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Market Wrap

Inflation or Deflation?

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     06-15-2004            High     Low     Volume Advance/Decline
DJIA    10380.43 + 45.70 10428.05 10336.51 1.61 bln   2225/ 626
NASDAQ   1995.60 + 25.61  2006.58  1982.41 1.49 bln   2085/ 971
S&P 100   552.79 +  2.73   555.67   550.06   Totals   4310/1597
S&P 500  1132.01 +  6.72  1137.36  1125.29
RUS 2000  567.92 + 10.25   569.69   557.67
DJ TRANS 3039.84 + 45.87  3051.89  2997.09
VIX        15.05 -  1.02    15.35    14.72
VXO        15.00 -  1.15    15.64    14.61
VXN        20.88 -  1.36    21.85    20.46
Total Volume 3,116M
Total UpVol  2,443M
Total DnVol    625M
52wk Highs     111
52wk Lows       80
TRIN          0.61
PUT/CALL      0.78

The markets were dominated with news and discussion surrounding the thorny inflation vs. deflation issue, with the CPI report released in the morning ahead of Greenspan's testimony before the Senate Banking Committee. Bonds staged a dramatic upside reversal, with milder but still solid gains in equities and metals.

The Dow closed higher by 45.7 points at 10380.43, the S&P 500 added 6.71 to close at 1,132 and the Nasdaq gained 25.6 points to close at 1995.6. Volume was modest, and volatility dropped strongly following yesterday's sharp gains, correcting part of those gains. The VXO fell 7.12% to close at 15, the QQV 7.09% to close at 19.27. The abortive morning rally and the failed afternoon plunge accompanied by big moves in the volatility indices reminded us that it is, after all, op-ex or "scam" week, a time for headfakes and false breaks. Today did not disappoint.

Daily Dow Chart

The Dow's gains lent support to the descending trendline at 10340, which once again supported the price with the day low printed at 10336. The move paints a complicated picture, as today's failed high at 10428 broke Monday's and Friday's high, but the gains blew off in a doji spike. Despite the higher high (and higher low), the overall descending trend from the June high continues, but it was sufficient to confuse the daily cycle oscillators, with the 10-day stochastic hesitating in its downphase. Macd confirmation of the stochastic sell signal from last week remains elusive, making this a dangerous and tricky level overall, below rising resistance but above descending support. A break below the descending trendline, currently at 10335-40, would be a good short entry with a stop just above the trendline, while a break of today's high on a closing basis would most likely abort the stochastic downphase and set up a test of rising resistance at 10490. Next support below 10335 is at 10290, being confluence and Fibonacci support, followed by 10240.

Daily Nasdaq Chart

The Nasdaq daily is a much simpler chart here, with a failed "return-to-the-scene-of-the-crime" rally rejected at the descending resistance line. Last week's upside close has so-far proven to be a classic throwover trap, and until a close above the trendline at 2005, the daily cycle downphase should continue to strengthen. A closing break of support at 1980-82 (session low at 1982 today) should provide the bearish Macd cross we've been awaiting to confirm the daily cycle rollover from last week, while another bounce from that level sets up another challenge of the broken resistance line. A break of 2005 on a closing basis would obviously be bullish, but I'd want to see a break of 2025 resistance before doubting the daily cycle downphase currently in progress.

It was a news-heavy day. At 8:30AM, the Labor Department reported that the Consumer Price Index, the most widely used gauge of U.S. inflation, rose 0.6% in May, the largest one-month gain since January 2001 and exceeding expectations for a 0.4% gain. The media emphasized that the core CPI, which is the CPI net of food and energy costs, rose just 0.2%, in line with expectations. The fact that everyone has to pay the so-called "volatile" food and energy costs doesn't seem to be a fact with which many analysts concern themselves. Furthermore, looking at the yearly trend, we see that the 12-month y-o-y change in the CPI (including food and energy) is now 3.1%. At 1.0%, the real Fed funds rate is -2.1% using the 12-month y-o-y change in CPI as the inflation measure. It's even more egregiously negative if we use the 5-month annualized rate which is in the vicinity of 5.1%. At 8:30AM with the release of the data, one could not help but wonder, if the alleged economic recovery is as robust as the Fed, the Treasury Department and our politicians claims, why is the Fed funds rate being maintained so far below the curve?

Also at 8:30, the New York Empire State Manufacturing Index was released, meeting expectations at 30.2. The New York Federal Reserve Bank said that the data showed strong economic activity, unchanged from its May reading. The press reported that other than during the March decline, the Empire State index has been above 30 since October. New orders fell to 26.5 from 36.6 in May, shipments fell to 33.4 from 42.3, and the employment index fell to 12.9 from 21.3.

The Commerce Department reported that business inventories in the rose a 0.5% in April, exceeding expectations for a 0.4% rise for an 8th consecutive gain. Business sales fell 0.1% after record gains in the prior month. The inventory-to-sales ratio remained at a record low of 1.30 months in April, which indicates strengthening demand exceeding the ability or willingness of businesses to grow their inventories, a generally bullish sign. A low inventory-to-sales ratio predicts a more direct increase in production in the event of increasing demand for products.

