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Market Wrap

Saved by the Bell (and a little short covering)

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After three days of hard selling it was starting to get downright ugly out there. And then after breaking some major uptrend lines (DOW, SPX and NYSE) and 200-dma (COMP) it was starting to get scary. It became a question of whether or not we were going to experience a no-bid situation (crash). But after a brief dip below major support a buy program or two probably hit and that sparked short covering into the close. I'm sure it will be debated whether or not the PPT came to the rescue once they saw those major support lines breaking--all they needed to do was buy a couple hundred thousand S&P futures contracts to get the ball rolling, then pull their money back out on the ensuing rally and then go home patting themselves on the back for a job well done. Could be. But I'm thinking it was just manipulation by some of the big funds--they knew where all the stops were so they drove the market down to hit the stops and as the final bit of selling kicked in they became the buyers. Once that was finished, they bought a little more to get the short covering started and then sat back and raked in the profits. How else do you think they can afford those houses out at the Hamptons.

This morning had only one major economic report which was the initial jobless claims number which came in at 390K, up 21K, versus 350K expected. Last week's number was revised up 40K from 356K to 396K. We'll probably see the same kind of upward revision of this week's number. The 4-week average jobless claims was up 15,750 to 404,500 and the continuing jobless claims was up 118K to 2.91M.


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We will of course continue to see the negative consequences of hurricanes Katrina and Rita. There have been the first wave of people needing immediate help--those who lost their jobs from having to move or because their companies are no longer there. But the financial hardships caused by the storms are expected to get much worse. Louisiana is reporting that unemployment payments more than quadrupled to $87.7M last month, compared with a year earlier. More than 183,000 workers filed for unemployment benefits during the week ended September 24th, up from about 29,000 the week before Katrina hit. State officials say they are expecting another surge of unemployment claims as companies that kept workers on the payroll after the storm decide they can't afford to keep paying them.

There were only a few earnings reports this morning. ATI Technology (ATYT 14.19 +0.94) posted a narrower than expected loss (-$0.12 per share vs. -$0.28 consensus) and issued upside guidance, while Marriott (MAR 63.65 +0.54) upped its outlook and came in well ahead of analysts' estimates (beating them by a nickel). Costco (COST 44.91 +2.01) beat forecasts by a penny, reported better than expected same store sales, and also announced a $1B share buy back plan. CVS (26.34 -1.75), the drug retailer, lowered Q3 guidance today so their stock was taken out behind the woodshed. However, a continued decline in the market and their drug sales should do much better (wink).

General Electric (GE 33.58 +0.91), announced that its Q3 and Q4 earnings will come in at the high end of its forecast. Retailers were generally positive in the morning, showing that September same store sales data was coming in better than the market may have feared. The retail index (RLX.X) was initially up on the news, sold off with the rest of the market and then recovered at the end of the day to close in the green, barely, and was one of only a few green sectors today. The three largest stores - Wal-Mart (WMT 43.91 +0.43), Target (TGT 52.05 +0.78), and Costco - all exceeded expectations.

Here was a 2:00 market update from briefing.com, "2:00 PM: The indices head south as fresh comments from Dallas Fed President Fisher sideline buyers. In a speech in Waco, Fisher continues to warn on inflation, calling it a "virus" that cannot be allowed to infect the "blood supply," and notes that inflation shows "little inclination" of declining. Even though crude ($61.45/bbl) has given up 2.1% today, traders appear to have readopted the inflation-flustered sentiment that has prevailed all week." The market had already begun selling off shortly after the high around 11:00 AM but Fisher's comments certainly helped traders make the decision to sell some more, or certainly to not buy. Fisher wasn't saying anything new but traders were just not willing to step in front of the selling, and it remains to be seen whether or not the late day buying will continue tomorrow.

Let's see if the charts offer some clues in that regard.

DOW chart, Daily

Just before the close a couple of buy programs probably hit and that started the short covering. But to work the DOW back up to close on its uptrend line from the October 2004 low, at 10287 on the nose), well excuse me if I sound like I'm accusing the market manipulators of being just a little too cute. This is obviously a very important trend line so watch it closely here. If price drops back down to a new low now, that would be bearish. If price stays more than 3 days below this trend line (and I'll count today as the first day), that would be a confirmed trend line break.

SPX chart, Daily

The same end-of-day buying into the close saved a major trend line break, which is at 1188. The short term pattern suggests we could get a bounce so first resistance is at the 200-dma at 1200.17. A 38% retracement of this week's drop is at 1201.56 so this area could be a tough one for the bulls to fight through. Until proven otherwise, I think the bears control the ball so look for a bounce up to 1200-1202 to fail and set up a short for the next leg down, which could be a doozy. If we do get a further break down, 1160 is the next downside target.

Nasdaq chart, Daily

The COMP broke its neckline at 2100 and found support at its 200-dma. Like the other indexes, this one dropped through support and was saved at the end of the day. If it is unable to hold the 200-dma then it will likely drop down to 2050 in short order. If things get really ugly then support won't be found until the uptrend line from August 2004 at about 1960.

