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Index Wrap

It's the jobs stupid - or, you can't fool the consumer

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Consumer sentiment, according to the U of M preliminary survey for June, fell to 87 from 92 in May, well below the forecasted 93. One reason why market folks were surprised by this drop is that optimism usually has risen with a rise in the market - generally, consumer sentiment takes its cue from the markets, but Friday saw the market take its cue from consumer sentiment. Like the CEO surveys, consumers may have (again) turned more negative on the economic outlook. One reason is the continued loss of jobs or no job growth.

The Labor Department indicated this past week that the number of Americans who remain on unemployment benefits rose 120,000, to 3.8 million, the highest since April 1983 or going back 20 years.

As OIN's Jeff Bailey suggested on Friday, those that believe psychology plays a role in how markets trade got some confirmation for their view, as a more bearish consumer "psychology" took the indexes down on Friday. I count myself as a true believer as I've long assessed that attitude about the market plays a major role in valuations. It's what can make the S&P multiple 20 versus 15.

Right now, a further sustained rise in the market is counting on both the consumer to keep spending and businesses to also at least start in opening their checkbooks. People stop spending when they get worried about future income and fear may be on the rise again.

THE BOTTOM LINE -
The indices got rather far extended for the first up leg of a recovering market. I anticipate further corrective action - not necessarily a very steep decline, but with downside to perhaps 960 in SPX, 480-485 in OEX, 1570 in COMPX and to 1185 or perhaps 1165 in the Nasdaq 100 (NDX).

LAST WEEK and FRIDAY'S TRADING -
The S & P 500 (SPX) finished the week with a gain of only 0.1%. The Dow fell nearly 80 points on Friday, to 9117.12 but was up slightly on the week, having a 6 tenths of a percent rise. The Nasdaq was lower by 0.1% (to 1626.49), breaking an eight-week winning streak.

The Labor Department on Friday reported that producer prices fell 0.3% in May, which was more than the forecast for a 0.2% decline. core prices (excludes food and energy) rose 0.1%, which was also just below a forecast of +0.2%.

A large decline was seen at the finished energy goods price level, which dropped 2.6%, as wholesalers continued to adjust prices lower after a run-up ahead of the Iraq war.

Consumer expectations of inflation have also begun to fall off, according to the aforementioned University of Michigan study. This outlook, along with the drop in wholesale prices and other recent data, again raised concerns about the risk of deflation, something that the U.S. Federal Reserve has been increasingly concerned about in recent months.

So, while a decline in prices is normally a positive for the economy, too much of this is not good for the Market as an inability to raise prices keeps a lid on corporate earnings and also then on stock prices in general.

Further economic data released Friday showed the U.S. trade gap contracting 2% in April to $42 billion from March's record $42.9 billion. Despite a weaker U.S. dollar, exports fell 2.2% to $81 billion, the lowest level in a year, while imports fell 2.1% to $123 billion, largely due to a decline in crude oil prices.

So far in 2003, the trade deficit is up 26% from a year-ago. While the weaker dollar has yet to result in a more noticeable impact on the U.S trade deficit, consumer price sensitivity around the world tends to be a more gradual trend and the dollar's declining purchasing power for imported goods slowly starts having greater effect.

An interest-rate cut from the Fed at its policy meeting in later this month is looking to be on track. Friday's economic reports added more fuel to speculation that the Fed will cut the fed- funds rate. Futures market activity Friday suggested that most investors expect a cut of one-half percent. Virtually flat growth in May retail sales Thursday combined with only a slight drop in weekly new unemployment claims had already increased speculation that a rate cut will be forthcoming.

OTHER MARKETS -
Government bonds advanced in price as yields fell, as the latest round of economic news reinforced hopes for a Fed rate cut. The 10-year Treasury note climbed 15/32 to yield 3.11%, while the 30-year government bond rallied 25/32 to yield 4.175 percent.

In currency trading, the dollar was slightly lower against both the yen (-0.2% to 117.44) and the euro, which gained 0.8% to $1.1857.

INDEX OUTLOOKS -

GOLD - If deflation is going to become a problem, we're not seeing it in gold prices, which have been quite buoyant. While much of the strength is likely due to the fall in the dollar - gold prices have to rise to keep the same value in dollar terms - it is unsettling in terms of thinking that equities have clear sailing ahead.

The Philly Gold and Silver Index or XAU is near to a bullish breakout, but bullion prices in terms of the nearest futures (continuous) contract look like they're hitting resistance. What's it all mean? Many explanations, none convincing, but I would normally expect to see less gold strength if we're heading into a bull market for stocks.

Low interest rates are a factor also, as the "opportunity" cost of owning gold diminishes. Also, we can't discount the fear factor in the mid-east about U.S. intentions - gold may have become more attractive than owning dollars.

S&P 500 (SPX) - Hourly chart:

As anticipated, resistance developed on the rallies that carried above 1000. Expect to see the same phenomena at Dow 10,000 and in the inability for the S&P 100 (OEX) to hold above 500. There is something about those big round "milestone" numbers that cause traders to pause or take a wait and see attitude on further buying. It's sort of like Joe and Moe at the door saying: "you first", no "YOU first" ad infinitum.

