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Index Wrap

A mouse for now, but watch for rats

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Maybe my head has been in the clouds and recent news about some banks that offer their own line of mutual funds having allowed some of their special clients, notably hedge funds, to buy and sell mutual fund shares after the 04:00 PM EST close is really no big deal and limited to just a few fund families.

However, here we are with some Enron executives just now pleading guilty to fuzzy accounting practices, where clever accounting initiated a much broader investigation into less than standard accounting practices, which brought down and helped drive telecom giant WorldCom into bankruptcy, when somewhat misleading accounting methods were discovered.

As Jim Brown quipped in yesterday's Market Monitor in regards to a former Enron treasurer pleading guilty to charges of conspiracy and being the first Enron executive to go to jail, "Having one Enron person plead guilty to conspiracy means there are definitely others to come. Hard to conspire by yourself as it takes more than one to conspire. Somebody is sweating harder today."

Now it looks to be a few bad apples, or maybe an larger crate has succumb to greed. In Arthur Andersen's case, some auditors may have felt the need, or greed, to allow some clever accounting practices get swept under the rug, which eventually crippled the firm as other clients of Andersen quickly found a new auditing firm so as to avoid any guilt by association. While New York Attorney General Eliot Spitzer announced a probe September 3 alleging New Jersey hedge fund Canary Capital partners made illegal and improper trades in some of Bank of America's (NYSE:BAC) $75.60 +0.97% funds, and that an executive at Banc of America Securities has been fired and a Nations Fund broker has left even as the banks mutual funds appear to be trading normally, a Stanford University study revealed after-hours trading of mutual funds for special clients when after-hours market moving news had been released, has been practiced by more than just a few mutual fund companies.

Morningstar Inc., a global investment research firm, recently recommended its investors to sell their shares in Nations Fund funds except those co-managed by fund manager Tom Marsico.

"There's been a big violation of trust here," said Laura Lutton, a Morningstar analyst. "The beauty of mutual funds is that all shareholders are supposed to be treated equally, and it appears this wasn't the case."

Is this going to be a crippling blow to the mutual fund industry and perhaps the financial sectors? Not hardly, but here's a catalyst for some investor pessimism where once again the question of "who can you trust" will arise amongst investors.

Just as the bulk of corporate America was practicing generally accepted accounting principles, it really didn't matter when the Enron scandal developed further. Soon it was Qwest Communications (NYSE:Q) $3.99 -1.72%, WorldComm and others where accounting practices were scrutinized and found to be somewhat erroneous.

As Jim Brown noted, it takes two to collaborate, and for mutual funds, it looks as if there has been some collaboration between some funds and special clients, where perhaps the refusal to mark an order prior to the close, which was received after-hours, was a way to keep a larger client.

Will a lesson ever be learned?

University of Stanford professor, Eric Zitzewitz, who headed the University of Stanford study, which showed more than just a few fund families allowing after-hours trading of mutual funds for some clients While Professor Zitzewitz declined to name specific fund companies, citing terms of his agreement with TrimTabs Investment Research, where he received his data from.

At some point, I would think it might take a court order from the SEC to get some names from either Professor Zitzewits or for TrimTabs to allow the release of funds that have shown a history of allowing after-hours trades.

It would be improper of me to begin speculating on what banks that offer mutual funds may be in Professor Zitzewits list of after-hours trading friendly fund (AHTFFs), but will only note that Wells Fargo (NYSE:WFC) $49.80 -0.47% traded against the S&P Banks Index (BIX.X) 300.47 +0.48% today, but like most banks, slipped lower into the close. The 04:00 PM EST close.

While we've been suspicious of the banks "lagging" some of the broader market averages, with thought that it has been largely due to a back up in Treasury yields, which has had consumer lending rates on the rise, this mutual fund mouse may turn into a rat, so lets stay alert on this developing front.

I've got to thoughts as it relates to this mutual fund stuff. First thought is, it is one thing if a bank makes a wrong bet on the direction of interest rates or lending decisions. These errors can often be corrected in time. However, the main point I want to make is in regards to investor confidence or sentiment. Psychology is such a large part of how markets will trade.

For now, lets call this mutual fund after-hours impropriety a small problem, but we can perhaps sense some hesitancy among investors to be getting full force behind the sector. It would be my opinion that another scandal situation of impropriety is not what this economy needs. Remember, a portion of consumer confidence is largely influence by the stock market direction and equity markets don't like scandals. Especially if they're found to be banking-related. After a nice move up from the March lows, it would be too easy for some mutual fund shareholders to simply "pull out" if they felt they couldn't trust their mutual fund, or any mutual fund. As most traders and investors know, it isn't what you've done for me lately that matters, it is what your doing to me now and what you'll do to me later that matters most.

