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Market Wrap

So Close!

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The S&P touched its four-year closing high today at 1225 and many technical analysts were hoping for a close over that level. That would have been a technical victory and one that could have triggered a new wave of buying. Unfortunately it was not to be and after about two hours of fighting resistance at that level the indexes rolled over and faded into the close. The massive bounce in the Dow ended after three days of gains and +350 points. The string broke with a minor -5 point loss. Not a big deal given the magnitude of the gains but it could be a crack in the foundation.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

Today depicted a typical summer trading day other than the altitude on the S&P. After three days of gains the majority of trading on Tuesday was dedicated to consolidating those gains and preventing any material sell off. Every dip was bought and every spike sold with the indexes ending almost exactly where they started. The economic news was sparse with only Chain Store Sales and the Labor Turnover Survey. The weekly Chain Store Sales came in at +0.1% and slightly less than last weeks +0.5% gain. Analysts said warm weather and pre-hurricane stocking of food and supplies offset the cash drain of higher gas prices. The ICSC conducted a special survey between July 7th and 10th and found that 50% of households were reducing their discretionary spending as a result of higher gas prices. The household income bracket most impacted was the $35K to $50K range.


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The Job Openings and Labor Turnover Survey (JOLTS) came in at 8.9% and much better than the 14.9% turnover for the prior month. The hiring rate rebounded to +3.5% and the termination rate fell to 3.3%. The JOLTS survey suggested that hiring was stronger than the recent Jobs report for June had indicated. The Jobs report showed a gain of +146,000 jobs and the JOLTS numbers showed a gain of +283,000. The Jobs report is calculated from a one-week survey in the middle of the month while the JOLTS data is captured from an entire month of data. This was the third consecutive month of improving hiring data in the JOLTS survey.

Reports on tap for Wednesday are Import/Export Prices, International Trade, Treasury Budget and Oil and Gas Inventories. The one most likely to roil the market will be the oil inventory levels. The data we will see tomorrow is for the week impacted by tropical storm Cindy. During that storm cycle 12% of the Gulf production was shut in. Last week the fear of Dennis caused a much higher shut in ratio in the 50% range according to various sources. A significant amount of that production was still shut in as of this morning. Getting all the workers back to the platforms and restarting all the processes from lock down status is time consuming. This two week back-to-back shut in process has likely put a serious crimp in inventory levels in the U.S. Analysts claim more than four million bbls of production was lost during the Dennis shut in. While platforms are being restarted everyone is keeping a wary eye on tropical storm Emily now gathering speed and headed for the Caribbean. Emily is not expected to approach the U.S. mainland until early next week. Emily is the fifth named storm and this is the earliest date on record for five named storms to appear. While damage in the Gulf from Dennis was expected to be very light there was one major problem. The Thunder Horse platform, a joint venture between BP (75%)and Exxon (25%), threatened to capsize and emergency crews were trying to find a way to rescue it. The 82,000-ton platform is anchored in 6000 feet of water 150 miles from New Orleans and was to be the largest new construction for the U.S. through 2007. Should the platform sink it would result in a loss to BP/XOM of around $2 billion. There is no insurance. The platform had not yet been placed into production but was scheduled to come online later this summer. Estimated production was for 250,000 bpd and a serious shot in the arm for declining U.S. production levels. That much additional production would increase Gulf output by +17%. 1.5 mbpd or 25% of U.S. oil production comes from the Gulf. BP is also building a platform called Atlantis in the Gulf that is expected to add +200,000 bpd in late 2006. There was no estimate yet as to the chances for saving Thunder Horse or for a new production date. BP and XOM both finished negative on a day when most oil stocks were near new highs.

TThunder Horse Platform

Oil prices rebounded from their post hurricane drop to $58 with a surge to $61.25 intraday and a close at 60.70. Oil stocks failed to pullback on the Monday dip and many hit new highs on Tuesday. AHC was the big winner with a +3.53 jump to $116. DO, RIG, APC and NE gained more than a buck as chances for offshore drilling contracts increased as well as rig repair.

The CNOOC/UCL/CVX saga continues with CNOOC starting an advertising campaign tomorrow in the major papers in an attempt to soften hostility against its takeover of Unocal. The House Armed Services Committee begins meeting tomorrow to discuss the military implications of allowing China access to the technologies used by Unocal in its drilling and extraction processes. The biggest worry making the rounds now in the official circles is that China is trying to lockup all available petroleum assets in an effort to hoard them until it needs oil at some point in the future. Remember, you heard it here first. I mentioned this potential problem several weeks ago when the CNOOC bid was first announced. China will eventually need more oil than the U.S. and the only way it can guarantee that oil is to buy it now and then hoard it, take it off the open market, until it needs it. This would be very detrimental to global demand/production scenarios and would hasten the peak oil scenario. China has already inked deals for 40% of the Northern Lights oil sands in Canada and for future production out of Venezuela.

December Crude Oil Chart - Daily

The markets continued their bullish ways despite the weak close. The Nasdaq was much stronger than the Dow with a +7 point gain and much of that gain came from the chip sector. In a continuing display of bullishness the SOX rallied over resistance at 450 and closed at a new 52-week high at 456. The chip sector has completely ignored the weak demand reports and the growing problem of aggressive pricing. The leaders are soaring with strong gains off their lows for the year. KLAC is up +27%, AMAT +20% and NVLS +17%. While these stocks lead the rebound they are all at or nearing strong individual resistance levels. TXN is by far the strongest performer with a +60 % gain from its lows around $18 this time last year. It is also nearing strong resistance at $32. Can the SOX continue this stellar performance as the summer progresses and if so what is the driving force? Orders and billings are still weak and so far 2006 visibility has not cleared. The strong gains in the SOX have been made with no profit taking over the last six sessions and it is well overdue.

