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A Revolting Development for Buyers

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A Revolting Development for Buyers

Bulls closed the week with a bad taste in their mouth after starting out the week with a very nice bounce. It brings to mind the phrase from the old 1950s "Life of Riley" TV show. What a revolting development this has turned out to be. So much promise of a Q2 earnings bounce and so little follow through. While the bulls were hoping for a rebound to take us back to the mid-May highs that hope was dashed when that rebound failed at 10400 and what we got was a retest of the May lows instead. This left little to cheer about into the long holiday weekend.

Dow Chart - Weekly

Nasdaq Chart - Weekly

SPX Chart - Weekly

The economic news for the week was not bad with the FOMC doing exactly as expected and various reports showing a pause in the economic decline. The lead report for Friday was the ISM and we dodged a serious bullet with a slight rise to 53.8 from 51.4. There was a lot of hand wringing over the possibility the ISM would come in under 50 for the first time in 25 months. The slight gain over May's 51.4 level should have taken us out of range for next month as well. The ISM showed strong gains in the New Orders, Production and Employment components. New orders rose sharply to 57.2 for a gain of more than +5 points.

The rise in the ISM surprised almost everyone and gave credence to the idea that the spring soft patch is over. Prices paid fell -7.5 points to 50.5 and the lowest level since Feb-2002. This suggests that inflation is as the Fed claims, remaining well contained. The impact of high energy prices was negligible. Inventories failed to build once again and continued to show a continuation of the three-month decline. Moving into the summer months this is still not alarming as anticipation of slower sales prompts caution in inventory levels. As the summer progresses we would hope to see those inventories begin to climb for the fall selling season. This was a strong report but the markets failed to celebrate.

Also surprising traders was a jump in Consumer Sentiment from 94.8 to 96.0 in the face of record high gasoline/diesel prices. Like the Consumer Confidence the Sentiment survey found consumers surprisingly optimistic after five months of worry. Sentiment dipped from 97.1 to 86.9 from December to May and the June reading showed a significant reversal. Expectations rose to 85.0 from 75.3 and present conditions jumped to 113.2 from 104.9. Considering the high prices of gasoline it was an amazing change. Part of the gain was attributed to the rebound of the Nasdaq to test five-month highs at 2100. Consumers love tech stocks and it clearly shows.

On the downside Construction Spending fell -0.9% compared to estimates for a gain of +0.5%. This was the third consecutive monthly decline. The main problem was the -1.7% drop in residential construction for the month. The constant talk of a housing bubble appears to be taking a toll on the sector making some builders more cautious. There was also a downward revision to February, March and April.

There was an announcement on Friday that the long awaited Chinese Yuan loosening could come within the next two months. The Treasury Dept comments put the tariff legislation on hold and were seen as credible. The Treasury Dept made the comments in an effort to quiet the current unrest that was seen to be increasing tensions between China and the U.S. at a time when discussions were occurring at the highest levels.

China was also in the news again in reference to the Unocal bid. The House voted on Thursday to reject the acquisition attempt on national security concerns. The vote was strongly in favor of the measure 333 to 92 and it was added as an amendment to a current spending bill. The measure would prevent the administration from spending any money to approve the purchase. The committee, which would consider the purchase for approval is the Committee on Foreign Investment in the U.S. (CFIUS). The committee makes recommendations to the president on foreign investment (acquisitions) after reviewing national security concerns. Of over 1500 reviews since the committee was formed only one was denied by the President. This was in 1989 against a Chinese acquisition and was largely symbolic in protest for the massacre in Tiananmen Square. Unocal shareholders are set to vote on the Chevron acquisition on August 10th. The board of Unocal has recommended approval but that was prior to the CNOOC bid. Chevron received approval for the acquisition from the SEC on Thursday and this was the last approval necessary to complete the deal. While Chevron has yet to sweeten its offer it is very possible they will wait until the last minute in order to avoid a bidding war with CNOOC. There are also rumors another bidder may enter the fray given the very low price in the neighborhood of $11 pre bbl of proven reserves. Exxon Mobil could pay cash for UCL and CNOOC both and have plenty of pocket change left over.

