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Market Wrap

Disappointing Earnings

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Most reports I read as we headed into earnings season were bullish. Most analysts believed the earnings would continue to be good but what is even more important is the company's outlook. If the market starts to sniff out a slowing in earnings growth, the high P/E valuations will begin to look too high. But today was more of a neutral to bullish day--it ended in the green and the RUT even made new all-time highs. Those new highs may not be so bullish though as I show in a chart later.

It was a busy day for earnings and economic reports although earnings are clearly taking front and center over economic reports. The headline number today was "U.S. [Jobless] Claims at lowest level since April 2000". In Tuesday's Wrap I quoted an analyst who said "though the market expects the economy to slow in 2006, it is noteworthy that growth is entering the new year with its most solid trajectory since the late-1990s." And now we have record low jobless claims since April 2000. Are seeing some similarities here? We entered 2000 on a strong note and yet it was a miserable year for the markets. Might we be setting up for a similar outcome? My answer is a short 'yes'.

So initial jobless claims were down 36K to 271K, much lower than the expectations for a 7K rise. Volatility in this number is common in January as the government struggles to smooth out the data from the large swings resulting from seasonal employment during December and January. If you had watched carefully while I said that you would have seen that my lips weren't moving. I think we'll see all the downward revisions after Greenspan departs the pattern. OK, that was a little cynical, but true. The 4-week average was down 12K to 299K and continuing claims were also down 158K to 2.53M.

Housing starts in December were a disappointment and the housing sector took it on the chin today. With housing starts down -9.9%, to a 9-month low of 1.933M units on an annual basis, there's lots of fretting about what this means for the housing industry. Naturally every housing analyst came out and talked about this being an anomaly, that it's because it's winter, and because buyers' mothers were sick, and... No one wants to recognize the elephant in the living room but instead they just keep trying to see around it. The number was lower than the 2.04M units that had been expected (down from 2.121M in November). Building permits, used as a sign of future growth, dropped -4.4% to an annual rate of 2.068M in December from 2.163M rate in November. Single family housing start fell 12.3% to an annual rate of 1.577M units while building permits fell 5% to 1.637M.

We then got crude oil inventories at 10:30 AM which showed a drop of 320.1M barrels, -1.2%, for December but the EIA reported inventories up 2.7M barrels for the past week. At 321.4M barrels, inventories remain well above the upper end of the average range for this time of year and are 12% above year-ago levels. But crude oil production was down -6.6% and U.S. petroleum deliveries were down -0.6%. Still, it sounds like a good direction to be headed and oil price should have dropped. Instead oil closed up $1.00 on the day. Go figure. This is why I say trading funnymentals will drive you mental. Oil looks like it should be topping though (been saying that for over a almost 2 weeks) as I'll show in the charts later. I think the fears from what's going on in Iran and Nigeria continue to control the price of oil. Assuming that will settle down soon, the price of oil could plummet. Just the opposite of course is also true.

December gasoline stocks rose +0.7% to 206.8M barrels, down 5% from a year ago. Imports of gasoline in 2005 were 20% more than 2004, exceeding 1M barrels per day. That has been worsened by the loss of refining capacity, already tight all year, as a result of the hurricane damages last fall.

Natural gas inventories showed a drop of 46 bcf from the previous week to 2,375 bcf as of last Friday, Jan 13th. This is 59 bcf higher than the year-ago level and 361 bcf above the 5-year average but within the historical average for the period. Again this should have been bearish for the price of NG but it was up $0.19 to $9.07 for the day (March contract). That's still a significant drop from December's $15.55 high. The fact that NG is below the uptrend that's been in place since 2002 is telling. The bull market started in October 2002 and now the price of NG has dropped below its uptrend line. I believe this is a prediction of a major economic slowing ahead.

Some of the more important companies announcing earnings this morning included Pfizer (PFE 24.96 +0.87) and UnitedHealth Group (UNH 60.19 -1.03), home builders Beazer Homes (BZH 78.70 +1.10) and D.R. Horton (DHI 38.81 -0.95) and Harley-Davidson (HDI 54.02 +2.42). PFE reported net earnings of 37 cents/share, missing by a penny but disappointing many analysts who had been expecting 42 scents. They will issue a financial forecast during their upcoming February 10th analyst meeting. UNH reported 65 cents/share, up from 54 cents a year ago but initially sold off on some confusion about some Medicare costs. They raised their 2006 outlook to $2.85-2.90 from the previous $2.82-2.85. This disappointed analysts who were expecting $2.91.

