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The day started with a strong gap up after futures ramped up the night before after the European markets opened. Futures dropped back down to test the overnight low within the first hour of trading, but did not close their gaps, and then it was up and away from there. The pullbacks were relatively minor in the cash indices, making higher highs and lows all day. At this point the big question is whether it means we're at the start of a new rally leg or is it instead just a correction to the decline that started on January 12th. Depending on which index I look at I'll give you a different answer.

We've got new highs being made by some and barely a bounce by others. The small caps (RUT) continue to press to new highs. The Transports (TRAN) made a new all-time high today (where's the DOW?). The SOX is close to making a new high for this rally from October. But the big cap techs (NDX) were barely able to get off the mat this week, including today. I look at the NDX and its consolidation this week is a screaming short. Even the slightly bouncier COMP looks more like a bear flag that may have topped today. So it's a market for stock pickers because it is clearly important which stock/sector you choose which will determine how well your trade works.

Economic reports today included Durable Goods, Initial Claims and Help-Wanted. Durable goods orders rose 1.3% in December vs. +0.5% expected. November had been revised higher to 5.4% from 4.4%. Shipments of durable goods, a measure of production, rose 3.5% which was the largest increase in a year. Core capital goods orders, a measure of business investment, rose 3.5%, the highest since August, and shipments of core capital goods increased by 3.2% which was the highest level in a year. Inventories remained flat. For all of 2005, orders for durable goods increased by 8.2% while shipments were up 6.2% (figures not adjusted to compensate for price changes). Those numbers are good but not quite as good as 2004's numbers (10.0% and 10.3%, respectively). Core capital good shipments for 2005 were up 10.4% while shipments were up 10.0%.

U.S. jobless claims were up 11K to 283K but the headline number today was the 4-week average being down 10,750 to 288,750 which was the lowest number since July 2000. It was August 2000 when the market peaked for the second time that year before it came crashing down in September. Any similarity to this year would be pure speculation (cough). Continuing claims were up 53K to 2.58M. The Help-Wanted index remained the same at 39.

The strong durable goods orders numbers and jobless data showing employment strength, along with good earnings reports today, was credited for the rally. If the market had sold off instead I suspect the anal-ists would have said it was because of the strong durable goods orders numbers and jobless data showing employment strength, along with good earnings reports today. Confused? They would have blamed it on the fact that the market is showing too much strength and that the Fed may have to keep increasing their discount rates more than the two more expected times. There was no discussion of that today. The market does what it was intending to do and all this other stuff is mere noise. Our job is try to figure out what the market is intending to do.

Earnings reports came out hot and heavy this morning as today was the biggest day for the earnings season, and it further encouraged sideliners to step in and do some buying today. Skip the following section if you're not interested in individual earnings reports but here's a list of some of the bigger stocks who reported, pulled off MarketWatch:

General Motors (GM) reported a fourth-quarter loss of $4.8 billion, or $8.45 a share, vs. a loss of $99 million, or 18 cents a share, in the year-earlier period. Excluding nonrecurring items, the loss would have been $1.2 billion, or $2.09 a share, vs. a year-ago profit of $726 million, or $1.28 a share. It was initially thought that GM would continue to do well after it was reported that Kirk Kerkorian up his stake in GM recently from 7.8% to 9.9%. Seems to me he's trying to average down and that's a big no-no in investing.

Ford Motor Co. (F) reported fourth-quarter earnings of $124 million, or 8 cents a share, up from a year-ago profit of $104 million, or 6 cents a share. Excluding a number of items, the company posted earnings from continuing operations of $511 million, or 26 cents a share, down from a year-ago equivalent profit of $554 million, or 28 cents a share. Ford plans to detail a major reorganization for its North America business at 10:30 a.m. Eastern.

Caterpillar Inc. (CAT) reported fourth-quarter net income of $846 million, or $1.20 a share, compared with $551 million, or 77 cents a share, in the year-earlier period. Sales at the machinery maker in the three months that ended Dec. 31 rose by more than 12% to $9.66 billion from $8.58 billion. Analysts polled by Thomson First Call forecast earnings, on average, of $1.10 a share and sales of $9.14 billion. The Dow component touched a record high Wednesday.