For goodness sakes! That was depressing. It wasn't meant to be. Hey... equities recouped some of yesterday's losses and there was a lot of green on my screen by session end.

The Dow Industrials (INDU) 9,459 +0.41% finished up 39-points, the S&P 500 Index (SPX.X) 1,016.42 +0.54% gained 5.5 points, the S&P 100 Index (OEX.X) 511.37 +0.51% rose 2.6 points, while the NASDAQ-100 Index (NDX.X) 1,350.80 +1.39% actually dipped into the red late this morning to then pull out of its funk to gain 18.5 points. The NASDAQ-100 Tracking Stock (AMEX:QQQ) 33.64 +1.11% held the $33 level with a session low trade of $33.01 to actually gain 37 cents by its 04:15 PM EST close.

While the Semiconductor Index (SOX.X) 448.87 +1.57% fell to a late morning low of 433.90 and was posting a 1.8% decline, the chips staged an intra-day turnaround to then trade a session high of 453.45 before edging back to the close.

Another decent intra-day reversal, which I'm just now noticing came from the AMEX Gold Bugs Index ($HUI.X) 202.20 +0.90%, which closed near its session high after a morning low of 196.34.

Sector losses were limited and fractional with the HMO Index (HMO.X) 715.29 -0.54%, Oil Service Index (OSX.X) 87.54 -0.51%, S&P Insurance Index (IUX.X) 273.35 -0.48%, Natural Gas Index (XNG.X) 192.51 -0.44% and Utility Index (UTY.X) 281.99 -0.28% as sectors that just couldn't muster a patriotic gain.

Pivot Matrix

Earlier this morning, banks, depicted by the BIX.X bid early and progressed above their WEEKLY S2 of 301.59, so I profiled the indices bullish, focus on the SPX/OEX. Tomorrow will be a test as we now see some correlative BIX.X resistance at the 303.82 level almost exactly at DAILY R2 and WEEKLY S1. My thinking is if we're going to see an extension of today's trade, monitor the BIX.X again.

The OEX parked itself at the CLOSE right at MONTHLY R1 and tomorrow's DAILY pivot. A rather neutral look, so early action in the banks may set the tone into the weekend.

The Dollar Index (dx00y) and here may be an important level tomorrow. Again, the Daily High,Low,Close created is from the dollar's 09:05 to 03:00 PM session and doesn't fully encompass the rather odd full session for the dollar, but the reason I mark this as a level to be alert to tomorrow, which may have ongoing implication, where I think a WEAKER DOLLAR could be a negative is what I quickly touched on last night as it relates to money supply.

Gosh darn it! I didn't catch the name of the fellow on CNBC this morning, but he evidently runs a money management firm, where primary buy/sell calls on the market are based on money supply. My ears perked up today at 11:46:25 AM EST when this gentleman said that he had turned more cautious on equities as M2 and M3 showed declines.

This evening I've quickly gone to the Treasury's web site and sure enough, M1, M2 and M3 are showing declines in early September, this fellow's (who is evidently a money tracker) expressed some caution.

I browsed around and found where the Treasury will update each Thursday, the various money supply updates for the week (I thought it was only posted monthly). The link is http://www.federalreserve.gov/releases/h6/hist/ , but I've also been tracking the monthly data in an Excel spreadsheet, using different securities/indices to try and compare money supply trends against.

Money Supply Spreadsheet

I would not attempt to short-term trade money supply data, but we will use this data as a more macro observation. We've discussed money supply in past wraps and some background on the above table can be found in an Ask the Analyst column from July 20, 2003 at this http://www.OptionInvestor.com/ask/ask_072003_1.asp

The "date" columns show Fed action, where one * designates a 25 basis point rate cut, and two * designate a 50 basis point cut. The Fed cuts it Fed fund rate in order to pump cash/liquidity into the system. (June 2003 underlined for 25 basis point cut).

Now, I've been a little concerned about a WEAKER DOLLAR only because Treasury YIELDS have moved up. from their May/June lows, which we've been correlating to a decline in mortgage applications and especially mortgage refinancing, which in itself has been one contributor to money supply. After all, if we refinanced our mortgage, we may have taken cash from our home and placed it in the bank, or perhaps lowered and existing monthly mortgage payment, which then gives us some extra spending money.

