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Market Wrap

Searching for a Top, and Not the Spinning Kind

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Searching for a Top, and Not the Spinning Kind

The market is actually doing better than spinning its wheels--it's methodically chugging higher like a slow moving steam roller that is squishing bears flat in its path. This market is frustrating both sides but at the end of the day the bulls keep hammering the bears who are trying to pick a top. Picking a top, or bottom, is probably one of the most frustrating things most traders try to do, and lose the most money trying to do. We all know not to catch falling knives or to get in the way of a runaway freight train. Our mothers taught us these lessons for a reason but do we listen? And so it goes, another week and the elusive top is still nowhere to be found. We should be getting close but I know of many bears who have been saying that since June.

After a bullish finish to the day on Wednesday the market had opened this morning to the up side after some good earnings reports and a benign unemployment report at 8:30. After some initial profit taking in the first hour it was all up hill for the rest of the day. Even the "pullbacks" were flat instead of dropping. The sellers couldn't get anything going and the buyers just kept buying. By the end of the day it wasn't anything exciting to write home about but each of the markets was up about 0.5%. String a few of those days together and you've got yourself a real rally. And this is where the bears are getting frustrated. Each new rally high is being met with more negative divergences, excessive bullishness, low volatility readings, etc. Just keep remembering that saying about irrational markets remaining irrational...we're in one now.

Pre-market we got some earnings report with blue chips like BMY, DCX, MRO and RTN beating analysts' forecasts, AET and CA matching estimates, and DOW, GP and WMI missing expectations. BMY reported better than expected earnings and raised their FY05 guidance. Exxon Mobil (XOM) reported a 32% increase in net income to $7.64B on revenue of $88.6B. Other companies beating analysts' expectations included CCE, NOC, NWL, PD, R and UST.

People are still feeling good enough to get their daily Starbucks which reported its fiscal third-quarter earnings rose 29% while their same-store sales growth was 7%. SBUX boosted its fiscal-year outlook and is looking to add 1,800 new retail stores in FY 2006.

About two thirds of the 311 S&P constituents have now reported and roughly 70% of them have beaten analysts' estimates--the highest rate since Q1 of 2004. As Jim had mentioned on Monday, much of this is a result of the companies lowering the bar so that they would have an easier time beating their estimates. But it provides further evidence that Q2 results could come in close to 10%. And this relatively good earnings performance likely has market participants feeling bullish.

The unemployment numbers were tame and didn't move much from previous weeks. The initial claims showed a rise of 5K to 310K (consensus 320K) which left a 4-week average of 318K, the lowest since early March, suggesting that the Labor Dept.'s report due a week from tomorrow could show strong July payroll figures. The continuing jobless claims rose 32K to 2.60M. We also got the June Help-Wanted Index and it rose to 38 from 37.

This week, being the last week of July, probably had some end of month buying going on. Many fund managers may have been looking to finish their shopping list today so that they could leave for vacation next month. It's why August is generally not a great month since gravity tends to take over after the buying dries up. Whether that will happen next month remains to be seen. There are many different things pointing to a top to the market being very close now, as I'll show in the charts. But many participants believe the market will have a good year (being 2005) and wanted to get in before the rally resumes. I'm sure many think they'll even risk a small pullback, convinced that the market will head higher again. My opinion is that that belief is false but I'm only one participant. I'll show again why I think we're very close to an annual high. But the month of July has been kind to bulls. The DOW, S&P and Nasdaq were up 4.0%, 4.2% and 6.3%, respectively. I don't think August, or the rest of the year, will be as kind to the market.

