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Market Wrap

Tick, Tick, Tick

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        WE 6-25         WE 6-18         WE 6-11         WE 6-04 
DOW    10371.84 - 44.57 10416.4 +  6.31 10410.1 +167.18 + 54.37 
Nasdaq  2025.47 + 38.74 1986.73 - 13.14 1999.87 + 21.25 -  8.12 
S&P-100  549.75 -  5.06  554.81 -  0.09  554.90 +  7.82 +  1.95 
S&P-500 1134.43 -  0.57 1135.00 -  1.47 1136.47 + 13.97 +  1.86 
W5000  11073.60 + 39.48 11034.1 - 11.83 11045.9 +109.64 +  9.95 
SOX      478.91 + 25.83  453.08 - 23.20  476.28 +  5.37 - 17.95 
RUT      587.70 + 17.16  570.54 +  1.42  569.12 +  1.37 -   .53 
TRAN    3164.18 + 95.61 3068.67 + 43.96 3024.71 + 32.43 + 44.27 

While most Americans are oblivious to the coming events the clock continues to count down to June 30th. Whether it will pass as a major calendar event or pass quietly like a mini Y2K is yet unknown. The volume of press the events are now getting should go a long way toward making them anticlimactic. Investors, if you believe the talking heads, are sitting on pins and needles worrying about Wednesday's events. Personally I think Friday's Jobs Report will be more critical but you never know.

Dow Chart - Daily

Nasdaq Chart- Daily

Russell-2000 Chart - Daily

In the economic arena investors received another blow when the final GDP for Q1 came in lower than expected at +3.9%. This was less than the 4.4% estimate and the last revision. This shocker contained offsetting components. Corporate profits were revised up to +1.7% from the +1.2% reported in the last revision. That is good news but there was an offsetting entry. The PCE deflator, a key inflation gauge used by the Fed, jumped to +2.0% from the prior +1.7%. The GDP price index was also revised up to +2.8% from +2.6%. It seems the inflation threat is increasing and the economy is slowing. This is bad news for the Fed and could put them in a bind when they make their rate decision on Wednesday. Business inventories were revised down to $25.5B from $28.2B. The bulk of the downward GDP revision came from a larger than expected trade deficit at -$535.6B. This was a $10B increase from the prior revision.

The Michigan Consumer Sentiment did rise as we expected but only slightly to 95.6 from the preliminary 95.2. This was more than a +5 point jump from May's 90.2. If you recall May saw a -5 point decline from April and the June bounce has now completely erased that drop. We speculated at the time that the Iraq prisoner scandal had depressed the May responses. Rocketing gas prices also impacted consumer wallets. It appears those problems have passed.

As I suspected on Thursday the Existing Home Sales roared higher than consensus estimates and set a new record of 6.8 million units. This was substantially over estimates and the 6.63 million units in April. For the same reasons I wrote about on Thursday the turnover in existing homes is ripping along at the same hot pace as new homes. Each move to a new home vacates an existing home and the ripples behind the scenes begins. Each time a high-end buyer upgrades it produces a series of vacancies/sales at lower levels. Firming consumer confidence/sentiment is helping promote the current wave of upgrades. Including new home sales the annualized pace of total home sales surged past the eight million mark for the first time ever in May.

The big news of the day was not the economics although a low GDP and negative Durable Goods did nothing to help stocks. The big news was the Russell shuffle at the close and it was nothing like anyone expected. Normally the Russell tanks into the close as fund managers sell the stocks leaving the indexes and buy the new stocks that will be in the indexes as of Monday. Surprise, surprise! The Russell failed to see any serious selling during the day despite constant conversations on stock TV about the possibilities. Just before the close, around 3:30, the Russell begin to climb, not just climb but accelerate into a vertical spike. The Russell posted a gain of +8.65 for the day and the Dow went out at -71 due to extreme volatility related to the rebalancing. This is crazy. The Dow closed at 10443 on Thursday and is showing a 4:PM close of 10412 for Friday. However, due to extreme after hours volatility right at 4:PM the after hours settlement is printing 10371 for a -71 loss. Needless to say there will be some serious volatility at the open on Monday.

Major drops in GE, -1.00 at the close, and several other Dow stocks tanked the Dow instead of the Russell. Dell moved +1.00 after the close. Somebody needs to reevaluate their computer models if stocks not really involved in the rebalance got thrown this severely out of whack. The normal pattern was supposedly disrupted by the lack of hedge fun participation according to one analyst. The current lack of interest in the market and the pending news events prompted many hedge funds to simply pass on trying to arbitrage the trade. Many funds were reported to have legged out of the deletions and into the additions over the last two weeks instead of doing the normal Friday dump and buy. Whatever the reason it appears there was a substantial short contingent in anticipation of the normal routine and that routine was broken. Shorts found themselves in a squeeze with nobody dumping stock and once the short covering began it skewed the delicate market balance into a serious imbalance.

On the charts the Dow is showing a solid stop at 10400 and a close at 10412. With the after hours imbalance we have no idea where this will resolve on Monday. I feel the 10400 level is the current support level and it held up very well on Friday. However, for the third consecutive day the Dow rebounded to 10487 and failed. It just can't seem to get to the strong resistance at 10500. With support at 10400 and resistance at 10500 we are looking at a very tight range next week while we wait for the Wednesday events. If the after hours volatility stands then I would expect that range to expand to 10360 to 10500. We could easily trade there through Wednesday except for several external factors.

