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Market Wrap

Productivity Prods Bulls

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It was an exciting, high-volume session for equity traders, treated first to a gap up open, a break to new multimonth highs, and an afternoon correction. The Nasdaq led the charge to the upside, and while breadth was positive for both exchanges throughout the session, the Nasdaq was stronger than the NYSE throughout.

At 8:30AM, the Labor Department reported a huge upside surprise in Q3 Preliminary Productivity, which came in at 4.1%, 1.5% higher than the 2.6% annual rate that analysts were anticipating. Q2's 1.8% number was revised up to 2.1%. Unit labor costs declined 0.5%, well below the 2% increase analyst were expecting. The news was seen as bullish across the board, as the decrease in unit labor costs was expected to keep a lid on inflationary pressures. Of course, that analysis focuses on "demand-pull" inflation by consumers while ignoring "cost-push" inflation caused by higher prices, but in the premarket as equities and bonds surged, all was coming up roses.

Also reported at 8:30 was the Labor Department's weekly initial claims, which declined by 8000 applications to 323,000, the lowest post-Katrina level. Expectations were for 329,000 new claims. Continuing jobless claims fell by 44,000 to 2.82 million, while the 4-week moving average of initial claims dropped 17,000 to 350,500.

On that 8:30 news, equities blew past yesterday's highs and surged into the opening bell. Bonds had initially rallied, and then pulled back to their pre-data levels ahead of the equity open.

The indices held firm and advanced to new highs after the open, edging back above their opening gaps. At 10AM, Chairman Greenspan's testimony to Congress was released, along with ISM Services and Factory Orders. Greenspan's prepared testimony emphasized that US economic fundamentals remain solid, but that budget deficit spending could cause "serious disruptions." The hurricanes were a drag on productivity and employment, but the rebuilding effort is expected to boost GDP. He said that the inflation outlook remains uncertain. While globalism has helped keep a lid on US inflationary pressures, Greenspan stated that that force won't persist forever as positive growth abroad reduces the effect of the deflation we are currently importing from those countries.

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Holding to a theme he has repeated many times, Greenspan said, "So long as health-care costs continue to grow faster than the economy as a whole, as seems likely, federal spending on health and retirement programs would rise at a rate that risks placing the budget on an unsustainable trajectory. Specifically, large deficits will result in rising interest rates and an ever-growing ratio of debt service to GDP. Unless the situation is reversed, at some point these budget trends will cause serious economic disruptions.

We owe it to those who will retire over the next couple of decades to promise only what the government can deliver. The present policy path makes current promises, at least in real terms, highly conjectural. If fewer resources will be available per retiree than promised under current law, those in their later working years need sufficient time to adjust their work and retirement decisions."

The text of Greenspan's prepared testimony was released along with Factory Orders and the ISM. The Commerce Department reported a 1.7% decline in Factory Orders in September, with a 7.8% decline in orders for capital goods. Computer and transportation orders declined 3.9% and 5.5%. The headline number missed expectations for a .6% decrease.

The Institute for Supply Management's ISM Index rose to 60% from 53.3% in September, showing an acceleration in US services activity. New Orders rose while price paid declined from 81.4% to 78%. Analysts were looking for a 56.9% increase in the headline number.

The indices initially pulled back at 10AM in a dip that last half an hour, following which they surged to new highs just past noon.

Daily Dow Chart

It was a session that struck fear into the hearts of bears. The gap up open stuck, and the rises weren't panicky or uncertain, just a solid advance with minimal pullbacks. It was all the more bullish for the highs it broke and resistance it violated. Looking at the daily chart of the Dow, that upper doji shadow to 10561 took hours to reverse- the mid afternoon, there was a clean break above declining resistance as well as a break back above the broken support line off the June lows.

Today's print did not reverse sufficiently to close red, and so the daily doji was not a true gravestone doji reversal. Although the volume was high, it also lacked the "feel" of a doji reversal day- as a friend mentioned years ago, a doji is best seen and heard live at the exchange, as the crowd lurches from one stance to another. Think of the scene in Trading Places when Valentine and Winthorpe reversed course with their OJ futures and the crowd went wild. That didn't occur today. It was a slow roll off the highs, picking up speed later but never erupting into a selling panic and bouncing back into the close.

