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Market Wrap

Buyers beat back bears as battle turns, Fed under attack!

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         WE 6-2          WE 5-26         WE 5-19         WE 5-12
DOW    10794.76 +495.52 10299.24 -327.61 10626.85 + 17.41  + 31.51
Nasdaq  3813.38 +608.27  3205.11 -185.29  3390.40 -138.65  -287.75
S&P-100  792.69 + 56.61   736.08 - 16.87   752.95 -  8.72  -  8.12
S&P-500 1477.26 + 99.24  1378.02 - 28.93  1406.95 - 14.01  - 11.67
RUT      513.03 + 55.66   457.37 - 22.33   479.70 - 11.24  - 21.90
TRAN    2829.36 +141.81  2687.55 - 54.45  2742.00 -132.02  -  2.09
VIX       24.11 -  3.38    27.49 -  1.28    28.77 -  1.23  -  0.44
Put/Call    .41              .65              .89              .53

Buyers beat back bears as battle turns, Fed under attack!

Yeee Haaa! Rally mode! Market bulls pulled a rabbit out of their hat Friday morning with a weaker than expected jobs report. The market, already up strong for the week, roared out of the gate and never looked back. Volume increased again with the NASDAQ posting a robust 1.9 bln shares and the NYSE 1.1 bln shares. The anemic jobs report came in with only 231,000 new jobs and a spike in the unemployment rate back up to 4.1%. This was exactly what traders were looking for, an excuse to discount the Fed and justify a "no hike" outlook going forward. The markets celebrated with a strong finish to the short week's rally.

The rally produced a strong finish to the best week ever for the NASDAQ with a +19% gain of over +600 points. The Dow turned in a similar performance on the back of HWP with a +495 point gain for the week. Every major sector participated except for Oil, Drugs and defensive stocks. Those sectors were hot when techs were out of favor last week but all gave back some of their gains on Friday.

The average hourly wage increased only +.1%, a much lower rate than the expected +.4%. Many analysts were so surprised with the report that there was a large amount of unrest. Many pointed to research on previous May reports that seemed to indicate that May reports were typically flukes. Many have been first reported abnormally low only to be revised upward the following month. The challenge appears to be the rotation of the work force as summer schedules arrive and schools go into recess. This abnormal "estimate" of job growth is then corrected in July with the June report. Still investors did not care and took the number at face value.

The next series of reports that could fuel the fire or derail the rally will start with the productivity report on Tuesday followed by Import/Export prices on Thursday. These are small change compared with the PPI on Friday and CPI the following Tuesday. The lightweights at the beginning of the week could give us a couple days more extension on the current rally before the obligatory pull back in front of the PPI. Over 70% of analysts now expect the Fed to take a pass on another rate increase at the June 28th meeting after the recent indications of a slowing economy. The debate of will they or won't they is heating up. There are analysts now that point to the rash of negative economic news as indications of an impending crash landing for the economy from an over aggressive Fed rate hike policy. The fear for the Fed is that they go one hike too far and send the economy into recession instead of steady growth. The only thing we need to worry about is stronger economic signals that would put the Fed back into the drivers seat. Once it appears the economy is truly moderating then the stock market should be be back on track. The Fed will slip back into the shadows and the next thing we hear from them is a rate cut. Now that would be a market mover.

The rally this week has been spectacular. Almost every high profile stock has seen strong double digit gains. Too far, too fast? +608 points is a big move for any week but with the NASDAQ beaten down so far we may have room left. The NASDAQ closed at 3813 on Friday. Thirteen points above my arbitrary 3800 level for confirmation that the rally was for real. This is a good news, bad news story. Yes, it closed over 3800 but barely and on a huge spike. I would really liked to have seen it get there a little more slowly with a sustainable pace. The rocket ride from the 3042 low last week of almost +800 points has me concerned. Nothing goes up or down in a straight line. Markets and stocks cycle every 3-5 days. We had one minor down day last week but it was after a +200 point gain. At this point most traders are concerned that the good economic news will continue to power the market next week until it is over extended and subject to a sharp sell off. Clearly the pressure needs to be relieved and hopefully it will happen Monday or Tuesday. The tighter the rubber band is stretched the faster and farther the drop will be when it finally comes. A small pull back Mon/Tue would allow the pressure to ease and provide another entry point for those still on the sidelines.