AT&T Inc (T), in its first report since SBC Communications bought AT&T and took on its name, said fourth-quarter profit climbed to $1.66 billion, or 46 cents a share, from $688 million, or 21 cents, in the year-ago quarter, with revenue up 26% to $12.97 billion. Adjusting for merger-related, severance, and Cingular hurricane costs, and a gain from tax settlements, it would've earned 48 cents a share, compared to Thomson First Call-compiled forecasts of earnings of 45 cents.

Honeywell International (HON) reported fourth-quarter earnings of $520 million, or 62 cents a share, up from a year-ago profit of $253 million, or 30 cents a share. On a continuing operations basis, the Morris Township, N.J., industrial giant posted earnings of $511 million, or 61 cents a share, in the latest quarter. Sales rose in the latest three months to $7.28 billion from $6.64 billion in the same period a year earlier. The average estimate of analysts polled by Thomson First Call was for a profit of 62 cents a share in the December period on revenue of $7.23 billion.

Drug maker Eli Lilly and Company (LLY) said fourth-quarter net income was $700.6 million or 64 cents a share, including 14 cents a share of charges from restructuring and asset impairments. In the fourth quarter of 2004 the company made a net loss of $2.4 million with no earnings per share.

Nokia Corp. (NOK) said fourth-quarter net income fell to 1.07 billion euros, or 0.25 euros a share, from a revised 1.08 billion euros, or 0.24 euros a share, with sales up 9% to 10.33 billion euros. Analysts polled by Thomson First Call were expecting earnings of 1.05 billion euros, or 0.24 euros a share, on revenue of 9.97 billion euros.

Siemens AG (SI) said fiscal first-quarter net profit declined 19% to 813 million euros, or 0.87 euros a share, while sales from continuing operations rose 22% to 20.72 billion euros. Orders climbed 31% to 26.79 billion euros, including an unusually high level of large orders, and shares rallied in Frankfurt.

DuPont (DD) reported fourth-quarter earnings of $153 million, or 16 cents a share, down from a year-ago profit of $278 million, or 28 cents a share. The latest results include a gain of 3 cents a share related to lower-than-expected tax costs from its repatriation of foreign earnings. The year-ago performance includes a charge of $93 million, or 9 cents a share. Sales fell 3% to $5.83 billion from $6 billion.

McDonald's Corp. (MCD) posted fourth-quarter net income of $608.5 million, or 48 cents a share, compared with $397.9 million, or 31 cents, a year ago. Analysts, on average, were expecting a profit of 48 cents a share, according to Thomson First Call. Revenues increased 4% -- 6% in constant currencies -- to $5.23 billion, driven by a 4.2% global comparable-sales increase. The company said it plans a $1 billion share buyback in the first quarter.

3M Co. (MMM) reported net income of $761 million, or 99 cents a share, compared with $720 million, or 91 cents, a year earlier. Sales rose 4.5% in the three months to Dec. 31. Analysts polled by Thomson First Call forecast earnings, on average, of $1.03 a share. Excluding accounting charges, 3M said it would have made $1.04 a share in the quarter.

Lucent Technologies (LU) reported a fiscal first-quarter loss of $104 million, or 2 cents a share, vs. earnings of $174 million, or 4 cents a share, in the year-earlier period. Excluding nonrecurring items, the telecommunications-equipment maker would have earned 4 cents a share, matching the average analyst estimate compiled by Thomson First Call.

United Technologies (UTX) reported fourth-quarter earnings of $626 million, or 62 cents a share, up from a year-ago profit of $612 million, or 61 cents a share. Excluding a charge related to an accounting change, the Hartford, Conn., industrial giant posted earnings of $721 million, or 71 cents a share, in the latest quarter. The average estimate of analysts polled by Thomson First Call was for a profit of 70 cents.

The market is at what we like to call an inflection point--it's either a turning point or an acceleration point for the market. Based on the number of resistance points that the market has reached (reviewed in the charts below), it looks like the current bounce should fail here and turn back down. But if the market jumps above this resistance then we could see an acceleration of the move higher. Answer that question properly and you'll put some good money in the bank. Let's see if the charts will share their secrets.

DOW chart, Daily

The DOW has almost made it up to its 50-dma in the current bounce and short term charts look overbought so I suspect this resistance will hold. It will be critical for the bulls to recapture this moving average otherwise a kiss goodbye against it would look very bearish.

There's lots of speculation in the market about this 2002-2006 bull market as to whether or not it's long in the tooth. It's certainly vulnerable to a steeper correction even if we haven't quite seen the high yet. I came across an interesting chart that shows the comparison of the current (2002-2006) bull market to previous bull markets.

