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Market Wrap

Don't get Too Comfortable

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08-26-2002                High    Low     Volume Advance/Decl
DJIA     8919.01 + 46.05 8949.53  8756.02 1231 mln  2001/745
NASDAQ   1391.74 + 32.66 1394.24  1360.43 1414 mln  2040/1180
S&P 100   477.59 +  3.09  479.23  468.25   totals   4041/1925
S&P 500   947.95 +  7.09  950.80  930.42
RUS 2000  407.73 +  7.60  407.73  397.71
DJ TRANS 2424.51 + 30.19 2425.05  2371.52
VIX        32.29 -  0.52   35.21  31.85
VIXN       48.42 + 0.80    48.24  50.93
Put/Call Ratio 0.81

Don't get Too Comfortable

After reading Jim Brown's weekend commentary, I'm having a hard time keeping a rosy outlook for the next couple of months. Having also stood on the trading floor over the last several years during the fall swoons, I've been tempted to let my inner bear out of hibernation and start shorting everything in sight. However, I keep looking at these pesky charts of the Dow and Nasdaq, and seeing rising support lines. In spite of frequent tech warnings, a new wave of layoffs and shrinking economic growth numbers, the broader market keeps finding buyers at successively higher levels.

The September 11 anniversary will only serve to increase the possibility of the "swan-dive" August-October pattern of previous years repeating itself, and at some point I expect a significant sell-off. This makes things complicated for the short-term trader, who doesn't want to miss out on rallies in the meantime. This is generally considered one of the lightest trading weeks of the year, as many traders are on vacation heading into Labor Day weekend. In fact, we saw only 1.2 billion shares traded on the NYSE and only 1.4 billion shares traded on the Nasdaq. Advancing shares outnumbered declining shares on the NYSE 3 to 1, however, with such light volume, the significance is somewhat tempered. Nasdaq volume was much closer (7:6).

This morning, it looked like the 50-dma of 8789.47, which had provided support throughout last week, would finally give way and the September slide would get rolling. However, once again the buyers came back right around this 50-dma level. Today that moving average coincided with the rising trend line from July 24, and lo and behold, that is exactly where we bounced.

Chart of the Dow Jones

A similar pattern has developed in the Nasdaq, although the upward sloping trend line is started later, on August 5. The steep line in the Nasdaq will be harder to maintain, and any pullback could be seen more dramatically here.

Chart of the Nasdaq Composite

A look at the two channels these indices have been in since their latest respective rebounds indicates that the pull back on Friday and this morning simply followed the ascending patterns.

Chart of Dow and Nasdaq Ascending Channels

The economy got some good news this morning with the release of record new home sales once again. The record is actually somewhat misleading, as previous numbers have set records and then been revised downward, subsequently allowing these "records" to be broken once again. Regardless of whether this is a record, it still shows that the housing market is going strong. The housing "bubble" is usually the last to pop in a poor economic environment, as laid off homeowners are forced to cash in the equity on their homes, and would-be buyers use savings for paying bills, rather than down payments. According to the Commerce Department, new single-family home sales rose 6.7% in July, to an annualized rate of 1.02 million. Considering the stock market swoon in July, and the shrinking brokerage accounts as a result, this looks very bullish for the economy. Estimates had been for an annualized rate of 975,000. On the other hand, this may not be a coincidence, as investors who lost faith in the equity markets took money out of stocks and invested in real estate. This fact was reflected by a record $49 billion pulled out of U.S. stock mutual funds in July. The July 2002 new home sales number topped 2001 by over 15%. The number grows more impressive after June sales were revised to reflect a 2.6% drop. In addition, existing home sales were also up, by 4.5%.

In addition to new home sales being strong, inventories also dropped from a June reading of 4.2 to only 3.9 in July. The median home price, however, dropped from $186,200 to $170,500, reflecting a shift from higher end homes to those at the lower end of the spectrum. This can be interpreted in a couple of ways. Bulls will see the shift to lower priced homes as evidence that those at the lower income levels (relatively speaking) are showing an increased ability to purchase homes. Because a higher percentage of the population exists at lower income levels, this may demonstrate that lower rates are helping create equity for a larger number of people. Bears, on the other hand, will note that the total amount of money spent on housing, and therefore used to build equity, has actually dropped. According to the annualized rates, based on the June and July readings, multiplied by the median housing price, we will spend $173.9 billion on new homes according to July's reading, while we would have spent $181.5 billion under June's numbers. Fewer dollars invested usually translates to smaller appreciation. Because this calculation is based on the median price, as opposed to an average price, it should be used for comparison, rather than an actual calculation of dollars spent.

