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Market Wrap

Another Opex Consolidation Day

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As often happens on Thursdays of opex week, the market seemed to be pinned and oscillated tightly in a small trading range today. As most positions are squared prior to Thursday, this day tends to be a quiet one and today was no exception. Even the trading volume was on the light side.

The pre-market futures got spooked after the European markets opened and it never seemed to recover all day. The DOW did relatively better thanks to Altria (MO) but the other indices struggled to lift their heads above water. Kicking off this morning's economic reports were the unemployment numbers at 8:30 am. Last week's Initial Claims were revised up 2K from 308K to 310K and then this week's number came in slightly higher than expected at 316K (consensus was 310K), but the futures market barely reacted to the numbers since they were close to the estimate and not much different from the prior week. The 4-week average jobless claims was up 2,750 TO 312,750 and the continuing jobless claims were up 28K TO 2.59M. The unemployment numbers were at a level that suggests August payrolls should rise at a rate consistent with the average of about 185,000 that has been posted so far this year.


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After the market opened, we got the Leading Indicators report which was up 0.1% versus a consensus estimate that looked for an increase of 0.2-0.3%. This was the second consecutive monthly gain after being unchanged in May. June's reading was revised upward to 1.2% from 0.9%. The market barely reacted to these numbers since it is comprised mostly of previously known numbers. Later we got the Philly Fed Index which is a regional manufacturing survey and it came in at 17.5 for August. This was ahead of the consensus estimate of 14.0 and was up from July's 9.6. Any number above zero reflects growth and the higher than expected number reflects stronger than expected growth. You guessed it--the market gave a ho-hum response to this number as well. I think the market was on Prozac today. And just think, we have a summer opex Friday to look forward to tomorrow. Vacation day anyone?

Today was a boring day so today's price action tells us very little. But let's see what the longer term picture looks like.

DOW chart, Daily

The DOW's pullback continues to look bullish. It could suddenly let go to the downside and in so doing it would decisively break below its 200-dma and the long term uptrend line from March 2003. That would at least tell us we've got something serious to the downside in progress. But so far it's just a choppy corrective pullback and is thereby signaling a rally could be just around the corner. I would not be an aggressive short seller here. A nibbler on the short side, yes, but I'd also be looking to start testing the long side.

SPX chart, Daily

The pullback in SPX has been a little steeper than the DOW's, thanks to the influence of the banks and oil stocks which have taken a more drastic hit lately. Like the DOW though, this looks like a pullback could be near complete and be setting up another rally leg higher. That goes against what most believe will happen in August/September, and the history of these two months tell us to be very cautious, but the chart is telling me I should be thinking about the long side here. Obviously if SPX breaks below the steeper uptrend line at 1215, I'd want to be short for the ride down to its 200-dma and next uptrend line around 1194.

Nasdaq chart, Daily

The techs (and small caps) have taken the brunt of the selling, as usual. Like the other two indexes above, the COMP has found support so far at its 50-dma. If this doesn't hold, watch for a retest of the neckline at 2100.

RUT chart, Weekly

The RUT is the most bearish index in my opinion. After meeting its Fib objective at the upper trend line of an ascending wedge, this weekly chart shows sell signals all around. This one looks like THE high is in and if the rest of the market gives us more rally, this index may not make a new high which would give us the typical intermarket divergence seen at major market highs.

SOX index, weekly chart

The SOX also met its Fib objective at the top of its flag pattern as shown on its weekly chart. However, unlike the RUT, the SOX looks like it needs one more small leg higher to complete its pattern up from the April low.

BKX banking index, daily chart

The banking index dropped back below the 50 and 200-dma's (bearish) and is now struggling to get back above. It's also fighting the broken uptrend line from April. Whether or not it will be able to fight its way back above those resistance levels will determine whether or not it will have a chance to retest the previous highs. Any consolidation below these resistance levels will be bearish and I'd look to short the banks.

XBD securities broker dealer index, weekly chart

We've been keeping an eye on the securities broker index because, like the banks, they make an excellent proxy for the broader market. This weekly chart shows how price has stalled at its Fib target of 172.40 and the upper trend line. But the pattern would look best with one more minor push higher. If we do get another rally leg out of this, it could also give us a typical throw-over the top of the pattern, perhaps up to around 180 and then collapse back inside. That would be a sell signal in a bearish ascending wedge pattern like this.

