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Santa Are You There? Hello!? Anybody?

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Jim Brown has been knocked out of commission by a nasty bug so I (Keene Little) will be filling in tonight.

Santa's hiding in the corner not sure whether or not he should come out. He's heard about all the crazy shoppers stomping all over each other to get what they want. So Santa is sitting in the corner deciding whether to bless all the good little boys and girls. In the meantime, sellers have been dominating the markets this week, withdrawing money to buy gifts. The question now is whether or not Santa will come back to repay them. My short answer to that question is yes, Santa will arrive.

Other than the DOW giving up yesterday's relative gains, the market simply marked time today and finished slightly down but basically flat. Stocks fell for the fourth straight day, giving us the longest losing streak since October. The DOW was hurt today by GM's drubbing (more on that later). The market looks it had a small consolidation today which could lead to another stab lower before we should be set up for a rally into the end of the month. This is by no means a given. In fact with so many expecting a Santa Claus rally, one could argue from a contrarian standpoint that it's not going to happen. We may have seen everyone already buying in (which gave us a strong November) and now there's no one else to help lift the market. But price looks like it's been consolidating near the highs for the past few weeks and this leads me to believe we'll see another rally leg, and it looks like it could start as early as tomorrow or Thursday depending on how quickly we finish the current pullback.

The day started out quietly, and even the overnight futures were relatively quiet, having slowly risen from the previous close but there was nothing very exciting. It suggested a quiet day ahead and that's in fact what we got. It was just a doji kind of day.

PPI data was released at 8:30 and was deemed encouraging. November PPI was down -0.7% while core PPI (which excludes food and energy costs) was up 0.1%. The drop in PPI was the largest monthly decline since April 2003. Economists were expecting the PPI to fall -0.3% and the core rate to rise 0.2%. Over the past year, the PPI has risen 4.4% and the core rate is up 1.7%. A review of crude goods showed prices fell -1.2% in November but were still up 21% year-over-year. Intermediate goods prices decreased -1.2%, but were up 8.4% over the past 12 months. The numbers were Fed friendly in that they showed inflation is under control. They'll be watching the impact of oil prices over time to be sure it doesn't filter through and raise the core rate.

November housing numbers were also released at 8:30 and housing starts were up 5.3%, at a seasonally adjusted annual rate of 2.123M units, which was above expectations of staying flat at 2.02M. Building permits, which show what the immediate future might look like, increased 2.5% to 2.155M annual units, also above expectations of 2.092M. "Housing once again shows its strength -- the zombie market that just won't die," said Robert Brusca, chief economist at FAO Economics. Umm, the housing stocks might argue differently since they peaked about 5 months ago and aren't looking particularly strong at the moment. I think that might be a better predictor of what's coming vs. what they're doing now. In fact that's one of the problems with economists (and I'm generalizing)--they predict the future based on current and rearview mirror analysis. The stock market does a better job at predicting what's coming down the pike.

One of the reasons discussed early in the day for the selling we've seen this week is because of the tax loss selling. When funds have losers on the books they like to trim those stocks from their portfolios before the end of the year so that they can take the losses against their gains thereby reducing their taxable gains for the year. See the end of this report for a quote from Don Worden on this tax loss selling--he's got some good insight. Some of the year's biggest losers for the year have been the autos, IT consulting services, photo products and auto equipment. And when you think of the big loser in autos, who comes to mind? Yep, General Motors (GM 19.86 -1.20, -5.7%), a new 18-year low today--down to a low of $19.63 this morning before getting a minor bounce. That level hasn't been since 1987. That's further back than my QCharts data will show me but I'm wondering if that was the 1987 market crash level.