The Russell also continued to press higher to set a new all time high just over 674 on a late day buy program but fell back to its consolidation range at 670 that took hold at 11:00 on Monday. This strength in small caps is very bullish but it did come to a complete stop at the uptrend resistance from May. Eventually the Russell and the SOX will have to rest even if it is just for short bout of profit taking.

Russell 2000 Chart - Daily

Russell 2000 Chart - 240 min

SOX Chart - Daily

The big topic of the day was the touch of 1225 by the SPX. Several commentators were positively hysterical about the potential for a new four-year closing high over 1225. While this would have been a milestone it is not the end of life as we know it. The recent SPX intraday high was 1229 back in March on the same day we saw the 1225 close. A higher close would be technically bullish but at this point in our current cycle it might be anticlimactic. Granted we did not sell off today and consolidated in place but we have gone from seriously oversold to seriously overbought in a very short period of time. The markets are at increasing risk for profit taking as each day progresses.

I have been projecting next week as a turning point in the markets due to the end of OpEx and the first really full week of Q2 earnings. The spike to SPX 1225 definitely caught me off guard. I did not expect 1220 to break but I should never underestimate the markets ability to overdo any move. I bailed on my early shorts at SPX 1210 and reentered on Monday's touch of 1220 as I discussed doing on Sunday. That plan self destructed with the breakout to 1225 but the intraday failure at the 1225 level provided a new short entry. The rebound all the way to 1225 although unexpected has given us a clear line in the sand for the coming battles. Any move over 1225 should be seen as bullish and a signal to go long. Any failure under 1225 confirms the short viewpoint. This is a key level and the setup for shorts would appear to be perfect. That is troubling since any perfect setup generally turns into a perfect trap instead. Once the market picks a direction contrary to conventional wisdom it tends to gain speed as it feeds off the traders betting against it. The short interest jumped substantially this afternoon while several previously bearish analysts were changing their tune. A move higher from here could substantially alter the landscape and setup a progressively higher move over the backs of disbelieving shorts.

Internals have been improving despite the increasingly higher index highs. New highs on Monday were 868 compared to only 38 new lows. This was the strongest level of new highs since December-1st. Tuesday was only slightly lighter at 708/44. Volume has picked up this week with nearly 4B shares each day. However, the 4:1 advancing over declining volume seen on Friday/Monday deteriorated to less than 2:1 on Tuesday. Is this the crack beginning to form in the bull's armor or just an indication of consolidation of the prior gains? We won't know until next Friday is behind us. Once options expire on Friday there will be a big drop in volatility and in market pressures. I suspect there were a lot of short calls/long puts in the July series with hedge funds the major players. If you remember just 60 days ago the economics were turning ugly and analysts were lowering their estimates for Q2 earnings. Suddenly over the last couple weeks those economic reports turned positive and there were no major earnings warnings after the FDX event. If you were long stock and wrote calls on it to profit from the summer swoon then you suddenly found those calls escalating and the increasing potential of your stock being called away. If you were just short calls in an attempt to speculate on premium then a similar trap appeared. Those long puts or short stock found themselves also in need of panic covering. This is a major reason I was targeting next week as a pivotal week in the summer market. Once that OpEx pressure is relieved and the earnings story begins to play out then traders will decide how they want to setup for the August-October period. I am betting they will enter their new positions with expectations for the normal Aug-Oct dip.

Nasdaq Chart - 10 min

On Sunday I speculated that the Friday ramp was mostly short covering from an oversold dip. In retrospect that was probably incorrect at least in part. With the continuation on Monday morning of the exact same buying pattern until 11:15 much of the move may have been fueled by an outside influence. There were several reports on Monday of a large foreign investor entering the market. I heard this from multiple sources, which does not make it true, but increases the likelihood. The other rumor making the rounds was a large asset allocation program had began at 10:30 on Friday morning. This makes more sense to me as there was a strong correlation between the bond sell off and the equity rally with both ending at 11:15 on Monday. As I performed a forensic examination of the short term charts for these periods it looks like the rebound from the terrorist dip was accelerated by both short covering and the asset allocation program. You can never know these kinds of things in real time and that emphasizes the need to not continue betting your bias if the market is moving against you. We could have had the perfect battle plan on Wednesday night and had market conditions change completely by Thursday's post terror attack opening. If the market is not reacting as you expect the best action is to step aside and reevaluate the plan.

My plan for the rest of the week is to remain short the broader market as long as the SPX stays under 1225. I will reverse to a long over that level and ride that horse until it stumbles. There were no major earnings tonight but the volume will continue to increase into next week with most of the majors reporting then. As of 6:30 August oil futures are nearing $61 again ahead of the Wednesday inventories. Should we see a sharp drop in supplies the market could react badly to a sharp spike in oil prices. Remember this is the data for the prior week when Cindy was the threat. There was a much stronger production halt for Dennis so next week's inventories could be even worse. This potential for two consecutive weekly inventory drops could push oil to a new high. Continue to buy oil stocks on any dip in oil prices. I would also be cautious on any market moves over SPX 1225. Jump on the train if it leaves the 1225 station but stay near the exits just in case the rally is derailed. As we move farther into the summer it is even more important to enter passively without emotion and exit aggressively should the market change directions.

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