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BZH reported 29% growth in their quarterly net to $2/share, up from $1.57 a year ago, which beat expectations by 4 cents. Their 2006 forecast is for them to "meet or exceed" expectations. DHI also reported a 29% growth in earnings to98 cents/share. They reported a strong backlog of $6.2B, up 30% from a year ago. Current earnings and 2006 forecast were in line with expectations but without the "higher than expecations" add-on, their stock sold off.

For you motorcycle enthusiasts (of which I'm one), HDI had a good quarter. They reported earnings of 84 cents/share, up from 71 cents a year earlier, and beating estimates by 3 cents. Good gas mileage, open air cockpit feeling, beautiful sound--what's not to like? While total sales increased +8.3% for the quarter, international sales increased +13% and +15% for the full year. At a time when we've farmed out most of our manufacturing capabilities to foreign countries, this company is truly one of our success stories.

Dueling analysts were out in force today. Prudential cut their price target for Intel to $17 from $19, citing the loss of market share to AMD and a reduction in gross margins. Goldman came out and cut AMD to under-perform from in-line, citing "cyclically peaking margins, rich valuations and excess supply concerns". Their concern is about an excess supply problem in the microprocessor market in 2006/2007 due to excess capacity coming on line in both Intel and AMD. AMD thumbed its nose at Goldman by stating it's seeing rising demand for its chips and that its share of PC and servers grew to 15% in 2005 from just under 10% in 2004. It's stock climbed 3.76, +10%, to close at 37.21. If Goldman had been hoping to pick up some AMD cheap through their downgrade, it didn't work. I do however think Goldman is right.

At noon we had the Philly Fed index which at 3.3 was below consensus of 12.0 and below December's 10.9. New orders index was 11.1 vs. 5.8 in December and the shipments index was 18.6 vs. December's 9.4. This showed manufacturing activity increased but at a slower pace and was the lowest number since June 2005. In a way this was Fed-friendly in that it lessens the concerns about inflation. Particularly under Bernanke, inflation will continue to be the monster under the bed and the Fed will continue to preemptively fight it.

We've now had a pullback against the January rally and starting yesterday into today we've had a bounce against the pullback. The big question of course is who is correcting who. Are the bulls going to get the ball back or have the bears wrestled control away. Let's see if the charts tell us anything.

DOW chart, Daily

The DOW was weak today. It bounced with the rest of the market but this index gives me bear-willies. When I look at this daily chart with negative divergence and oscillators pointing hard down, it's hard to get excited about the upside. When I look a little closer at the bounce from yesterday's low, it looks corrective (overlapping highs and lows, lacking a strong impulsive move). What that means is the bounce looks like it's correcting the decline from the January high. This suggests the bounce will fail and the decline will continue. The problem if that happens is that we will likely see the 50-dma fail as support and the Jan 3rd low get taken out. If that happens then the larger upward pattern from the October low would look complete. And if the rally leg from October is complete my interpretation of the larger weekly pattern says the bull market is complete. If you're long this market I would place my stops no lower than just below the January low. It's getting critical now.

SPX chart, Daily

While the DOW was only able to retrace a little more than 38% of the decline from the January high, SPX retraced a little over 62% so obviously this index is relatively stronger. Based on this index I would say the market has a chance to continue its rally to new highs. But again, the bearish divergence on the daily chart and oscillators rolling over makes it look dubious at best. Price rallied back up to the trend line along the highs from January 2004. At this point it's looking like price may have given us a small throw-over above that trend line (which is the top of a weekly bearish ascending wedge) and the drop back below the line is a sell signal. If the current bounce can not get back above the line (1288) but instead gives it a kiss goodbye, fasten your seatbelts, protect long positions (be sure your insurance protection is in place with some put options) and get shorty.

Nasdaq chart, Daily

The techs were also relatively strong in that they too retraced a little over 62% of their decline from January's high. Like the SPX if I were basing my opinion about the future direction of the market off this index I'd still be hopeful that we're going to see new highs. I don't discount that possibility but again, look at the oscillators rolling over, leaving a bearish divergence. This is not the stuff of new rally legs.

Russell 2000 chart, Daily

I wanted to show the small cap index tonight because I think it could be making an important high here. Price has rallied up to the trend line along the highs from January 2004. It could easily rally above it, giving us a throw-over like we've seen on the SPX so far. The trend line along the highs of the rally from October intersects this upper trend line where a minimum Fib target exists for this leg up, all right around 715 and this is where price stopped. Getting through this area will be difficult. Short term charts are showing bearish divergence at today's new high (if it rolls back over tomorrow). The daily chart looks ready to roll back over at stiff resistance. I look at this chart and it's screaming at me to short it. You can place your stop just above and easily control your risk. This is a pound-the-table short. OK? Just don't blame me if it doesn't work (wink). That recommendation goes with all the usual disclaimers and warnings, like don't play in traffic, don't eat yellow snow, etc.

