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Market Wrap

Finally A Convincing Close

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After weeks of three steps forward, two steps back, many of the indexes broke out of their range bound patterns to surge sharply higher. The S&P-500 has struggled over and over again with new intraday highs only to return to 1230-1235 on closing sell cycles. Today the cycle was broken with the S&P closing at new four-year highs. Strong internals and strong economics overcame record high energy prices and produced a convincing breakout from the July consolidation.

Dow Chart - Daily

Nasdaq Chart - Weekly

SPX Chart - Weekly

The daily economic calendar started out with a jump in Personal Income to +0.5% for June and well over the +0.2% gain for May. Consensus estimates were calling for a +0.4% gain. In what should surprise nobody personal spending rose +0.8% and savings fell to 0.0%. Jack and Jill Consumer continue to spend more than they make and fail to prepare for the proverbial rainy day. Wage growth for hourly employees was weak with only a +0.2% gain. The major gains in the headline number came from gains in proprietor's income and asset income suggesting self-employed owners and investors in things like real estate are the first to profit from the economic rebound. If the labor market continues to improve the lagging wage growth could begin to catch up soon. The Jobs report on Friday will give us our next clue on the employment picture. Fortunately for investors the lack of any material wage growth will continue to keep inflation in check. The PCE component of today's report was unchanged with core deflator growth falling under 2% inflation for the first time since last August.

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In conjunction with the jump in Personal Income and Spending the weekly Chain Store Sales jumped +0.9% for last week. This was the largest jump in sales since August 2004. Year over year growth rose to +4.9% and the highest level in a year. Warm weather, record heat in many areas, is driving summer sales and just when retailers are marking down summer items to reduce inventory in anticipation of the switch into fall goods. Despite the strong sales the high gas prices are continuing to put a drag on consumers. Surveys regarding spending habits in light of the high gas prices all show consumers are cutting back in other areas to cover the higher prices.

New orders for manufactured goods rose +1.0% in June and a drop from the very strong +3.6% in May. However, the +1.0% gain was inline with consensus although nondurable goods declined -0.2%. A durable goods increase of +0.2% offset that drop. This is a lagging report and while it shows a continued growth in orders the internals suggest the pace of growth is moderating. Since this was a summer month some seasonal weakness should be expected. The August report, not due for two months, should show a pickup in activity. Excess inventory levels appear to have been corrected and the economy is positioned for a new inventory build cycle.

The Risk of Recession fell to only 21.2% in July from 29.1% in June. This is a very strong drop and should be seen as confirmation the economy is finally self sustaining. The Fed should see it as additional freedom to continue their rate hikes and even increase them as conditions improve.

If there is a hidden problem to all the positive economic reports it is the Fed's perception of the speed of economic growth. The Fed meets next Tuesday and there is a growing perception that they will remove the measured pace language in preparation for a larger hike in the future. Even if they do not eventually make the stronger hike the fear of a potential hike should raise short-term rates and help the Fed. The improvement in the ISM and the very restrained rate of inflation should give them a green light to accelerate their pace. The Jobs report on Friday could be the deciding factor. The consensus for Friday's report is for a gain of +180,000 jobs. Something in the +150K range would be the sweet spot where the Fed would not get overly excited but still show investors that employment is improving.

The story of the day was the Unocal/CNOOC/Chevron battle. CNOOC formerly withdrew its $18.5 billion bid for Unocal paving the way for Chevron to complete its acquisition of Unocal next week. Unocal shareholders will vote next Wednesday but without any competing bid the vote is only a formality. CNOOC dropped its bid due to the continued political outcry against giving China access to any of our oil assets. Critics claim the reasoning was due to interest free financing from the Chinese government but the real fear is much worse. China owns 70% of CNOOC and they are actively trying to contract for oil assets in other countries for decades to come. The fear is that China will hoard the assets for future use and not sell the oil on the open market. Many analysts claim just transferring ownership of oil does nothing to the global picture other than shuffling the direction tankers take to refineries. Where I disagree and many others are coming to the same conclusion is that China is going to eventually be the biggest oil user on the globe and locking up supplies now only for future use appears to be their goal. What good would it do them to buy a company like Unocal and then continue selling the oil on the open market? Sure that would make them a few bucks but they will need that oil and much more before the end of this decade. That effectively takes those supplies off the global market until China needs them. This could be very detrimental to current oil prices as those supplies are removed from the market.

Oil closed at a new record high today at $61.89 with the December contract reaching a new all time high of $64.50. Various refinery outages and production problems continue to plague the sector. Inventory levels to be announced tomorrow could be lower for the fifth consecutive week according to the Energy Information Association. Oil stocks, many breaking out to new all time highs, benefited from the this worry and the fear that CNOOC will now take aim at some non-U.S. assets to continue its acquisition strategy. Just because CNOOC was not successful with Unocal does not mean they will go home and sulk.

December Crude Oil Chart - Daily

December Natural Gas Futures Chart - Daily

Another problem benefiting energy stocks was a new record high for natural gas. The September contract for gas closed at a new all time high at $8.37 with the December contract hitting $9.31 at the close. The current contract has risen +1.20 or +16% in just the last week. Most of our U.S. readers are probably buying gas somewhere in the $7.50 range today but that is changing rapidly. Our consumption of natural gas is soaring, some of it due to the current heat wave, and it is not going to get any better. Gas drillers are punching holes as fast as possible but a shortage of drilling rigs and production services once completed is limiting the addition of new supply. Secondly, the normal gas well peaks quickly and declines substantially within 3-5 years. Gas wells have to be dug deeper and deeper each year with the average Chesapeake well now over 10,000 feet. Increased expenses and a quick peak in production means prices will continue to rise and while demand increases almost daily. New electric plants using gas are in the works and each adds the equivalent demand of tens of thousands of homes.

