Sunday, June 08, 2008

Oil falls or the stock market falls?

- Worst case scenario unfolds: breakout reverses sharply on oil price blowout.
- Oil blowout is its own worst enemy as world economies, government intervention will work to bring about lower prices, but not without pain.
- The irony of it all: household unemployment survey dismissed in each month's jobs report, but when the market needs an excuse its hypocrisy knows no bounds.
- Wholesale inventories jump, but only because of huge stores of crude.
- Volatility spikes: Bernanke put in a floor with the BSC take under, and Bernanke started to address oil with the dollar, but the French used him and oil got the draw on him.
- Oil falls or the market falls? Been here before.

Thursday breakout washed away by oil price flood.

The jobs report had investors in a sour mood on the jump in the unemployment rate (commonly called the household survey) and futures were lower, but it really didn't rattle the market. After all bond yields fell right after the jobs announcement, but then recovered those losses quickly; a quick flight to safety and then rational heads prevailed. There were reasons the report was not as bad as the headline number and the resulting gloomy headlines made it out to be, but nonetheless the market got off to a modestly slower start.

What did not recover from early gains was oil (recover, that is, to lower levels). It rose through the pre-market, continued through the morning, and then simply exploded in the afternoon. It closed at a new high at $138.48, up $10.69. It was the biggest single day percentage move since 1991. Why did it move? Some said Israeli threats to attack Iran's nuclear facilities added to the spike. Morgan Stanley issued a prediction oil would be at $150 by July 4, and oil got a head start on that move Friday. Now where is that Iraqi oil that was supposed to be a boon?

Oil's charge sent waves through the financial markets, swamping all of those areas that turned positive of late. The dollar turned lower helped to the downside also by comments from Trichet, the head of the ECB. After begging the US to do something about the dollar and getting Bernanke to broach the subject Tuesday, Trichet slapped Bernanke in the face with the announcement the ECB will hike rates next month. Interest rates, after shrugging off the distorted unemployment number, could not overcome the oil spike as investors ran to safety in treasuries (2.38% two year, 3.92% 10 year). Gold surged back over 900 (905.20, +29.80). Growth stocks and their Thursday breakout were undercut.

Indeed, the oil spike reversed the Thursday growth sector breakouts and destroyed the NYSE large caps as transports reversed and financials were murdered yet again. The Thursday gains were returned unopened with things really getting out of hand late in the session when a last hour bounce failed and the indices slumped to new session lows. There was some panic selling late as even the energy stocks reversed their strong early gains. Some profit taking on those after the spike, but also the concern that the oil spike was overdone and calmer heads may prevail over the weekend (or some discussions about opening the SPRO). We sold some positions that were breaking below support, but given the panic move we were not just bailing out of everything. If it was holding support nicely we let it ride to Monday even though there may be more weakness Monday. If they hold up they are in position to bounce. Being in position and actually bouncing are of course completely different things, particularly after this kind of nasty reversal.

TECHNICAL. Low start to a low finish with only a couple of hour to hour and one-half attempts at rebounding. All things considered, that is not bad; have definitely seen a lot worse on downside sessions. The best attempt to move higher was from midmorning through lunch, but that was before oil just blew past anyone's comprehension. That rally failed. Low to lower, giving back the breakouts. Obviously poor intraday action.

INTERNALS: Breadth was impressively negative at -4.4:1 on NYSE and -4.3:1 on NASDAQ. There were a swath of new highs on NYSE as energy, ag and metals stocks made early gains but then reversed. Thus you have the odd condition of a surge in new highs as well as a crush of negative breadth. Safe to say that you can toss the new highs data in favor of the negative breadth. Volume was surprisingly mixed. NYSE volume jumped to its highest level in 2.5 months. Clear dumping, and with the financials getting a serious helping of the licking, easy to see why volume jumped. NASDAQ trade lightened a bit. It was still above average but was in the ballpark of the recent trade and was lower than the Wednesday and Thursday upside sessions. Tech stocks were sold, but not with any additional vigor; investors still see them as the place to put some money and they were not out and out getting rid of them.