Crude may start to get a little more volatile on us as we reach what I believe will be a longer term high for oil. Whether or not we've already topped out is debatable and the sharpness of the current pullback along with the strong sell signal on the oscillators would say there's a decent chance we've seen the high that will last a while. But we'll need to watch this one longer to see what the next bounce looks like.

Oil chart, August contract, Daily

Oil didn't quite reach the top of its parallel up-channel and I have a potential Fib target up in the %68.35-$69.60 area. Once I heard just about everyone agreeing we'll see $70-75 oil, I figured we're probably about topped. I've been looking for oil to peak out below $70. We haven't broken any uptrends yet, including one from the May low, so there's nothing bearish about this chart yet. I will want to see the 50-dma hold on any further pullback (currently $60.56) and I want to see what the next bounce looks like to see if it's pointing higher or if we should expect another leg down once the bounce is complete. The oil index is giving us a heads up about potentially lower oil prices.

Oil Index chart, Daily

I've been saying that the oil index is typically a good leading indicator for the price of oil. The oil companies usually foresee the changes before it's registered in the price of oil. The fact that this index has broken its uptrend line from May is a big heads up. If you were long any stocks in this sector you should have taken some money off the table with that break down. Now we'll watch to see if the 50-dma provides support, if the broken uptrend line acts as resistance on a retest and what kind of bounce we get next. We might have seen the highs in this index and the next move will be down to the bottom of the longer term up-channel.

Transportation Index chart, TRAN, Daily

The chart on the Trannies is a mess. It's a hard read as to where this one is going next. Best guess on this one is that we haven't seen the highs yet, just like the DOW and SPX. If it continues lower though, watch for the 50 and 200-dma's for support, both coinciding just below 3640 currently.

I've covered the housing market quite a bit in previous Market Wraps and most of you know I'm bearish on the longer term outlook for housing, and by its effect on the greater economy I'm bearish the stock market longer term. I've been looking for signs that the housing market is topping and the charts show that we may have peaked already. Now we're getting some additional signs in the housing market. The hottest markets are starting to show evidence of slowing. The combination of higher interest rates and a sudden glut of homes for sale are starting to bite.

A couple of weeks ago I noted the significant drop in lumber prices since the spring and how that may been a heads up for the broader home building industry. It appears it may have been an accurate predictor so far. The busy summer building season is turning out to be weaker than many had hoped to see. According to The Wall Street Journal: "The number of homes available for sale has increased sharply in some of the nation's hottest real-estate markets--one of several recent signs suggesting that air may be seeping out of the frenzied U.S. housing market." The Journal cites three examples of rising supply. In San Diego County: "the number of homes listed for sale totaled 12,149 on July 8, more than twice the 5,995 available a year earlier, according to the San Diego Association of Realtors." In northern Virginia, "inventories are up 26% from a year earlier." And in Massachusetts: "home inventories are up 31%, according to officials of real-estate organizations there." The Journal also reported that "Real-estate brokers say inventories also are up in such markets as Chicago, Las Vegas and Orlando." Let the correction begin.

We've also discussed many times the impact that high oil prices will ultimately have on the consumer, and businesses too of course. It's a hidden tax that the equity market has thus far pretty much ignored but it will eventually register. High energy prices may also be contributing to the slowdown in the housing market as the ability to pay a higher mortgage will become more difficult due to higher energy costs (especially as the public starts thinking about what the high oil and natural gas costs will do to their home heating bill. According to the Wall Street Journal: "In some markets, such as California and Florida, prices have surged past the ability of many people to afford a home. Additionally, banking regulators have begun to raise questions about whether mortgage lenders are being prudent enough, which eventually could prompt some lenders to tighten credit standards." We've discussed the lax standards that banks have used in order to pull in more home buyers. Even they recognize this may cause them some significant problems down the road. "House prices have continued to rise partly because some lenders have promoted loans that help people buy houses they otherwise couldn't afford. For instance, Countrywide Financial Corp., the nation's largest mortgage lender, says that about 20% of its home loans so far this year have been ["pay option"] mortgages. These loans give borrowers the option of delaying any repayment of principal and even paying less than the interest due some months, which results in a rising balance due." This is downright scary because unfortunately we have many home buyers in this situation who are not savvy enough to understand the huge risks they've taken on. If a large number of people suddenly find they are unable to pay the mortgage, and have no equity in the house, they'll take the only way out and that will be to leave the house with the bank. Banks don't like houses in their inventory and will dump it just to get as much out of it as they can, which may not even be enough to cover their loan. So the banks will start taking losses. Notice what's happening to the banking stocks lately. And take a look at Fannie Mae (FNM)--that stock is hitting lows not seen since 2000 ($50) after climbing to nearly $90 in late 2000. The weekly chart says $50 is going to give way very shortly. My guess is that that stock is headed for $30 before it finds any kind of lasting support, potentially much lower than that by the time the next leg in the bear market is finished.

