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Market Wrap

Oversupply and Undersupply Stories

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         WE 8-20          WE 8-13         WE 8-06         WE 7-30
DOW     10110.14 +284.79  9825.35 + 10.02 9815.33 -324.38 +177.49
Nasdaq   1831.02 + 73.80  1757.22 – 19.67 1776.89 -110.47 + 38.27
S&P-100   536.04 + 15.32   520.72 -  1.11  521.83 - 15.84 +  7.29
S&P-500  1098.35 + 33.55  1064.80 +  0.83 1063.97 - 37.75 + 15.52
W5000   10648.75 +344.09 10304.66 -  3.18 10307.84-393.81 +147.83
SOX       386.00 + 19.35   366.65 – 20.23  386.88 - 29.55 + 10.85
RUT       547.92 + 30.53   517.39 -  2.26  519.65 - 31.64 + 12.07
TRAN     3090.87 +123.95  2966.92 +  0.84 2966.08 -145.61 + 68.25

Jim Brown attends a conference this week, and will return next week. Writers and subscribers alike look forward to his return.

Oversupply and undersupply stories dominated reports early Friday morning, with those reports pressuring markets. Futures eased during the overnight session. Cash markets dipped at the open, too. They soon found support and waffled around for a number of hours, looking for next direction before heading higher through the afternoon until a steep dip off the highs in the last few minutes. Internals had been strong all day, with advancers ahead of decliners on both exchanges throughout the day. TRIN had trended down from bearish to neutral in the early period and then quickly into bullish territory, signaling the up-thrust to come in the equities before it actually arrived.

Those oversupply and undersupply stories did not start the day on a bullish theme, however. They included oversupply issues related to LCD's. Isupply Corporation, a California-based business, reported that global supply of LCD's needed for computer and television screens surpassed demand in the first half of the year, and that the excess was likely to widen. In European trading, companies such as Royal Philips Electronics had already headed down before the U.S. open. As James Brown reported later in the day on OIN's Market Monitor, CNBC later reported that the oversupply was likely to bring prices lower on flat-panel televisions.

Concerns about rising inventories in semiconductor and tech stocks have pressured semi-related stocks lower through the summer months until August's bounce. Figures released by the Semiconductor Equipment and Materials International after the close Thursday did not ease those concerns. According to a Bloomberg article, the semi-book-to-bill report showed the smallest month-to-month increase in global orders since August, 2003. Although the book-to-bill ratio remained above the benchmark 1.00, the July ratio fell to 1.05 from June's revised 1.07. Credit Suisse First Boston reportedly termed the number worse than expected, with CSFB expecting 1.08 from a revised 1.07 for June. As Jim Brown has often reminded us, that book-to-bill ratio reflects a three-month average. That means that the July number must have been lower than 1.05 to achieve that lower three-month-average. For those who would like to view the complete report, it can be accessed www.semi.org.

During the morning, the SOX's behavior remained lackluster, dragging down other indices that appeared to want to bounce from support, then doing some waffling of its own. That waffling took the form of a neutral triangle before the SOX finally pushed above that triangle and joined other indices that were breaking out at the same time.

Annotated 15-Minute Chart of the SOX:

Gap Inc. (GPS) might have experienced a bit of an oversupply problem, too. Poor attendance at summer clearance sales impacted the retailer, causing it to be lumped together with JWN and NOVL, other companies with earnings reports deemed disappointing. The RLX, the S&P Retail Index, managed a gain Friday, but that gain straddled the 200-dma, showing the RLX spending a fourth day testing that average.

Annotated Daily Chart of the RLX:

The RLX looks ready to roll down into a right shoulder or punch up through the converging 50- and 200-dma's.

Another oversupply story concerned GM. According to a WSJ story, GM may trim production as much as five percent due to dealers cutting back their orders as they experience rising inventories. GM opened $0.54 below Thursday's close, but managed to make up all but $0.21 or 0.51 percent of those losses.

