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An Apple a Day

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An Apple a Day

Apple's positively positive earnings report last night gave the bulls more to cheer about this morning. Here's Market Watch's closing comment:
"Stocks end higher; Nasdaq at new 2005 high ($SPX, $COMPQ, $INDU) By Mark Cotton
NEW YORK (MarketWatch) -- U.S. stocks ended higher Thursday as positive data, a steep fall in the price of oil and a strong earnings report from Apple Computer lifted the Nasdaq to a 2005 high and the S&P 500 to its best level in four years. The Dow Jones Industrial Average ($INDU) was up 72 points at an unofficial close of 10,629, its best level in four months. The Nasdaq Composite ($COMPQ) was up 8.78 points at 2,152.89, closing just above its previous high for the year of 2,152.15 reached on January 3. The S&P 500 ($SPX) rose 3.21 points to 1,226.50. Both the Nasdaq and the S&P have now risen six sessions in a row. The market gapped up and then ran higher, running the DOW up over 100 points before stalling. The rest of the day was spent backing and filling and accomplishing little. But the bulls have to feel good about not giving much of the day back to the bears. The market continues to look bullish, no two ways about that. We may be getting close to seeing a top and setting up a much larger decline but for now keep buying those dips. Just keep a daily eye on this market and keep pulling those stops up behind you. There's no sense in giving up hard earned profits back to Ms. Market.

There's trouble brewing under the surface and it's like the movie "Jaws". I don't like scary movies and I don't like what I see in the dark waters below us. Bulls are happy on top, basking in the sun and waves, oblivious to some of the dangers lurking below. Part of what we do in this newsletter is obviously talk about the charts and what the price action is telling us is likely to happen days to maybe weeks from now. I say likely to happen since as we know trading is a game of probabilities. There are no sure trades and that's why we use stops. Stops are simply our cost of doing business and that's how you must treat them. But I also like to read and discuss what's happening in the broader economy or world stage, things that will likely have an effect on the market, both good and bad.

I've discussed in the past few weeks how the Fed has been pumping money into the monetary system (increasing the M-3 supply) at a rate faster than the current inflation rate. This of course raises the question why would the Fed feel the need to do that when they talk about their efforts to combat inflation. Then I discussed information about the Fed encouraging banks to unload Fannie and Freddie paper since they are apparently worried about the banks being exposed to too much mortgage risk. That shouldn't make home owners feel very comfortable but of course they don't talk about it publicly lest they scare people away from owning homes. They're doing quite the opposite and coming up with creative ways to entice more people into the housing market. We all know the excesses in this country when it comes to the debt burden. The enticement of new buyers into the housing market with low interest only loans, no down payments, etc. is downright scary. It appears the banks are trying to do everything they can to lend money and now they're lending it to people who never would have been considered for a loan even three years ago.

But while the Fed is encouraging banks to unload mortgage paper the FDIC is doing just the opposite. (Imagine that, one hand of the government is something the opposite of what the other hand is doing. I'm shocked.) Bear with me while I describe a story I came across that I believe bears witness to the overly optimistic attitude and excessive risk tolerance that's prevalent in our society at the moment (which shows up as an overly bullish stock market) Apparently a bank in Wisconsin was concerned about the lack of depositors and to combat a dwindling of their asset base the bank turned to new immigrants as a potential solution. It started out as just an effort to lure Latinos to the local bank for normal banking business and then the bank president found a loophole in the FDIC statutes and laws that allowed him to make mortgages available even to illegal immigrants. The FDIC law requires banks to invest in the communities in which they gather deposits, according to the bank president, so that's what this bank did.