Another reason the real estate market has probably done so well over the past few years is because it became the new investment game in town (at least new to a new group of investors). After the dot.com bomb consumers have been generally avoiding the stock market. After the stock market drop, corporate scandals, and low bond yields investors have had a decreased appetite for stocks and bonds, the traditional investment vehicles. The result has been that housing has replaced the stock market as the major, or at least a significant, portion of the country's wealth building apparatus. Banking and real estate companies, have created all kinds of creative ways for the public to get in, including aggressive adjustable rate mortgages, including no money down, interest only loans and all their derivatives. All of these factors have combined to create a feeling of invincibility and to the "flipping" phenomenon, which has been fueled further by television shows on "The Learning Channel," and HGTV, where "reality" shows document the progress of house wives and young entrepreneurs as they take an old house, remodel it, and then turn around and sell it for a profit in a few months.

This reminds me of the story of a great trader, the name of whom escapes me at the moment, who had sold every share he owned shortly before the 1929 stock market crash. When asked how he knew when to sell he said when his shoe shine boy gave him a stock tip he knew everyone was in and it was time for him to get out. When everyone was comparing stock tips at the water coolers in 1999-2000, it was time to get out. I recently read about someone being told by a NY cabbie about the money he was making flipping houses. It's time to get out.

Remember the good old days when you could throw a dart at a list of stocks to pick which one you wanted to buy? You'd buy calls on them, wait a week, sell them for a handsome profit and then repeat. Many thought they were freakin' geniuses. And there is one thing that the flippers and would be real estate moguls have yet to learn, and may be about to learn the hard way, and that is that houses, unlike stocks, aren't liquid. Even the usually exuberant real estate pros are starting to note that things are changing. As The Journal reports: "Sales have slowed down for sure, says Tip Powers, president of Realty Direct Inc., Sterling, Va. He says home prices have flattened out and speculators are starting to shy away from the market because they no longer can count on quickly unloading properties at a profit." The speculators are usually a little savvier about these things and they watch the road ahead for such things. The normal home owner however is simply unaware until higher interest rates or a loss of a job creates a situation in which they have no way out. And if banks get more nervous about their home loans, a couple of missed payments could get the bank to call in the loan. It doesn't take a lot of creative thinking to see how this could all spiral out of control quickly.

Recent comments by Greenspan have registered his concern about the inflated housing market. He has made similar comments about the bond market and has essentially said that any expectations of long term stability could lull investors into complacency which is dangerous. There are many analysts who harbor this same complacency about the housing market, just as we heard in 1999-2000 how we were in a new economy and how different it was this time. Turned out to be not so different. Yesterday there was an article in the WSJ where William Apgar, senior scholar at Harvard University's Joint Center for Housing Studies, made the following comment: "It's not going to be a big dramatic event. Unlike stock prices, the housing market can't collapse in a few days. People can dump their stocks almost instantly, but it often takes months to sell a house." He misses the point. Because of the illiquidity of houses, if they sit on the market for months and the seller really needs to sell, he will continue to lower the price until it sells. But Apgar did go on to state, "... the end of the boom is likely to be painful for many people. Among the most vulnerable: people who may have to sell in a weak market because of a job loss or transfer; those with little or no equity in their homes and big mortgages; and those counting on big gains in home equity to make up for a lack of retirement savings." The last part of that quote is the scary part. There were many people who dreamed of retiring early, or who thought they'd at least have a nest egg to retire on, due to the huge run-up in the stock market in the late 90's. Many retirees lost a good chunk, if not all, of their retirement savings and the dreamers who thought they'd retire at 55 or hoping they can retire at 65. Have you noticed all the Wal-Mart greeters and their ages? Now we have the same scenario but people's savings are in their real estate holdings. I'm afraid the same outcome will hit many. Americans' savings rate has dropped to zero because so many think they'll simply live off the proceeds of their house. All bubbles end the same way and it's never a pretty ending.

