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Dr Deflation Strikes Again

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      09-04-2003           High     Low     Volume Advance/Decline
DJIA     9587.90 + 19.40  9609.09  9541.72 1.82 bln   1779/1402
NASDAQ   1868.98 + 16.10  1870.00  1848.95 1.87 bln   1858/1367
S&P 100   516.18 +  1.68   516.72   513.04   Totals   3637/2769
S&P 500  1027.97 +  1.70  1029.17  1022.19 
W5000    9967.22 + 20.10  9975.58  9912.29
RUS 2000  512.56 +  1.85   512.56   508.99 
DJ TRANS 2757.15 -  4.30  2763.17  2743.01   
VIX        19.89 -  0.54    21.24    19.86   
VXN        30.91 -  0.28    32.16    30.75 
Total Volume 3,977M
Total UpVol  2,953M
Total DnVol  1,328M
52wk Highs  872
52wk Lows    21
TRIN       1.03
NAZTRIN    0.38
PUT/CALL   0.68

Dr Deflation Strikes Again
By Jim Brown
Click here to email Jim

Not one, not two but three Fed heads took to the podium today and tried to talk up the economy and talk down bond yields. We will not know if they were successful for sometime but the impact on the stock market sent it back to new 52-week highs once again. Ben Bernanke went on record not once but twice on Thursday saying there was a good chance the Fed could cut rates again. Somebody pinch me I must be dreaming.

Dow Chart

Nasdaq Chart

S&P Chart

This was a day full of surprises. In fact I am surprised we are not butting heads at 9700 instead of 9600. There was good news, great news and just enough lingering economic problems to keep the plot in motion. The morning started with the Jobless Claims which "surprised" everyone (except us) with a reading over 400,000 once again. Actually I expected it next week but it appears enough workers went back to job hunting for the Fall to turn the tide a week early. The headline number was 413,000 and last weeks number was revised up to 398,000 and just nipping under the 400K level. The four-week moving average broke the 400K barrier once again at 402,000 and continuing claims rose again to 3.663 million the highest level in eight months. Get this, the Labor Dept actually said the short week prevented some numbers from being reported and the 413K would be revised next week. Duh! And what is different from any other week? This is setting up next week as a pivotal number for the markets.

The Factory Orders for July jumped +1.6% compared to estimates of only +0.7%. This is the highest level since May-2001. Nondurable orders rose +2.4% and shipments +2.5%. What the heck is going on here? We are actually seeing the economic reporting for the bounce that Intel said they saw in July. This number is a very lagging indicator and could decline in August but investors have their sights set on Dow 10,000 and they are not going to be deterred by old data. The key here is the positive trend and one that is not likely to go negative again.

The ISM Services blew past estimates of 62.0 with a headline number of 65.1, which matched last months surprise number. The global services business has been trending up so this number was expected to be strong but nowhere near this strong. New Orders rose to 67.6 while inventory fell to 49.0 from 49.5. This is setting up a strong future bounce when that inventory needs to be replenished. One component throwing the number out of line was the rise in prices to 55.7 from 50.6. This is primarily due to higher oil prices being passed through to the consumer. This distorted the headline number to the upside.

Productivity rocketed +6.8% in the 2Q according to the revision posted on Thursday. This was higher than estimates of +6.3% and most of the increase was due to higher output numbers. This is a two edged sword. While the output and productivity is increasing it is doing so at the expense of more job cuts. Hours worked fell another -5.9%. We are likely to see more evidence of this with the Jobs Report on Friday. The current unemployment rate is around 6.2% or nine million workers out of work. I will get to the differing outlooks later but the Jobs report is the key for tomorrow. The estimate is for a gain of +10,000 jobs. The whisper number has been heard for a loss of as many as -50,000 jobs. Even if we get a drop in jobs the unemployment number is likely to fall as more and more workers decide to give up looking. We will get to hear Elaine Chao go on CNBC once again to tell viewers that the drop in unemployment is good for the economy and proof the administrations employment program is working. It makes no difference what the numbers are tomorrow because she will say the same thing and she will probably quote the numbers wrong once again. I do not know whose idea it was to put her in front of a camera but they need to be demoted. More disposable camera fodder I assume.

Elaine Chao

The Jobs Report is the last major economic report for the week and it is before the open. Elaine is not the only one confused about jobs as different Fed governors voiced different opinions about the jobs future today. Ben Bernanke said he expected the jobs picture to remain bleak through Q4 of 2004 at the worst. McTeer said he felt the growing economy would increase jobs before the year end and drop the unemployment rate under 6%. Obviously if there is a difference in opinion at the top the outlook is very cloudy. The term Jobless Recovery has turned into Jobloss Recovery in common usage. Historically employers will not want to add new hires until they are confident the recovery and demand is here to stay. We are still a long way from that stage now.