Rising fuel costs number among the reasons for those rising inventories that car manufacturers and others experience. Crude costs and the reasons behind those costs composed the undersupply story for the day. In the overnight session, crude futures for September delivery traded a new record high, variously reported as $49.20 and $49.27, on supply concerns. The clash between radical cleric Muqtada al-Sadr's militia and U.S. and Iraqi troops escalated overnight, with one headline Friday morning mentioning 77 killed and 70 wounded in the fighting since Thursday morning. The cleric's militia had threatened to attack Iraq's pipeline and other elements of the oil infrastructure.

By midmorning, reports began surfacing that Iraqi police had gained control of the Iman Ali Mosque, the shrine where the cleric had taken refuge. Witnesses had reported seeing Iraqi police transporting arms out of the mosque. Markets began hesitant climbs off their lows of the day.

Some speculated that the cleric had fled the mosque, and Iraq's Interior Ministry spokesman appealed to the cleric to turn himself in, saying that the police were in control of the shrine. Those reports were soon disputed, however. A senior aide of the cleric claimed that the shrine was still in control of the Mehdi army. News correspondents associated with the U.S. Marines reported that the Marines were unable to verify the reports that Iraqi police had taken control, with witnesses reporting fighting continuing near the shrine where Mehdi militia have been holed up in the mosque complex, the adjoining cemetery, and the alleyways leading to the mosque. The Iraqi national security adviser reported an inability to establish communications with the governor and chief of police of Najaf and verify those earlier reports. Later in the afternoon, U.S. time, witnesses began reporting the Mehdi militia in charge of the shrine and its approaches, with Iraqi police not seen. One must wonder whether the initial reports of a takeover of the shrine and a disarming of the cleric's militia were not intended to convince Sadr to turn himself over and call off his militia.

As this report was prepared Friday evening, Iraqi police in Najaf had reportedly just confirmed that they did not control the site. Sadr's aide said that talks were underway to transfer control of the site to another cleric.

As the day wore on, however, markets seemed to care less and less about what was happening in Najaf. Perhaps some reasoned that the conflict was drawing to close, whether that close came on Friday or another day. Crude futures dropped throughout the afternoon, with crude futures for September delivery dropping from that overnight high all the way to $47.60. Equity markets began bouncing as crude futures dropped.

As the conflict dragged through the week, at least some of the quick inflation in crude futures might have been attributed to the fast-approaching expiration of crude futures for September delivery, however, with that expiration occurring Friday. Shorts who had expected a resolution any day as the cleric agreed to ceasefires and then rescinded his agreement almost as quickly must have been feeling the squeeze as expiration Friday approached.

Rising crude costs have benefited the OSX, of course, and Lehman Brothers upgraded the group to a positive rating from its previous neutral rating. The firm also upgraded companies CAM, CLB, TDW, OII, RIG, GSF, NE, and SII. Almost all of those stocks gapped higher Friday, but although none closed the gap, most could not hold onto all their gains and printed bearish shooting stars Friday.

The intraday chart for the SOX shown above indicated that the SOX also could not hold onto its gains. Wednesday's Wrap had suggested that indices might print small-bodied candles at resistance, perhaps through Friday, and the SOX followed that scenario.

Annotated Daily Chart for the SOX:

The theory presented Wednesday had been that many indices had seen strong gains Wednesday, and might need a day or two to consolidate their gains. Many indices also displayed the possibility of forming inverse H&S, with either descending necklines if the indices turned down from then-current levels or from horizontal ones if they rose up to next resistance. The expectation had been for many indices to print candles like the ones shown on the SOX daily chart for Thursday and Friday. That did happen for the RLX and some other indices as well as the SOX. However, other indices confounded that theory by showing larger- range days than expected Thursday and Friday while still maintaining the possibility of turning down into another shoulder.

Annotated Daily Chart of the SPX:

The bearish 50/200 cross and the continued trade within the descending regression channel still suggest that selling rallies remains the preferred strategy, but the possibility that the SPX could trade all the way up to the top of that descending regression channel or even break out of the channel cannot be ignored. The weekly chart presents a more bullish view of the SPX's actions.