One more note on bubbles and why I feel strongly about what will likely happen in the housing market bubble (a little history here). Without boring you to tears by using Elliott Wave analysis, much of the bubble analysis has to do with EW analysis. Usually the final move in a bull market is a 5th wave and it often produces a spike up that becomes frenzied but lacks the fundamentals to support it. It's built on froth, the greater fool theory, etc. The kind of wild speculation that took place in the Internet and Technology sectors is typical of a fifth wave that precedes a major economic bust. Such was the case in the Tulip Mania in the mid 1600's, the South China Sea and Mississippi Bubbles in the early 1700's, the roaring twenties leading to the 1929 crash, the Nikkei in the 80's, our tech boom and now the housing bubble. In addition, speculative bubbles generally involve government intervention in monetary policy as was the case in 1716 when Scottish financier John Law convinced the French government to let him open a central bank (The Bank Generale) that could issue paper money or bank notes. The same holds true for our Federal Reserve which was created in 1913 and which then issued paper money and bank notes against Gold reserves (which were eventually done away with in 1933 when we went off the Gold Standard). In 1982 Fed Chairman Alan Greenspan began what was to be one of the most aggressive interest rate cutting sprees we have ever seen. He was determined to beat the Kondratieff cycle that called for "winter" during his years at the helm. This easy money policy of the last 23 years fueled the economic boom of the 80's and 90's. what goes up must come down. Even Greenspan can't stop the boom and bust cycles.

In June of 1999 Fed Greenspan began hiking the discount rate in an attempt to cool off the economy and he promised a soft landing. The discount rate had only reached 6.5% but the bottom in 2002 was anything but a soft landing. At least his definition and my definition differ on that score. After the market crashed the Fed took an even more aggressive stance on lowering the discount rate, dropping it to a 45 year low in 2003. This has helped to artificially prop up the US equity markets with the Dow Jones gaining back nearly 80% of its value. The S&P gained back 56% and the Nasdaq gained back 27% from its market high. But these rallies are simply the first bear market rallies in what will ultimately turn out to be the greatest bear market that anyone living today has ever seen. The easy money policy of the last two decades has come to a close. With 10 consecutive rate hikes, the discount rate now sits at 3.50% which is probably just the beginning as we begin a new long-term uptrend in interest rates. As the bear market continues, we will likely see fluctuations in the Fed rates and we might even see a last ditch effort to lower interest rates in an attempt to prop up the market again, but this time it will prove futile (as Japan's efforts have proven over the last 20 years). After the 1929 crash, the Fed lowered rates from 6% to 1.5% by mid 1931. This helped get a rally started that lifted the DOW from its low of 199 by 50% up to 294, much like the recovery we have seen in the major indices since the lows in 2002-2003. However, in April 1930 the market ultimately reversed course and continued its downward spiral and didn't bottom until July 1932 losing 89% of its value before the bear market was done. Our markets are playing out the same pattern, albeit in a longer time frame, and it appears we are either at or very near a major high for the current cyclical bull market. We should soon be starting the next leg down which will ultimately take out the lows set in 2002-2003 and drop to much lower levels. During the recovery from November 1929 to April 1930 the investing public, including many famous economists and stock speculators such as John Maynard Keynes and Jesse Livermore took very bullish stances on the market concluding that the low of 199 in November of 1929 was indeed the market bottom. Today we see the same bullish sentiment toward the US equity markets among the investing public and the majority of economists. It's not until the general public is totally disgusted with stocks will we have a true bottom.

But this is all longer term stuff and we need to be concerned as traders what's happening tomorrow and next week. I just wanted to discuss the longer term to give you a heads up where my thinking is so that you can use that as part of your own analysis and decision making. Other than the housing stocks, houses are a longer term proposition for most of us and I like to get people thinking longer term here. It is the second leg down in the great bear market that will take housing down with it. The housing market has always crashed after a bear market gets started and to say it will be different this time is nonsense. So the housing stocks have begun to register the slowdown and we'll watch them carefully for additional sell signals. As can be seen in the following chart, the housing index is now in an early downtrend, having broken its previous uptrend. This index is the warning shot across the bow of the USS Houseboat. The next shot could be the one that sinks it.