There was so much news today the following paragraphs may seem unconnected but I need to get it all out. Retail sales was stronger again at +5.1% and many of the majors reported strong gains in same store sales. Wal-Mart reported a +6% gain in sales BUT, and here is the key, they lowered estimates going forward. The late summer binge and a stronger than expected back to school rush just as tax checks and tax cuts hit consumers produced the perfect retail storm. While rejoicing most retailers are cautioning that the majority of the impact from those factors has already been seen. Most retailers traded down because expectations were for an even greater gain in sales. Investors are never satisfied.

Home buyers got a boost from Hovnanian (HOV) who said they were able to raise prices due to demand outstripping supply. Whoa! What happened to that bursting housing bubble? This is just a historical trend when interest rates spike up. Buyers rush to snap up available homes and lock in rates before any further increases. If Bernanke was able to put some fear into bonds again today then that interest rate window may be opening again soon.

The chip stocks were back in form today after a brief hiatus. The fear of the Intel mid quarter update tonight was diffused by AMD saying business was picking up despite concern over a potential lack of staying power. Cypress Semi said demand was picking up although prices were still dropping. National Semi reported earnings of 15 cents and said current quarter bookings were the strongest in the last ten quarters. UBS upgraded most of the chip stocks this morning and added to the euphoric stupor. This kept the Nasdaq from selling off at the close on fear of Intel. Intel came through in the clinch despite the four days of back tracking by the officers after the August update. It appears the caution was misplaced and Intel raised its guidance to the top of the previous range and affirmed the gross margin at 56%. Considering the expected revenue is between $7.6-$7.8 billion that is a massive profit. Pass the chips please, I think we are about out of dip. Of course once all the good news is out there is nothing for investors to look forward to. Futures are up only slightly in after hours on the news.

An August survey of CIOs showed that 46% planned on increasing their hardware budget while only 15.5% were planning on decreasing it. Security software was the big winner with 51% planning on increasing spending on security. Spending on infrastructure software fell to only 28.6% down from 33.2% in July. The total for the study projected an increase of +6.4% in IT spending over the next 12 months compared to only +4.5% for the same study in July. This matches the Dell comments earlier in the week that there was improvement but no meaningful pickup in spending. Intel also said the product mix was responsible for the improvement in guidance more than unit volume. Laptops are still leading and those chips are more expensive than desktop computers.

Cisco added their voice to the "orders improving" chorus but Chambers was quick to add it could only be temporary and may not be sustainable. The caution across tech land is very thick and I think everybody is looking behind the increase in orders to see if there is anything in the pipeline but they are afraid to look real close.

The Fed heads were at it today on all fronts. Mcteer, Gramlich and Bernanke all spoke with Bernanke wielding the biggest hammer. His speech summarized several outside groups that do economic projections and on average suggested the GDP would grow at a 4.7% rate through Q4-2004. Not exciting but decent. Where he drew the most attention was commenting on rate changes. He said he could see no "significant" rate hike in the near future. OK, does that mean we are going to be quarter pointed to death every month? Not according to Ben. He even went so far as to say the next change could be another rate cut. This slammed bond yields along with his comments again that inflation was not the enemy but the return of an unwelcome drop in inflation. This failure to use the D word in repeated Fed head speeches just amazes me. They don't trust us with the D word. We might hurt ourselves so they are spelling it out so only the financially educated among us can figure it out. Get real. Bernanke has tackled the deflation monster so aggressively he has earned the title of Dr Deflation in some circles. Just in case he did not make himself clear in the morning speech he repeated his comment about the next move could be a rate cut in a late day appearance. Get this, he also said it was not the size of the cut that mattered but how the Fed talked about it. Bingo! This is exactly where the Fed floundered in June and the bond market penalized them for it. It appears Ben has taken it upon himself to be the standard bearer for the Fed and to preach to the choir every chance he gets. Might not be a bad strategy for a promotion should Greenspan not get the nod for a new term. Go get them Ben!

The markets extended their run and closed at new 52-week highs. Will wonders never cease? The Nasdaq stretched its winning streak to seven days and a feat not seen since Feb of 2000. The Nasdaq is closing in on 1900 and even the bullish traders are wondering when the pause will appear. The Dow traded over 9600 several times and tacked on a respectable +19 points but the excitement seems to be fading. It could have been fear of Intel keeping the wallet on the hip. Now that Intel has passed the test we will see if the bulls can hold the line for one more day and the Nasdaq stretch its streak to eight.