Microsoft Windows NT, Made in Canada? Don't laugh! This story was floated on Friday and the networks ate it up. In a story attributed to Michael Murphy by some, it was rumored that Microsoft might move from Seattle to Vancouver, just across the border, and escape from the current breakup battle. While Canadian authorities were glowing and promised to do everything but sacrifice virgins to get Microsoft to seriously consider a move, it will not happen. Microsoft would still have to answer to the Justice Dept as long as it did business in the U.S. What it could do is cost the U.S. billions of dollars in lost tax revenue by making such a move. While taxes are technically higher in Canada, it is a given based on the smiles of authorities that they would cut a very good deal to get Microsoft to move a little further north. Many think the story was simply another shot across the bow by Microsoft in the constant posturing of the current players. How strong would the government press its case if it stood to lose hundreds of billions of dollars over the next two decades in taxes and wages? Who knows but I would not put it past Bill Gates and company to float this trial balloon to make them think twice before the case closes. Kind of like calling a timeout just before a winning field goal attempt to give the kicker more time to be nervous.

With no real market moving news or events other than above I won't ramble on trying to interpret things that are not there. This is black and white. The market is up because the economy is slowing. Economy slowing equals no more rate hikes. No more hikes equals stable markets. The only topic of discussion is what day next week will the euphoria wear off? The answer nobody knows but the sooner the better. The markets should move up from here into July earnings but we need to consolidate first. Consolidate is a nice word for down, choppy, sideways and backwards but in no particular order. Consolidate means most stocks will pull back, lose ground or drop in price. This means your call options will go down in price. (I am being specific because many readers accuse me of not telling them exactly what is going to happen.) If I say consolidate for several days they think it means that their stocks will just go up slower while stocks that others own go down. This is the selective reading disease.

Here is the point. I think the NASDAQ has come too far too fast and needs to backup about -200 points before going forward again. We debated here at the office Friday afternoon about selling our calls and buying puts at the close. Some bought puts, some held their calls hoping for a bump on Monday morning to sell into. The consensus was unanimous that there would be a pull back next week. The division was when it would occur. We even considered dropping some of the big movers from the pick list to prevent people from buying at the top.

Take SDLI, up +100 points from last week. Should you buy now? Heck no! Is it still a good stock? You bet! But it needs to drop 20-30 points to provide a new entry point. We left it in because we think it will continue up after any correction. Multiply this problem across all the picks. They are up huge for the week. Should you buy more on Monday? NO! We need to wait for a pull back. Should you sell on Monday morning? NO, not if you can set stops. If you have stop loss capability we suggest setting stops where you would like to get out assuming the stock dropped $10. If your call is $20 in the money then a $10 drop would take about $8 off the option price. Do you want to risk that amount? If you set your stops tight and the stock pulled back then you would be taken out at the top and you could get back in when the market/stock started back up again. By setting stops instead of outright selling you can get the benefit of any continued rally on Monday. Just keep moving your stop up until the stock/market pulls back.

Just remember before you get back in that not all stocks may go back up after a pull back. The rising tide of euphoria this week floated almost all stocks as traders threw money at anything. After a market pull back traders will not be so eager to just throw money at any stock. Many stocks will plateau or start drifting downward again while others will continue to run. The farther the market goes the fewer stocks will participate. The first rally from last week was very broad. Each market up cycle from this point forward will involve fewer stocks as each stock slows when it nears where investors feel they are fairly valued. Last week, all stocks were beaten up equally. Next week many investors will rethink the ones that set new highs or were up $30-$40-$50 in only five days.

In April many investors gave back their profits from January and February because they kept hoping the rally would come back. They just KNEW that their stock would turn around the next day. Instead they bled to death and suffered serious losses. Don't give back your gains from last week. Take a profit. Even if the market continues up selected stocks will start falling back. Get out when it starts. Don't bleed to death again. When you decide to get back in, be selective. Invest in stocks that have not had the huge gains. These are the ones other investors will be searching out. Plan your trades with the idea that July and August will be bad months. Typically, the summer months are the worst months of the year beginning the second week of July. One only needs to look at these charts from the last two years to see about a -15% drop each year.

The VIX dropped to 24.16 on Friday and the put/call ratio to .41, still not in the danger zones but real close. Be very careful next week. Enjoy the rally but be ever vigilant for the next market change. With the piles of cash on the sidelines we expect any pull back to be brief. AMG Data said that fund inflows were actually positive last week with +$7.8 bln moving into equity funds. This stopped a multi week pattern of outflows from stock funds. With the NASDAQ soaring almost 800 points in one week you can bet the money inflows for this week will be huge. This influx of cash is sure to be put to work immediately. Mary Meeker called the bottom for Internet stocks last week and she was only one of dozens of analysts who think the worst is over. This positive press could create a real June rally. Now if only we can get a pull back Mon/Tue to give everyone still on the sidelines a comfort factor about not buying at the top!

Because we have so many new readers I am going to update the series of ten educational articles from last fall and reprint them again. I am starting next Sunday with Entry Point, Entry Point, Entry Point. Look for it in the Options 101 section of the website.

Trade smart, don't buy too soon.

Jim Brown
Editor

Disclosure: My current long positions: NOK, VOD, MSFT, VIGN, YHOO

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