The point that I took from the CNBC guest was we are indeed seeing some decline in M1, M2 and M3 money supply, the weaker dollar also tells us some money has left U.S. assets. A slight decline in the 10-year YIELD, or steady YIELD the last couple of months find the PRICE of the 7-10 year Treasury iShares showing some capital moving to that security (yield and LQD in the spreadsheet are basically tied together), junk bonds as depicted by the closed end Pacholder High Yield Fund (NYSE:PHF) $8.40 has attracted some capital since August 29 close of $8.15, while the SPX (equity market) has attracted some capital, as well as gold stocks, which is our "hedge against inflation" security we are following.

With money supply edging lower, something has to give, or give up some gains. Doesn't it?

While I've only been able to populate my spreadsheet with the data above, one observation has been that when we see red, or decline in one of the money supply indicators, we've seen some red or decline in a following end of month reading for the SPX.

Again, just as the gentleman on CNBC said he was simply taking profit and not looking to short the equity markets, his caution came from the money supply indicator, which he likes to follow on a very basic supply/demand type of analysis. Evidently he too was rather bullish in February (a little early) ahead of the March rebound as he observed an easy Fed and gains in money supply.

I'm going to use this as an alert to some declines in money supply, when combined with a WEAKER dollar, yet higher Treasury YIELDS may have a dampening effect for equity prices at this point.

Let us also tie in the past several weeks of rather poor mortgage refinancing and some recent increases back above the 400,000 level in weekly jobless claims, that these darned corporations still seem to be in a cost cutting mode and letting workers go to try and drive as much profit to the bottom line as possible.

Dow Industrials Chart - Daily Interval

With an early bid in the BIX.X above its WEEKLY S2, and INDU trading so near its WEEKLY S1 along with an aggressive upward trend, I was thinking bullish thoughts this morning. All be darned though if the INDU didn't find the WEEKLY pivot of 9,500 as resistance late, and just couldn't get a push above. Still looks bullish to me. MACD did cross below its Signal with today's trade, and this oscillator bearish cross below signal is simply a sign of caution to bulls. INDU bull looks for Stochastic now approaching "oversold" to provide similar kick higher for the INDU as it did a couple of weeks ago on test of a rising 21-day SMA.

Today's trade saw a net loss of 1 stock to a point and figure sell signal in the Dow Industrials Bullish % ($BPINDU) with Caterpillar (NYSE:CAT) $68.07 -1.34% finally giving a sell signal after achieving an almost impossible to achieve bullish vertical count of $72 that was generated back in March. Nice move for the cat, but it looks like it deserves a rest and profit taking may start to take its toll. I don't think bulls are going to completely be abandoning the stock, and would certainly revisit a bullish trade back near $60 or so.

S&P 500 Index (SPX.X) Chart - Daily Intervals

Just as the Dow Industrials and S&P 100 Index traded "inside" yesterday's range, so did the SPX and gives a rather neutral look after a two-day decline and some snap back today.

Economic data tomorrow has August PPI, August retail sales before the bell PPI forecasted at 0.3%, core PPI at 0.1% and retail sales at 1.5% with ex-autos at 0.8%. Then at 09:45 we'll get the preliminary September University of Michigan Sentiment which is forecasted at 90.4 compared to the August reading of 89.3. The sentiment and retails sales will most likely get the bulk of the attention with the job market still struggling.

Today's trade saw a net loss of 2 stocks to point and figure sell signals in the broader S&P 500 Bullish % ($BPSPX). Still "bull confirmed" at 81.2%.

The narrower S&P 100 Bullish % ($BPOEX) saw no change in its bullish %. Still "bull confirmed" at 88%. Remember, CAT is a component of the INDU and SPX, but not the OEX.

NASDAQ-100 Tracking Stock (QQQ) - Daily Intervals

Tech's showed the most "notable" weakness early this morning as Smith Barney came with a downgrade on tech bellwether International Business Machines (NYSE:IBM) $87.92 +0.09%. That may have created some nervousness among tech bulls early. I kid you not. In reviewing some time stamps on intra-day notes from Briefing.com, they said one of their floor trading sources mentioned that institutions were going to try and make sure the markets closed positive in observance of 09/11 holiday. I wouldn't doubt it for a minute. Maybe institutions weren't doing a lot of buying, but if they just lightened up on the offer, we can imagine the markets bidding on such psychology and emotion.

Today's trade saw a net loss of 1 stock to a point and figure sell signal in the NASDAQ-100 Bullish % ($BPNDX) as the bullish % slips back to 78%. Still "bear correction" status at 78% and would need a reading of 82% to reach "bull confirmed" status. If playing the QQQ long today, it is still my thinking that a bull is really looking for support from the shorts that have been getting sideways for months.

Jeff Bailey

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