lost strength and even turns negative for some months. But if the underpinnings of the economy remain strong, well, it picks back up and expands once more. As we have discussed of late, ECRI shows an expansion resuming at the end of the summer. It forecast the slowdown we are in now and then an expansion later. There are things that can forestall that, but for now it looks to be on track.

This is very similar to 1994-1995, when we had that big burst of activity when we came out of the recession in 1992 and then things slowed down. We had the Fed becoming active in 1994 when it became scared of its shadow just like it did in this past tightening round. Then the Fed backed off and the market rallied. Lo and behold that is exactly the same thing that happened last August when the Fed paused. The market anticipated this by a couple of weeks and started the 2006 rally.

So we have a very similar situation with a mid-cycle slowdown; we have seen this before in history. A lot of people like to panic when the economic numbers downturn, and that is what we are experiencing now. There is still a whiff of inflation that is an Alan Greenspan hangover that he gave Bernanke that he is having to fight with, and there are some issues still with the housing market where there may be another shoe to fall. The main obstacle facing it is oil with price back up over $60/bbl after Iran kidnapped some British servicemen at gunpoint. But the main problem we are having is with gasoline as some refineries are down for maintenance after hard use and fires because they are being run hard. You have to have maintenance and when they are run hard you have fires and they go down. We have plenty of oil but the ability to turn it to gasoline is the problem. Oil inventories were way up once more but gasoline inventories were way down because they cannot make enough with current capacity outages. Consequently we are getting gasoline over $3/gallon in areas of the US. With wholesale prices hitting over $2/bbl at the end of the week, we are going to see $3/gallong gasoline across the nation before too long.

That is a serious problem. If we have people who are a little skittish about their mortgages and their wealth because of their home values, then if we ladle on top of that $3/gallon gasoline, then we have a problem for those folks. That combination can be trouble. And that is usually the problem you have; it is never just one thing that can bring down an economy, but a combination or confluence of events and some serious events that curtail spending whether it is the consumer, business or both. Right now it is the consumer with the housing and gas issues because businesses simply pass along their costs to their customers. Not all can do it 100% dollar for dollar, but we all pay higher prices for goods when the producers have higher energy prices. This is the main cloud on the horizon. We could handle the housing market, but if oil remains high throughout the summer we could have a problem pulling out of this slowdown at the end of the summer as ECRI suggests we will do.

THIS WEEK

That gives us the background on the market and the economy. What are we going to do about it this week? We still have a market that has corrected and has shown a follow through off of a nice little, but short, double bottom base. It is now building a handle, a lateral quiet move that often precedes the next breakout higher. It looks like the recovery in stocks will continue next week. The question is how high can it go? Historically, the majority of these short 4 to 5 week bases in a correction don't pan out into a sustained new rally. What that means is the market is going to rally up to the old trendlines or highs, then start to struggle and correct back, finishing the base, i.e. testing those old lows hit on the intraday reversal two Wednesdays back.

Now what we see is NASDAQ recovering back up to 2500ish (the trendline) or the February high at 2531. SP500 is looking at 1455ish; 1462 was the February high. Those are the points we have to look at as natural resistance as this short base with NASDAQ leading with some metals, energy and medical thrown in as well. If that is the case with NASDAQ primarily leading the market is going to have trouble when it gets to those levels. If SP500 and the financials come around that will help, but we are still very skeptical that the market can make the move that breaks this resistance and resumes a sustained run given the short base compared to the long run higher prior to this correction.

This is still a playable, tradable rally up to that point as we are looking at over 50 NASDAQ points. We still see some great stocks setting up for a move higher. We took some gain on positions that rallied well last week and we also bought into new positions starting good moves. We are also letting positions run higher and we will let them do that as long as the market shows us it still wants to move up. When it gets to the old highs and it starts to stall we have to be careful because history is on the side that the market goes back and tests that intraday low hit two Wednesdays back because the base simply wasn't big enough. If it does breakout to a new high you still have to be concerned that the short, narrow base did not give the market enough consolidation time to sustain a breakout or a run of significance after the breakout.

If that is the case we will be ready for it and start taking gain off the table when the stocks move up toward those levels. Many leaders have already broken through their prior highs and are having no trouble running. For most of the market, however, as we get close to those old highs and it starts to slow and/or we see some distribution, prudence says we take some gain off the table, button up positions, see what the market is going to give us and then we take it. That is how we play the game. We always look at what the market and big picture is telling us. We look at what resistance points there are, what support points there are, we look at the economic indications, and then we move forward. We look at the big picture to prepare, but then we let the market show us what to do.