For the day, the Dow gained 49.86, closing at 10522.59. The opening low was 10470.49, and the bounce in the last half hour kicked off from 10490. Those levels are first support, below which is the broken descending trendline at 10450. Resistance is at the session high, 10561.

Daily S&P 500 Chart

The SPX added 5.18 to close at 1219.94, its 1214.76 low printed at the open and the final half-hour's bounce from 1216 support. The upside break from bearish expanding wedge resistance ran into trouble at 1225, 78.6% off the April low, but the pullback held above the broken rising wedge trendline. To complicate the picture further, the 1225 level is just below the old broken rising trendline off the April low. With the daily cycle indicators nearing oversold territory, the October rally is running out of racetrack. However, until it reverses, confirmed with a break back below 1208 support, the bulls will continue to get the benefit of the doubt in that timeframe.

Daily Nasdaq Chart

The Nasdaq printed a doji star after tagging a high at 2169.98, right at old confluence at 2170-75. The steep upper wedge resistance line was never broken, and while the price action was more bullish than that of its peers, the unfilled gap looms below. The daily cycle upphase has reached overbought territory, and with the daily print completely above 20-day Bollinger resistance at 2150, bulls will want to keep their stops snugged up. For the day, the Nasdaq gained 15.91 to close at 2160.22.

Daily TNX Chart

There were no treasury auctions today, but the recent treasury announcements have shown an increase in the pace of bond issuances / borrowing, and project further increases in the months ahead. Today, the Treasury announced that it will raise $4.974 billion in new cash via an auction of $36 billion in 13- and 26-week bills at next week's auction. These new sales would normally represent a drain on liquidity available to the market, and with the Fed saying that it will seek not to monetize treasury issuances, my expectation would have been for the liquidity picture and bearish for bonds and stocks. The Fed's 25 bp rate hike on Tuesday fits that view as well- except for the fact that stocks have been rallying strongly on this supposedly dwindling liquidity picture.

The Fed's open market desk gave its dealers a $2 billion gift today via its open market desk, refunding $10.5 billion in maturing repos with $12.5 billion in new repos, $7 billion of which in a 14-day repo and the remainder via overnight money. Despite the net add for the day, ten year notes finished their cash session at the lows, with ten year note yields going out +3.4 bps at 4.644%, just off their session highs. On the daily chart, the advance above 4.6% set a new high for the upside trending move and marked the first test of 4.65% resistance.


Daily Chart of Crude oil

Crude oil traded within its descending channel off the September high, well below its Katrina highs. It closed +2.025 or 3.39% at 61.775, gunning its way to a high of 61.85 in the final minutes of the session. Production continues to come back online, and gasoline prices are back to levels that no longer provoke dinnertime conversation. The Fed, in Tuesday's rate decision, repeated its mantra of inflation being well-contained, and those of us whose spending is not limited to "core" items continued to sigh with relief at the pullback in energy prices, still at multiyear highs.

On the daily chart, today's move exceeded the past 3 days' highs, resulting in a bullish kiss for the 10-day stochastic. Trendline resistance is at 62,above which 64 is confluence resistance. A break of yesterday's low would target the bottom of the channel at 57.

The Fed's position, reiterated today by Chairman Greenspan, is that the economy is strong, inflation is uncertain but so-far contained, and rates can continue to rise slowly and predictably to remove the stimulus that's been in place in recent years. Bulls see this as a confirmation of strength in the economy, while bears may see it as a defensive move to defend the dollar against a dangerous rally in "non-core" and eventually core assets. A quick look at the price of natural gas since 2002 shows that while "core" inflation may be "contained," this essential asset on which so many rely for heat and electrical power generation has risen 4-fold in as many years.

