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Market Wrap

Tech Divergence Easing?

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WE 02-25 WE 02-18 WE 02-11
DOW 10841.60 56.38 10785.2 -10.79 10796.0 79.88
Nasdaq 2065.40 6.78 2058.62 -18.04 2076.66 -10.00
S&P-100 578.57 3.15 575.42 -1.76 577.18 2.09
S&P-500 1211.37 9.78 1201.59 -3.71 1205.30 2.27
W5000 11934.05 92.34 11841.7 -33.77 11875.5 9.57
SOX 443.70 15.97 427.73 -7.79 435.52 17.36
RUT 637.53 7.40 630.13 -4.63 634.76 -2.68
TRAN 3715.17 95.20 3619.97 6.94 3613.03 16.22
VXO 11.49 11.18 11.43
VXN 17.34 17.87 17.19

Tech Divergence Easing?

In a miraculous recovery from Tuesday's drop the Dow managed to rebound to a new closing high for 2005. The Nasdaq remains the anchor for the rebounding markets with a gain to 2065 but much less exciting than the Dow and S&P rebound. It may not be dragging much longer after rebounding +40 points from the Wednesday low. This attracted some buyers and triggered some buy programs as it moved slowly higher. Is the tech divergence about over? Will it succeed in overcoming the very strong resistance at 2100? Next week may hold the answer for tech traders.

Dow Chart - Daily


Nasdaq Chart - Daily


Friday started out well with an upward revision to the Q4-GDP to +3.8% growth from its originally reported +3.1%. This may be old data but the upward revision back to near the 4% range relieved a lot of concern about the economy. When the initial +3.1% number was announced it was a shock to many given the Fed's insistence that the economy was improving. Friday's revision was driven by a sharp jump in exports as well as business investment. Consumer spending was revised downward but was not a material factor. The initially reported -3.9% decline in exports was revised to a +2.4% gain which caused the sharp jump in the headline number. Business investment was also revised higher from +14.9% to +18%. These revisions suggest that the economy is indeed gaining strength despite the series of inconclusive reports we see each week.

Existing Home Sales dropped only slightly for January to an annualized rate of 6.8 million units from 6.81 million in December. However, the inventory of homes for sale continues to shrink. In November there were 4.4 months of supply on the market but that has fallen to a record low of only 3.7 months at the end of January and we are heading into the buying season. The talk about a housing bubble continues but demand continues to increase. According to the Brookings Institute and a survey they did last year the demand for housing in the U.S. will require 60 million new homes to be built before 2030. That will require nearly 2.5 million homes to be built each year and this is above the current pace of 2.16 million as reported in the January New Home Sales numbers last week. The drop to the record low of only 3.7 months of supply sent homebuilder stocks soaring once again. RYL gained +2.55, PHM +5.17, TOL +2.39 on top of an already strong week, BZH +5.78 and NVR +5.45. With inventory and demand numbers this strong and builders trading in the 8-12 PE range there appears to be plenty of room to grow.

Like builders the oil sector exploded higher once again after Prudential upgraded Exxon saying it could have another +15% upside despite its recent breakout to new highs. All the major oil indexes also moved to new highs on the upgrade and oil prices continue to hold just under the $52 level. We have not seen a pullback from last week's expiration induced spike and we are seeing a continued pickup in demand despite normal trends for softening in March. Cold weather is depleting heating oil supplies and refineries are hesitant to produce more this late in the cycle. Refiners are also seeing new highs with Valero tacking on +4 after Carl Icahn said he was investing $1 billion in the oil sector and Kerr Mcgee in particular. With billionaires willing to invest billions at these levels it suggests there is plenty of upside still available. Boone Pickens restated his $60 before $40 claim and the smile on his face at $52 is widening. I am joining Pickens on the prediction platform with a $100 before 2010 prediction. That should send gas to about $5 a gallon. Have you ordered your hybrid vehicle yet? I am going to an Oil Crisis seminar n Denver on Monday. It should be interesting to see if their views differ from mine.