Stock Market Rallies chart, courtesy chartoftheday.com

This shows the current Dow rally is the 6th longest in duration but the 5th weakest in strength. The relative weakness of this bull market is a reason to be cautious if you're long the market. And given the concerns of the economy, the poor growth in personal income (and soon to be lack of income from home equity extraction which I'll discuss more later), high energy bills, an increase in credit card payments starting in January due to new legislation and the lag time before Fed rate hikes have an effect, there's reason to believe the bull market may be on its last legs here.

SPX chart, Daily

SPX bound support at its 50-dma (1264.55 currently), unlike the DOW which could find it as resistance tomorrow. Not shown on this chart, the 20-dma at 1274 was resistance today so a resolution should be upon us here--a rally above the 20-dma will be bullish whereas a break back below its 50-dma will be bearish.

Nasdaq chart, Daily

Like SPX, the COMP found support at its 50-dma, currently at 2255. Any break back below that moving average would be bearish but if it can continue its rally it could be headed for the 2350 area.

SOX index, Daily chart

Triple top or breakout in the making? That's what everyone is wondering as they study the SOX tonight. There is bearish divergence at these retests of the highs which does not look bullish but if it manages to break higher tomorrow, it could make a run up to the top trend line above 550. The uptrend line from October and its 50-dma are well below near 500 but any break below 515 would spell trouble for the semis.

BKX banking index, Daily chart

The banks have bounced big over the past 2 days but slammed into its 20 and 50-dma's, both located near 104.45, which is also the 62% retracement of the January decline. That will be tough resistance to crack on the first try, especially with short term overbought charts and negative divergences at the last high today. Look for a pullback tomorrow. If it drops back down and closes today's gap right away, there's a good chance it will just keep dropping. A recovery back above 105 could send this to new highs, but that's not what I'm expecting.

Before looking at the home builders, yesterday's reports on the housing market (existing home sales falling 5.7% to lowest rate in 2 years, and unsold inventory at a 5.1 month supply) reminded me of some information that I recently came across that I thought would be worth sharing. I've discussed several times in the recent past our housing market, how inflated it is and what that has meant for the US consumer. It's been a veritable treasure chest of gold as homeowners have been able to tap untold riches called home equity.

The ability to pull out large quantities of money from homes has compensated for a significant drop in labor income over the years. The outsourcing of higher paying manufacturing jobs and higher paying white collar service jobs (software programming, engineering, accountants, consultants, financial analysts), has resulted in a drop in real labor income for the US workers, estimated to be about a $335B loss in 2005. Home equity extraction of about $600B in 2005 helped to offset that drop. That's very significant since we're not likely to get those offshore jobs back but we're about to see a significant decline in home equity extraction. The economic impact to the US consumer, and therefore businesses, could be quite painful.

U.S. home equity loans ran about 5% of all housing loans through the 1990s and then started spiking higher after 2000. It climbed above 10% in 2004 and is now around 12%. That's a huge increase. As homeowners have tapped out their equity this percentage is likely to drop just as fast as it rose. And as we've been seeing in the reports from the Mortgage Bankers Assoc., the percentage of refinances is starting to drop. All of this means we'll see less money in consumers' pockets and that will be reflected not just in consumer spending but also consumer sentiment. The over-extended U.S. consumer will have little choice but to bring spending and saving back into alignment with income. And if the stock market corrects again, making retirement accounts shrink, many people will begin a more sincere savings program which of course means even less future spending. The kids won't be happy and Mom and Dad won't be happy.

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Of the $600B that was pulled out their homes, about half of their "new income" was spent on goods and services. That $300B spent on non-housing goods accounted for 40% of GDP growth. Mortgage refinancing has been responsible for at least 2-3% of GDP growth for the last few years. Therefore the removal of that component of growth will likely make GDP growth significantly less, probably cutting it at least in half. Obviously we're not going to see a cessation of refinancing but it will certainly slow down from its red-hot pace of the past few years. We have already seen mortgage applications for refinancing decrease by about 25% or so.