On Friday there was another shot heard around the world but only if you were listening carefully. Chinese President Hu Jintao met with Russian President Vladimir Putin to discuss issues related to joint space exploration, energy, metallurgy and joint military operations. Together they signed a joint declaration critical of U.S. policy. Excerpts from press releases: "Russia and China with one voice declare the inadmissibility of efforts at monopolising world affairs, the dividing of states into the leaders and the led, the imposition from outside of models of social development and the application of double standards." Also "by such cooperation with China, Russia hopes to form an axis of cooperation" (As opposed to an axis of evil? Interesting choice of words) "between Moscow, Beijing and the Central Asian country of Uzbekistan, aimed at more effectively resisting 'destabilizing external influence' -- meaning the growing influence of the West." If you remember last week I described large purchases by China of military equipment from Russia including various weapons, warships and submarines. This is a meeting that will likely not be reported in the mainstream press but clearly a relationship is being built that could be very well be preparations by Russia and China for the future oil wars. Remember, the U.S. consumes 25% of global production and will therefore be the country most hurt by the lack of adequate supply. It appears the other kids on the global block are planning their strategy for handling the bully when he goes into withdrawal panic after missing his injection of the black crack.

August Crude Oil Chart - 60 min

December Crude Chart - Weekly

Oil prices fell this week to $56 and just above the 100-day average and promptly rebounded +2.25 on Friday to close at $58.75. I suspect the drop was related more to end of quarter profit taking than worries about supply and demand. Now that we are in a new quarter the buyers appeared at the open and never slowed despite the early holiday close. The gains were sector wide with oil gaining +4%, gasoline +5.2%, heating oil +4.6% and natural gas +2.7%. I suggested again on Tuesday to buy the dip and again that was the right move. Boone Pickens has been on TV almost daily with his $3 gasoline prediction and he has been putting his own money to work as well. His hedge fund, BP Capital, has an amazing record. An investor putting $1 million into his commodity fund at inception in 1999 would have earned more than $28 million to date. An investor putting $1 million into his equity fund at inception in 2001 would have seen his money grow to $3.7 million. Pickens sees no relief for oil prices in the future. He said on Thursday that current global production is in the 84-85 mbpd range with about 500K of excess production going into inventory reserves around the world. When demand accelerates in Q3 he expects those reserves to evaporate quickly. As demand grows in Q4 to 86-87 mbpd there will be insufficient production to meet that demand. He expects this to produce a feeding frenzy in the markets as a bidding war breaks out for available supplies. The world will consume more than 30 billion barrels of oil in 2005 and that is far more than has been discovered in any year since 1970. Even if the Saudi claims of 250 billion bbls of reserves were true they can only produce about 11 mbpd or 4 billion bbls per year. Any investor with any common sense can do the simple math and see the future. That future contains a brick wall according to Pickens where demand exceeds supply and that wall could come as soon as Q4 of this year. Continue to buy oil companies on dips and you will not regret it.

GM came back from the dead in June and blew away the competition with its employee-pricing program. GM sales surged +41% in June, the largest monthly jump since Sept 1986, compared to a slump of -3.2% at Ford. Buyers deserted the other makers in favor of the lower prices at GM. Only Toyota showed a decent gain at +10%. The Cadillac division of GM saw sales surge +54% and trucks sales soared +68%. This was the largest sales jump for trucks in the companies history. Ironically GM only gained +.65 cents with the news coming after most traders had already left for the weekend. The Postal Service announced on Friday that it was buying $60.5 million in postal vehicles from Daimler Chrysler.