The Fed meeting has become a non-event. More than 25 points have already been priced into the market and with the two weak reports, GDP and Durable Goods, and the high Jobless Claims the Fed is back in the hot box. They have gone out of their way to prepare the market for a rate increase and yet the economy is not holding its prior pace. On the other side of the coin it appears inflation is rising on all fronts. The Fed is trapped and has to raise rates and a 25 point hike should be market positive. The uncertainty will be gone and a calming statement with the hike could put the bond junkies at peace until after the election. Bottom line, the Fed meeting should not have any negative impact on the market.

The Iraq turnover has been cussed and discussed so much that everyone expects the worst and anything short of a Saddam escape should be ignored. The new Iraq officials are talking a good game and everybody knows there will be numerous attacks. I believe this is already priced into the market. I do not believe we will see any event that will cause us to tank except an event on U.S. soil. We saw 75 deaths and nearly 400 injured in the big attack this week and the market barely blinked. As one reporter put it on Friday, Iraq will revert to prime time next week and while we are not sure they are ready for the spotlight even the bad side will not be anything we have not seen before. The more they exaggerate the event the less impact it may have on the markets. Traders tend to glaze over after days and days of the same news.

On the positive side this is the end of the quarter and retirement funds will be flowing. Some analysts think most funds are heavy in cash because they were waiting for the June implosion from the convergence of events. With no implosion and the events upon us and priced in those funds will want to put the money into stocks before the quarter end statements. With more cash about to hit those retirement accounts this should accelerate this need to invest. This should provide a positive bias into Wednesday's close.

Conventional wisdom suggests we are going sideways until after the June 30th events. I have been buying this argument myself up until last week. When I started seeing the bullish factors lining up a week ago I began to reevaluate this outlook. Friday's action convinced me we still have more potential to move higher than lower next week. Of course any material event not currently contemplated could change that in an instant but that is my view today.

To expand on this thought process I think the longer term view is the key. By longer term I am thinking three weeks. I have to clarify that because "longer term" means different things to different people. My longer term view is a post Fed rally into the holiday weekend and then a continuation of that rally for the week after the holiday. This will set us up for the Q2 earnings and the Q3 guidance. Once we get to July expiration all bets are off for the rest of the summer.

One of the potholes in this yellow brick road is the Nonfarm Payrolls next Friday. The current consensus for the June jobs gain is +275,000. This is very strong for a summer jobs report. John Challenger was interviewed on Friday and he said employment was slowing. According to his surveys 69% of corporations did some hiring in the first six months of 2004. For the next six months the number of firms considering hiring drops to only 44%. Also the pace of hiring is slowing. Corporations have staffed up and now they are only looking at filling the vacancies rather than a new wave of additions. This view along with some of the slowing employment components from the various manufacturing surveys suggests the next Jobs Report could be a disappointment. That report is next Friday. But, depending on what the Fed says on Wednesday it could be completely ignored.

For Q2 earnings we have had very few warnings and also very few guidance upgrades. Racing into the earnings cycle with no material earnings news could have a dual impact. No news could be good news for stocks as all the optimists line up at the buyer window. This allows us to speculate about how good things might be without really having any evidence to back it up. That sets us up for an earnings challenge for the last two weeks of July if there is no positive news from the early reporters.

Most analysts expect a deceleration of earnings and an increasing failure to hit the high bar as we near 2005. In fact 2005 estimates are positively anemic compared to the last two quarters. This will put added emphasis on the Q3 guidance, especially in front of a tossup election. Traders will be looking for a reason to stay in the market not necessarily a reason to exit.

To net all this out into a trading plan for next week I would again suggest buying the dips in anticipation for a retest of the 10500 resistance level. We may not hit it until after the Fed decision but I suggest you plan your trades for the eventuality. With the high volatility at Friday's close there is no telling where we will open on Monday. The Dow is showing a close at 10371 based on the after hours settlement. Using the 10360 support I mentioned earlier I would look for a long entry on a rebound from that level. Should the market gap up in a correction from the Friday volatility skew I would probably look for another dip to enter. Try to get in as close to the 10360-10400 range as possible.

The risk on a long entry is the extended Nasdaq at 2030. This is the beginning of a strong resistance range for the Nasdaq and a level that could produce some profit taking. 2050-2070 is the next major resistance. The Nasdaq could see an additional bounce on Monday as funds complete their Russell purchases. Quite a few funds will normally wait until after the volatility event to enter the new stocks. This could provide support for the Nasdaq if not an outright upward bias.

I hope I have given you a general idea of what may happen but please realize this will be an event motivated week. These events may be already priced in but there is always the potential for the unexpected. For instance Bush is out of the country and could try to sneak into Iraq for the changeover. A truck full of explosives was reportedly found in a Turkey airport on Friday. An airport Bush will use this weekend. On Friday an air strike in Fallujah knocked al-Zaqawi to the ground with a near miss but he was helped into a car and escaped. A direct hit could produce a significant market bounce. The Fahrenheit 9/11 film opening this weekend could start something and change the entire election balance. I hope you get the picture that this is a critical week and the picture could change in a heartbeat. Plan your trades including your exits and trade your plan. Don't get married to your market bias, divorce is painful.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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