Many say we'll never see a large price correction in housing because it's not like owning stock that you can dump in a minute, that people need a place to live, we have a growing population (including new immigrants), etc. We've seen housing corrections in the past but they've always been regional problems such as the oil patch regions following the oil price collapse in the 1980's, and the tech bubble collapse in CA. But for the first time since the 1920's we have a housing bubble on a national scale. The reason the housing bubble is different this time is due to three primary factors: one, very low mortgage rates; two, aggressive lending practices (interest-only and option ARMs, high loan-to-value mortgages and use of equity and 2nd and 3rd mortgages); and three, housing became the investment of choice after the stock market bubble burst. The use of sub-prime loans with weaker borrowers has already resulted in a rapidly increasing delinquency rate. FHA loan delinquency rate was running less than 8% during the 1980s and 1990s but has jumped up to almost 13% as of the end of 2005.

A. Gary Shilling wrote in his "Insight" that he feels the housing bubble will burst in 2006 and he offers some compelling arguments. His view, he admits, is decidedly non-consensus, so understand this is just one side of the argument. In addition to the above observations he notes that CPI increases in past local housing bust cycles moderated the losses. With the decrease in CPI as of late, we will not have that to help cushion the housing price decline. He notes that a 20% housing correction from a bubble would be optimistic (the average decline in the oil patch cities in the 1980s averaged 28%). California suffered 18% corrections and New England saw 17% declines, and again that was during a period of higher inflation. Nationwide a 29% pullback is required to get house prices back in line with rents and a 35% decline is needed to restore balance with CPI. As with most things though, when they correct they tend to overcorrect. It's not at all unusual to see corrections of 50% in high priced markets.

Here's a chart to show the comparison between CPI and housing prices.

Existing Median Home Prices and Consumer Prices, courtesy A. Gary Shilling

As more and more sub-prime loans have been made, and the delinquency rate has shot higher, lenders are getting more reluctant to make risky loans. This will obviously curtail the demand for homes as buyers are no longer able to qualify. As Shillings notes, "Investors are not amused. Credit default swaps on sub-prime ARM pools, in effect insurance policies against defaults, have almost doubled in price from mid-September to December of 2005. Buyers of these derivatives obviously anticipate more trouble. As delinquencies and defaults mount, mortgage lenders will withdraw, much as they abandoned manufactured home lending when that market collapsed in the late 1990s. Lender exits will only add to the plight of desperate, overleveraged homeowners.

Since speculators have been a big part of the housing run-up, they will in large measure control what happens from here. A substantial fall in house prices will wipe out many highly leveraged speculators. Even where prices are still rising, the gains aren't fast enough to allow speculators to flip properties quickly and still cover brokerage, closing and other costs. The number of investors buying properties in San Diego has been cut in half, by some estimates. In Phoenix, 30% of the properties for sale are investor-owned, so inventories of houses for sale rose from 8,600 in April to 22,340 in October of 2005."

While speculators are only a small part of homeowners, they tend to be the most aggressive in their buying and selling. Given their lack of staying power, their dumping of houses will rule the start of the decline in prices. Prices of houses, like most things, are set on the margin by the most zealous sellers and buyers. I think what we're seeing in the home builder index is recognition that things are not so rosy, and haven't been since last summer. And with recognition will come fear and with fear comes selling.

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

The housing index is fighting to hold onto support. It has broken below its bear flag pattern in place since the October low, and broke below both its 50 and 200-dma's. It bounced today and is trying to recover above this support, now turned resistance, level. It looks short term oversold so this could bounce back above and if it does, watch 20-dma resistance at 969.

Oil chart, March contract, Daily

The A-B-C correction to the Aug-Nov decline should be finished and we should now see oil had for new lows. Obviously it has lots of support beneath it but it should stair-step lower from here. The next decline should ultimately break the moving average and uptrend line as it heads below $55. If this happens it would be a warning shot across the bow of the USS Bull that the economy is slowing down and there's less demand for oil.

The EIA reported working gas in storage was 2,494 Bcf as of Friday, January 20, 2006 for a net decline of 81 Bcf from the previous week. Stocks were 191 Bcf higher than last year at this time and 445 Bcf above the 5-year average of 2,049 Bcf. Natural gas closed down today at $8.43 after dropping to a low of $8.00 before bouncing back up.

Oil Index chart, Daily

With that last run up in the price of oil, the oil stocks tried it also but only managed a minor new high. Resistance at the top of its bear flag (my interpretation) has held and it looks ripe for a pullback at t minimum. My interpretation of the pattern is that it is finishing a corrective bounce against the initial decline into October (the minor new high doesn't negate it being called a correction in the type of EW correction I think this is in). The type of correction I believe this is calls for a strong decline now that will take it down to the 420 area (2nd leg down to achieve 162% of the 1st leg down). This would take it down to the 2005 low and makes for a natural support level.