CHARTS: The Thursday breakouts over the May highs by SP400, SP600, NASDAQ and NASDAQ 100 were dumped. The small and mid-caps are still in decent shape given they basically just gave back the Wednesday and Thursday moves, but that does not mean they are unharmed. The reason for the breakout was undercut and now they have to prove they can hang onto the prior gains and set up once more. SP500 made a new low on the selling, confirming its downtrend. DJ30 made another new low in its downtrend, reconfirming its weakness. NASDAQ turned back below the 200 day SMA and 2500, falling the March 2008 up trendline. It has not made a new low on this move. It did not suffer distribution. It is at a point where it could form a double top a la DJ30, and we see what that did for the Dow. Different index, different investors, and many are still talking as if tech is the place to put money. They will have to put that money where their mouth is and prove it.

LEADERSHIP: There were stocks that held gains to the close. Coal stocks. Some energy stocks, but as noted, a lot of energy gapped higher and rallied only to turn negative by the close. Profit taking perhaps; worry the spike may be too much and some of the drivers (Israeli threats) may soften over the weekend. Energy is still strong, but at some point it eats itself as it prices itself out of widespread usage. Most of the leaders before Friday are still in good shape; they just gave back the Thursday move. How they respond from here will tell the real story.


A new leg in oil or a continuing blow off?

Last time oil hit this region (all of two weeks ago) it quickly reversed as data showed even before the spike occurred that gasoline usage was down. With Indonesia, Malaysia and others lifting or in the process of lifting government subsidies on gasoline, this spike is going to destroy more demand. It will also curtail other economic activity as travel, air, ground, or otherwise, is truncated. Of course, here in the US we want to pile a carbon tax onto everyone in business right when times are bad. Hmmm.

This after thirty years of neglect during good economic times with no energy plan forthcoming. Oh as we noted a couple of weeks back we do have an energy plan: every time energy prices rise Congress holds hearings to point the finger but no one is guilty; prices just rise when events (weather, geopolitical, etc.) cause them to rise. This time there is no storm, no ongoing international intrigue driving prices temporarily higher. This time there are two huge countries with huge populations coming to the industrial table and taking what is theirs. If the US catches cold they just suck up more oil because our demand declines.

No, we have sat back after the 1970's warning, preferring to set ourselves up once more for a shock that won't go away outside of a significant economic decline on a global scale. Even then, once the economies recover, the problem will arise again. A likely response, despite the Bush administration's adamant stance, is to open the SPRO to try and take some of the speculation out of price. There is a lot of supply, it is just fear of a cutoff of the supply that is driving price. Opening the SPRO would help . . . but just a bit.

This is what the SPRO is for, i.e. a debilitating rise in prices such that the economic vitality and thus the security of the US is threatened. With an $11 spike in oil during an election year, Congress will want to do something, and the SPRO is ready-made, quick, and easy. It won't solve the problem of course. We have yet to address the problem. We have raised our food prices and denuded millions more acres of our country for corn production with an ethanol program with dubious potential results in the best case scenario. We won't drill for oil, we won't use goal gas, we won't build nuclear plants, Ted Kennedy (whom our prayers go out to) doesn't want wind turbines off his beloved Massachusetts coastline.

Thus we are going to pay the price of debilitating fuel costs AND the costs associated with getting our land-based vehicle fleet off internal combustion of fossil fuels. We are already paying a hefty price in the greatest transfer of wealth in the world's history with our monthly purchases of foreign oil. Worse yet, we get nothing from it. It is like renting; you have a place to live and survive, but after the lease is over you have no place to live. With these price spikes taking more of our wealth away and our ultimate need to shift to an alternate fuel source (and at a time when we are struggling economically), we will be lucky to come out of this still an economic superpower.

That is, unless we do it right. Some want to use the old stick method: tax those that are viewed as benefitting from the spike or having 'more' and dolling it out to those who are in need and also using some of the money (tax money, that is) to 'attack' the problem, basically redistributing the money to where our leaders feel is best. History demonstrates that doesn't work, or you tend to get a preordained solution, and that may not be the best solution. The carrot has proved to be the best method: provide incentives to do the research and come up with a viable solution. Give tax credits for R&D and manufacturing. Give better patent protection to further incent innovation and creativity. In this way we spend the money (or more accurately, allow those who make the money to spend it) and get something in return: a solution, the technological advantage that solution gives us (new technologies arising similar to after the space race, just what we need to get the world to come to us to buy as we grow old), the associated economic advantage (no longer shipping 25% of our wealth overseas), improved health and thus lower medical costs. The list of positives is simply tremendous. You don't even have to juxtapose it to the negatives if we don't, but they only make the decision more imperative. Why spend money and get nothing? Let's unleash our ingenuity and entrepreneurship and get our financial independence and technological lead just as we have always done. In short, let's allow ourselves to be great once more.