1020 is resistance implied by the top end of the broad hourly (uptrend) channel as shown on the hourly chart below, with 960 as potential support implied by the lower trendline boundary. The very steady and strong uptrend is especially apparent in the hourly closes going back to mid-March.

The longer that we have such a strong rate of ascent, the greater the likelihood of a more prolonged correction - which is of course what oscillators like RSI, Stochastics and MACD attempt to highlight. These indicators "work" for the approximately 70% of the time that markets are not in one dominant trend.

For the 30% of the time that indexes ARE in strong trends, forget about using oscillators as an automatic guide to buying puts or calls. Eventually the law of averages catches up and we get a pattern like we see above in SPX - lower rally or upswing highs. Because of this I rate it more likely that SPX will reach 960 than having a move above 1000 first.

S&P 100 Index (OEX) - Daily & Hourly charts:

Bullish "sentiment" is still measuring in a neutral range as far as my CBOE equities (call volume relative to daily put volume) option indicator. However, quite bullish buying interest from big investors, fund managers mostly, has carried the S&P 100 steadily higher as can be seen in the daily chart below.

The hourly chart highlights better the correction that is underway. It becomes a relatively shallow pullback if OEX stays at or above 490-492. If so, there could be a further attempt for a breakout type move to above recent highs in the 503-505 area.

What would be more "normal" corrective action such as in retracing half of the last upswing would be a retreat to the 480- 485 area, which is my best prediction of the unfolding pattern here. If you bought puts on the last failed rally attempt, my current trade objective would be 480, but with an exit point or stop at a new high daily close or at 505 anytime.

While the RSI or stochastic can stay up near the extremes for a long time, eventually these indicators get back into the center of their range. The most bullish action is when there is only a sideways correction before the index rallies again. However, OEX is pretty overdue for a pullback.

A definite wild card in terms of some volatile price swings is triple expiration in the coming week, ahead of the FOMC (Federal Open Market Committee Meeting) in the following week. Maybe they'll keep the OEX up near 500 to cause the bears some more punishment.

Dow Industrials (INDU) Daily & Hourly (DJX.X) charts:

9200-9250 looks like the area where there is selling interest (or where buying tapers off) in the Dow Industrials. A daily close above this area is needed to suggest potential for another up leg ahead after only a shallow correction. Hard to figure without further price action if there will be a deeper correction than has been seen so far in the strong rally since the March upside reversal.

The 90 level in DJX could be key here as an area of prior highs - if the Index holds at or above this area, the correction remains shallow and suggests a still strong outlook on a technical basis. A daily close or two below 90 would suggest otherwise - I would then focus on the potential for a possible retreat to the 88 area at the daily uptrend line or perhaps to 87, at the lower end of the hourly channel.

Eventually - especially if the Industrials stay above 9000 - a longer-term objective is for Dow 10,000. As mentioned last week, 2 consecutive closes under 9000 suggest that a top has formed for the time being.

Nasdaq Composite Index (COMPX) - Daily & Hourly:

Will history repeat itself in the tendency for COMPX to have 3 upswings, followed by corrective action? A key to this is what happens if/when the Index retreats to its 21-day moving average, which currently intersects at 1577. If this moving average is pierced on a closing basis, it suggests that there will be another down leg, perhaps carrying the Composite to the 1500-1480 area, where there is likely to be good buying interest again.

Traders and investors may have gotten too bullish relative to the current earnings picture. If this is also too bullish for the future earnings potential will depend on whether there is some pick up in business spending, which will be better gauged in the next round of earnings announcements post-June.

I find the hourly chart to be insightful if you go back a 100 days and can find the broad boundaries of a trend channel. The one shown above for COMPX would suggest that the Composite could be headed back down to a test of the low end of the channel around 1570. 1550 also appears as a key area of potential technical support, as the "line" of prior hourly closing highs.

A close above 1670 would re-confirm the bullish chart picture. 1600 is near technical support and if any pullback holds at or above this area, this is also bullish as it marks a relatively shallow correction.

Nasdaq 100 (NDX) Index (NDX) - Hourly:

The NDX looks like it is headed lower still, perhaps to around 1160 and completion of a 62% retracement. The index would look stronger if it held around 1180 on any further drop. Resistance or selling interest is anticipated in the 1220 area. I would rather buy puts on a rally than calls on a decline. However, a daily close above 1220 would suggest possible more upside and cause me to exit puts if there was follow through strength the following day.

A note for affectionados of technical analysis - prior support often later "becomes" resistance and this includes trendlines. The move back up to the upper trendline had 3 moves to or above the upper trendline line, but NDX couldn't stay above it. The third time marked the start of a correction when it gapped above the line, then immediately retreated.

Nasdaq 100 Tracking Stock (QQQ) - Daily & Hourly:

I mentioned shorting QQQ last week in the 31-32 zone. I continue to look for a pullback to the $29 area as a minimum downside objective. If there was daily close under 29, the Q's look less bullish in its chart pattern. It looks like the 27.5 - 28 area is must hold support. 30.75 is my exit or stop out point currently for short stock or long puts.

It now is looking like the recent spike up on daily trading volume, coinciding with the rally peak (so far), may have marked at least an interim top in QQQ. Nasdaq traders could be thinking more about waiting for the next round of earnings announcements before doing much more scale up buying.

There is downward momentum currently as suggested by the daily and hourly stochastic models.

Good Trading Success!

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