There is a lot of economic data this week from new home sales, final GDP, consumer confidence, personal income and spending, to the Chicago PMI. That regional one is important due to the slowdown in manufacturing. Be prepared. We are still not likely to see any changes in the data as we are still in a slowing phase right now that has everyone worried. But note: people will say 'gosh the economy is slowing' and think that the market is going to slow as well. The market factors in economic increases and slowdowns ahead of time. The rally started to distribute and show topping signs before the sub-prime issues became mainstream. Even if the economic data gets worse the market won't necessarily follow because the market is more of a leading indicator. Maybe this correction turns into something a lot worse and is foretelling a serious economic slowdown ahead. We will have to watch how it performs as it rallies further and keep an eye on gasoline prices as well. As noted, ECRI is suggesting a resumption in the expansion, but that can change if there are significant changes in the economy.

We hope you had a great week. It was a lot of fun watching positions run higher, taking some gain, and moving in on some new good movers. This rally is setting up for more upside with the nice lateral move to end the week, and we are looking to play that up to the old trendline channels or highs and see how the market is acting at that point. With that further rally we will have gain ripe for the picking, then we see how the move plays out and whether it shows the strength to continue on or wants to test again. We have our feelings as to what it will do, but we always have to temper that with what the market is telling us and not look at the market with any preconceived notion as to what it ought to do. Have a great weekend and we will be at it again this week as the market tries to rally on up to the prior highs.

By: Jon Johnson, Editor

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

Technorati tags: stock trading stock market investing Jon Johnson Eric Aafedt InvestmentHouse.com

Who, or more precisely what, benefits from higher taxes.

SUMMARY:
- Jobs report continues the rally . . . for the morning.
- Upward revisions keep the jobs report in decent shape.
- Who, or more precisely what, benefits from higher taxes.
- Still some great looking upside plays, but the market looks heavy heading into next week.

Jobs report gives the market what it wants but even that doesn't satisfy it.

After the Monday dump lower stocks fought back all week, rising to next resistance at the bottom of the November/December lateral range. It stalled at that point, but it was just waiting on the jobs report to either send it higher or choke off the rally. As it turns out the market pretty much got what it wanted when jobs came in at 97K (100K expected) with an upward revision to December and January. Lower yet higher. Weaker, but stronger as well. In a market still pondering the Fed's next move the dichotomy was nirvana-like.

The overseas markets were lower, but unlike the prior sessions when the US financial markets deferred to foreign direction, US stock futures surged on the jobs report, running 10 to 15 points above fair value. Looked promising, looked as if the jobs report was the juice to continue the rebound move and perhaps deliver a follow through to the Tuesday reversal.

Of course you always have to view a very strong open with skepticism, and the fact that the market has started a correction underlines the need for caution. On top of that the market spent the week rebounding from the spanking it took the prior week, a low volume rebound that indicated fewer and fewer upside participants. With the correction you knew the sellers were going to take a shot at the early bounce. It was just a matter of time.

That turned out to be at the open. Stocks opened higher but that was the high. Indeed the first leg lower was the sharpest of the day. The indices managed to hold onto positive ground and put in a midday bounce. When the sellers finished lunch they had dessert on the market, driving stocks into negative territory. It took a late session rebound to turn the indices back to positive, and even with that NASDAQ and NASDAQ 100 could not pull it off.

Problem is, they lost their strength after that first move. Volume was low and the indices could not hold the move through near resistance as leadership was scattered and sporadic. If you were looking for a follow through or at least a jobs-induced rally continuation you were disappointed with the marginal, low volume moves higher. As they say on the streets, all show and no blow (or vice versa; I don't know the streets too well).

In the end it was a day where neither the buyers nor the sellers could take the advantage. The market pitched back and forth a few times, but after a week that started sharply lower and then fought back on low volume, a low volume, flat on the close session was about all they had left.

The Technical Picture: Does it make sense this would be a bottom?

In the glow of the jobs-induced higher futures, some financial station journalist majors crowed how they had called the bottom on Tuesday. The resumption of the upside move on Thursday after the Wednesday stall combined with the Friday futures surge was enough proof for them. Of course the week itself in no way proved that hypothesis. Volume was lower each session as the indices climbed back up from the initial thumping. The rebound stalled at the first possible resistance, the 10 day EMA. Though the weekend influence can slow the Friday trade, the fact that the market could not make anything of the 'just right' jobs report other than a weak test of near resistance suggests a dearth of remaining buying interest.