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

Timber! First came the collapse in lumber prices and now here comes the housing index. We're close to completing a 5-wave move down from its high so I'm looking for a bounce soon. It could first stretch its decline down to its uptrend line near 930 but it's now risky to enter short positions on this index. After the next bounce, look to short the housing stocks again.

U.S. Dollar chart, Daily

Looks like we got a little bit of short covering off the 200-dma. The US dollar got a sharp rally back up to its 50-dma and back up for a retest of its broken uptrend line. If it continues to rally above its current level of $88.55 it would look bullish. Until that happens the dollar looks like a good short right here. And if the dollar drops back down that could be good for gold. And gold needs to bounce, like now.

Gold chart, August contract, Daily

Gold has come back down for a retest of its broken downtrend line, the top of its previous triangle consolidation pattern. Gold bulls want to see a kiss goodbye here--a test and now it needs to bounce right away and get the daily oscillators turned back up. If gold drops any further it will drop back into its consolidation pattern and leave us guessing which way it will ultimately head.

Sector action was mostly red today. While the balance between advancing issues and declining issues was skewed towards the decliners, the declining volume was more than double the advancing volume. The green sectors today were the Natural Gas index, utilities, banks, oil service, biotechs and health and pharmaceuticals. But they were all only marginally in the green. The red sectors were leg by the airlines, high tech and computers, the SOX, cyclicals and oil index. Retailers like Hot Topic (HOTT 14.33, -1.48), Cost Plus (CPWM 21.86, +0.32), Children's Place (PLCE 42.76, -2.14) and Limited (LTD 22.34, -0.94) all issued guidance that fell below expectations for either Q3 or the full year and that started retailers off in the hole this morning but they recovered to near the flat line by the close.

Altria was the Dow's best-performing component and lent support to the broader market as the other tobacco companies were bought as well. Altria Group (MO 70.75, +2.89) drew support from the favorable reaction to the Illinois Supreme Court decertifying the Avery class action suit against insurer State Farm. Today's rotation into these stocks was also part of the defensive move seen when the market's not sure what's happening. Tobacco's performance contributed to the out performance of the Consumer Staples sector (+1.0%), which was the best-performing of the economic sectors today. Conversely, Materials (-0.70%), Telecom Services (-0.70%) and Information Technology (-0.70%) were some of the weakest sectors as traders shied away from the economically-sensitive stocks known to be volatile (part of the defensive posture of the market today).

GOOG saw some excitement today and showed their true geek colors. The company filed to sell 14.2M shares in a stock offering, which took many analysts by surprise. As reported by the WSJ today, Google said it planned to issue 14,159,265 shares of Class A common stock. "If that number looks familiar, you probably paid attention in algebra class; the numerical value of pi, or the ratio of a circle's circumference to its diameter, is 3.14159265, after lopping off an infinity of other digits. This jokey number of shares will raise some serious cash, about $4 billion at today's share price." The stock offering is intended to raise funds "for general corporate purposes (or) for acquisitions of complementary businesses, technologies or other assets." With some $3B already in the bank, they must have some serious buying in mind. Shares of GOOG dropped 12% in pre-market trading on the news.

There are no major economic reports tomorrow.

While I am longer term bearish the stock market I can't help but feel this market has another rally up its sleeve. The bears have jumped big time on the current decline, spiking the put/call ratio up to a level where we've typically found significant bottoms. Same with the oversold breadth--the Nasdaq advance/declining issues number is at a low that has typically marked significant bottoms. It seems to me the bears have been sucked in here and the market is about to slap them silly. The Elliott Wave pattern suggests to me that we've been in a large sideways/down consolidation for the past 5 weeks which would say we've got a rally coming to a new annual high. Sounds crazy to me too but I just report what I see and let you be the judge for what you want to do with your money. As for me, I'm not entering any long term short positions yet since I don't see enough evidence that a major market high is in. I continue to scalp this market and suggest the same for you.

If we do get another rally leg then I've got a potential Fib turn date window around September 16th that could mark a major high, as in THE high. That's all speculation at this point since we obviously need to bounce first to see if that's a possibility. If the market instead tanks, I'd look to be short SPX below 1214 and watch for support around 1194 initially. If we didn't get much of a bounce from there then I'd be looking to get short in a big way since the likelihood would be that we've put a major market high behind us. Until then take profits early and play the turns both ways. Good luck.

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