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Market Wrap

New Dow High, Ho, Ho, Ho!

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      12-16-2003           High     Low     Volume Advance/Decline
DJIA    10129.59 +106.70 10137.63 10023.34 1.84 bln   1892/1361
NASDAQ   1924.29 +  6.00  1927.09  1901.66 1.81 bln   1577/1670
S&P 100   534.75 +  4.28   535.17   530.47   Totals   3469/3031
S&P 500  1075.13 +  7.09  1075.94  1068.04 
W5000   10441.40 + 56.20 10447.74 10366.46
RUS 2000  537.74 +  2.49   537.77   529.44 
DJ TRANS 2967.28 + 16.50  2970.44  2942.01   
VIX        15.93 -  1.30    17.45    15.90
VXO (VIX-O)15.70 -  1.21    17.11    15.60
VXN        26.15 -  0.92    27.59    25.88 
Total Volume 3,949M
Total UpVol  2,286M
Total DnVol  1,597M
52wk Highs  347
52wk Lows    36
TRIN       0.88
NAZTRIN    0.85
PUT/CALL   0.68

Great economic reports did what Saddam's capture could not. The Dow set a new closing 52-week high and came within two points of breaking yesterday's spike high. It definitely did not hurt to have the Saddam news clear out all the resistance between 10,000 and 10,140 and pave the way for today's gain. Maybe Osama will volunteer to surrender and clear the next resistance all the way to 10,250. Now that would be a holiday treat.

Dow Chart

Nasdaq Chart

The morning reports began with the Consumer Price Index and more evidence the Fed may be on the right track with their no inflation in sight position. The headline number fell -0.2% and well below the estimates for a small increase. The core rate fell -0.1% and pushed the trailing 12-month number to a 38 year low of only 1.1%. The -3.0% drop in energy prices helped to offset the continued rise in food prices. We are exporting more food than normal due to the mad cow problems in other countries and that extra demand is continuing to raise our prices at home. Used car prices are falling through the floor with another -2.3% drop. Those new car deals are flooding the market with older models and dealers are having to give them away. The headline number would have been even lower except for a sharp rise in college tuition. Bet your glad to hear that. The main reason for the drop in produced goods prices remains the excess capacity.

Prices down and production up, what a perfect world. That is what traders thought when the Industrial Production number blew out at +0.9% compared to estimates for only a +0.4% gain. The two prior months were also revised upward. The +0.9% jump in the headline number was the strongest gain since 1999. Suddenly there is a real recovery underway and traders celebrated. Capacity Utilization also jumped to 75.7% from 75.1% and suggests a significant jump in demand and the highest rate in more than a year. (these numbers do not move fast) Production has now risen for five of the last six months. If you remember exports were up +$500 million last week which indicates the global picture is improving and that production is showing up here.

Adding to the positive economic picture was yet another upside surprise in Housing Starts. Single-family homes set another record with overall housing starts hitting an annualized 2.07 million units. October numbers were also revised upward. Since housing impacts dozens of other industries like lumber, roofing, appliances and electrical components to name just a few, this is a very good view of the potential fourth quarter GDP. The dip in mortgage rates back down to decent levels again is spurring one more building cycle. Homes started in Nov will be completed in the spring and just in time for the buying cycle to begin again. With $165 billion in tax stimulus scheduled to hit in the first quarter you can bet there will be buyers waiting. The only obstruction to this process could be a Fed rate hike in March. This is the last meeting they can safely raise the rates before the election. The Fed is not stupid and they recognize this and the psychological impact it will have on home buyers. I doubt they will be anxious to trip up the consumer just before the summer doldrums appear. This inventory buildup is poised to give the economy another quarter (Q2) of improvement.

The morning started off rocky despite the great economics with more negative retail news. Wal-Mart warned yesterday that sales would be at the low end of plan and gave traders a clue that December was not going to set any records. Target followed up with a warning that sales were slowing as well. Today Sears was downgraded due to reported heavy discounting and slowing sales. Reports surfaced that high dollar toys, really high dollar like Harley Davidson motor cycles, snowmobiles and ATVs were down between -5% to -9%. Pier One said sales were not going well and would be down -4% to -8% for December. This retail hiccup gave investors a headache despite the positive economic news.

Add to this headache a Merrill downgrade of the chip sector on valuation concerns and it is not surprising the Nasdaq was the weaker performer.

The Dow roared out of the gate despite an earnings warning from HON. The company guided down for 2003 and 2004 saying higher employee costs would hurt performance. HON dropped significantly at the open but only held the Dow back for a couple minutes. HON immediately recovered all its losses but then shed them again as the volume picked up. The Nasdaq did not fare so well due to the chip downgrade and fell from the start to come very close to support at 1900 before recovering to close up for the day. In reality the Dow reached back and plucked the Nasdaq from danger with its +100 point gain. Dow 10084 remained resistance most of the day with the Nasdaq and Russell holding the Dow back. Once that resistance broke everyone joined the party.

That party came to a halt at 10137.64, less than 2 points from Monday's Saddam spike high. Had that Saddam spike not cleared out significant resistance to that level today and probably this week would have looked a lot different. If you remember last Friday we closed right below resistance at 10050 and internals were turning weaker. The outlook for this week was a move higher but nothing impressive. The Saddam spike cleared the way for better gains than we could have made on our own.