Jobs report is not the stinker the headlines make it out to be.

It is indeed ironic how the household survey (the unemployment number) is month in and month out ridiculed as a poor indicator of the true jobs picture. Just last week there was an argument on a financial station about it, and one pundit very self-assuredly commented that 'everyone' knows the household survey is a poor indicator of the jobs condition. Heck even Alan Greenspan said so to Congress.

Of course, he was wrong. In the recovery from the 2000/2001 recession it was the household survey that showed people were indeed working. They just were not working at traditional 9 to 5 jobs because there were not any. They created their own businesses in the explosion of LLC's and other small companies at that time. Thus the non-farms payroll report simply did not pick them up because hundreds of thousands of people started their own companies and were no longer employees.

Then when it posts a really bad and anomalous result such as the 5.5% reading in May versus 5.0% in April, suddenly the household survey is telling the true economic story. Give me a break.

First, it depends upon what kind of recession you are in and what kind of recovery. This one is not like the 2000 recession where there was massive consolidation of the tech and internet industries with millions laid off. Those jobs were not coming back because the industries underwent fundamental change. That is not the case here. Second, there were reasons the reading was off. April posted a surprise drop from 5.2% to 5.0%; no real reason for it and it was viewed as aberrant. In May there was an influx of job seekers into the market from the teen and young adult demographic. The government adjusts for these in the June report. This year due to a lot of changes in school attendance schedules they hit the market early and were not adjusted for. If you make the adjustment you get . . . 5.2%. This is exactly where the number has run of late.

Thus the jobs report that showed a 49K decline versus the 60K decline expected and a properly adjusted unemployment rate of 5.2%. That is not bad. That is not a 'recessionary' number as the more hysterical were calling the erroneous 5.5% reading. The market saw this and was rather calm in the reaction. As noted, it was the oil spike that set the pace for the session.

SUM: The Friday data did nothing to change the economic data trend.

There was other economic data for the day. Wholesale inventories jumped 1.3% versus the 0.4% expected and the 0.1% gain prior. That was viewed as a negative as well given higher inventories can indicate slower economic activity, causing goods to pile up. Plausible argument, until you look at what the cause for the rise is. In April the largest contributor to the rise was a massive build in, of all things, crude oil stockpiles. The economic reports Friday were just dripping with irony.

To the point, Friday none of the economic reports did anything to change the improvement in the economic data registered the past couple of months. The jobs report failed to make an adjustment. Wholesale inventories surged because the main problem Friday, oil, jumped in supplies. The data is improving. The big issue confronting the economy, however, is oil and its second surge over 130. That is what threatens the modestly improving economic data. It is our judgment based upon what we saw in the reaction to oil hitting this price level with respect to demand destruction and alterations in consumer and business habits that this level is the choke point, the Roberto Duran 'no mas' point.



You are hearing the talk, the 'Black Monday' talk. Every time there is a nasty Friday selloff in weaker economic times you get the 'you know, this reminds me of the Friday before Black Monday' reminiscence. That is fine. Actually that is good. Go ahead and ratchet up the anxiety and let's see if we can get this over quickly. Sentiment is hard to get a handle on. It has to get really bleak. It is not candy and roses out there now, but a few remembrances of Black Monday is not quite there.

Big bounce in volatility, the largest single session move since the March selling just before the market put in the bottom at that point. That was on the crescendo of the credit issues with BSC take out. Now VIX is not in the same league that would register a bottom. The January and March lows found 35 to 37 as the sweet spot; at 23.56 VIX is not there.

The Fed changed the game when it attacked the credit issue in new and creative ways in March. It worked. Problem is, now there is a completely different issue that is out of control, and that is the surging oil prices. After quelling the credit issues Bernanke turned to inflation, and he includes oil in the inflation equation (remember the Fed shifted to looking at overall inflation versus just the core?). Tuesday he made the seminal address of the Bush administration on dollar protection. Sad that it has to come from the Fed in the last year of an 8 year presidency, but at least it came.

It helped pump up the dollar and oil and gold started down. Trichet, the head of the ECB congratulated Bernanke Wednesday, then cut his legs off Thursday by announcing the ECB would hike rates a quarter point next month. The dollar fell, gold shot higher, oil exploded. Bernanke must want to slap Trichet, challenge him to a duel, or something similar. Certainly this was not coordinated; it could have been handled so much more subtly. We know the French don't like Bush, but don't take it out on the rest of us.