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GM's recall of 426,000 vans did not help the company nor did the report that GM may lose its No. 1 position (by total volume) to Toyota in 2006. The continued threat of a strike at Delphi, its main supplier, is also making investors nervous. Do you think GM might have trouble continuing funding its pension and health care plans? I just feel sorry for the employees, retirees and other stock holders of this company. As if today's selling in GM wasn't bad enough, Kirk Kerkorian announced after the close that his Tracinda Corp had decided to throw in the towel and disclosed in an SEC filing that it sold 12 million GM shares over the past few sessions. Me thinks his purchase of GM, around $30 I believe, did not pan out well for him. His stake in the company is still a healthy 7.8% from his previous 9.9%. The announcement knocked another -2.8% off the stock price, driving it as low as $19.06 and closing after hours at $19.34.

The DOW might see an early hit tomorrow morning from GM although the DOW futures didn't drop on the news so it may already be priced in.

DOW chart, Daily

The DOW has been cycling around the downtrend line from 2000 and the level at which the DOW started the year--10,783. There's a downside Fib projection for the current move down at 10,782, magically close to that 10,783 level. Whether it stops there is hard to tell but watch it just in case. The SPX suggests it will likely move a little lower than that.

SPX chart, Daily

SPX currently has a little cleaner pattern for EW analysis. Its daily chart shows resistance just above near a Fib target of 1285 and potential support by the downtrend line from 2000, as well as the major Fib retracement level of 1253 (50% retracement of the 2000-2002 decline). As shown in the next chart below, there's also potential support by a parallel channel at 1254.

SPX chart, 120-min

A little closer view of the consolidation since the November 23rd high shows a parallel channel, the bottom of which is near 1254. The internal pattern of the decline from the December 16th high suggests only one more new low is needed to finish it. That new low should also finish the final leg of the consolidation pattern (a 5-wave move counted as a-b-c-d-e). This should then set us up for a rally to new annual highs, possibly achieving it by the end of the month. There is an important Fib turn date on December 27th, /- a few days so a market high on or around that date could prove to be an extremely important high (as in THE high).

Nasdaq chart, Daily

The COMP gives the most bearish feeling of the different indices. It has broken back below the upper trend line that has acted as resistance and recently broken. Breaking back below it is not bullish. I'll be watching this one carefully since it might give us a heads up that something more serious to the downside is starting. But the move down could be a head fake. Today left a doji candlestick, normally a mark of hesitation. But if tomorrow's candlestick is green, it could be the sign of a reversal pattern.

SOX index, Daily chart

The SOX is also more bearish than I'd like to see when I'm thinking long the market soon. I was hoping for a smaller pullback at its resistance marked by the top of its parallel up-channel (which looks like a bear flag on the weekly chart, shown in last Thursday's Wrap). Between gap closure at 481.49 and a downside Fib target of 480.26, I am hoping we'll see support in that area to get long for a rally to a minor new high for the index, probably something shy of 520.

BKX banking index, Weekly chart

The weekly chart of the banks shows weekly stochastics flattening in overbought, a sign of trending. The daily stochastics has tipped back over but I've noticed the past month that stochastics has been unreliable. This is to be expected during topping and bottoming and I believe we're in a topping formation. I have an upside Fib projection for the leg up from the October low at 106.50 so a minor new high could give us that. As indicated on the chart, I also have targets at 108 and just shy of 112 so we'll have to see how the rally progresses, assuming it will. The important thing to remember on this weekly chart is that sideways triangle pattern. It always predicts the last leg of the rally--that triangle is a 4th wave in the rally up from October 2002 and so the spike up out of it is the 5th wave. Once it's complete we will be due at least a very large pullback.

It was interesting to read today that the U.S. regulators, which includes the Fed, came out and warned banks to be careful about their lending practices, specifically as pertains to nontraditional mortgages. This is a bit like closing the barn door after the horses got out. Regulators urged banks and other mortgage lenders to exercise more caution when offering products such as interest-only lonas and payment-option adjustable rate mortgages (e.g., negative amortization loans). Many of these loans of course were made so that home buyers could afford the payments. The assumption has been that home prices will continue to rise so that even negative amortization loans will be covered by increases in equity. Dangerous assumption. While mid-priced homes (that would be $750,000 in CA) typically don't see the kind of correction high-end homes see, corrections in similar times in the past have seen 20-50% drop in value over 18 months. I think a few highly leveraged buyers might find that kind of haircut a difficult adjustment.

