Monday, October 29, 2007

Financials come back to life

- Techs pick themselves back up and financials come back to life, delivering a strong 1 - 2 punch.
- The rest of the world views the US economy as a leper. Expecting a market breakout as a result.
- FOMC decision is on tap for Wednesday and a 50BP cut will spring the next leg.

Market finds some additional leadership as indices attempt to end the choppy earnings trade.

You have to love it you diligently take positions in stocks when they show you it's time to buy even though the market action is questionable. After you move in, the reason why stocks were telling you to buy in then appears when the good news hits and other investors rush in to buy and drive your stocks higher. That is what occurred Friday.

Looking at Friday in isolation, the action was no different from the up-and-down movement seen day today over the past two weeks. The forces that cause the movement, however, changed somewhat. With Microsoft's blowout earnings, technology was back in the leadership mode, coming back from some wobbly sessions over the past week, but this time technology was not playing lone Wolf. The financial stocks finally stepped up to the plate and were taking their cuts as well on the heels of Countrywide Financial's prediction that it would return to profitability in Q4. That gave S&P 500 a new shot of energy lacking for the past two weeks. For once, it was not just Goldman Sachs leading the financials while all others sold off.

The earnings and forecasts of profitability were more than enough to take the sting out of a falling Michigan sentiment report (80.9 versus 82.3) and once again surging oil prices ($91.86, +1.40). Futures were sharply higher, and stocks indeed opened the session with gaps to the upside, even S&P 500.

Unfortunately, as is often the case with strong opens, stock started to sell almost immediately. It is always a risk that a strong open is used by sellers to unload positions, particularly when the market is as choppy as it has been over the past two weeks. NASDAQ lost 32 points off of its opening high right before lunch started on the east coast. That was not a good move given that one of the main reasons for the gap higher was the Microsoft earnings. Once more, however, the market found its bottom midmorning (at least by Central Time zone standards) and started to rebound. The market continued to rebound into the close, fighting off a rather eat last our intent to sell the stocks back down, and closing at or near session highs. It was good to see S&P 500 are really pushing hard into the close and moving to a new session high as the closing bell rang.

Technically, the action was solid overall, particularly on NASDAQ and S&P 500. Stocks started higher, but as noted, they immediately started to move lower. As they have done most all week, however, they resumed the move higher into the afternoon. Even though S&P 500 and DJ 30 struggled to move higher on the week, this low to high action intraday shows that there is some underlying strength in the market as buyers moved in on the lows to accumulate shares. You can call it the Fed bid or just plain old buying on the dips, but either way there was steady buying as the indices held key support during the week (e.g. S&P 500 testing 1490).

As for the internals, breadth improved nicely on both NYSE and NASDAQ on Friday, but it was really lopsided to the downsides for most of the week. Volume dropped off on Friday, but it still held the elevated levels that showed up to Fridays back. As discussed Thursday, volume improved as S&P 500 tested key support at 1490. That increased volume showed that big money was stepping in at that support level and buying into stocks. Thus, even though volume was lower on Friday, we do not view that as an overall negative, though we would've preferred volume to surge as stocks broke higher.

The charts showed a pretty good picture for a change after some pretty weak action during the week. NASDAQ broke over 2800 that acted as resistance for the past two weeks. It did not break to a new post-2002 high, but it was a key move as the index installed at that level. S&P 500 broke over the late September highs that represented the left shoulder in a potential head and shoulders topping pattern. The Dow is not quite bear, however, though it did rise nicely on some very solid upside volume thanks to Microsoft. Once more the indices are breaking up a potentially toppy pattern as they've done on many occasions during the runs higher this year. The rather striking feature of the Friday move higher is that with this move you can see an ascending triangle building on DJ 30. It still has a ways to go, but it is making higher lows below a rather constant peak for the past four months.

With respect to leadership, once more technology took the lead gratis Microsoft, but as noted above, financials were there as well, gratis CFC. It was finally not just Goldman Sachs leading higher in the financial sector, and that hold out some hope or S&P 500 as the market moves out of October and into the last two months of the year. China was hotter than a pistol as EJ, CTRP, BIDU, and EDU to name a few posted strong gains. Metals continue to rebound, in agriculture came back to life as well. Energy was not bad either, but given that oil prices were surging higher last week is not all that strong. The drillers, the tar sand plays, independents, and natural gas producers performed well, but service companies and large integrated companies continued to struggle. Leadership is not really spreading out across the market, but instead just returning to the prior leadership after it paused during this last pullback... with the addition of some financials.


One of the reasons the Thursday night report was chock full of typos was that I was traveling and having to use a new voice recognition software program that still has some bugs in it. After having a bout in the hospital couple of weeks back, I was playing catch up on some economic research that I was undertaking when I had to make that unexpected visit to the hospital. I've been traveling around the country to certain real estate locations to ascertain the status of the commercial and housing markets. First, in the formerly hot housing areas such as Phoenix and Sarasota, Florida, the market is as bad as you hear. In Sarasota for instance, but was told by many in the industry, but they're typically 200 300 houses for sale in any given month. That is the land to 800 to 1000 units over the past six months. When you look at several similar markets across the United States, you understand that the housing market is definitely in a deep slump.

In addition to looking at housing markets, we also were talking with many visitors to the United States from foreign countries. Almost unanimously, the people we spoke with, while more than happy to be here to take advantage of shopping opportunities given the weak US dollar, had absolutely no interest in investing in the United States right now. Over and over we were asked when would things improve in the United States. Almost to a person the view was, things were too weak in the US for money to work here.

That kind of negative sentiment would love to hear. Just as with the stock market, sentiment about an economy can get to an extreme level and indicate that a turn is coming. Right now the sentiment in the rest of the world is that the US economy is bad and getting worse with no end in sight. That kind of sentiment starts brewing the recovery as the smart money starts moving in long before sentiment changes. There are indications that the worm may be turning a bit. The Countrywide CEO may conjure up images of a used car salesman, but he is CEO of the largest mortgage lender, and he is no fool. He indicated that there is liquidity returning to the market, and he has changed his forecast to profitability, not sometime in 2008, but in Q4 2007. Moreover, some very savvy people, Florida region were telling us that the market was very near a bottom, and that another quarter of bad results would likely see the money starting to move quietly back into the area. There are some waiting as patiently as possible to move in, but you get its the sense that some very smart people were already a bit itchy to take action.

The stock market typically show the move start before the actual recovery begins. The market is always leading in its view of the economy. Perhaps the moves in the homebuilders, mortgage lenders and the financials on Friday is the start of such a move. It is still much too early to determine that, but with the Fed actively in the game and likely cut another 50 basis points on Wednesday, there is very good reason for the stocks to start moving higher. In the market in general, you can see former leaders took a pause over the past two weeks to a month starting to move once more. There were fears of a global slowdown on top of the US slowdown. Given that the US still plays a dominant role in the world economy even with a slowing economic picture here at home. These indications that the weakest US economic sectors are bottoming might be one of the reasons that we're seeing the materials, metals, agriculture, and other early leaders starting to move once more as the market sniffs out the recovery long before it is evident.

We can prognosticate a bottom if we want to, but that really doesn't do us much good. We can think whatever we want and the market won't give a damn. All we can do is get the best lay of economic landscape and then look to see what the market is doing and whether or not that corroborates what we think we see. In the end, however, the market tells us what to do because as we've said, the market is the best economic prognosticator.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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