The U.S. government has essentially subsidized the homebuilding industry by keeping interest rates at their lowest level in 40 years. There has been much debate over whether the Fed will further lower the Fed Funds Rate at the September 24 FOMC meeting. Last week, however, three Fed Governors gave indications that the economy was growing and further rate cuts may not be needed. Today a fourth Governor chimed in with the same sentiment. If there is another attack around September 11, all bets are off and we may see as many as 50-75 basis points taken off of the current 1.75%. Outside of that possibility, however, the chance of another cut seems to be getting slimmer.

On the flip side of the argument for a growing economy, the world's number two employment company, Manpower (MAN), released the results of a study that indicated U.S. firms do not plan on increasing the pace of hiring in the fourth quarter. When viewed in light of recent layoff announcements from the likes of IBM, American Airlines and Lucent, these results suggest a recovery in the job market could still be a ways off. Although wages are currently rising faster than inflation, continuing layoffs could wind up greatly affecting this equation.

The defense stocks took off today, after comments from Dick Cheney indicated a more aggressive stance toward Iraq than George Bush had indicated last week. Bush had stated that he was a patient man, and that he would consider non-military ways of removing Saddam Hussein. Cheney, however, was whistling a very different tune. He said that Hussein, now in control of 10% of the world's oil reserves, could be expected to seek domination of the entire Middle East and manipulate the world's energy supply. Cheney also stated that waiting for Saddam to possess nuclear weapons is a deeply flawed logic. "We realize wars are never won on the defensive... We must take the battle to the enemy. We must take every step necessary to make sure our country is secure, and we will prevail... We will not simply look away, hope for the best and leave the matter for some future administration to resolve," Cheney said. "As the president has said, 'Time is not on our side." Sounds an awful lot like an eviction notice for Saddam is in the mail. Although White House lawyers have concluded that Bush does not need Congressional approval to launch an attack, White House press Secretary Ari Fleischer added that Congress has an important role to play. With many countries lukewarm on the idea of a U.S. invasion, Bush is not likely to attack without first receiving support from leaders at home.

Oil prices have maintained themselves, with the October crude oil futures still trading over $29 a barrel, pricing in a possible Iraqi invasion. This is in spite of Saudi Arabia's pledge to increase supply if Iraq takes some oil off the market. Rising oil prices will not help the economy, and could make the Fed rethink what appears to be a plan to leave rates unchanged until a possible increase is warranted at some point in the future.

The fuel that has kept the economy from collapsing is consumer spending, which accounts for 2/3 of GDP. Evidence of this factor eroding came from Wal-Mart this morning, which warned that overall August same store sales will be at the low end of previous forecasts. It attributes this to a drop in apparel sales due to unseasonably warm weather. This is the second week in a row that the retail giant has echoed the same sentiment. Federated, which owns Macy's and Bloomingdale's chimed in with the same sentiment for the third week in a row. With school starting, it is hard to believe that the slowdown in apparel sales is due more to weather, than to a reluctance to spend in light of the recent wave of layoff announcements.

The broader market is still going up on relatively light volumes, yet we see a historical cliff just ahead. Add to this the likelihood that investors will begin dumping long positions as we close in on the September 11 anniversary, rather than risk holding stocks after another attack. The technicals all seem to be pointing up, yet history and logic seem to be pointing the other direction. The housing numbers this morning show the possibility that we are actually spending less on homes, in spite of the fact more homes are being sold. All of this feels as though we are being lulled into a false sense of security. This hunch is underscored by the Market Volatility Index refusing to break 30 on a slow trading day at the end of the summer. Apparently I'm not the only one with this feeling - there are still put buyers around. The put/call ratio of .81 is also a little high for a sustained rally like we've had over the last month. I would be more confident in the recent rally if we weren't talking tough with Iraq two weeks before September 11, and if the bounces we've seen were on stronger volume. While I don't want to fight the upward trend, I simply can't ignore all of the other factors weighing on the market. I would not be playing with full long positions here, and looking for technical breakdowns before going fully short as well. If this seems wishy-washy, that's because it is. There is nothing wrong with capital preservation when it is called for. Watch for heavier volumes after the holiday weekend before choosing a longer-term direction. In the meantime, there may be plenty of swings to trade this week. Stay nimble, don't be stubborn and respect your stops.

Steven Price
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