At any rate, the regulators have made a proposal that banks should assess borrowers' abilities to repay their loans before approving them. They're also suggesting banks should recognize that these loans warrant "strong risk management standards." Reading between the lines what they're saying is that they need to increase their reserve requirements for these loans in the event of higher than normal foreclosure rate. Greenspan has been hinting recently (as part of his CYA plan since he's the one that created the problem in the first place) that the GSE's (government sponsored entities, i.e., Fannie Mae and Freddie Mac), banks and other lending institutions need to prepare themselves for a possible increase in loan defaults and a higher foreclosure rate. He of course says all this in Greenspeak but the message is quite clear--he's been worried that the consumer is over-borrowed, in debt up to his eyeballs in riskier loans, and if the economy turns south and interest rates head higher (which he's trying to accomplish), the home owner could be in a world of hurt. And that of course would put the banking system in jeopardy.

Interest rates have leveled off somewhat since the rally from August to November followed by a small pullback. Interestingly, 10-year yield is only slightly higher, at 4.5%, than it was at the end of last year (4.3%). The 30-year yield is actually lower than a year ago, 4.7% now versus 4.9% last year. But that hasn't helped the housing industry maintain its glutinous pace that it saw the 1st half of this year. The daily chart shows the housing index is in danger of creating an ominous H&S pattern with the neckline at the October low.

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

After a relatively sharp drop from its July double-top high to the October low, the housing index has been climbing in an overlapping corrective bear flag pattern. This index could still rally a little higher, with 1000-1020 as potential targets but what this looks like is a right shoulder being built. It's too early to tell until at least the short term up-channel is broken to the downside followed by a break of the neckline at 800, but the downside objective would then become about 490, which is back to level found in mid-2003.

Oil chart, January contract, Daily

This is the last day for the January contract so be sure to switch to the February contract tomorrow. Oil got a bounce today and there was some speculation that the expiring January contract may have created some short covering. We switch over to the February contract tomorrow so we'll see if there's any follow through or if today's buying gets reversed. Oil does not look bullish to me. It only managed to retrace 38% of its drop and is now dropping back towards its previous low. Dropping back into its down-channel is not bullish. Note though that the top of the parallel channel when drawn on the February contract (CL06G) is where price has currently pulled back to. This makes the February contract look a little stronger than the January contract. But the daily stochastics makes it look like it has further to fall. If a further decline takes a few days, after a possible small bounce, it could make a double-bottom test at its uptrend line. If a double-bottom test is met with bullish divergences I'd be more comfortable going long. For now I'd be more comfortable shorting the bounces.

Oil Index chart, Daily

The oil index looks bearish to me. If it follows through to the downside it may be projecting that oil will follow. After briefly breaking above the ascending triangle I thought it was a small throw-over finishing the correction. I wanted to see proof of that with a drop below the uptrend line which it did yesterday. Today's rally took it back up to the broken uptrend line so now bears want to see a kiss goodbye here and a continuation lower. That would be an excellent shorting signal. The larger pattern of the decline suggests a downside target of 440.

Transportation Index chart, TRAN, Weekly

The weekly chart of the Trannies shows a similar pattern to what I showed for the banks--a 4th wave sideways triangle pattern followed by a spike out of it. This is the mark of an ending pattern to the upside so now it's a matter of identifying the top. This may have already peaked but the current pullback is looking corrective and suggests a high has not yet been seen. So I'm looking for another leg up and will watch the 4275 area for possible resistance.