Several energy company CEO's were interviewed today and the outlook was the same from everyone. Increasing demand and increasing costs for both oil and gas. Rowan Drilling (RDC) is currently drilling a well in the Gulf called the Blackbeard to a depth of 32,000 feet. This is the deepest well every drilled in the Gulf and demonstrates the lengths companies are having to go to find new resources. The RDC CEO said global demand has never been greater with rig rates up +50% and no rigs available. He said the new jack-up rigs cost $120 million to build and rent for nearly $120,000 per day. 1/1000th of the cost is the target rate. They also have a very long lead-time and manufacturers have a multiyear backup of orders. National Oilwell Varco (NOV) controls 50% of the rig building market if you want to play the rig demand market. The bottom line to this story is higher oil prices. Long-term investors should continue to buy the dips.

Oil and Gas were not the only commodities hitting new highs today. The CRB Commodity Index hit a new six-month high as the metals and materials joined the new high party. Copper rose to a new all time high at $1.66 driven by the rebound in the global economy and the continued demands of the housing market. Phelps Dodge jumped +3.69 on the news. Various companies warned on Tuesday that the high cost of commodities was going to depress future earnings. TYC, MAS and CTB to name a few. A rebounding economy growing at what some people claim will be a 5+% Q3 rate can handle the higher prices. Even the higher energy prices will be a footnote as long as the economy continues to accelerate. Unfortunately an accelerating economy at this stage in the cycle will force the Fed to act faster and the weight of high prices combined with high interest rates will eventually produce the next recession cycle.

That future appears to be the farthest thing from trader's minds with a major breakout by multiple indexes. The lethargic range bound market we have seen the last three weeks finally found some traction and new highs were the news today. The internals were very good for a summer day with advancers nearly 2:1 over decliners. New 52-week highs continued their fourth consecutive day averaging over 700. This is very strong and shows conviction at market highs.

The Nasdaq finally broke over 2200 convincingly with a +22 point romp to close at 2218. A major reason the Nasdaq did so well was the surge higher in chip stocks. The SOX rallied out of its two-week consolidation top at 475 to close right at major resistance at 485. This was a very strong performance and hopefully the two weeks it spent getting ready to tackle the 485-490 resistance range will produce some follow through. However, after the close tonight ADI and TECD both reported earnings that disappointed the street and both took severe hits. ADI fell from $40.75 at the close to $37.25 in after hours but rebounded to $39 before trading ended. TECD fell from $39 to $33.50 before rebounding to end at $36. With the SOX rally built on hope at this point we could see some weakness at the open from these earnings reports.

It may sound like a broken record but the Russell was again a major contributor to the Nasdaq rally. The Russell sprinted to a new all time high at 688 and appears to have 700 in its sights. With all the analysts saying big caps is where you want to be at this point in the cycle and cautioning about small caps there is serious confusion. The bulls appear to be on a buying binge and there is no stopping them. Small caps are finding more buyers than a donut store across from a police convention. Each day produces a new high and there are only minimal pullbacks to rest. Good news appears to be breaking out everywhere.

SOX chart - Weekly

Russell Chart - Weekly

The Nasdaq finally made a convincing breakout and the next material resistance is 2250. That level restrained advances for six months in early 2001 and it should be difficult to cross at this point in the summer rally. We did not get any material pullbacks from the July bounce and 2250 would represent a +200 point rally from the July lows and a +10% move. Rarely does a +10% move go unpunished. The Russell is up +20% from its April lows with only a couple hiccups along the way.

After using 1235 as support all day Monday the S&P finally broke out to a new four year high and hopefully rid itself from the 1235 jinx. 1245 was the high back on the 28th and it recoiled back to the 1235 level to get one more running start higher. Energy stocks and commodities helped power it higher.

The Dow remains the weakest link but it is also creeping back up to knock on the 10700 door once again. The high today was 10699 and a breakout there seems imminent as long as support continues from the Nasdaq, SOX and RUT. The Dow transports are still in a confirming position for the Dow with a solid grip on 3800 and only a blink away from a new high. Considering oil is at record levels this positively amazes me. It suggests business is booming with all the shippers and fuel surcharges are alive and well.

I have been cautious on the attempted breakout over SPX 1225 but the Nasdaq and Russell strength is very convincing. I added to my long positions today but I will continue to keep my stops tight. The futures eased a bit after the ADI/TECD disappointments but are starting to firm again at 7:30ET. I believe I am not alone in being cautious ahead of a typically weak period in the markets. If I was prompted to add to long positions today there are probably a lot of others in the same boat or afraid of missing the boat. These contrary rallies have a way of sneaking up on everyone and turning into a race to buy the highs in disbelief. Shorts, bless them, are still trying to short each successive move higher and the bulls are laughing all the way to the bank. With oil trading right at $62 while I type this, the odds are good we will see another spike higher in the oil stocks at the open. Inventory data could either fuel that spike or kill it so be forewarned about entering new oil positions before that data. The Fed meeting is now less than a week away with the Jobs report on Friday. This would be the perfect time for a bout of profit taking ahead of uncertainty but the bad news bulls are in control. As long as they keep buying the very shallow dips we could find some more surprised bears just ahead. Just keep those stops tight, enter new positions passively and exit aggressively if the historical August weakness finally appears.
 

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