You know what is going to happen? We are hearing from across the Atlantic that many businesses in Europe are experiencing sudden slowing. Oil is really hurting them as well even though they are more efficient with their nuclear plants, more efficient autos, etc. Trichet is so focused on inflation (he has to be; that is his only mandate), he will not back off to give the economies some breathing room. The irony is, if they slow down, there will be inflation.

That is the way it works. When economies slow supply falls off because businesses pull in and demand can easily run past supply, especially when things turn back up. Trichet has to walk the tightrope with his single mandate and that means if he smells inflation he hikes. It builds on itself as further hikes slow things further bumping up inflation. Then things go slack altogether. There are a lot of proud traditions in France and all of Europe. One of their traditions is thwarting economic expansion before it risks getting really healthy and entrenched. Vive la France!

VIX: 23.56; +4.93
VXN: 26.04; +3.19
VXO: 24.8; +5.39

Put/Call Ratio (CBOE): 1.15; +0.17. Back over 1.0 on the close. That makes it 4 of 5 closes over 1.0 and that is getting to a healthy level. Ten or eleven would be a better indication of wanton speculation on further selling and fear from the big money managers that the downside will continue (and their buying of protective puts).

Bulls versus Bears:

This is a reading of the number of bullish investment advisors versus bearish advisors. The reason you look at this is that it gives you an idea of how bullish investors are. If they are too bullish then everyone is in the market and it is heading for a top: if everyone wants to be in the market then all the money is in and there is no more new cash to drive it higher. On the other side of the spectrum if there are a lot of bears then there is a lot of cash on the sideline, and as the market rallies it drags that cash in as the bears give in. That cash provides the market the fuel to move higher. If bears are low it is the same as a lot of bulls: everyone is in and the market doesn't have the cash to drive it higher.

Bulls: 44.8%. Despite the prior week's selling and the weak rebound, bulls surged higher from 37.9%. that quick drop lower from 47.3% the prior week seems to have evaporated. Did its job, however, as the market broke sharply higher. That quick decline occurred after a string of steady gains: 44.4%, 40.9%, 39.1% and 37.8% where it held for a few weeks. Fell to 30.9% in mid-March as the low. The indicator did its job with the dive below 35% and the crossover with the bears. The bulls and bears were eye to eye in mid-February and have crossed. A move into the lower 40's is a decline of significance. A move to 35% is a bullish indicator. This is smashing that. For reference it bottomed in the summer 2006, the last major round of selling ahead of this 2007 top, near 36%, and 35% is considered bullish.

Bears: 31.1%. Bears fell but not nearly as dramatically as bulls (32.2% the prior week). This after a couple of weeks of surprising gains as the market bounced. Up from 30.8% the week before and 29.9% the prior week. During that strong three of four weeks saw bears rise. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March that was up from an already freakishly strong 43.3% the week before. That was a surge from an already high 36.6% the prior week. Up sharply from a low of 19.6% on the last rally. It is over 30% and indeed over 35% the prior week, meaning it has blown past the range that means business. Big move after falling to a low of 19.6% on this round. Bearishness peaked at 37.4% in September 2007. It topped the June 2006 peak (36%) on that run. That June peak eclipsed the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005). This is a huge turn, unlike any seen in recent history.


Stats: -75.38 points (-2.96%) to close at 2474.56
Volume: 2.136B (-4.8%). Lower volume on an ugly downside session. With this kind of point loss you don't get too worked up over a bit lower and still above average volume on the selling, but there is an important aspect to this and that is despite the wrecking ball hitting the market, the sellers were not stronger than the buyers on the upside. May be nothing at all given the severity of the selling, but we will continue to look for tech opportunity if it turns back up after they hold near support.