There has been much speculation about the U.S. dollar, gold and oil, and other commodities. With the U.S. consumer doing what they do best--consuming--we have been literally feeding the world. Not by necessarily shipping them our grain, apples and other products, although we do a lot of that, but more by buying everyone else's products. Americans have had an insatiable appetite for the past many years, two decades really, and since we produce less of what we consume we've had to go to our global partners to buy it. Cars, appliances, toys, you name it, we've been buying more and more from our neighbors. This has created a distribution of wealth that many feel is a very good thing. We've been helping to lift the standards of poorer countries as we help them establish manufacturing bases and buy their products. Many will argue that we unfairly take advantage of poor countries and there are some valid arguments in that respect but that's an argument for a different time and place. Suffice to say, we've been freely spending our money throughout the world.

The 1997-1998 Asian banking crisis left a powerful fear in the minds of Asian leaders who vowed never to let it happen again (we'll see about that since Indonesia is in danger if we get another oil price spike since they subsidize oil for their citizens). The last crisis was a result of banks being caught in a credit squeeze and an inability to pay. These developing nations do not want to be put in a position of being held hostage to another country providing dollar-denominated credit. So they've embarked on the opposite path by providing credit TO other countries instead of being dependent on credit FROM other countries (through organizations like the IMF). These countries have been producing more than they consume and exporting the difference. These consuming countries, primarily the U.S., have been buying up the excess capacity of other countries thus enabling them to have a positive trade balance.

The extra money earned by these countries ends up in their banking system and the "excess" money is then invested. Much of that investment has made it into our system through the purchased of equities and treasuries. So far this has all been beneficial, a symbiotic relationship, and could continue for a quite a long time. The problem comes when something happens that tips this apple cart. And what will tip the apple cart? It will be Americans' inability to keep consuming. Let's face it, we've been buying things like drunken sailors given their year's pay all at once, in cash. We have a negative savings rate, we're borrowed ourselves to a level never before seen in history, including the binge that led to the 1929 crash, and we may be running out of steam. The housing market has been an unbelievable bank for many Americans. It's been like free money--take a bunch out and spend it and magically it reappears next year when the house appreciates another 20%. Take that out and do it again next year. Life is wonderful. We've outspent our income by more than 6%. The problem of course is that it's not free money--all that borrowed money will cost to repay it with interest, interest that's on the rise.

It may be time to pay the piper. Even if housing prices simply level off for many years to come (that would be the best scenario that follows a housing bubble), Americans will be left without increasing equity to continue to tap into. Horrors of all horrors, Americans might have to save for what they want. Shreek! The ignominy of it all. That would be a healthy change of habits but the problem is more global than that. If Americans stop spending, our foreign suppliers will suddenly have excess capacity, start laying off their workers, and will have to start internally funding their own projects. This will require the repatriation of some of their U.S. investments and that will likely have negative consequences for our markets. Longer term it should be a good global rebalancing and cleansing but short term could see some pain spread all around.

For now there's still a demand for U.S. dollar denominated assets and that has been strengthening the dollar. This should continue for another couple of months before the dollar tips back over.

U.S. Dollar chart, Daily

The U.S. dollar got a good bounce today (moving counter to gold today which hasn't been true lately). The bounce has taken it right back up to the level that has been acting as support/resistance, just under $91. If the dollar continues its pullback, I expect the uptrend line around $89 to act as support. If it gets back above $91 it may be starting its next leg higher.

Gold chart, August contract, Daily

This is what you call a bull trap. There were a lot of buyers of gold once it got above $500. Everyone on TV and other media outlets were pounding the table about how gold was headed to $1000. A lot of people popped their cookies all over the floor once gold started to sell off but you know there are a lot of people who were left holding the bag at higher levels. Any rallies will get sold into as people thank their lucky stars for a bounce to just get out. Gold should be close to some kind of support that will provide another "buyer's opportunity". It will suck in more gold longs but beware--it should lead to another leg down once it's finished bouncing. I'm expecting firmer support around $460-470 probably some time in January.

Results of today's economic reports and the rest of this week's reports include the following:

As you can see, tomorrow will be a quiet day as far as economic reports go. The market will need to find another reason to get out of its funk and get a rally started.