That likely means the next phase of the down leg starts sometime this week given the indices are already struggling below resistance. Monday could still prove to be the bottom if the indices hold at that level and make a double bottom, but this is likely not any knifepoint turn or 'V' bottom. Indeed, there is likely two more pretty sharp downside legs before this correction finds its bottom.

Think of it this way: after a 7 month rally, is a week of sharp selling and a lower volume rebound enough to wring out the froth and set up another 7 month move? In the correction of '06 it took 10 weeks and 3 down legs to find the bottom before the indices found the bottom and started the final phase of the bottoming process. That rally that preceded that correction was 6 months (5 months from the breakout) and covered roughly 150 SP500 points.

The current rally lasted 7 months and covered 225 SP500 points in a much sharper ascent. Now the market doesn't make a habit of acting logically, but it is somewhat consistent in what it needs to decompress after long runs and set up for the next move. If it took 10+ weeks to shakeout a shorter and flatter rally, one week of selling is not going to do the trick on a longer and stronger run.

There might be more upside to this current relief bounce. They can last more than a week and this one is just a week old. The action to end the week, however, suggests it is running out of steam, and it is doing so at the earliest lower resistance level. That does not speak well of the upside conviction. Thus it behooves us to keep our upside stops fairly tight and be ready to play some more downside. Indeed we dabbled in some positions Friday with another dump lower in SBUX and taking an earlier and more aggressive position in some SPY puts. There are many more stock patterns indicating some more downside ahead, and we will cherry pick those that look to be in a hurry to move lower.


THE ECONOMY

Jobs continue steady pace as revisions continue to save the day.

The 100K jobs expected were no great shakes and were in line with the 111K reported in January. Thus when the payroll report slid in at 97K the market did not wince. Indeed, it responded favorably because once more the prior months were written higher. January was pushed up to 145K while December received another 20K boost. As noted above, weaker yet stronger. On top of that, the unemployment figure fell to 4.5% from the 4.6% it was expected to hold from January. What a bonus. The Fed is perceived not to pay much mind to the unemployment rate versus non-farm payrolls, so this was viewed by some as hidden strength in the report.

As we have seen, the household survey reflected in the unemployment percentage is the more accurate indicators for this recovery given the complete bust of so many businesses in the last recession, but you can be the Fed is not overlooking it. There are still those on the FOMC who subscribe to 'Phillips Curve Quarterly', and they view higher employment as inflationary. The PC's acceptance is strange given history debunks it. It is a theory said to apply to the economy as a general overlay for all economic periods, but ironically it only correctly tracks 6 years of economic history. Talk about the exception swallowing the rule.

As for the details, it was not a banner report. Construction lost 62K jobs due to bad weather and the continued slowing (or is it 'sucking'?) housing market. That was the largest decline since a January 1991 75K decline. Hmmm. Services gained a fat 168K jobs, but with the government portion rising 39K and the loss of construction workers, that left just 58K private sector jobs created when the average has been 180K. Government jobs provide nothing to the economy, at least nothing that really pays for itself. They are created with tax dollars and as discussed below that makes them a real drain on the economy. Government does not produce as much as the private sector, it is more wasteful, and thus we get less out of a government job than we do a private sector job. And the tax money it takes to create the job adds an additional burden on the economy in that the money is taken out of the system. The disposable income provided by the marginal government job in no way offsets the economic drain the jobs creates.

Why do we say 'hmmm' about the 1991 comparison? Because that was a time of recession in the US. Recall when we were starting to come out of the last recession we made comparisons to growth rates in the early 1980's when the US came out of that nasty 1970's depression? While so many were badmouthing the economy it was throwing off growth numbers in sector after sector that had not been seen since the recovery of the 1980's. Yes, that means they were better than the 1990's that so many wistfully pine for.

Comparisons on the upside are valid as they are on the downside as well. Of course you have to factor in all of the other variables in your analysis, and so far there is still a lot more strength right now than back in 1991 (that was in the actual recession). It pays, however, not to sweep these comparisons under the rug as some are doing. That is how you get blind sided. The economic data is definitely not as strong as it was in the first half of 2006. The long leading indicators still show accelerating growth, but the apple cart can be upset if mortgage issues grow and impact expectations, causing investors and consumers (business and individual) to pull back. Surprises can happen and thus we are keeping a close eye on this. We are not bearish on the economy by any stretch but we are not as comfortable with it as we were a quarter ago.