Up Volume: 238.169M (-1.615B)
Down Volume: 1.945B (+1.568B)

A/D and Hi/Lo: Decliners led 4.33 to 1. Ouch. That is all: ouch.
Previous Session: Advancers led 2.88 to 1

New Highs: 64 (-33)
New Lows: 149 (+60)


Thursday night I talked of NASDAQ missing the May intraday high by a gnat's b*tt. Might as well been an elephant's, huh? It gapped lower, ripped through the 200 day SMA for a 3% single session decline. Damn. But . . . there is that lower volume. NASDAQ still held above the rising lows in its uptrend (on an intraday basis). It held the March up trendline on the Friday close. It was one day of sharp point losses, and that left it at an important point all in one session. How it responds from here is the key, but I want to point out that techs were not the whipping boys on Friday. They got whipped, they just were not the focus of the flogging. That said, you also have to worry about a potential double top formation similar to the one that took out DJ30. A pair of highs at 2525 stalled it out.

NASDAQ 100 (-3.15%) fared a bit worse but it too held the March trendline, the steeper one formed second. It too has that potential double top in place.

SOX (-2.89%) turned in a lower high and fell back below the 200 day SMA. It also made a slightly lower low. Very dicey here after looking quite solid with its break back up through the 200 day SMA.




Stats: -43.37 points (-3.09%) to close at 1360.68
NYSE Volume: 1.484B (+12.92%). Volume jumped to its highest level in over two months as the NYSE indices turned over. Sellers took control, especially on the large cap indices in the NYSE.

Up Volume: 115.001M (-988.023M)
Down Volume: 1.366B (+1.185B)

A/D and Hi/Lo: Decliners led 4.46 to 1. Ugly. Coyote ugly.
Previous Session: Advancers led 4 to 1

New Highs: 138 (+32). New highs aplenty as the energy sector jumped higher early on.
New Lows: 145 (+63)


Gapped lower, unusual for SP500. It sold off 43 points. Also unusual for SP500. It undercut the recent lows, broke the neck in its head and shoulders. Makes it a logical short here; a bounce higher to test the neckline at 1375 would make it even better. Support down at 1325. Not very pretty. Failed at the 200 day SMA on the high, sold to the neckline, bounced back up but failed at 1406, a familiar level, and fell again immediately after trying to break up the pattern. Without the financials participating and the small and mid-caps selling, SP500 was doomed.

SP600 (-2.95%) reversed a beautiful breakout and gave up the 200 day SMA all in one session. It held the 18 day EMA, and that keeps it in decent position, but it now has to prove it can still hold and continue the move. With oil over $130 again, however, the economic outlook is cloudy at best, and that should continue to negatively impact SP600.

SP600 Chart:



Broke below its neckline at 12,250 where it bottomed in April as it completed the left shoulder to the 9 week head and shoulders. As with SP500 that makes DJ30 a logical short even with a 400 point drop. It would be better to get a bounce out of it given that drop, and if DJ30 sells off on Monday then you look for a rebound first before shorting the next drop from this pattern.

Stats: -394.64 points (-3.13%) to close at 12209.81
Volume: 307M shares Friday versus 236M shares Thursday. As with NYSE, the biggest trade in 2.5 months and on a massive drop lower.



Black Monday? Give me a break. It will be what it will be, and you can bet oil will play the key role. We will watch this weekend to see what the geopolitical climate holds (Israel/Iran and whatever else arises) and what our fearless leaders in Congress, the administration, and the Fed say. Maybe some mitigation of the tensions that helped trigger the spike on Friday and the late panic selling in stocks. Maybe not.

Whatever the case, oil will have to drop a long way to make a difference. It has to get below 120, over 18 clicks from the Friday close. Not counting on that right away. We said two weeks back that either oil would go lower or the market. Oil started but it was just a feint, at least on this move. After a duck lower and the market's jump higher, they did their version of trading spaces and reversed roles. Now it looks as if the market is going to head lower. The economy is already weak, and this is piling on. It simply cannot withstand this kind of surge in prices. Filled up all my fuel tanks after the close (vehicles, four wheelers, boat, Gator, all fuel tanks) and had to loan a neighbor $66 and change for 14 gallons of diesel (she forgot her purse). Prices are projected to rise 15 cents/gallon or so this weekend as a result of the Friday spike. More of that $150B in stimulus will be burned in the fuel tank. That is not going to create any jobs or jumpstart us out of recession.