Techs, semi's in particular, got a big boost today from gains in several chip stocks, helped along by AMD's strong Q4 earnings and improved margins as well as several analyst upgrades within the semiconductor space.

SOX index, Daily chart

The SOX look about the most bullish of all the charts I've looked at tonight. There are no bearish divergences (except on the 60-min chart if it rolls back over tomorrow and leaves a lower high on MACD), there is upside potential to the top of a parallel up-channel and a potential Fib target of 573 (although it has already met its minimum Fib target of 536). If it weren't for all the other charts I'd be recommending buying the next pullback. If I were looking at just this chart I'd suggest trying the long side. But if the broader market is in trouble, a retreating tide will lower all boats. Be careful with this one--I wouldn't want to short it but I wouldn't want to buy it either. Leave it alone for now.

Getting to the banks, quarterly disappointments from Washington Mutual (WM 43.33 -1.08) and BB&T Corp (BBT 41.08 -0.83) overshadowed Merrill Lynch's (MER 72.05 +2.20) impressive Q4 report and 25% dividend hike. Another negative for the sector could have been concerns about a flattening yield curve again, as the yield on the 10-yr note (-10/32) rose to 4.38% vs. the 2-yr yield of 4.37%.

BKX banking index, Daily chart

The little flag pattern that I thought would give banks one more chance for a run to a marginal new high seems to be failing. The 50-dma hasn't been able to support this index and any further drop will look bearish. The negative divergences on MACD since the November high doesn't look healthy. The flip side of the MACD interpretation is that it has come back down to zero while price has consolidated. I don't discount that possibility but if MACD makes it into negative territory (flirting with it now), I expect to see banks make a quick dash down to the 200-dma for starters.

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

It's looking less and less likely we'll see this index poke its head up into the 1050-1060 resistance area. The 20-dma supported price today so if that doesn't hold, I suspect this will just rip through 200-dma and short term uptrend support (after the obligatory bounce there).

Oil chart, March contract, Daily

I've switched over to the March contract for oil. Oil has refused to roll over even though it's been supporting lots of short term bearish divergences. However, as seen on the daily chart, daily MACD is still supporting the rise, making new highs along with price. Stochastics has gone flat which simply indicates an uptrend in progress. Time to leave them and watch the moving averages and potential upside Fib targets. First up is the Fib target just under $68 which is based on a measured move between the two legs up from the November low. This is also the area of 78.6% retracement, often considered the maximum for a correction (to the Aug-Nov decline in this case). Emotions are running high right now (fears about Iran and Nigeria) so I could easily envision an over-throw of these Fib targets. The 10-dma (65.24 and rising rapidly) and 20-dma (62.82) have to break before we have some confirmation that a more significant high is in. But the current leg up shows bearish potential as far as finding a high soon.

Oil chart, March contract, 60-min

A closer view of the current leg up shows a potential bearish ascending wedge playing out. The negative divergences seen in MACD support this interpretation. However, upside potential, especially with a small throw-over above the top line, is closer to $69 than the $68 target shown on the daily chart. The $70.95 high in August could be retested as well but I'm thinking it won't get that high. Somewhere between $68 and $69 is where I'm guessing we'll see a top in oil. It should then turn back down hard.

Oil Index chart, Daily

A few bullish reports out of the some of the oil stocks, and the rally in oil, helped this index today. It's still knocking on the door of resistance at the top of its up-channel (which I'm calling a bear flag) and its Fib target just under 579. I do not expect to see significant new highs in this index and may have topped out today as shown as a possibility on the 60-min chart.

Oil Index chart, 60-min

The oil index broke below its uptrend line yesterday and is currently bouncing back up to. If it rolls back over after not being able to recapture this trend line, it will look like a bearish kiss goodbye. It would be time to get shorty your least favorite oil stock. I had reviewed VLO for a reader (posted 10:39 PM, 1/18/2006 on the Futures Monitor) and noticed it rallied a little further today and tested the highs on Tuesday and Wednesday. But if it rolls back over from here it will leave a negative divergence on the 60-min chart, the same as we see on the 60-min OIX chart. Button up your stops if long these stocks.