The risk to the bank became greater than it was comfortable with because it had to hold all the mortgage paper (Fannie and Freddie don't deal in loans for illegal immigrants as a matter of official policy). So the bank went to Wisconsin's Housing and Economic Development Authority which wanted to start a pilot program to increase home ownership by low-income families, specifically for undocumented immigrants, to help develop poor sections of cities and stop predatory lending practices to the poor. The requirements for a loan were the following: "To be considered for a loan, illegal immigrants must fulfill the same criteria as applicants who hold Social Security numbers--proof of regular income and state residency. If they qualify, the undocumented borrowers get the same terms as other state residents." The banks then got creative when it came to ways to determine the creditworthiness of their new customers since they typically did not have standard credit ratings. I think one of the credit requirements was that they had to be able to fog a mirror. The housing authority finances these mortgages which the banks then sell to their customers. The banks no longer are exposed to any of these high-risk loans. You can see where this is headed. Wisconsin is putting the highest risk mortgages on the backs of their tax payers.

We already know that tax payers are being saddled with the under-funded pension plans through the under-funded Pension Benefit Guarantee Corp. and now tax payers are going to foot the bill when risky mortgagees start defaulting. What a country. Several government agencies and Congress are fully aware of this help in integrating illegal immigrants into the system and without getting into a discussion about the merits or faults about that policy, the only thing I'm discussing here is the risk that's being assumed by the tax payer to make this happen. As a side note, to the credit of these illegal immigrants, their record of on-time payments and lack of defaults on loans puts many of our other classes of citizens to shame.

The success of these small banks in Wisconsin has been noticed. Other states are following suit, like Ohio, Illinois, Iowa and Texas. Banks in Alabama, Minnesota, Mississippi, South Carolina and Washington, among others have expressed interest in serving undocumented immigrants. Big banks, like Wells Fargo and Bank of America, say they plan to launch their own programs within months. All of this suggests that U.S. property rights are no longer the privilege of its citizens, but instead of anyone who can help a bank whose business plan is no longer viable. Congress, the IRS, and the White House are getting caught looking the other way, and most of the American public has no clue that any of this is going on. The thought that illegal immigrants are being given what some might consider preferential treatment for buying a house, while we ignore the plight of our homeless could eventually cause some heartburn in many Americans.

No matter how one tries to sugarcoat this, it looks as if banks, with the government's blessing, have found a way to keep the housing boom going for an extended period of time. The housing bubble that's been created will experience the same demise as all other previous bubbles, whether it's in tulips, gold, techs or real estate--supply exceeds demand, peoples' mood sours and price collapses. The statements being made that "housing isn't like stocks and therefore won't experience the same consequence" is pure ostrich-stick-your-head-in-the-sand naivety. And unfortunately for our economy, a collapse in the housing market will take banks and citizens down with it. But again, the point that I'm trying to make is that we see a huge amount of bullishness and a high level of risk tolerance in our society and this excessive bullishness shows up in the stock market (good feelings prompt buying not selling). The excessiveness is now greater than that which we saw in the late 1990's and 2000 and it's being aided and abetted by the Fed's desire to pump up the liquidity. They couldn't create extra demand through cheap money (low interest rates) so they've drawn their remaining card called housing and hoping it will save the economy. Unfortunately the house of cards they've built will likely get hit this hurricane season.

On that note let's see how the market is doing. It's bullish so enjoy! Just use protection like in other enjoyable endeavors. Use stops, puts, or short selling to start protecting or hedging your positions. If you learned nothing else in 2000 and 2001, remember that excessive bullishness doesn't typically end well. We are now reaching levels of bullishness never seen before so caution is warranted. Let's see what's happening to give us some clues for what's around the corner.

DOW chart, Daily

Like many of the indices, the DOW gave us a good head fake by making a false move below the uptrend line from March 2003. After giving us a bullish hammer doji last week, the market followed through on that signal and has come roaring back to life in a week. While the DOW is challenging the high in June, the SPX made it to a new annual high. So far this kind of intermarket divergence is bearish not bullish. First reistance level on this chart is the previously broken uptrend line, currently near 10720. As discussed below, if the SPX manages to make it up close to 1260, that would be about 300 more DOW points which would bring it up to near 10,900.