Annotated Weekly Chart of the SPX:

Because of the possibility that the SPX's weekly morning-star pattern could be signaling a reversal up through its descending regression channel, those who prefer to play the bullish side could wait for a test of the 200-dma, with a move above it confirmed by a move above the 100-dma. Plans should be made to protect profits in the 1130-1135 zone, however, in case the SPX turns down again instead of breaking out through resistance line. In actuality, with the exception of the breakout above 1080, it has been difficult to find a safe place from which to suggest a bullish play because of multiple resistance zones ahead as the SPX moves up through that congestion zone.

The Nasdaq printed its own potential reversal signal on the weekly chart, although not in as classic form as did the SPX. The daily chart shows that the Nasdaq stopped short Friday at a descending trendline that has been in place for more than a month, also the site of the diving 30-dma.

Annotated Daily Chart of the Nasdaq:

The descending red trendline depicted above could serve as the neckline for an inverse H&S, but the Nasdaq oscillators indicate that the Nasdaq could push higher. Those who prefer to play the bullish side could watch for a push above that trendline, confirmed by a move above the 30-dma, but should have profit- protecting plans in place as the Nasdaq approaches 1890-1900, the likely site of the descending 50 and 200-ema's by the time that level could be approached. If the Nasdaq is to form an inverse H&S from a horizontal neckline, that would be the appropriate spot for a rollover into another shoulder.

Like the other indices, however, bearish MA crossovers suggest that selling rallies could still be the preferred strategy, with the knowledge that crossovers tend to come late in a movement. Bullish MA crossovers, confirming strength, could come just as late in the movement.

Out of all the indices, the Russell 2000 may be the closest to reaching an appropriate rollover level from a horizontal neckline or a push through the neckline, rejecting the potential formation and preparing for a climb up toward the 200-dma.

Annotated Daily Chart of the Russell 2000:

Like the positioning of the oscillators on other indices, their positioning on the Russell 2000's daily chart presents the possibility of more upside. A rollover at the potential horizontal neckline for an inverse H&S may not occur, and the Russell 2000 may instead shoot up to test its more closely watched 200-sma and then perhaps the top of its regression channel. A bullish trade in the Russell remains problematic, however, as there has just been a bearish 100/200-sma cross, it does still remain within a descending regression channel, and so many potential pitfalls in the form of various MA's exist in the path of any bullish play. Some oscillators signal incipient bearish divergence as they've already reached higher highs when compared to the early August period while price has not. The Russell 2000 can erase that potential divergence, however, by the simple method of climbing higher than that early August high.

The Dow, too, may be aiming for a horizontal neckline to a potential inverse H&S, if it intends to form one.

Annotated Daily Chart for the Dow (using DJX as proxy):

The Dow also produced a nice-looking morning-star reversal signal on its weekly chart. It had also been showing bullish divergence on this daily chart. Note that the last approach to the bottom of the regression channel stopped before touching that channel, when the previous approach had not only touched it, but breached it. However, a bullish trade in the Dow appears as problematic as one in the Russell 2000, with a group of important moving averages converging overhead. While the Dow can plow through those averages, it appears more likely that it would need consolidation or a pullback from that resistance before doing so. Look for a test of 10,130-10,170 and a rollover from that zone as an opportunity for a bearish play. A break above the 200-sma would be one indication for a bullish play, but profit-protecting plans should be in place as the top of the descending regression channel is approached.

If indices begin rollovers sometime next week instead of punching up through next resistance levels, special note should be taken of the shoulder levels in the possible inverse H&S formations. If in bearish plays, profit-protecting plans should be place ahead of tests of those potential shoulder levels. OIN readers are not the only ones capable of noting potential formations, and those intending to buy could step in ahead of the actual shoulder level. Anywhere ahead, actually. With weekly charts showing bullish reversal signals and daily charts presenting the possibility that even a pullback could be part of a bullish inverse H&S formation, some might be willing to buy well ahead of such a test of the shoulder level. Those profit-protecting plans could include plans that allow for participation in further downside if the shoulder levels are violated.

Taking over for the SOX lately as an indicator index, the TRAN may provide our first clue as to whether other indices are likely to roll over or break out to the upside.