The Producers Price Index was delayed again indefinitely with the BLS again citing computer problems. The missing report was originally scheduled for release on June 11th.

The US Dollar Index dipped on the 8:30 data, sparking a rally in equities, treasuries and precious metals. At 9:45, the University of Michigan announced that consumer sentiment rose to 95.2 in June, a 2 month high, up from the 90.2 May reading and exceeding expectations for 90.5. The admittedly subjective index reading is down 8% from its January high. Despite this strong data, bonds remained firm near their highs of the day in breakout territory on the daily charts, just in time for Greenspan to begin his testimony before the Senate at 10AM.

Around the same time, it was reported by oil minister Thamer Ghadban that "A pipeline south of Basra was targeted by saboteurs with explosives," in what he felt was an act of sabotage. Oil rose on the news of yet another attack on oil production and delivery assets. Iraqi oil exports were reportedly brought to a standstill by the blast. The gains were short lived, with crude futures settling back into negative territory to finish the day down 1.29% at 37.39.

Greenspan said relatively little in his Senate testimony. He told the committee that he would be honored to serve a 5th term as Fed chairman. Most notably, he did not confirm if or when the Fed would be raising rates, and emphasized uncertainty and the difficulty in determining monetary policy overall. He said that the Fed would focus on probabilities in the face of the wide range of events that the future might hold, and noted that the economy has been very resilient in the face of what would formerly have been destabilizing shocks. In the Q&A session, Greenspan stated that the Fed views inflation to be benign currently, and not a problem. He nevertheless admitted that high energy costs could present a threat to productivity. Moving from that topic, he reiterated his warnings from last year, saying that he found the numbers concerning the imminent retirement of the baby boomers around 2008 to be "very disturbing", urging that deficits be reduced or eliminated, primarily by reducing government spending. In response to a question from Senator Sarbanes, he added that he would be very surprised to the boom in home sales and prices continue.

Equities had been in the process of rolling over, but spiked higher on the "inflation is benign" comments from the Fed chief. Gold spike to new session highs and similarly held those levels during the Q&A session.

Chairman Greenspan is scheduled to testify before the House Budget Committee tomorrow at 10AM.

In last night's Futures Wrap, I cautioned against being too confident that Greenspan would be quick to do what the market so obviously expected. With a rate hike appearing almost unavoidable, I noted that the bond market, which determines the rates that concern the whole world (other than the Fed's 23 primary dealer banks), had already fallen very substantially from its March highs, raising yields (read: interest rates) sharply from their March lows. Central bankers prefer to jawbone the markets than to actively buy or sell them, and Mr. Greenspan today did not disappoint. The markets over the past 3 months have done most of the heavy lifting, and his testimony and Q&A responses were only a step above bare chit chat.

Also in the morning, President Bush and the Afghan president Hamid Karzai addressed the press from the Rose Garden. They delivered an upbeat assessment of economic developments in Afghanistan, and announced a bilateral trade agreement between the US and that country, including a dedication of $5M to promoting the advancement of women in the Afghan's public and private sectors, including training and small business grants. In the Q&A session that followed, the President answered questions about the US economy, stating that he's pleased about the strong economy and optimistic for its future. No one asked him why he thought the Fed is pegging its rates so far below even the official CPI number.

The House Financial Services Committee approved a bill tabled by Richard Baker, R-LA. that would require companies to expense only those stock options granted to their five highest-paid executives. This watered-down bill would also require the SEC and Labor Department to conduct a joint study to study the economic impact of stock option expensing despite the fact that the Financial Accounting Standards Board has already recommended that companies should deduct the value of all stock options from their income statements. This is also a point on which Warren Buffett has been particularly outspoken in the past, arguing that stock options should be required to be expensed by the companies that grant them.

In corporate news, MSFT was higher on analyst Rick Sherlund's speculation that MSFT may announce a share buy-back program to reduce part of its massive cash position. The Goldman Sachs analyst said that "We believe an aggressive share repurchase would be materially additive to earnings and could be a positive catalyst to the stock," but admitted that the Company had yet to make any announcement. Speculators didn't wait, however, bidding MSFT up to a 1.56% gain, stock closing at 27.32.

After the close, ORCL announced Q4 earnings of $990M or 19 cents per share, up from $858 million or 16 cents y-o-y and beating expectations by a penny. Sales rose 9% percent to $3.1B, exceeding expectations of $3.071M, up from $2.8B y-o-y.

For tomorrow, we await the 8:30 release of May housing starts (est. 1.95M) and building permits (est. 1.97M), followed by May industrial production (est. .8%) and capacity utilization (est. 77.4%), followed by the 2PM release of the Fed's Beige Book. And, to repeat, Chairman Greenspan's testimony before Congress is scheduled to begin at 10AM.

For tomorrow, I'm expecting more downside attempts based on the ongoing daily cycle downphases. Because it's op-ex week, complete with failed moves and spiky volatility, I'm trying to stay flexible and not get too surprised by whatever sudden move happens next. The trendlines on the daily charts provide a good working range that can either be faded for reversals or followed on breakouts, but I'd urge you to be disciplined with your stops out of respect for the op-ex factor. Greenspan's testimony should also be good for some swings, if it doesn't result in a teeth-grinding stall such as we had at various points this morning.


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