SPX chart, Daily

Also after a false move to the downside the SPX came roaring back to life and made a new annual high today, above the last one set on March 7th. It should be noted that after a very tight consolidation during May (tightest on record since October 1928), the market followed through as in past tight consolidations--we got the false move to the downside followed now by a strong rally. Sometimes the market doesn't give the false move but in every single case the market has rallied strongly after a very tight consolidation like we went through. Nice to see historical patterns hold true. Like the rest of the market, we should get a pullback soon and it may have started today. But there's a strong magnet at 1253-1257 where trend lines and Fibs point to. I'm looking for that to mark an end to the cyclical bull market we've been in since October 2002. From there we should start the next bear market leg down that will last perhaps 18-24 months. It could be a nasty one so protect portfolios.

Nasdaq chart, Daily

That consolidation underneath firm resistance turned out to be bullish after all. Now the big question is whether or not that inverse H&S's price objective of 2330 will be achieved. Jonathan did an excellent job in his last Market Wrap on Monday explaining why an inverse H&S here (near the top of a run versus at the bottom) is not reliable. Secondly, a trend line along the highs from January 2004 will likely be the high for the market (it has to do with a longer term Elliott Wave pattern on the weekly chart). We could see a throw-over above the line but watch the 2200-2250 area for topping.

SOX index, weekly chart

The SOX broke out of its shallow down-channel and its downtrend line from January 2001 so it's time to look at this as in an uptrend. Drawing a shallow up-channel now shows the top of the channel intersecting a Fib level where we would have two equal legs up from the April low--at 481.41. We may first see a pullback to the broken downtrend line near 450 and then watch for that Fib level for potential resistance.

IBM, daily chart

I don't watch many stocks but IBM is an important one. I noticed while playing around with Fib projections that the current EW pattern has a projection for the current leg up at $83.58. I don't believe in coincidences in the market and notice that this Fib projection is right where IBM would close its gap down in April. I believe if IBM is able to reach this level it would be prudent to protect any long positions you may have in IBM. I might even be tempted to unload all my stock if I owned it.

BKX banking index, daily chart

After two months of entanglement in its 50 and 200-dma's the banks have finally broken free. It's about to bump its head on an old uptrend line just under 102. It also achieved an internal Fib projection for the move up from the April low. Therefore watch this index to see how it behaves around this level. It could give us a heads up if it starts declining while the rest of the market tried to push higher.

XBD Securities Broker Dealer index, weekly chart

The broker index is still going strong. The ascending wedge on this chart depicts a bearish outcome to this rally which is fitting if the broader market is near topping and getting ready to roll over (personal opinion on that). We'll see but this strong of a climb is still too much too fast and the combination of its steep ascent and the bearish ascending wedge does not paint a pretty picture for its correction that is coming. Ride it while it's hot but protect positions here.

Heading into this morning's open the futures were already boosted by overseas action. The 8:30 reports were then viewed as bullish and gave us the big gap open and early morning strength. We got better than expected CPI data as June CPI came in unchanged versus an expected 0.3% rise. The core CPI rate was up just 0.1% which was below forecasts of +0.2% and this provided further confirmation that inflation remains under control. The core CPI is up 2% in the past 12 months, the lowest year-over-year gain since September and this places it in the middle of the Federal Reserve's comfort zone. Energy prices fell 0.5%. Food prices rose 0.1%. Housing prices increased 0.1%. This data was considered a very positive development after the inflation scare of Q1. Total CPI was unchanged (consensus +0.3%) making it the slowest rise since last September. June retail sales were up 1.7% while sales, ex auto, rose 0.7%, both encouraging with regard to consumption patterns. Retail sales were up 9.6% year over year for June.