Transportation Index chart, TRAN, Daily

What got into the Trannies today?! Oil rallies and the Transports had one of their best days. Too bad it didn't do anything for their chart. The daily pattern has me confused on this index. The daily bearish divergences after meeting some upside targets that all coincided just under 4300 have me bearish this index. That doesn't mean we can't get another high with another negative divergence. It's just that I wouldn't buy this index if it were someone else's money. And I certainly wouldn't touch it with my money. But it looks a little dicey to try to short it. Leave it alone for now.

U.S. Dollar chart, Daily

The US dollar continues to consolidate just above its 200-dma and 62% retracement near $88.60. Daily stochastics is turning back up but I still think that lower level will get tagged, perhaps leaving a bullish divergence in the process. Once this pullback is finished I think we'll then get the next, and last, leg up to the mid-90s before the bear market resumes.

Gold chart, February contract, Daily

The new high in gold is leaving a negative divergence if it rolls back over from here. Sounds like a common theme doesn't it? I think that's telling actually. Stocks, gold, oil, housing--they're all looking fragile at the moment and if they all sell off together it will be forecasting a slowing economy dead ahead. Gold obviously has a large drop before it confirms a high is in--its 50-dma at $511.56, and rising, has to be broken before we'll know we've got a bigger correction in play. I think that's what will happen so depending on your time frame, consider protecting profits in gold here.

Gold chart, February contract, 60-min

A closer view of the last leg up in gold shows price has broken below a bearish ascending wedge. Today price has bounced back up to the broken downtrend line so if it rolls back over from here, it will be a bearish kiss goodbye and a good short.

Time prevents me from going into gold a little more but I'll try to provide some hopefully useful information about how to use gold in your own portfolio. Briefly you want to consider gold in two different lights--as insurance (with no expectations for appreciation but instead purely as protection from economic Armageddon) and as an investment. I've got some interesting numbers to share as pertains to gold as an investment. I'll be writing next Monday's Wrap so look for it then.

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

Earnings reports will continue to be the focus of the market through next week. Tomorrow's only market report is the Michigan Sentiment which is not expected to move the market (unless it came in monstrously bad, which is not expected).

The internals today looked stronger than price would say. Up vs. down volume and advancing vs. declining issues showed a better than 2:1 advantage to the buyers. Why the major averages didn't better reflect this I'm not sure. If there's not a recovery in the majors tomorrow I'd be worried about the health of the market. Sector action today was also almost universally green. The only red sectors in my list were the banks (BKX) and health providers (RXH). Doing less well but still in the green were financials in general, airlines and big caps in general. The leaders to the upside were gold and silver, energy, SOX, Transports, securities brokers, networkers and disk drives. Essentially small caps and tech stocks did well, big caps lagged.

So with the relatively strong showing in the sectors and the strong breadth in the market, I think it will be important for the current bounce to keep progressing higher. As I showed in many of tonight's charts, I'm left with a bearish feeling about this market. I've been saying that a pullback from the January rally will tell us volumes about the importance of the high. The reason I say that is because a corrective pullback followed by an impulsive bounce should indicate we're heading higher (corrective meaning overlapping highs and lows within the move and 3-wave counts vs. 5-wave, whereas impulsive means no overlap between waves in a 5-wave move).

The decline from last week is subject to interpretation as to its correctiveness vs. impusliveness. Therefore I'm now hoping the bounce and pullbacks will provide some more clues. Again, as usual, there's not enough definitive movement yet. If I look at the techs I see higher. If I look at the DOW I see lower. However, as of tonight I'm leaning to the bearish side. Based on my best guess about the EW pattern, the negative divergences, daily oscillators rolling over, breaks of trend lines and a few other things, I'm thinking the January high was THE high. The fact that the RUT made another all-time high without the other major indices, and hit major resistance, is actually bearish--it's a non-confirmation between indices, typical at market tops.

If the DOW is unable to make new highs it obviously calls into question, from a DOW theory perspective, the health of the rally because of the non-confirmation between the DOW and Transports. It would be bearish, pure and simple. So it's time for the market to put up or shut up--it Must rally back up to new highs otherwise the longer term wave pattern turns ugly. If SPX and the DOW drop below the Jan 3rd low, I think that would be it, rally over, finit, complete, stick a fork in it and serve it up as steak tartar. Until then, anything can still happen. If the SPX manages to make it to a new high instead, the upside potential over the next several weeks is 1340-1350. Wouldn't that shake a few bears out the trees! Trade carefully here and hopefully we'll have some firmer answers within a few days. Good luck and I'll see you at the Monitor.

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