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Market Wrap

More Profit Taking, Getting Ready for Santa

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The market continued to give up some of its recent gains. Since peaking around Thanksgiving, the DOW has given up 200 points from its high near 10960 which is more in percentage terms than the other indices. So far the pullback looks like a correction to the rally and it appears we're due one more push higher before thinking about a longer term top. This fits with the expectation of a Santa Claus rally into the end of December, maybe even into the beginning of January. It's possible we'll see a bounce tomorrow and another drop lower before the rally sets up but there are some indications that we could be getting close (if not already there) to a bottom for this pullback.

It was a pretty quiet day with only one economic report on jobless claims and company news was also relatively quiet. New jobless claims for unemployment benefits rose 6K to 327K, the highest since the week ended Nov. 19, which was unexpected. The consensus forecast was for a drop of 2K to 318K. The 4-week average of initial claims fell 250 to 322,500. Continuing claims fell 137K to 2.60M, the lowest level since the week ended Sept. 3. The four-week moving average of continuing claims fell 46,750 to 2.73 million, the lowest since Sept. 24.

While the jobless data was benign, one of the concerns is the number of layoff announcements, up 22% in November to 99.279 (as reported yesterday by Challenger). And it looks like Ford (rumors only at this point) will join GM in a large number of layoffs as they close several of their plants around the country. So far in 2005, corporations have announced 964,232 job cuts, up 3.6% from the year-to-date total a year ago with more than 10% of those cuts coming out of the automotive sector. Considering the number of businesses feeding the automotives, this will have a negative trickle down effect. It sure smells like an economic slowdown coming.

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TrimTabs reported that stock funds took in $4.82B in the past week, with $1.96B going into U.S. funds and $2.86B going into foreign-focused funds. Interestingly, people seem to be upping their risk tolerance. Carl Wittnebert, director of fund-flow research at TrimTabs said, "Risk tolerance may be slowly rising...over one-third of this week's domestic inflow went into aggressive growth [funds]." I say this is interesting because it's classic. We all see the signs of complacency in the market, be it a low VIX, large number of bullish vs. bearish advisors, low cash accounts, etc., and this is at a time when we see evidence of topping in the market (at least I think there's evidence of topping).

It's classic that we'll pull the last of the bulls into the market, especially into the riskier aggressive growth funds, just as we're topping. Year 2000 playing out all over again. I can understand people forgetting the lessons learned in 1929--that had been 71 years prior to 2000 and there probably weren't too many traders in 2000 that had experienced the 1929 crash. But it's only been 5 years since the 2000 crash and here we are again with the same signs of a top and the same exuberance for risk. Simply amazing.

Onto the charts to see where all this leaves us.

DOW chart, Daily

The DOW chart looks bearish, no two ways about it. Its pullback from the November high is more significant than the other indices so it's difficult to judge the larger market on this index. Also, the internal pattern of the rally from the October low does not look complete but instead looks like it needs one more push higher to call it complete. This fits with what Jim talked about on Tuesday about a typical pullback into mid-December followed by an end of month Santa Claus rally (that often times extends into the 1st or 2nd week of January). The way I'm interpreting the rally pattern, this is the way I see it setting up. I think we're close to making a bottom in the current pullback, maybe one more up and down sequence to a minor new low, although it's possible to call today's low as the bottom. We'll see how the market reacts to INTC's report tomorrow.

SPX chart, Daily

SPX looks more bullish in its pullback because it looks more like consolidation near the highs. Like the DOW it might pull back a little further but we should be close to getting the next leg up. I see 1280-1300 as the upside target.

Nasdaq chart, Daily

The COMP also looks bullish here in that it's consolidating on top of it broken trend line across the highs since January 2004. It did tag its first upside target of 2277 so I'm alert to the possibility that that's all there is. But any push higher will have me watching for the higher target of 2306.

SOX index, Weekly chart

Keeping with the weekly chart from last week, the top of the bear flag acted as resistance and the SOX pulled back. Watch for support at its broken downtrend line near 476 since this could still bounce back up for another test of the top of its flag.

Before looking at some more charts, I wanted to continue my discussion about pension plans and their potential ramifications on our system. A couple of weeks ago I had discussed the pension plan problem (actually I've discussed it several times about the sorry state of affairs we're in). I've been hearing more mainstream media picking up on the topic and last night I heard Brian Williams report on NBC News that many companies are now considering just dropping their pension plans. That would certainly be one way to fix their underfunded plans! Companies have already gotten Congress to back off on its demand for companies to present a plan to make their plans whole. I guess that was to give them more time to just close them down. A lot of people will face retirement with very small, if any, 401(k) plans and pension plans that are going to simply vanish, whether or not they go bankrupt first.

