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Market Wrap

Low Ceiling

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10-28-2002                High    Low     Volume Advance/Decl
DJIA     8368.04 - 75.95 8531.45  8325.45 1650 mln  745/888
NASDAQ   1315.83 - 15.30 1346.21  1310.63 1628 mln  658/940
S&P 100   452.09 -  3.56  460.84  449.64   totals  1403/1828
S&P 500   890.23 -  7.42  907.44  886.15
RUS 2000  369.01 -  3.63  374.86  368.52
DJ TRANS 2279.48 - 33.83 2332.54  2270.26
VIX        35.67 -  0.60   36.35  34.20
VIXN       51.52 +  1.13   52.77  50.47
Put/Call Ratio 0.71

Low Ceiling
By Steven Price

It appears that the markets have decided to take a breather, with most of earnings season behind us. After the recent rally, we have been moving sideways for the last week, and picking a long- term direction has become more difficult. Today saw red across the board, but didn't break any major barriers. However, those investors who do choose a direction have some decent stop loss targets that have defined the recent range.

We have started to approach resistance in several of the sector indices. These sectors will help determine whether we break to the upside, or drift back where we came from. It is probably time to take a look at some of these sectors from a macro standpoint and see just where we stand. While individual results will always affect individual stocks, a look at the sector charts should give traders an idea of just what they are up against as they consider jumping back into the market.

One of these sectors is the financials. The sector headed higher today, after American Express (AXP) reported earnings that beat the street by a penny and more than doubled from a year ago. The banks have been on fire recently and this morning Citigroup (C) also received an upgrade from Lehman Brothers. However, after a three-week rally, the Kbw Banks Index (BKX.X) has hit a consolidation level that seems to have a thick ceiling on it. The rallies in both C and AXP were turned back and the stocks finished up only $0.60 and $1.12, respectively. Luiz Inácio Lula da Silva came out victorious in Brazilian elections. There has been widespread concern that he would not hesitate to default on Brazil's international debt. He has talked down that possibility, and apparently investors today didn't seem too concerned. However, if that were to happen, then there are a number of large U.S. banks that could see heavy losses, including Citigroup and J.P. Morgan. If the banks start rolling downhill once again, then any broad market rally will likely be over.

Chart of the Kbw Banks Index (BKX.X)

Another important sector for the economy is the retail group. Wal-Mart came out this morning and announced that its October sales were tracking within its projected goal of 2-4% sales growth. The lead lining in that announcement was twofold - the 2-4% goal reflects lowered guidance from previous months and Halloween candy and costume sales were below expectations. While the average trader may not care about M&Ms and Frankenstein masks, the implication could be much greater. If consumers aren't reaching into their pockets and increasing purchases at times when they traditionally do so, then what can we expect as we head into the holiday shopping season. Halloween may represent only a minor holiday, but the message from last week's Consumer Sentiment decline is clear. Consumers are concerned about their jobs and the stock market and are simply not in a spending mood. The Retail Index (RLX.X) has also run into resistance after the recent rally and appears to be rolling over. Tomorrow's Consumer Confidence number could give the group a boost if there is a positive surprise, but that seems unlikely.

Chart of the Retail Index

Another group that will have to participate in order for a rally to really get going is the cyclicals. The Cyclical Index (CYC.X ) includes heavyweights over a broad range of sectors that tend to perform closely according to the economy. Components include Alcoa, Citigroup, Ford, Hewlett-Packard, 3M and FedEx. While the Dow and S&P have broken through their 50 day moving averages and held those gains, the cyclicals have actually found resistance there and begun to roll over. I generally view the CYC.X similarly to the Dow, only more comprehensive. The weakness here has me concerned about the Dow rally. If the group can breakout to the upside through the 50-dma, the broader market rally will have more credibility.