Hey, let's raise taxes and cover all of our expenses. What a bad idea.

Despite all of the rhetoric in the election run up about tax hiking as the last resort, there has not been one dime of proposed spending cuts and already there are plans in committees to raise taxes though they are veiled behind claims of eliminating the AMT. Well, some of them are not even veiled. Seems the list of possible actions was rather short with the last resort being choice number 2 (maybe even choice number 1).

It is easy for some to rationalize raising taxes. First, they harp about the deficit, saying it is the largest ever and is going to be a burden on future generations. It is not the largest ever in real, inflation adjusted dollars. As a part of GDP it is running at to below historical averages. It is the household mortgage analogy we used last week: if you make more money you can have a bigger mortgage and it is the same or even a smaller percent of your income than a lower mortgage at a lower income level. In other words, the economy is so much larger now it can afford a higher deficit in dollar terms.

There is also the idea that if you have a $50B shortfall you can simply raise taxes by $50B and solve your problems. Without even considering how Congress will squander most of any gain on pork barrel projects or new useless programs, the reality behind the impact of tax hikes on citizens and how much is actually collected undermines this simpleton belief.

An oft-cited recent report on the effects of tax cuts and tax hikes is being used to purportedly debunk the benefits of tax cuts. Those using it, however, fail to read the entire report that shows tax hikes are much more damaging to the economy and to US citizens. If you raise taxes on dividends by $1 the Treasury gets just $0.50. At the same time it costs the average citizen $2 in lost income plus the additional tax paid. If you raise taxes on all forms of income the Treasury does better with $0.77 per $1 tax increase.

So if you want to raise $50B in tax revenue you have to increase the tax even more, and the net cost to the US citizen is $2.25 to $5.00 in taxes and lost income as a result of decreased economic activity due to the tax. Sure the government gets its $50B, but you and I lose in the form of lower wages, no job creation, or worse the loss of jobs. In other words, there is a loss to citizens above the tax paid in the form of simply lost income through lost wages, salaries and other income. The kicker is this additional burden does not fall on just the rich as the tax proponents claim. It hits the middle and low income the hardest because it is their incomes that fail to rise or fall, it is their jobs that are lost or are not created at all. That means even the lowest end who pay no income taxes are hurt as well because their job may simply disappear or not even be created due to slower economic activity.

The only beneficiary of such a tax is a growing, bloated federal government that gets another huge chunk of money to spend. They sell it by saying they are taxing only the rich, but that money they collect comes at the cost to all citizens far in excess of the extra tax paid. Sure you may not be hit with the direct tax, but is that much comfort if you don't have a job because the additional tax money kept a business from creating another position? How about if you don't get a raise because of the tax?

It is easy to sell a tax hike on the 'rich' because most can understandably only see what appear to be the direct links: raise taxes on the higher incomes and those higher incomes pay the tax and they bear the burden. The empirical evidence, however, shows that the cost of the tax is passed down to all members of society through slower economic growth, fewer jobs, lower wages, etc. Higher taxes divert money to tax shelters, taking it out of the economy. That makes it harder for government to collect and results in more taxes to try and cover the 'tax gap.' It gets worse and worse as we saw in the 1970's, and the result is an incredibly convoluted and inefficient tax code that costs the economy $500B per year just in determining what tax is owed.

If they want to get serious about helping the economy and all citizens, then congress should seriously consider scrapping the IRS and going to a flat tax or a national sales tax. While both have their limitations (they are, after all taxes) they are infinitely better than what we have IF we totally scrap the income tax AND IF the rate is reasonable and not the absolutely absurd 24% to 35% levels we heard from the 'blue ribbon' tax commission. Let's face it, with people such as Heinz-Kerry worth hundreds of millions paying a net tax rate of just 12.5%, there is no way a flat tax will receive any support unless it is at that level. Given the absolute economic boom such a tax rate would create, however, the Treasury would be in the green inside 10 years, not just eliminating the yearly deficit, but the accumulated deficit as well.

By: Jon Johnson, Editor

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

Technorati tags: stock trading stock market investing Jon Johnson Eric Aafedt InvestmentHouse.com