Initials claims rose 16K to a six-week high of 336K (consensus 322K) and the 4-week average claims were steady at 321K. The increase in seasonally adjusted initial claims was "primarily" due to temporary seasonal layoffs in the auto manufacturing industry, a Labor Department spokesman said. Meanwhile, the number of former workers collecting unemployment checks rose by 45K in the week ending July 2 to 2.62M, a four-week high. The four-week average of continuing claims dropped by about 5K to 2.60M.

The initial reaction to all this good news was that it would prevent the Fed from feeling like they have to keep raising interest rates. Even the bonds rallied initially on the news (driving interest rates down). But upon reconsideration of the data I guess cooler heads prevailed and figured the Fed probably won't be done with just one more rate increase (they have to make Sure they drive us into recession first). Soon after the initial rally in bonds they sank to new lows below yesterday's lows (highs in yields) before getting an end of day bounce back to even on the day.

With the hurricane scare temporarily over, and not as much disruption as had been feared, oil has backed off from its recent high:

Oil chart, August contract, Daily

Oil continues to consolidate near the $60 level but looks like it will find support above its 50-dma if not at the mid-line of its up-channel, currently near $56.70. The top of its up-channel is approaching $65 and that's where oil is expected to head before we get a deeper correction.

Oil Index chart, Daily

The oil index is consolidating just like oil. It looks stronger relatively speaking and that's likely bullish for oil. Watch this index as a leading indicator for oil price itself. The top of the up-channel near 540 is still a good profit target for this index.

Transportation Index chart, TRAN, Daily

With a break of its downtrend line from the March high, and back above its 200-dma, it's time to look at this index as in an uptrend instead of a downtrend. It might only be a shallow one as drawn on the chart and the top of the channel matches a Fib projection for where there would be two equal legs up in its bounce from the April low--at 3700.91. This index has been a good one for a heads up for the broader market so if it can't make it above that level and starts to decline hard before the rest of the market, that would be our canary in the coal mine and a warning to get out of Dodge.

U.S. Home Construction Index chart, DJUSHB, Daily

The housing market is still getting a lot of press and as discussed in the beginning of this report, they're getting a lot of help. The chart is still bullish but it's close to giving us a major high. The price pattern would look complete with one more minor new high and at that point I would call it stick-a-fork-in-it done and start looking for the weaker housing stocks to consider shorting.

U.S. Dollar chart, Daily

The US dollar is now on a sell signal. After breaking down from a bearish ascending wedge pattern, it's bouncing back up for what could be a kiss goodbye against its broken uptrend line near $90. These ascending wedge patterns will often retrace quickly back to the origin point which for the dollar is back around $84 in May.

Gold chart, June contract, Daily

If the US dollar drops I would expect that to give a lift to the metals. It better because gold is in danger of breaking down. After a false break out above its downtrend line, gold had pulled back once again to the bottom of a descending triangle (flat bottom, descending tops) which are often bearish. But the larger pattern suggests gold has more rally ahead of it. I would say $415 is the line in the sand for the bulls.

Sector action today was mostly green today. It was a strange day because most everyone was green (not the small caps but they needed a rest after the week or two they've had) but the internals were not bullish. While advancing volume outpaced declining volume, declining issues were ahead of advancing issues. Total volume was respectable today and typical of an opex Thursday. The leading sectors were the airliners (they liked the dropping oil prices, biotechs, transports, SOX and the other technology sectors. The losing sectors today were led by gold and silver index and the energy sectors.

Tomorrow's economic reports include the following:

Today's price action suggests we may have topped in the leg up from last Thursday's spike low. I am expecting a corrective pullback that lasts a few days into next week which will set up one last hurrah of a rally to new highs. I have Fib, Gann and cyclical studies that suggest this month (mid to end of month) will be a high for the year so I would think about how you want to protect your portfolio in case that forecast comes true. Think about hedging strategies and stop levels where you don't want to see your stock/portfolio drop below. I'm thinking we'll have an opportunity to review this again next Thursday to see if there are any major changes to that forecast. In the meantime, trade light, trade carefully and take profits early. Good luck.


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