As discussed last week, we are getting a very large disconnect between price action and the technical indicators that normally tell us a high is here. The market is ignoring all those signals, such as extremely low volatility readings (VXO is now under 10), very low put/call ratios, very bullish sentiment, etc. This was to be expected for the end of a bull market in some indexes like the small caps and the end of the cyclical bull market in other indexes that are finishing their upward correction against the 2000-2002 bear market decline (phase I). These technical indicators are at present unreliable to use and just emphasize the market's current irrational behavior. Trying to pick a top with these measurements is an exercise in frustration, a costly one at that for many traders. I'd rather see a top in my rear view mirror and then trade the bounce instead of losing my shirt trying to nail the top. I'll do my best to identify the top but personally I'm not loading up on short positions until after a top has been identified. I've learned the hard way it's too expensive the other way around. So let's take a look at the charts to see how close resistance is, maybe even the top.

DOW chart, Daily

After a brief pullback it appears the DOW is on a mission to tag that upper broken uptrend line, now approaching 10,800. The daily stochastics is pointing down hard so price will either follow or price will lead stochastics back up. Watch for a reversal in the stochastics and then when it rolls over the next time it will leave a negative divergence at a new price high. That's the signal you want to short.

SPX chart, Daily

I redrew the parallel up-channel this week to include all of the price action since the April low. The top of this parallel channel crosses the trend line across the highs since January 2004 at the Fib target of 1257 (internal projections of the wave pattern) on August 11th so just maybe... It could be a very choppy ride to get there.

Nasdaq chart, Daily

The trend line along the highs since January 2004 currently sits near 2215. But the top of its present steep up-channel is near a Fib target (for two equal legs up from the April low) both coincide in the next day or two up at about 2248. That kind of move would give a throw-over above the trend line from January 2004 and a collapse back down underneath the line would be a good sell signal.

RUT chart, Weekly

Since the April low price continues to remain trapped in a very tight parallel up-channel. This weekly chart shows price pressing ever closer to the top of the long term ascending wedge pattern and at the same time towards a Fib target of 690. One more day could do it. Or a week, or two, or...

SOX index, weekly chart

Like the RUT, this weekly chart shows the SOX very close to its Fib target of 481. It actually hit the target last week so it could start to drop off at any time. However the pattern to the upside since April would look better with a small pullback and then a final high after that. That kind of move would also suck in the bears and then fool them again, something this market seems to be very good at.

BKX banking index, daily chart

After bumping up against the broken uptrend line, the banks pulled back and then made another run up towards it this week and failed to make a new high. This index continues to look lower and I think is a good proxy for what the broader market will do. They just don't know it yet.

Providing some support for stocks, especially interest-rate sensitive areas like Financial and Utilities, was a decline in benchmark yields. The 10-year note closed at its best levels of the day, up 16 ticks so yield dropped to 4.18%. Bonds appeared to get a boost upon further analysis of yesterday's Beige Book (tame inflation) and month-end buying from money managers trying to match their portfolios to benchmark indices.

Looking at some additional earnings reports and individual stock performers today shows generally stronger than expected performance. Phelps Dodge (PD 108.21 +0.21) had a strong quarter and Praxair (PX 49.98 +1.83) had a new 52-week high. Telecom Services also climbed more than 1.0% for the day, getting a lift from new legislation that could help telecom carriers like SBC (+1.7%) and VZ (+1.1%), coupled with strong Q2 earnings and upside FY05 guidance from CenturyTel (CTL 34.50 +0.90).

Exxon Mobil had an excellent earnings report but as always disappointed a little because people expected better. The oil index was not one of the leaders but as can be seen below it's been doing better than oil itself recently. While oil price has continued to consolidate around the $60 mark (for front month contracts), the oil index is holding up a little better, probably due to the influence of the general market.

Oil chart, August contract, Daily

Oil price dropped back below the mid-line of its up-channel and got a bounce off its 50-dma. It now will need to get back above the mid-line otherwise it risks dropping back to the bottom of the channel currently near $55.

Oil Index chart, Daily

The oil index was doing a little consolidation with the oil but is holding up better and is making new highs. The negative divergences are a warning here and if oil price drops back down, this index may reflect the dropping price in oil. If long any of these stocks, you may want to tighten up your stops and see if you can't take profits at the top of this channel near 540.