Annotated Daily Chart of the TRAN:

Unlike some other indices, the TRAN has the support of both the 200-sma and -ema below it.

The indices are printing beautiful potential reversal signals on their weekly charts. Some have broken above the midlines of their regression channels. Daily chart oscillators still indicate there's plenty of upside to go. What could precipitate a rollover now?

Crude could, of course. If the theory about an expiration- related run-up in crude coupled with an actual price increase is wrong, crude could continue higher next week. An incident in the final days of the Olympics or a blown-up pipeline in Iraq could precipitate a rollover, although it's difficult to even give words to that first possibility. The terrible historical trading pattern for the last week in August, mentioned by James Brown in OIN's Market Monitor on Monday, could reassert itself this year, resulting in a rollover.

Fear of the GDP could also do it. That GDP will be released Friday.

No important economic releases are scheduled for Monday, and the calendar for the entire week will be lighter than last week's heavy calendar, although not without its share of weighty releases. Tuesday sees July's Existing Home Sales at 10:00 EST. Expectations are for a decrease to 6.78 million, down from the prior month's 6.95 million.

Wednesday's numbers include July's Durable Orders at 3:30, with expectations for that number at a 0.8 percent rise after June's 0.9 percent climb. Wednesday's releases also include July's New Homes Sales, with expectations for 1,280 thousand sales, down from June's 1,326 thousand sales. Also, Wednesday has become important because of the 10:30-11:00 releases of the Department of Energy and API figures for crude, distillate, and gasoline inventories. Thursday, natural gas inventories, watched less closely lately, will be released, but more might be watching for the earlier, 8:30 release of Initial Claims and the 10:00 release of July's Help-Wanted Index. Economists expect the Help-Wanted Index to show an increase to 39 from June's 38.

Friday draws more attention, however, with the 8:30 release of the second-quarter preliminary Chain Deflator and GDP, and the 10:30 release of August's Revised Michigan Sentiment. Earlier this week, a French minister quantified the effect he expected rising crude to have on the French GDP, saying that if crude reached $50/barrel and stayed at that level, he expected the GDP gain to decrease by one percent. During much of the second quarter, crude futures were retracing gains and hadn't approached $40.00, so that preliminary GDP might not yet show the effect of increasing crude costs. Crude futures for September delivery increased from the March 31 close at $33.65 to the June 30 close at $37.14.

However, Japan's shocking Q2 GDP number certainly could make markets jittery, concerned that the U.S. could be in for a similar downside surprise. That's especially true since June's trade balance, released last week, showed that the gap had widened to a record $55.8 billion, with prices paid for crude oil and other industrial supplies showing up as one of the factors in that increasing deficit. Perhaps those crude costs earlier this summer, although minimal by comparison to today's costs, were still high enough to impact the GDP figure, too, some might wonder.

That widening trade balance last week also revealed that exports had decreased. Upon the release of that number, some began speculating that growth estimates for the U.S. economy might require revision. The too-low estimate for June's trade gap had probably been folded into the calculations for economic growth, some commented.

Forecasts for the preliminary GDP are for 2.8 percent, a small decrease from the previous 3.0 percent. Estimates for the preliminary Chain Deflator are for a flat 3.2 percent, and no change in expected in the revised Michigan Sentiment number, either, according to one source.

Monday begins a week that's been bearish for six out of the last seven years, with drops in the major indices averaging more than 3.5 percent. We begin that week with weekly charts showing beautifully completed morning-star reversal signals. Switching back and forth from weekly, daily, and intraday charts show differing pictures for the indices, so that one could form wildly differing market outlooks. Weekly says up. Daily bar charts say up, but maybe with pullback first. Daily nested Keltner charts suggest that the two S&P's, at least, are nearly jammed up against next strong resistance. Facing Friday's possible GDP downside surprise and uncertainty over what will happen with crude costs, trade carefully during this traditionally bearish week, prepared for a rollover into shoulders for potential inverse H&S formations or for moves up through to the tops of the descending regression channels on daily charts. Be prepared to jump out of the way if your bias is proved wrong and indices head the other direction.


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