Near term even a drop in price won't forestall near term pain. Oil was making the drop you wanted to see, but it held the trendline and surged with a vengeance. Now we can say this: as a trend ages, the moves become more volatile. Teach this all the time in my seminars. The first bounces after a breakout are nice and even and nice and orderly. As the run ages and starts to peak, however, the up and down moves get more volatile. That is a sign the move needs to correct back, rest, and try to reload. This last move would certainly qualify as volatile. Violently so I would say. Still in a classic uptrend, but with the massive volume (and we thought the volume a week ago was massive) and ballistic trajectory of the move you have to be thinking about a blowoff top. The beauty of that is the fall can occur quite rapidly, and that is what the economy needs: rapid rise, then a stomach dropping plunge. Blow off tops, by the way, can result in a 50% reduction in price. Wouldn't that be sweet? Too good to be true, but while exploring a possibility let's take one to the extreme and smile for a minute. A blow off could produce that fall below 120, however, and that would put oil looking at a test of 100. That would be nirvana compared to where it is now.

The weekend could make a bit of difference as noted. The SPRO could be opened, providing a temporary respite, a bit of a rah-rah, B-12 injection to confidence. If there is no change to how things were left Friday, then Monday could very likely start downside once more as more try to get out of positions given that there was no weekend change. Unless there is a reversal and relatively quick collapse in oil prices, however, we fear there is a lot more downside driven by oil prices that finally hit the choke point for the economy.

That means if we do get a respite to start the week we will look at using that to lighten some upside positions and prepare to play some downside as SP500 and DJ30 reach up toward the breakdown point in a relief bounce. Many of our positions held up quite well Friday considering the bloodletting in the market, though in one day they are down to testing support, not the kind of orderly pullback you like to see. Nonetheless, if they were holding support we left them alone for the most part as there was some fear selling in the afternoon. If they were breaking support we sold them; may rebound but with the floor broken out and a lot of downside momentum we did not want to ride them lower.

The character with respect to the growth indices that were performing well started to change Friday. They did not break down but a breakout was derailed and they are now in position of needing to prove once more they can rally. With oil spiking that is going to be a heavy burden and thus we have to protect positions that are unable to hold support. If there is a gap lower Monday it is best to let the initial drop run its course and see if there is a concerted effort to buy the dip. If so, those stocks that held near support and remain in solid patterns are potential upside buys for the bounce move. Those that break down are potential downside plays as they bounce and stall at resistance.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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Sunday, June 01, 2008

NASDAQ Leads Market to Weekly Gains

- NASDAQ leads market to weekly gains, but still no new breakout.
- Economic data in line to better, and while no great endorsement of economic activity, things are not as bad as made out.
- Market advance since March forecast modest economic improvement, but is there more to come?
- Some money comes out of commodities stocks on NYSE, but has yet to move elsewhere.
- New month, some new money, but also the dog days cometh.

A week of gains leave market still seeking a more definitive move.

The shortened week was one of gains, and Friday was no exception, though the gains once again were not felt throughout the market. Spending and income were in line with modest gains (0.2%) though if you adjust for inflation both were big goose eggs. With PCE inflation at 0.1% on the core and 2.1% annually, however, investors found some reason to push stocks higher at the open. When the Chicago PMI and the Michigan sentiment reported better than expected results, the market added to its early gains with all indices in positive territory.

The market survived a midmorning test of the early move, and then went into a slow, steady climb into the afternoon. It was the end of the month, however, and that meant money was going to get moved around. It was. In the last hour the indices dropped sharply in the fist half of the hour, then recovered just about up to session highs. A literal last minute decline shaved 6 points off NASDAQ and 40 points off DJ30, leaving the Dow negative on the day. With the overall narrow range for the session and the end of month shuffle, it is somewhat pointless to play 'pin the tail on the meaning of the session.' Best to look at the entire week to get the flavor.

The week showed gains on all of the indices as they rebounded from the sharper selling in the week before the Memorial Day of honor. Those gains, however, were modest and left the indices, overall, shy of significant moves that reverse that downside move. Of all the indices only SP600 and Russell 2000 broke new closing high ground for the rally off the March lows. That the small caps led to new high ground in the rally is significant given their close ties to a stronger domestic economy (hurray!), but the fact that the majority of the other indices did not really even scare new highs leaves the continuation of the rally somewhat problematical.

Again, there were solid moves in individual stocks, and we bought into quite a few of those in anticipation of the small and mid-caps continuing to lead higher, but as is often the case, we tend to buy in when things are unsettled because emerging leaders tend to tell you to buy them when the outcome appears still problematical. Many pronounced the rally dead two Fridays back after that reversal at the 200 day SMA by the large cap indices. You have to like that pessimistic view from a contrarian standpoint, but it sure would have been nice to see some of the other indices come along with the leading stocks and SP600.