Chart of the Morgan Stanley Cyclical Index (CYC.X)

The housing market has continued to keep consumers positive about at least one asset - their homes. Record low rates and record setting housing purchase numbers have salvaged home values, while investors' 401(k) retirement plans have taken a beating in the equity markets. However, last week's economic data showed that while sales in the Northeast were strong, the South and Midwest housing sectors were seeing a pullback. Homes at the higher end of the pricing spectrum are also seeing a slowdown and the number of homes on the market is at its highest point. With mortgage rates creeping higher, the catalyst for much of the hot housing market may be cooling off. The homebuilders are measured by the Dow Jones U.S. Home Construction Index (DJUSHB). This index, in following the trend of other sector indices, has also reached a level of resistance and looks to be rolling over. This is in spite of recent positive earnings news from a number of builders, as investors are beginning to wonder what future earnings will look like if the housing market cools.

Chart of the Home Construction Index

The telecom sector has been showing some strength after a brutal couple of years that were filled with bankruptcies and accounting scandals. Companies have been cutting staff and capital spending, attempting to crawl back out of the red. The North American Telecoms Index (XTC.X) includes companies such as AT&T, Lucent, Qwest, Verizon and Nortel. The group has finally been showing some promise, putting together a nice run, along with the rest of the market. However, a look at the chart shows yet another sector heading into resistance. Unlike some of the others, this one has not begun a significant rollover, but the rally has definitely slowed.

Chart of the North American Telecoms Index (XTC.X)

The Semiconductor Sector Index (SOX.X), which has been the biggest surprise in the last few weeks, continues to make headway. In spite of constant warnings about a lack of IT spending and a host of companies lowering fourth quarter guidance, the index continues to set higher intraday highs. However, we may be looking at yet another sector that has hit its ceiling. After a 38% rally in less than three weeks, the 300 level looks like a challenge, with additional resistance 10 points higher. The sector broke through its 50-dma in impressive fashion and has continued higher, but the last couple of rallies have found resistance at a familiar level.

Chart of the SOX

The reason for posting the above charts is to show readers that want to pile on a rally that this may not be the best time to do so. While the market "feels" bullish after one gain following another; particularly gains that seem to shrug off bad news, we really have reached a point where another push will be needed to break through. That push may be coming next week. Or at least many investors and traders are beginning to assume it is. The Federal Reserve Open Market Committee, which sets the fed funds rate, meets on November 6. The chance of a rate cut, following continuing weak economic indicators, is being pegged at 50%. The last rate cut was almost a year ago and the rate has stood at 1.75% since. This week will bring a host of economic data, including Consumer Confidence on Tuesday and third quarter GDP on Thursday, along with Chicago PMI, October unemployment, non-farm payrolls and personal income. The market action we see at the end of the week may seem counterintuitive on the surface. As this economic data is released, the markets are likely to rally on soft numbers and drop if the numbers are above expectations. The reason for this is that there will be a focus on the FOMC meeting and negative economic news will increase the likelihood of a rate cut (and vice versa).

We now seem rangebound in the Dow between 8250 and 8550. The sideways movement may continue, however volatility is likely to pick up toward the end of the week when the economic data is released. The Market Volatility Index (VIX), which hovered near 40 last week, has now dropped to 35.67, indicating that there is less fear of the downside in the marketplace. The longer we are stuck in this range, the more significant a breakout is likely to be. The S&P 500 has found its own range, between 880 and 900. While it has made several forays over 900, it has been unable to hold those gains, making me weary of a continued rally. The trade today of 905 was a triple top point and figure breakout, which is usually bullish. However, one of the concerns with this type of pattern is the "bull trap," which is a one-box breakout (which this was), is followed by an immediate reversal. A trade of 910 would satisfy the PnF bulls, and I would need to see a close over 900, as well.

Charts of The Dow and SPX

The sideways movement can be frustrating for traders looking for entry points. However, sometimes there is nothing you can do but wait. We are likely to see a pick up in activity later in the week, so those itchy trigger fingers may have to wait until then. Keep an eye on the above outlined levels and be ready for a breakout in either direction.

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