Oil Index chart, 60-min

A closer view of the last leg up in this oil index shows that price has broken down from its steep up-channel. If it manages to bounce back up tomorrow and fail below that uptrend line, it would be bearish for at least a larger pullback.

Transportation Index chart, TRAN, Daily

This push higher is forming a bearish ascending wedge on its 60-min chart and has the negative divergences associated with this pattern. It looks like a top forming, either here or slightly higher tomorrow before finishing. This continues to look like a very bearish setup, and the fact that it continues to make new highs without the DOW has Dow Theorists all abuzz.

U.S. Dollar chart, Daily

The US dollar bounced up to resistance at its broken 200-dma and with another low expected, this is a good place for it to fail. I think we'll see the dollar down closer to $87 before it's ready to rally to new highs again. It's setting up for a rally into the spring I believe. With the gold chart telling me it's topping out (again), if they trade counter-cyclically, that could mean the dollar is getting to rally from here.

Gold chart, February contract, Daily

If the US dollar continues to trade counter-cyclically to gold, any rally in the dollar could see gold start to pull back. I see a top forming in gold and the negative divergences confirm the fact that the buying is losing momentum. If short term uptrend lines start to break it will be the momo players who will bail first and that could start this cascading lower, which is what I expect to see. Protect your profits if you're long gold and you're a trader versus holder.

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

Tomorrow's potential market movers will be GDP and new home sales but this week is primarily about earnings and guidance. Certainly helping the DOW today were the earning's reports from CAT and HON, up 5% and 3.7%, respectively, on this morning's reports. CAT closed at a new all-time high of $65.17. On the flip side, GM's report knocked it back down to the bottom of today's pile, down -3.3% to 23.05.

Sector action was naturally mostly green on a strong up day like today. The leaders to the upside were financials, SOX, securities broker index, disk drives, TRAN, gold and silver and the biotechs. The few losers were the networkers (thanks to yesterday's earnings report from QCOM), utilities (they're rate sensitive and yields were up today), computer hardware, airlines and natural gas index.

The big earnings report after the bell was Microsoft (MSFT 26.52 _0.10) which reported a profit increase of 5.5% as revenue increased 9.4% to $11.84B from $10.82B on demand for its software used to power PCs and corporate servers. It earned $3.65B, or 34 cents a share, up from $3.46B, or 32 cents a share, a year ago. Expectations were for 33 cents a share. MSFT issued a financial outlook for the current quarter and year that was in line with current estimates--diluted earnings per share are expected to be $0.32 or $0.33 for the quarter and in the range of $1.28 to $1.31 for the year.

MSFT bounced in after hours, up to a high of $27.17 and closed at $27.01. I find it a little more than interesting that price stopped at the downtrend line from its November high. It will be critical for MSFT to break this resistance tomorrow otherwise a gap up to resistance and failure from there would look bearish.

After-market futures were up and therefore we could see a continuation of the rally tomorrow. But I never like to guess the market's direction based on overnight futures action. We've seen far too often sentiment get immediately reversed after the cash open. It's no surprise that we have mixed signals from the various charts (very rarely will they agree and only then should you not trust what you're seeing). As the day was ending today I was feeling like we were seeing a top put into place. Between the price patterns, negative divergences, short term overbought, trend lines, Fibs, and other technical signals, I was thinking we should see an immediate drop out of the gate tomorrow. But if the futures hold up we could see another gap up, even if it's a small one. Based on what I'm currently seeing, I would not trust an early morning gap up. Watch for the pop n drop. But if a gap up holds, it could be worth trying to buy it. Again, the inflection point says we're either at a turning or an acceleration point.

The DOW and S&P futures did not close their opening gaps today so they are there calling price back down. Whether it gets closed tomorrow or waits until after we've made new market highs is an unknown. If the gaps did get closed tomorrow, I would say it probably won't stop there. At this point in the pattern, any early rally that finds support at today's high should be bought. But any early failure that drops below today's close has the potential to start something more significant to the downside. I would then look to short the bounces. We've seen these rallies that offer very little in the way of pullbacks and then zoom higher again so don't let a rally get away from you if you're short. By the same token, if this is just a corrective bounce that we've been in all week, the next leg down could be a hard and fast decline. Protect long positions. Good luck tomorrow and I'll see on the Futures Monitor.
 

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