After the bell on Friday Oracle said that despite the recent rise in the dollar it was affirming guidance for Q2. IBM announced that Microsoft would be paying them $850 million to settle some antitrust claims. Looks like IBM will make their numbers for Q3. Also, the FDA issued its strongest warning on some Guidant products. A malfunction in some defibrillators recalled last month could cause injury or death. 20,000 of the devices are being urgently recalled. Another recall of a much easier nature came from Cold Stone Creamery, which is recalling its products containing cake batter after people in four states became ill after eating it. When given the choice to have my ice cream or defibrillator recalled I think we all know it would be an easy choice. They will only get my ice cream when they pry my cold dead fingers off the cone. Of course after a defib failure that may be exactly what would I would get, cold and dead.

The various indexes eked out a minor gain on Friday thanks to a late day buy program and some short covering at 3:30. Unfortunately it cam too late to help the indexes recover from a nasty first half of 2005. The Dow lost -4.7%, Nasdaq -5.4% and the S&P -1.7%. The Dow closed the week at 10300 and clinging to that level as a support lifeline. This level has been penetrated twice over the last week and each time buyers bought the dip with less than convincing volume. Bulls had hoped the mid week rebound to just over 10400 would hold and be a stepping-stone to a retest of the June highs but it did not happen. The end of week decline to retest the June lows suggests the future may not be bright. A break of 10250 could easily see a retest of the April lows in the near term and a retest of 9800 by September. Investors had hoped 2005 would not be a repeat of the 2004 summer from hell but it is shaping up as another range bound summer with a negative bias.

The Nasdaq rebounded to 2075 from Monday's dip to 2040 but it could not hold the gains. After two days of trying it finally succumbed to profit taking and retreated to rest on the 2055 level that was support back in early June. The Nasdaq was barely able to rebound +50% of the late June drop and then could not hold it. A break of the 2050 level runs into several averages clustered around 2025 and major support at 2000.

The same story was true of the S&P with a retracement on Friday to the 1195 support that has held since June-1st. That support level was only pierced once during the last month on an intraday basis and was stopped at the 100-day average at 1187. The support levels below 1190 are varied and numerous with 1160-1165 the crisis level likely to be strongly defended. This was the spring highs in 2004 and the lows from Nov-2004 to late March-2005. A summer break of that level could pause at 1140 but targets 1100.

The Russell recovered from its rebalancing dip to 626 and returned almost all the way to its recent 645 resistance highs. Friday's close at 642 came on a late day spurt of buying as laggard funds continue to square positions. The 647 level is a 50% projection level dating back to the Jan-2003 lows. I would continue to expect an upward bias to the Russell for another week as the rebalance activity tapers off and end of quarter fund flows provide lift.

Russell 2000 Chart - Weekly

Volume was very low on Friday despite it being the first day of the quarter. The Nasdaq posted only 1.2B shares in a lackluster day. Traders hit the exits early for the holiday weekend and even rumors of an impending July-4th attack by Al-Qaeda were ignored. At least they did not cause any material drop but there was still the lack of a meaningful bid. Next week should be interesting as we close in on the Q2 earnings reporting period. We only have about 45 early reporters due to announce during the week with the pace growing to about 200 for the following week. The first week of the quarter normally has a bullish bias, which corresponds to money flows from retirement accounts. As such it could provide an opportunity for hedge funds to reestablish some short positions going into the late summer period while using the incoming volume as cover. The early week economic reports are minimal with Factory Orders on Tuesday and ISM Services on Wednesday. The big hurdle is the Nonfarm Payrolls on Friday and one more clue as to the stability of the recovery.

Now that we are into the July period I would be even more cautious about any long positions. The expected rebound from last week fizzled like a 4th of July dud and failed to achieve any real height. That should give traders some additional concern about the health of the market. I did not expect any material declines for about two more weeks but the weakness we saw as the quarter closed has cause a little more caution to creep into my outlook. This is definitely a week to enter passively and be ready to exit aggressively if conditions change.


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