I hear all the arguments about why we (companies) can't afford pension plans. Jim Cramer was explaining how we can't remain competitive against foreign companies who don't have the burden of pension plans. But he forgot to mention one silly little difference--those companies that he was referring to are in countries with socialized medicine and generous government payments, supported by high personal tax rates. To simply cut people off from their expected retirement benefits will have huge negative ramifications.

I'm not sure how it will all play out but it won't be positive. Even with most companies who currently have pension plans planning on keeping their plans, few are properly planning on the correct amount of funding. After a strong bull market in the 1990's fund managers became more and more risk averse and were happy with rates of returns matching major indices. That's because what they were trading were baskets of stocks representing the indices vs. picking and choosing stocks (that became too risky). The well paid entrepreneurial stock pickers were slowly replaced with accountants and other "professional" money managers who wanted to reduce the risks taken by the individual fund managers. By the way, this frustrated to no end these fund managers who left in droves to start up their own hedge funds. Hence the explosive growth in hedge funds.

By allocating capital to index funds, money gets wasted. That's because everyone gets a piece of the pie according to their size/weighting, not by their individual performance. This creates waste as money is not invested wisely and the waste over time reduces the rate of return on that money. In reality this is a more socialistic than capitalistic approach to investment. We thought the Soviet Union had it all wrong and yet we're following their example. So these index funds have been declining in performance, and will likely continue to see declining performance. And pension funds, run by "professional" money managers, will continue to see declining rates of return on their portfolios.

That sets up a future rate of return that will be sub-par at best. But pension funds have been overly optimistic about their expectations for good returns. Even on an historical basis, considering the current high P/E ratios, they should be looking for rates of returns of about 2% over the next several years (on a balanced stock/bond portfolio). If we enter another phase of the bear market, as I think we will, they'll be lucky to avoid a blood bath. But even a 2% rate is far lower than many pension managers who are using 6-8% returns. So not only are they not contributing enough to catch up on their underfunded plans, they will continue to underfund themselves with an expectation for higher returns than they're likely to get.

The bottom line is that we should expect to hear about many more companies who are forced to dump their plans rather than belly up to the bar and pay into the fund what is needed to meet their obligations. And if they pay into it to catch up, they'll kill their stock prices because of the higher than expected costs (lower earnings and Wall Street will have a hissy fit). It's just not a pretty picture ahead and yet so few are talking about it. It's the elephant in the living rooms and no one wants to recognize it for what it is. It's the sign of another bear market coming and unfortunately a lot of retirees, present and future, are going to feel a double whammy from another swoon in the stock market. Don't let yourselves or family members get caught in this trap. And speaking of money, let's see what the banks are up to.

BKX banking index, Daily chart

After a sharp rally from the October low, the banks have started a sharp reversal but it's been volatile. It looks like this one has room to run to the downside. But if the broader market is to rally, as I think it will, it will be interesting to see if the banks can also manage a new high. If not, it will be very telling about where we are in the rally leg (intermarket divergence will be bearish).

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

I've drawn in a new potential downtrend line and parallel but I'm not sure yet if the high for the bounce is in. I think it is but if you're short any home builders, watch the current downtrend line. I like the fact that we got very close to two equal legs up in its bounce, while achieving a 50% retracement of its drop, it has created overlap in its bounce which has left it as a corrective 3-wave bounce, it was not able to hold its 200-dma and is now struggling at its 50-dma. I say struggling because the daily chart is still pointing down. I continue to like the homeys from the short side.

Oil chart, December contract, Daily

Oil finally broke its downtrend--it broke above it, came down for a retest and now is bouncing again. This means the leg down from it August high is complete and we're now into the corrective phase. I say corrective because the move down was an impulsive 5-wave decline. That says to expect some kind of correction to the decline but then look for another leg down. I think we'll see this rally leg maybe make up to the 38% retracement at $61.71, pull back maybe to the downtrend line again and then rally back up to another new high for the move, maybe up to a 50% retracement. That's all speculation at the moment but it's the kind of pattern that would work. Once all that is done (into January/February) I'll be looking for a setup for a big leg down in oil. If this pans out in this way it will be telling us an economic slowdown is for real and there will be a significant decline in demand for oil.

U.S. natural-gas stocks fell by 59 bcf for the week ended Dec. 2. IFR Markets predicted a fall between 60 bcf and 70 bcf. Total stocks are down 58 bcf from the year-ago level but up 205 bcf from the 5-year average. Consumers, and businesses, are going to have a rude awakening when they get their heating bill. It's one thing to hear it on the news but it's quite another to open up your bill. Congressmen will be getting calls, we'll have more witch hunts about the obscene prices being charged, Congress will puff up their indignant chests and look all holy and the high bills will still need to be paid. Today NG rallied over 9% closing at $14.98 (January), the highest for a front-month contract. In today's later session it has tacked on another 3.4% and is trading up around $15.50. Just in time for the cold weather. High heating bills may put a damper on peoples' desire to spend a lot on Christmas presents so watch the retail index for signs of weakness ahead.