Transportation Index chart, TRAN, Daily

The strong bounce in the Trannies leads me to believe it will press higher to a Fib projection of just under 3900. It's possible that price will stall right here at the December high of 3815. In either case I expect this index to soon roll over and start heading for new lows by the end of the year.

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

Like the RUT, the housing index has been on a tear and shows no desire to let up. Whenever we see this steep a climb in the market we know they tend not to end well. It's too early to short this but I would place a stop alert at the last low of 1052.57 since that will be a lower low as well as a break of the steep uptrend line. I think that would be the warning that a top has been found in this index, and the housing market.

U.S. Dollar chart, Daily

The US dollar tried again to rally back up to the same level it gave its broken uptrend line a kiss goodbye. I've drawn in a light purple parallel trend line to the one along its highs. This identifies a potential up-channel and if price manages to stay above this line while consolidating sideways I would expect to see a new high in the dollar. A break of the lower line, near $89, would suggest a deeper pullback is in progress.

Gold chart, August contract, Daily

Other than scalping small moves, gold is currently in a position where it's difficult to tell which direction it might go. Watch for a break down or out and play that direction.

Sector action was mostly green today, led by Health Care, benefiting from a rebound in HMOs, helped by a Q2 report from Aetna (AET 78.40 +3.78), and strength from Bristol-Myers (BMY 25.17 +0.07). While not included in the S&P, Europe-based AZN (+4.8%) and GSK (+1.5%) were two other drug companies that had strong quarters. The Trannies were 2nd on the list of leaders, followed by the REIT and disk drive index.

The Consumer Discretionary sector was also influential to the upside, helped by strong earnings reports from SBUX, PHM, AN, NWL and SNA (which averaged gains of 5.1% today), as well as a Merrill Lynch upgrade on LTD (+2.4%).

Technology has been the month's best performing economic sector, up +6.5% so far, and the main driver behind the Nasdaq (+6.4%) outperforming the Dow (+4.0%) and S&P (+4.2%) in July. However, the computer makers closed slightly lower today--losing the most ground included HPQ, AAPL, YHOO and GLW, all of which have recently traded at or near 52-week highs. The only other red sector of note was the gold and silver index. The SOX finished flat on the day.

Industrials got a huge boost from Caterpillar (CAT 54.45 +1.66), which hit an all-time high, and Honeywell (HON 38.99 +0.97), which climbed 2.6%, helped by a Merrill Lynch upgrading the stock to a Buy from Neutral.

Tomorrow's economic reports include the following:

Today's price action fits the expectation that we'll see some important trend lines and Fib levels to be hit. The three clearest indexes to me to watch are SPX, COMP and RUT. They appear to be nearing their targets simultaneously which gives me greater confidence in calling a top if and when they're hit. Those levels are SPX 1253-1257, COMP 2215-2250 (a little less tight on that one), and RUT 690. The RUT often runs past its targets, both to the upside as well as downside so I won't be surprised to see 690 get exceeded. And that leaves SPX as the index with the tightest target zone. We're not far away now--SPX closed near 1244 so it could be 9-13 points away, easily a day's worth of rally. But the way this rally has been progressing I wouldn't be the least bit surprised to see some backing and filling as it works its way higher over the next week or two. This market will likely frustrate bears even more by shaking them out of their short positions to get them to quit trying. The bulls will get frustrated because the market keeps threatening to go higher but pulls back instead. It's just the nature of the market which is why I wouldn't be surprised to see it take a week or more to get a measly 10 SPX points (100 DOW points). As this picture changes (and hopefully achieve our targets sooner) I'll try my best to identify it in the Futures Monitor. See you there. Good luck and be patient--you'll have plenty of opportunities to get some good short entries once this market rolls back over. In fact they could be easier entries on the bounces.


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