I've been reading some interesting material, courtesy Elliott Wave International, that I thought would be interesting to pass along. Don't worry, I won't start throwing EW labels at you. I will however refer to some Fibonacci numbers that shows an uncanny rhythm to the market. Refer to the following weekly chart of the DOW:

DOW chart, Weekly

First, the diamond patterns that I've drawn on the chart--the first one is back in 1998-2000 and did a pretty good job at forecasting a top. The current diamond is a bit funky looking and encompasses price action for 2003-2005. The trend line of most interest to us now is the uptrend line from August 2004 and that's the one that was broken today but then recovered--at 10287. It needs to hold this line or else. I placed on the chart some interesting little factoids about the symmetry of the patterns as far as Fib ratios and numbers go. I won't repeat them here but note that these relationships are intriguing to say the least. The market has a rhythm to it that is often hard to see until you review numbers like these. It tells us we could be at a very important turn date as of the last high in September. That high happened to fall in the week of an important Fib turn date that was based on previous turns in the market since the DOW's January 2000 high.

There are other reasons to be cautious about the market right now. In the past couple of weeks I've discussed some potentially major sell signals that we're getting right now. One was the Hindenburg Omen--we've gotten a cluster of signals in the past week and it's potentially ominous. I showed a comparison chart of 1987 to 2005--it is uncanny how similar they are and the similarity continues into this week's hard sell off. We're due for a small bounce and if it continues to follow the same pattern, it could get very ugly into the end of October. We have the potential influence of solar events. Monday was a solar eclipse (and this week's high on that morning spike up and then down) and then a lunar eclipse on October 17th. In 1987 the same pattern ended on October 7th and the market crashed October 19th. The same pattern sets up a bad end of month so we'll just have to see if the comparison holds true (which would be October 29th and 30th).

The move into small caps this year is similar to the activity we saw in tech stocks heading into 2000. While blue chip mutual funds experienced net withdrawals this year, small-cap funds had inflows of $240M. Some funds (14%) have had to close their funds to new customers. Many high tech funds closed their doors in the same way in 2000. Watch the RUT because it could be a good indicator for us.

Weve talked at length about the vulnerability of our banking system. Weak mortgagees could tip the balance if they can no longer keep up with their payments. The credit derivatives in our market, while touted as wonderful by Greenspan, have created a potential nightmare if the dominoes start to tip over. Credit derivatives are designed to reduce risk but they've morphed into something far more sinister. They allow participants to shift the risk of default on debt from primary lenders to third party "insurers". These credit derivatives have exploded in value sold--up more than 800% in the past three years and up another 50% in just the first half of 2005--now worth over $12 trillion dollars. To put that into context, the U.S. GDP is about $11 trillion.

As a general rule, the further a loan gets from the originating lender, the more complex the counterparty claims become in the event of default. If the dominoes were to start falling and loan defaults start to spike, the problem becomes one of figuring out who owns what and who owes who. There's currently an eight month backlog of unconfirmed trades in the credit derivative market. And you think you're behind on your paperwork!

Lastly, watch the daily cartoons. Just like in 2000 when only the cartoonists seemed to understand that we were in tech bubble-land, the cartoonists today are the only ones talking about a housing bubble AND another stock market bubble. The flight to junk bonds is another example of rampant speculation. The signs are all there and now it's up to us to heed them and prepare ourselves. We may not see a hard market correction this month but it's coming.

And speaking of techs, the SOX chart shows it's on the verge of a confirmed breakdown, or it could save itself with another rally leg higher:

SOX index, Daily chart

The SOX had bounced up to give its broken uptrend line a kiss goodbye at 480 and dropped sharply away. This is bearish. If its recent low near 452 breaks then we have a confirmed break down and I'd look to the 200-dma at 433 for support. We could get a little bounce before heading lower.

BKX banking index, Daily chart

I drew a little down-sloping diamond pattern on the chart mostly out of curiosity since I don't know if it has any meaning or not. If it's a reversal pattern then we should see price come flying out the top of it. Price is currently stalled just beneath the broken uptrend line from May 2004, near 95, so a retest of the line and failure here would be bearish and instead we'll probably see price come flying out the bottom of the diamond pattern.

Oil chart, August contract, Daily

Oil dropped to a low of $60.70 which got it close to the point where it achieved two equal legs down from its high (at $60.65) and the bottom of the longer term up-channel which is at $60.50. So far the pullback is corrective (3-wave decline) and if it reverses back above $68 it will signal new highs ahead even if it first consolidates for an additional period of time. But if oil instead does a small consolidation at its uptrend line and then breaks below $60, we may have clues that a longer term top in oil is in. I would then look to its 200-dma under $56 for its next support level.