The day's internals showed mixed performance. The advancing versus declining issues and volume showed a modestly negative day. It showed a lack of conviction on both sides and the negative day was likely more a lack of buying than actual selling (except for poor GM). Sector action showed that the leaders to the upside were the energy indices, the healthcare index, and securities and brokers (thanks to a stronger than expected Q4 report from Morgan Stanley (MWD 57.71 1.04). The SOX, biotechs and retail held onto the green side of things. Leaders to the downside were the gold and silver index, telecoms (thanks to reports that ex-Qwest Communications (Q 5.65 -0.12) CEO Joseph Nacchio was indicted), disk drive index, airlines, computer hardware and pharmaceuticals.

The indictment of Qwest ex-CEO Joseph Nacchio follows a grand jury investigation into Nacchio's $50 million stock sales that he executed in the spring of 2001. Slowly the wheels of justice grind away...

Google (GOOG 429.56 5.14) was in the news this evening as it announced it is going to pay $1B for a 5% stake in Time Warner's (TWX 17.73 -0.21) AOL unit. TWX got a minor pop on the news after the bell. A few days ago we heard the Microsoft was no longer interested or in the running to buy into AOL. GOOG and TWX will be the only share holders of AOL and there will obviously be all kinds of joint activity between AOL and GOOG.

Jim wanted me to pass along a comment he read from Don Worden of Worden Brother's TC2000 service. "...I must warn that the last two weeks of the year are always impossible to analyze with any degree of confidence, because of the chaos of various year-end cross-currents. The second to the last week may be the worst, because that is the week the tax selling reaches its peak. Anyway, there is no way you can figure out what exactly is happening or who is causing it. But remember, tax selling is not rooted in bearish opinions. And when it lets up, the market may do something different than we expected, something it intended to do anyway and didn't want you to know. Remain humble, and you can't get hurt too badly. If you find that difficult, make sure you don't forget for a minute that the market is probably smarter than you and doesn't care a hoot about you."

Saner words have probably never been spoken, especially the last sentence. I think it was Bill Fleckenstein who said something like "I will often predict what the market will do and will do so with confidence. More often than not I will be wrong." Honesty in the market; gotta love it. It's also the best way to stay alive in the market. Always be looking for where you'll be wrong and be ready to stop yourself out or switch directions (if the reversal makes sense, otherwise flat is a good position).

In light of that, I too have no problem making predictions and will then constantly test it to see if I'm on track or need to change. I'm currently thinking the pullback this week is near an end, as in very close. I believe the DOW will find support above 10,750, possibly 10783 area which is where the DOW started the year. There are a lot of people who want to claim an up year for the DOW for 2005. SPX should find support above 1254, so perhaps another 5 points down. It may not get that low but that's where I see support. As Don Worden stated above, the selling this week is not necessarily because people are feeling bearish but in fact is simply tactical selling--getting rid of the losers. When that's done, we could see the Boyz take this higher.

The downside pattern supports this view as it suggests we should be looking for support to buy since the larger consolidation over the past few weeks strongly supports the idea that we should be close to finishing it and a rally to new market highs should be right around the corner. As I mentioned on the SPX chart above, a target of 1285, possibly as high as 1306, should be our target. The upside target for the DOW is just over 11K to as high as 11,200. If 11,200 were to be exceeded then there's a real good chance we'll see the DOW rally to new all-time highs above 11,800 next quarter, but I don't currently believe that will happen.

It's more difficult determining at what downside level I would turn more immediately bearish. A large pullback could be tolerated without violating the uptrend. For starters though I wouldn't want to see the DOW drop below 10,250 but that's a long ways down from here. I would say test the long side with a new low tomorrow or the next day, but don't hang onto it if it goes against you. Test the lows a couple of times if the buy signals are there. Otherwise wait for a bottom to be put in and then buy a pullback. For those of you who follow us on the Monitor, that's what I'll be trying to identify and I'll call it as I see it. See you there and good luck tomorrow.

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