Weekly chart of Natural gas

Dollars spent on natural gas (as well as gasoline, oil and other commodities) are not available to be spent on other items, and so the threat to the economy from the energy rally is real. There was a ticker headline today quoting Greenspan as saying that this winter's high energy prices would "surprise" consumers. The Fed's rate increases are arguably beginning to take a bite out of this impressive rally, and so far, those hikes have been benign as regards the equity markets. However, as Linda noted yesterday, mortgage activity dropped year-on-year in the latest Mortgage Bankers Association figures, and the outcome of the current rate-hike cycle has yet to be written. Given that home equity extraction has been one of the vehicles buoying consumer spending in recent years, a continuation of this slowing trend and its deleterious impact on housing prices cannot help but be felt in the broader economy.

WMT announced a 4.3% increase in same-store sales, with total sales rising 10.5% from October 2004 to $23.26 billion. Costco (COST) reported a 12% rise in net sales for the month, and US comparable sales +10%. COST attributed part of the rise to "gasoline price inflation," and said that comparable sales would have risen 8% net of gasoline. Sharper Image (SHRP) reported an 18% drop in same-store sales from October 2004. Jewelry retailer Finlay (FNLY) reported a 1.3% rise in same store sales from this month last year. While one month and 4 retailers does not a trend make, we see consumers shifting their focus away from discretionary luxury items toward essentials.

On the bright side, Standard & Poors reported that the S&P500's operating earnings rose 12.3% during Q3 2005 from the year-ago quarter. Marketwatch reported that prior to the hurricanes, a 17% gain had been expected. Notwithstanding that slowdown, S&P expects double-digit gains for Q4 as well as for Q1 2006.

In other news, the European Central Bank left its overnight rate unchanged at 2%, unchanged since June 2003. ECB President Jean-Claude Trichet reiterated that while he retains a "strong" vigilant stance against inflation, he sees little to suggest inflation pressures in Europe.

The US entered a zero-tariff agreement with the Eurpoean Union, Japan, Korea and Taiwan, on multichip integrated circuits. Marketwatch reported that US-headquartered companies account for more than half of all production of these semiconductors, a $4 billion+ market in 2004. The US will remove its 2.6% duty, Korea its 8% duty and the EU its 4% duty.

In corporate news, the market moved this morning as Merck (MRK) received a favorable verdict holding it not liable on all counts in its 2nd Vioxx-related product liability trial. Among other things, MRK was found not guilty of consumer fraud. A spokesman for Merck reported that MRK faces "about 6,400" liability suits arising from the Vioxx affair, and has already been help liable in a $253 million judgment in favor of the widow of a Vioxx user. Merck spiked as high as 30.90, but the quote feeds failed with some reporting trades as high as 35. The stock settled to close +3.77% at 29.48 for the day.

MBNA (KRB)'s shareholders voted to approve KRB's acquisition by Bank of America (BAC) today, in a $36 billion deal that awaits regulatory approval. If cleared, the transaction would be expected to close in January. KRB closed -.31% at 25.70, while BAC lost .16% to close at 44.01.

After the bells, UTStarcom reported a loss of $3.40 per share or $402.7 million, down from a net profit of 4 cents or $4.9 million in the year ago quarter, blowing out estimates for a 70 cent loss. UTSI gained a cent afterhours to 5.42 after losing 3 cents during the regular session.

CSC also reported, with earnings down to 53 cents or $99.5 million from 56 cents in the year-ago quarter, but with an 18 cent charge for a written-down contract with Nortel Networks. CSC closed -4.89% at 53.50.

Tomorrow brings the October employment report, with Nonfarm Payrolls, the Unemployment Rate, Hourly Earnings and Average Workweek, scheduled for 8:30AM. With the indices up against resistance in the latter stage of their daily cycle upphases, there's the potential for surprises in both directions. An upside surge would need to be watched for a reversal, as the terminal phases of daily cycles are often explosive before reversing. While disbelief in the sustainability of the rally is high, traders can cut through the fog by basing themselves on the previous day's range. Above today's low, the daily uptrend is intact, while below it, we evaluate the move for a possible reversal. We'll be following the action tick by tick in the Market Monitor and Futures Monitor. See you there!
 

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