The blue chips were mixed today with MMM getting killed to the tune of -2.61 on valuation concerns but was offset by PG +2.63 on another guidance increase. IBM spiked back over $88 and GE is about 30 cents away from a new 52-week high. Speaking of new highs there were 1186 yesterday across all markets and 872 today. This compares to only 21 new lows today. This market breadth is tremendous but the A/D line is only marginal at 4:3 advancers over decliners. The volume today was nearly a billion shares less than the total market volume yesterday but still decent. Wednesday's volume was the strongest since June.

It appears we are in the eye of the perfect storm across the broader markets. Internals are good, volume is decent, economics continue to improve and tech stocks are raising guidance. The Fed is talking rate cuts, yields are dropping and we are in earnings warning season with no warnings. What else could go right? Multiple press conferences of fraudulent insider trading by mutual funds and hedge funds as well as massive bond trading allegations failed to deter investors. Bullishness has risen to 55.5% with bearishness only 18.2% according to Investors Intelligence. These are very bad numbers on a contrarian view. The VIX closed under 20 once again and nobody seems to care. Should they?

Apparently not if all the possible factors are lining up in favor of stocks. At least that is the predominant view. If the economy is on fire and several estimates for the 3Q are now over +5% GDP growth then damn the technicals and full speed ahead. Shucks, Martha, 10,000 is just over the hill. We can get there before we run out of gas. In a month where the term "new highs" is seldom mentioned the markets are setting them on a daily basis. There appears to be nothing to hold them back. Professional traders are dumbfounded over the lack of weakness despite the good news. It is simply a law of the market that pullbacks on profit taking occur routinely. Except, when the bulls are charging. With nothing but green pastures in sight each bearish stand is promptly trampled into the dirt. The wall of worry has turned into a super highway and traders simply see no reason to sell. Today was a prime example. With Intel after the close and the Jobs Report before the open you would have thought there would be some cautious profit taking but it did not happen. Right at the close when you would have expected it to happen we had Dr Deflation promising another rate cut if economic conditions did not continue to improve. Instead of taking profits traders were adding to positions. Pass me some more of them chips Martha. I can't wait to see if those Fed boys will speak at the NFL halftime tonight. Do you think they will bump Britney so Dr Deflation can speak again?

All seriousness aside there is no reason for the markets to sell off other than profit taking. There is also no real resistance other than psychological between here and 10,000. What am I missing? I feel as clueless as the dummy they send to the kitchen for more drinks in a Scream movie never to be seen alive again. Traders are acting like a corral full of bulls fighting to get on the ramp to the truck thinking it was going to a greener pasture just a few hundred points away. They just don't know it could be going to the slaughter house instead. Or is it? Just how high is high?

Using four different ways to calculate the potential top on the S&P we get a surprising confluence of numbers. Using the Bollinger bands on a monthly chart we should see an intersection of price with the top band somewhere in the 1140 range. Using a target from the reverse head and shoulders from 2002-2003 we project 1140 again. Coincidence? Taking a Fib retracement from the 2000 high to the 2002 low we run into the 50% level at 1160. Finally using a horizontal resistance from 1998, 2001 and 2002 highs we top out at 1175. I am not saying we are going to be anywhere close any time soon but if we did continue up this is where the granddaddy of all resistance levels appears to converge. Somewhere in the 1140-1175 range and it promises to be serious resistance. Now, with that in perspective Keith's 1060 possibility for this current rally looks like a real possibility. (Keith gives Elliott Wave projections in the Futures Monitor.)

S&P Monthly resistance chart

Friday could be a pivotal day in the markets. We could easily go either way a couple hundred points and nobody knows which way. The Jobs report is already factored in despite what Elaine says on CNBC tomorrow. The 413,000 Jobless Claims today accomplished that task. Unless it is a disaster it will be taken as just one more month in the Jobloss Recovery and a necessary mile marker in the road to 10,000. Once that is out of the way the direction will be up to the bulls. The bears have no strength and every dip they manufacture is quickly bought. Until the bulls tire of the game and garner more profits than they want to risk we are still in dip buying mode. The bulls have shaken off their fear of the calendar and until that fear returns we are likely to see even more higher highs and higher lows. Just remember that some of the worst sell offs came when the markets were the most bullish. Keep those seatbelts fastened and those stops in place.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
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