Oil Index chart, Daily

That's what I call a break down. When they wanted out of this index it looks like the exit door was too narrow. With price having reached the mid-line of the longer term up-channel, it could find support here and bounce back up to its 50-dma for a retest. If it continues dropping then the 200-dma near 491 would likely be the next potential support level.

Oil Index chart, 120-minute

Zooming in a little closer on the oil index shows what a good short play setup looks like (or a signal to cover longs). This view shows the steep up-channel on the daily chart. The steeper uptrend line from the August low was broken towards the end of August. That was a heads up that things could be getting weaker. When price then went up and tested the uptrend line and pulled back, that was a sell signal. The first one was on Sept 26th but price then rallied to a new high so you would have been stopped out. Then the test on Sept 29th with a pullback on the 30th was your next signal. From there it was all down hill. This is the kind of signal you want to take every time and keep your stop tight until it works. It's a highly reliable sell signal (and just the opposite for a buy signal).

Transportation Index chart, TRAN, Daily

Watch this index carefully because I think it will tell us a lot about what the broader market is going to do. It's EW pattern is fairly clear at the moment and it's bearish, potentially very bearish. We could get a small bounce off the uptrend line, perhaps up to its 50-dma near 3689, but a break below the trend line, confirmed with a break below the September low of 3570 would likely be just the start of a swift decline. If the uptrend line holds, we could see a consolidation inside the current triangle pattern which could be considered bullish.

Before looking at the home builders, which have also seen some profit taking lately, it's not surprising to see that they're down. Mortgage rates are climbing and in fact have hit a six-month high. Average 30-year fixed mortgages are just shy of 6%. While that still sounds extraordinarily low, it is nevertheless climbing and it makes it difficult for new, less well-healed, buyers in the door. The market has gotten the message that the Fed is targeting the housing bubble and it's making them nervous about how high mortgage rates will head.

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

Another index, another kiss goodbye. Technically this index actually trades pretty nicely. It follows trend lines, moving averages and Fibs. The current decline looks like it's in the early stages of a much deeper correction on the way. But watch its current down-channel for clues--watch for support at the bottom of it and resistance at the top. Sometimes it's as simple as that.

U.S. Dollar chart, Daily

Even the dollar is into the broken trend line kissing. After breaking its uptrend line back in August, it has tried twice to get back above it and twice it's been slapped away. The dollar may have more pullback in its immediate future, especially when you look at stochastics and MACD but watch the 50-dma for support and if that fails then the new uptrend line that's now down near $87. I believe the dollar has much higher to go (upper $90's) before we see another long term leg down.

Gold chart, August contract, Daily

Gold remains bullish but should consolidate for a little while to work off its daily overbought indicators. After that we should see a press higher that takes it up near $500. After that it gets a little trickier figuring out where the metal is headed. It could set up another consolidation before heading higher still or it could set up a much deeper pullback. But we can worry about that more when the time arrives. For now I would expect a consolidation here to stay above $460 and would look to buy a pullback to that level.

Tomorrow's economic reports include the following:

Sector action today showed mostly red which is no surprise. The green sectors were led by the airlines which were up 4.4% today (this one seems to flip between the bottom and top of the pile week to week). This index is up near 17% since the September 22nd low and is primarily attributed to the drop in oil prices. Following the airlines today, in the green, was the gold and silver index, Transports (also helped by a drop in oil price) and a couple of banking indexes. Leaders to the downside today were the energy sectors, the biotechs, the SOX and other tech sectors, and the cyclicals and utilities.

After the market closed, Accenture (ACN 25.14 +0.30) reported a Q4 profit of $0.38 per share, versus $0.30 a year ago, on revenue of $4.31B versus analysts' expectations for $0.36 per share on $3.85B. Shares spiked up to 26.02 in after-hour trading.

Tomorrow's job report could influence the start of trading. Estimates are all over the map from as little as 25K to as many as 350K jobs lost. The market is expecting -150K. The technical picture at the close leaves us guessing about tomorrow's initial move. The question is whether or not that short-covering rally will continue tomorrow or whether the selling will kick back in. The indexes rallied back up to the downtrend lines from Tuesday so we're left wondering if the short term downtrend lines will break or the longer term uptrend lines will break. The answer to that question should set the tone for tomorrow's trading. And the economic numbers tomorrow morning could determine which one it will be. This week, being the start of the 4th quarter, has set the quarter off on the wrong foot. Week-to-date, and Q4-to-date, the DOW, S&P and Nasdaq have respectively lost 2.7%, 3.1%, and 3.2%. We have our line in the sand and it's the uptrend line from 2004 or 200-dma, depending on which index we're looking at. As long as we stay above those lines you might want to try dipping your toe in on the long side but be very careful. This market is very vulnerable right now. Any drop below the major support that we're at, which sticks for 3 days, says we have a major down leg in front of us. Look for shorting opportunities as that could be the much more profitable team to join. As always, I'll continue to give updates on Monitor to help fine tune some entries (and exits). Good luck and be careful--we're entering some emotional and volatile days ahead.

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