If you look at the market internals and charts of the major indexes you will see a troubling divergence. On December 2nd the Russell-2000 hit its high for the year. On Dec 3rd the Nasdaq hit 2000 and both indexes immediately headed lower. From that day forward the OEX (top 100 blue chips) and the Dow started moving higher. Why? The answer is right in plain sight. Portfolio managers know there is a profit taking dip coming in January. Despite knowing there is trouble ahead they do not want to go into the year end in cash. They still have to be invested so those year end statements and advertising literature looks impressive. The way to do this is rotate out of the small caps and techs and into blue chips. They can get out of the most volatile stocks early and into the highly liquid stocks in advance of the decline. Who would not want to own a fund with IBM, MMM, GE, UTX, CAT, KO, MO and PG in it when most are at 52-week highs? This allows the funds to dress up their statements and still participate in any further market gains with their flight to quality. Once January begins they can be poised to exit those highly liquid blue chips in a heartbeat without much risk. Exiting $10 million in IBM is only a downtick on the chart but exiting $10 million in a low volume small cap is a major blow to the price. Anyone notice NTE today? Or YRK, GWW or INFY? These low volume stocks got seriously whacked on the slightest bit of news but they were just those leaders where the incentive to exit and take profits was accelerated by events. Multiply that by many of the small caps and you get the picture. Funds want to be in something liquid in January, not something that will drop -10% if five funds decide to exit at once.

Russell-2000 Chart

Nasdaq Chart

Dow Chart

OEX Chart

With the Dow closing at a new 52-week high the obvious question is what now? There are 5.5 trading days before Christmas and another 3.5 days before January. The odds are very strong that there will be major profit taking by the second week of January. We are counting on that in the Top 50 Stocks for 2004 renewal special. We are targeting specific entry points on key stocks for January to produce the most gains for the first quarter. Now if everyone but the retail traders knows there will be profit taking in January once the 2003 tax year and calendar year ends then why should the Dow go higher?

The Dow "should" continue to see gains due to the rotation out of small caps and into blue chips as I described above. Funds want to be invested for year end statements AND they are expecting the historical pop on Jan-5th from year end retirement contributions. TrimTabs.com is estimating over $10 billion in inflows between Dec-29th and Jan-9th. This cash bonanza will provide one last bounce and the volume needed to exit gracefully. For historical reference I checked the highs for January for the last six years. In Jan-2003 the high for the month was set on the 8th trading day. In 2002 the high was set on the 4th day, 2001 the 3rd, 2000 the 9th, 1999 the 5th and 1998 the 2nd day. The average high for all six years was made on the 5th day. That targets Jan-7th for 2004 but we have had a bigger gain in 2003 than any of the other prior years. This would suggest an earlier exit for less risk. Personally I am targeting the 5th or 6th for the January high.

I got sidetracked on the short-term topic. Yes, I think we will see a higher Dow between now and year end despite the rotation we are seeing in the small caps. How much higher? There is significant resistance beginning at 10,200 to 10,300. That would be my target range for the next three weeks. If we get to 10200 I am going short and I am doubling down at 10250 and backing up the truck at 10300. My only question is where will the cheating start? We are not the only ones that can look at a historical chart and count. With 9,000 mutual funds and thousands of mini-funds and hedge funds there has got to be some with enough profits that they want to beat the pack to the door. Once this cheating starts it may be difficult for the rest to maintain discipline until January.

To complicate things we have the elusive Santa rally. This is probably the most abused and over used term mentioned in holiday trading. The official Santa rally timeframe is considered to be the last five trading days of December and the first two days of the new year. Those seven days have averaged a +1.5% gain in the S&P since 1950. Even at these levels, S&P 1075, that +1.5% is a whopping +16 points. Not exactly a banner week. Retail traders hear the term Santa Claus rally and conjure up visions of strong gains and a prosperous new year. As I have outlined above the real result of the Santa Rally is to line up the sheep for the slaughter. I do not intend to be a sheep and hope you feel the same way.

The VXO closed at 15.70 today. That is a low not seen since November 1996 in pre-Internet trading days. When sentiment is that lopsidedly bullish the danger is very real. I know you have heard it before because we have been flirting with 16.0 for over a month. It is off the scale for the reasons mentioned above. The VXO is calculated on the OEX, the top 100 blue chip, most highly liquid stocks. Sound familiar?

There are no material economic reports for Wednesday and it will be left up to earnings warnings or news reports to move the market. The strong gain today could give traders another opportunity to lighten up but the more likely prospect will be just holding the high ground. Every dip today was met with decent volume and the same is probably true for Wednesday. Regardless of what happens tomorrow or the rest of the week we are trading on a tight wire at these rarified levels. Everyone has high hopes for the end of the year but there is always the chance for a bolt of lightning out of a blue sky that changes the picture instantly. Party on but be prepared to hit the exits if the punchbowl suddenly runs dry.

Time is growing short for the end of year renewal special. Our goal is to have the Top 50 Stocks for 2004 in your hands before the holidays. They will be mailed by priority mail on Monday Dec-22nd so you can have the entire holiday period to review it and plan your trades. TIMING IS CRITICAL. Do not delay. We based the entry points for each of the stocks on the expected January dip. Don't miss out on this opportunity to profit. Full details below.

Jim Brown
Editor

*****************************
2003 Year End Renewal Special
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