The markets rebounded off their Tuesday lows with the help of continued market inflows. I suspect the mutual funds did their best to paint the tape as we head into month end in an effort to attract more money. TrimTabs reported again today that $2.2B flowed into funds for the week ended on Thursday. That brings the totals for the year to inflows of +$2.8 billion into international funds and outflows of -$6 billion from domestic funds. That gap is closing on the domestic side after three weeks of positive flows but we are nearly two months into 2005 and still negative for the year. Piper Jaffray reported on Friday that 85% of the inflows for the year were into international funds with the last four weeks the strongest inflows since March 1994. In 2004 TrimTabs reported a total of $16 billion flowed into international funds and $35 billion into domestic funds. Given these numbers it should come as no surprise that the majority of market gains over the last three days has come on the backs of dozens of buy programs. Funds are pouring what money they have into the market as we approach the month end in an effort to attract more contributions. Money flows follow performance and so far they have been successful in pushing the Dow and S&P to new closing highs for the year just in time for the weekend/month end newspapers to make the proclamation. To say mutual funds were fishing for cash would be an understatement. If they paint the picture correctly the money will flow and it appears they produced a Rembrandt this week.

XLE Chart - Daily


CRB Index Chart - Weekly


Oil is not the only commodity on fire and the CRB commodity index rose to close over 300 on Friday and a 24-year high. This is a +7% gain from the early month lows and a strong breakout of its four-month congestion range. Commodities soared from the 2003 low of 228 to 285 in early 2004. They languished at those high levels for all of 2004 as they consolidated the gains with a solid top at 290 in Q4. The talk about China slowing its growth rate kept them in check but recent reports suggest not only that China has not slowed but other countries are picking up speed as well. Commodities are normally late cycle bloomers and this also suggests the U.S. economy may be gaining strength. Commodities are purely demand driven and breakout to a new 24 year high suggests demand is very strong.

The markets rebounded out of Tuesday's drop with the indexes posting their best three-day performance since November. Leading the charge was the Dow where those commodity stocks like DD and AA led the charge along with XOM, now the largest company in the world by market cap. CAT, BA and UTX played strong supporting roles. The Dow closed at a new high for 2005 as well as the S&P. Unfortunately the Nasdaq at 2064 remains the weakest link and is still well below its 2005 highs at 2191. The big techs, MSFT, CSCO, DELL and Internets EBAY, GOOG, YHOO and AMZN remain very soft and in some cases at critical support.

SOX Chart - 60 min


SOX Chart - Weekly


The Nasdaq did manage to post three days of gains but it was almost entirely on the back of the SOX. The SOX rebounded off its 420 lows on Wednesday and rallied back to 443 and critical resistance in just three days. This was a very strong performance and sets up a retest of very strong resistance at 450. A break over 450 would produce some strong short covering and could give the Nasdaq new life. With Intel the only big tech showing a pulse and facing its mid-quarter update on March 10th it is questionable how much farther it and the SOX will run. The SOX also came to a dead stop right at the 200-week average, which has been solid resistance all year. I believe the trading bounce the Nasdaq is currently seeing was propped up entirely by the move in the chips. If fund managers were going to paint the tape with a small amount of cash the chips would be the way to do it. Most have relatively small market caps compared to the giants of the Nasdaq like CSCO, MSFT, EBAY, GOOG, etc. Throwing $2B cash at those giants would hardly generate a bounce. Using the same cash spread around the chip sector could generate a sizable move with less risk given the broker upgrades over the last two weeks. I may be imagining things but I suspect this scenario may be closer to the truth than we think. They are hoping that by using their small amount of cash and some chip stocks for month end kindling they can attract some additional contributions leading to a bigger fire under a Nasdaq.

For next week the Dow is faced with having to fight the 10850 resistance once again. This has been strong resistance since late December and it is not going down without a fight. We now have nearly a +235 point Dow gain over the last three days and if the tape-painting scenario is correct those funds may be running out of cash. Pushing it higher on Monday will do them no good. They had to produce the gains before the weekend newspapers to attract the cash. This could have left them winded after the sprint into Friday's close and breaking that 10850 resistance without a pause could be a challenge. The S&P is also going to be fighting that 1215-1217 resistance that has always held before.

We are facing some major economic reports next week with the PMI, NAPM and Personal Income on Monday, ISM on Tuesday and several employment reports culminating with the non-farm payrolls on Friday. These reports could confirm the Fed's economic viewpoint or turn into a wall of worry the bulls will have to scale. Either way I have a hard time seeing the Dow and S&P breakout without some more excitement from the Nasdaq. So far our trading bounce from 2023 is looking good but I continue to believe that 2100 is going to be a major hurdle. If we do move higher next week I would look to take profits on the bounce at 2080 and target 2090 for another trading short. If the Dow and S&P do make a break higher and the Nasdaq breaks 2010 I would switch to aggressively long because I think that breakout would drag a lot of cash back into the game. Until that happens we continue to trade the range using the Nasdaq as the weakest link.


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