TECHNICAL. Low to high action intraday Friday was again a positive for the session, but it was a volatile day inside an intraday trend higher. The action in the last hour showed how fragile the move was as end of month shuffling easily shoved the indices down then up then back down as some window dressing and positioning for the coming month took place. Hey, that is normal; we participated in that as well as we picked up several positions in solid stocks that broke higher and then held their gains into the close with modest pullbacks that gave us some good entry points.

INTERNALS: The advance/decline line was nothing special with 1.2:1 readings on the indices. Volume advanced, moving to above average levels on both NYSE and NASDAQ. That suggests some accumulation on the session, and given some of the moves in leaders that was the case, but it also is simply a characteristic of some end of month portfolio adjusting and positioning both for window dressing in some monthly reports as well as getting ready for the next month. The new high/new low ratio lagged a bit on this move over the prior 7 weeks, suggesting this last rebound is not as strong as the previous upside legs in this rally. New lows were a bit more prominent on this dip than in the April decline that more or less matched the last decline. A bit of deterioration in the quality of the move based upon this indicator, and frankly, the other indicators paint a similar picture.

CHARTS: As noted, the indices rose on the week but with the exception of the small cap indices and a new closing high on NASDAQ 100, there were no new rally highs. The large cap NYSE were again the laggards, coming nowhere near the prior rally high before the latest significant downside leg in the rally. Note that in the week following the April downside leg (the leg that the last pullback most closely matched in points) the indices bounced right back up to new rally highs. Not nearly the case on the large cap NYSE indices, and NASDAQ, even with its move back over the 200 day SMA on Friday, did not move past those prior rally highs. That leaves a major challenge for the week ahead for the rally to survive. Either new leadership in the small to mid-caps takes over and drives the rally further or the large cap laggards will drag it down.

LEADERSHIP: Speaking of leadership, there was a continuation of the same theme from later in the week as some new areas asserted or reasserted themselves. Technology both large and small put up some decent gains. Growth areas in medical areas (biotechs, medical appliances and equipment) posted gains. Industrial stocks (and this does not mean large industrials) led all week. Small foreign financials were up once more. It did not hurt that some commodities and energy stocks scored gains to end the week even with the declines in the underlying commodity prices on the week. There are many smaller issues and overlooked large cap issues that are setting up nice patterns and moving higher, flying under the radar. Thus despite the sluggish upside last week, there is good promise ahead for the coming week.


Things are not great, but they aren't as bad as they are made out to be: welcome to the politics of economics.

Remember back in 1992 when the recession from 1991 (the economy was already pulling out of recession in 1992) was described by some as the worst since the Great Depression? Please. Classic election year hyperbole. It was in fact one of the shallowest, but everything is magnified and distorted in election years. It is similar to a court case where both sides highlight and argue the points they view as the most important to the case. They are often arguing about the same facts but the presentation based upon perspective is truly different. You can take any angle, any data point, and build an argument. As we always try to do here, however, you have to take it all into account and not cherry pick an indicator or data point and build a case around it.

Right now the economic data is not that great. It shouldn't be, however, given that the economy is still in a slowdown and is not even a year out from the credit issues that put economic activity in a deep freeze for several months in 2007. To think they should be roaring ahead so quickly is rather absurd simply because it takes time for that freeze to ripple on through the economy.

At the same time, the economic condition is nowhere near as bad as it is made out to be each night on the news. There are indeed serious problems with oil over $120/bbl (closed at 127.71 Friday) and food prices surging given we have opted to tie our food prices to energy prices, but the data also tell you that the economic times, while down, are not the typical stuff of major slowdowns.

The Friday data underscore that. Consumer spending and income rose 0.2% for April, down from 0.4% in March and stood at 0% when you factor in inflation. Since the start of 2008 and the mediocre GDP growth exhibited, however, consumer spending is still flat to trending slightly higher and NOT declining as the media would have you believe. Those big energy price increases and the declines in home prices are not sending consumption negative, but have only slowed the growth in spending. Not bad given spending will only increase over the summer into September as the stimulus checks fans out across the nation.

The key takeaway from this data is that while spending and income point to sluggish economic conditions, there are not those negative readings that are so pernicious and are associated with serious declines in economic activity.

Michigan sentiment stays in the 50's.