Oil Index chart, Daily

The oil index has an interesting pattern and my current interpretation of it is that it's consolidating in an ascending triangle before proceeding in its next leg down. Many interpret these patterns as bullish but that's only when they're located within a rally leg. This could go a touch higher but watch for a break of the uptrend line for a shorting signal.

Transportation Index chart, TRAN, Weekly

My last comment here was watch for a pullback below the broken top trend line as that would be a sell signal. We got the sell signal this week. Again, if the broader market rallies I would expect the Trannies too as well so I'm a little reluctant to trust this sell signal yet. But if it doesn't rally with the broader market, look out below.

When the Trannies went ballistic from the October low there was a lot of head scratching going on. With higher oil prices (even coming down some, it was still high) and businesses not appearing to be shipping that much more than usual, it was hard to figure out why everyone was so excited by the Transports. As it turns out it may have been a little manipulation going on. Say it isn't so. How can that happen? There were a couple of laggards in the index, namely Northwest Airlines and Delta Airlines so these 2 of the 20 stocks were booted. Even though the weighting of these two stocks had been lowered to 0.65% and 0.53%, respectively, and therefore had minimal impact on the average, that wasn't the point. Those in charge needed to goose the average and it may have been an effort to incite broader market buying based on the Dow Theory.

They added small-cap Overseas Shipholding Group (OSG) and mid-cap JetBlue Airways (JBLU). Normal practice is to choose companies with a large market capital base but in an attempt to juice their average by over-rating the newbies they gave OSG a 5.5% weighting and JBLU a 2.1% rating (so an even higher rating to the small cap). These two companies have a combined market cap of $4.1B. Compare this to the other companies composing the average which individually have market caps 20 times the market cap of the two companies combined! I'm not sure what the total effect of this change was since neither JBLU nor OSG have had a stellar quarter as compared to overall average but it's disturbing to see shenanigans like this. Where's the integrity in the people controlling these averages? Following this example we'll probably soon see GM bounced off the DOW and they'll bring in a micro-cap and give it a 30x weighting. And I wonder sometimes why it's so difficult to figure out what the averages are doing and why there seems to be such a difference sometimes between them. Ah, the games people play. Anything to keep the illusion of a bull market going so as not to let the sheep know anything is changing.

U.S. Dollar chart, Daily

No change to the dollar picture--it continues to consolidate above support and I expect to see it proceed higher.

Gold chart, August contract, Daily

Wow, any questions?. Why didn't we all buy gold at the beginning of November? I'd be a seller right here, or at least be taking some profits. Here are the headlines that will suck in the remaining bulls, afraid they've missed the boat:

NEW YORK (MarketWatch) -- Gold futures climbed to their highest level since 1981 on Thursday and chalked up a sixth straight day of gains, propelled by strong physical demand for the metal and inflation worry. Gold for February delivery added $4.90 to $522.70 an ounce, after earlier peaking at $523.90, its highest level since April 1981. Silver added 11.30 cents to $8.99 an ounce, platinum rose $8.80 to $1,007.10 an ounce and palladium gained $6.20 to $288.15. Copper futures finished down 15 cent at $2.03 a pound.

I guess copper just isn't shiny enough. Gold is so ripe for a fast drop it's not funny. Don't be caught up in this.

Results of today's economic reports and tomorrow's reports include the following:

After the close INTC gave a little mid-course guidance and lowerered the top end of their sales forecast. What they really did was tighten the range, raising the low end and dropping the high end. What everyone heard of course is that they dropped the high end. Their price dropped on the news. They forecast sales between $10.4B and $10.6B, as compared to the previous range of $10.2B to $10.8B. That keeps the median at the same $10.5B against analysts' expectations for $10.6B. INTC maintained its gross margin of 63% of sales.

Sector action was mixed today. Leaders to the upside were the oil service and then other energy related sectors, gold and silver, healthcare, and utilities. At the bottom of the list was the SOX and other technology sectors, the Trannies and airlines. The breadth indicators show relatively even performance between sellers and buyers with a tilt towards the seller. But new 52-week highs outweighed new lows 299 to 140. These higher new highs vs. new lows has been apparent during the current pullback and tells me there's accumulation going on while the major indices pull back, which could be funds' preparation for Santa Clause.

For short term traders, we could be nearing the end of the pullback, if not now then by early next week. I would be careful about being short the market. Look for opportunities to test the long side since I believe we'll see a rally into the end of December. But don't get glued to your long positions either. Bulls are in danger now of getting caught. Any rally to a new high will get me salivating for a longer term short position. It's too early but I'm making my list and checking it twice. There may be a great after Christmas sale and I want to be ready.

As for tomorrow, it could be a little tricky figuring out how the market will react to INTC's news. See you on the Monitor where we'll call it as we see it.
 

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