But what about consumer confidence and its impact on spending? Both the Conference Board's reading and the University of Michigan show confidence levels in the fifties, and that is historically associated with recessions. What about a recession now?

By our measure of a recession, we have been in one. We said that back in Q4 when the market peaked and rolled back down given all of the volatility we were seeing. To us a recession is not the textbook two quarters of negative GDP growth but the relative decline in economic activity from the growth trend. After humming along at 3.5% to 4.5% growth rates, a decline to 1% or less GDP is a recession. All of the market volatility and the pullback in economic indicators showed a significant change in the growth trend that would be more than just a normal pause in a continuing uptrend.

The consumer sentiment indicates that as the case even as GDP has held positive though well off its prior established growth trend. Is this lower sentiment predicting a recession to come? Conventional wisdom would say that if the consumer is worried spending will contract and that will translate into slowed consumption in the future and thus even slower economic activity than seen to this point. Indeed that is what you hear right now on the financial stations with respect to the housing shoes still to fall.

Historically, however, sentiment is lagging because it is an emotional indicator. It remains suppressed or declines further even as the economy begins to improve. Levels in the fifties are associated with recessions, but they hit those levels after the damage is done. Just as corporate CEO's remain pessimistic even as the economy recovers and their own numbers improve, the consumer remains emotionally battered even as things recover simply because you are not where you were before the economy hit the skids. Thus, while sentiment continues to slide and this is a cycle low for Michigan sentiment (78.4 in January and a constant slide since basically the start of 2007), it does not presage further economic weakness in itself.

Improvement in the economic foundation has been priced in. Is there more?

As discussed Thursday, the foundation in the economy is improving as certain pieces fall into place, e.g. a top in gold, a higher low in the dollar, a breakout in real interest rates (i.e. not inflation), some serious distribution in oil. Those are all positive set ups for further economic improvement.

The market has priced in this economic improvement, or should we say, the lack of a serious further economic slowdown as GDP skirts negative and the Fed's innovative actions taken last year and early this year (in particular this year) thawed the credit market and put that part of the economy on the road to healing. Hence the March bottom in stocks coincided almost perfectly with the Fed action re BSC and its broader use of facilities to get the liquidity to where it was needed by letting just about anyone bring their junk collateral to the discount window, get a 28 day swap for money, and thus conduct business as necessary. The inability to do this is what killed BSC; the Fed took the steps to ensure none others would fall in that manner.

Is this economic set up going to lead to more growth or has the stock market priced this in already and this last leg higher and the failure to make a new rally high indicates that there is no more? After all, oil sold hard and was under distribution, but it did not break its trend. It closed at 127.71, bouncing back 1.09 Friday after some nasty downside sessions the past week. It is under duress, but unless it falls near 100 the economy, and thus the market rally, are in jeopardy. When oil spiked to 135 we found the choke point. It needs to back off sharply from that for the economy to really benefit.

ECRI, the best human index for predicting economic cycles, was up the past week, hitting a 22 week high. That, however, left it at -6%, still indicating the same kind of recession-like sluggishness the economy is feeling right now. Not a nasty tank lower but not much of a recovery there either.

Indeed, the slowdown, as noted above, was not this massive turn to negative GDP growth or the same kind of 10% GDP to negative GDP growth rates seen in the last Greenspan recession from 2000 (though you could call the current one his as well given the sorry state he left things in). No big slowdown means no big backlog of pent up demand that is typically the catalyst for a strong recovery. Modest slowdown, modest recovery. Equal and opposite reaction.

That could very well be one of the probable paths ahead, particularly with the type of stimulus the federal government decided to bestow upon us. This is the same kind of rebate methodology that failed to stimulate the economy in 2001 and 2002; it took the business side stimulus to unlock the economic potential once more. A bit more of the same would not hurt, particularly given the continuing pundit angst over housing. Will a few hundred dollars change consumer buying habits if their home values continue to fall as they need to do? Of course not. Better to give businesses, small and large, incentive to invest to create new jobs and hire more workers. That is how you get a recovery ramped up.

Thus the current market rally needs that something extra to get it going. We noted that Thursday when we said that a break in oil's uptrend would be the goose the market needed. That did not come last week despite some ugly downside sessions in oil. Thus the market is holding back as it needs something new to price in. Some might even say its failure to make new rally highs even as oil struggled suggest oil is not going to break its trend. That means we just have to wait and see if that occurs, watching how leaders perform in the interim.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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