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Market Wrap

The Day After

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Yesterday there was great fanfare behind bringing the NYSE (NYX 76.10 -3.90) public. There was a lot of speculation by many, including yours truly, that there was a false propping up of the market in order to make the launch of NYX successful. There's a lot of money riding on the successful launch of an IPO and this was a big one. A lot of brokerage houses stood to make a lot of money and the Big Boyz weren't about to let this one get away. The reason I was feeling the Tuesday and Wednesday's price action was phony was because of the very negative market breadth while price stood still on Tuesday and then rallied yesterday afternoon in the face of bearish internals. And then after a brief rally to start the day today, the Boyz let it drop.

It didn't drop by much today and there's even a possibility we'll see another leg up for this week's rally tomorrow. I was actually expecting another leg up today after the pullback but it never came. After today's negative close it's got me wondering if will come. My best guess is that we'll see a little more downside tomorrow (maybe from a negative reaction to the jobs numbers) followed by another rally leg. That has more to do with the shape of the rally on Wednesday than anything else and I'll discuss a little more later.

But the intermediate term picture, into next week, looks bearish. Whether or not we first get a bounce tomorrow, we should see this market pull back further. Slowly but surely the different indices are giving up their support levels, namely uptrend lines and 50-dma's that I pointed out on Tuesday. I'll review those in the charts.

Today's economic reports were light, as has been true for the week. Tomorrow will be busy with reports but today we only had the Initial Claims and Trade Balance numbers. The initial unemployment claims rose 8K to 303K which was higher than expectations for the number to be the same as last week's 295K. The 4-week average increased by 6,250 to 293,500 making it 8 weeks in a row now with it below 300K. Unfortunately this is such a lagging indicator that it's useless for telling us what's going to happen 6 months from now.

The trade balance number was -$68.5B which was 5.3% more than December's revised -$65.1B. Exports had increased over this period but imports increased even more. I've made note that there's actually an economist out there, Ian Shepherdson of Valhalla, NY, who feels our economy may be headed for a slowdown. He didn't say that directly but instead commented on the trade deficit but I wonder if he realizes he just admitted the economy is slowing down. I'm sure he's now been ostracized from the Men's Economic Club. He said that the imbalance won't last as the economy cools, "But that is not the story in January." It's too late, he let it slip out. Now he's in trouble.

The equity and bond market didn't react to any of this news in the early morning. The only other newsworthy item was the decision by Dubai Ports World to sell the U.S. operations of P&O Ports North America, acquired from London-based Pennisular & Oriental Steam Navigation Co., to a U.S. entity. It's all very secret who this "U.S. entity" is but it relieves the Congress and President from a nasty showdown. The U.S. entity could be another government sponsored entity (GSE) like Fannie Mae for all we know. Buying it certainly wouldn't be a problem since we can just print up the money needed to effect the exchange. I'm sure DPW did very well in the deal.

Not much else happened that's newsworthy so let's get to the charts.

DOW chart, Daily

The DOW continues to show relative strength to the rest of the market. That's great for the public to see but it's not good when you see the techs and small caps in trouble. Rotation into large caps looks like a defensive move. So again, the DOW's chart looks bullish. It continues to chop its way lower towards support at its 50-dma and October uptrend line just above 10900. Daily stochastics is working its way down to oversold and MACD is holding above the zero line. All is well with the world. And in fact it could be for the DOW. While I think the market in general has some downside work to do, the DOW could hold its relative strength in preparation for another rally leg into April.

SPX chart, Daily

As before, SPX is in the middle, between the DOW and the COMP. Today the SPX broke support at its 50-dma and October uptrend line and that makes today's action look bearish. It managed to close at its broken January downtrend line so there's still hope. A break of an important support level like the 50-dma can't be tolerated for than a day or two otherwise the break is for real and not just a head fake. The upside pattern from Wednesday's low leads me to believe we're going to get another rally leg to match it and that could happen tomorrow. But regardless if we get another push up first or just drop straight tomorrow, I expect to see support for SPX break. It could drop down to test the January low near 1253 or it might find support at the uptrend line from January's low, currently near 1261. If the DOW can hold support the SPX might hold above that uptrend line.

I've mentioned many times in the recent past how I believe the market is in a topping process and that it will likely take months to play out. If you look at how the market topped in 2000 you will see a rolling top of sorts (except for the techs--they just got body slammed to the mat) and different indices peaked at different times. Even the DOW and SPX peaked at different times (January and March 2000). This is all very typical as money is rotated around while each takes its turn at being supported and then sold. I mentioned on Tuesday I didn't like what I was seeing in the market internals in that they looked bearish. The advance-declining volume and issues were both negative while price stayed buoyant. The number of new 52-week highs has been dropping while the number of 52-week lows has been climbing. These are all indications that there is a lack of participation in pushing the market to new highs, and in fact a sign of distribution of stock. So as not to scare the public, the major indices are held up with strategic buying while the large funds distribute the rest of their inventory to an unsuspecting public. Baaaa...

This chart shows what's been happening to the number of advancing-declining issues in the NYSE. The chart is messy because I can't get rid of the "price" line on the chart but focus just on the red trend line which is the 10-dma.

Advancing-Declining Issues chart, Daily

Two things I wanted to point out on this chart: One, the declining peaks between January and February. If you compare the NYSE to this time period you will see that the NYSE made a new all time high in early January, another one in late January and then another one in late February. But look what was happening to the a-d line--the new highs in NYSE were being met with lower highs in the number of a-d issues. This is a classic topping signal. Two, the current 10-dma line is at a low not seen since October 2005 and yet NYSE is still near its all time high. But not for long.

Nasdaq chart, Daily

The techs continue to show greater relative weakness. The COMP has now broken 3 forms of support around the 2275 level--the 50-dma, the October uptrend line and the broken January downtrend line. The next test is the trend line along the highs from January 2004, currently at 2245, but I consider that minor support at best. More solid support may be in the 2200-2220 area.

Many of you trade the QQQQ so showing its chart may offer some guidance for what I think could be playing out there.

QQQQ chart, 240-min

Looking at price action since the January high, price has been pulling back in a corrective fashion. There is a way to consider the move down from January to the February low as an impulse (a leading diagonal with a small 4th wave for those of you following EW patterns) but first impression is that it is a corrective 3-wave decline. This says the market has not found a high yet. We then got a very corrective bounce into the March 3rd high. Therefore we're due another leg down and when the decline is finished we could see another rally set up that takes us to new market highs in Q2. That's speculation at the moment but that's what this pattern is telling me. If we get equality in the two legs down (wave-A = wave-C) I get a Fib target of $38.96 as a downside target and it intersects the bottom of a potential parallel down-channel at the end of March. Keep an eye out for possible support at its gap close from November 3, 2005 at $39.35.

SOX index, Daily chart

I hope they're not throwing the baby out with the bath water. Look out below on this one. I don't see much support between here and the 480 area which is previous price support/resistance last year. The 200-dma at 476 might come up to catch it in that area as well.

BKX banking index, Daily chart

I didn't trust the bank rally on Tuesday and sure enough we got no follow through to it. Maybe it was part of the market prop job for the NYSE IPO. Hard to say. Assuming the market doesn't fall out the bottom, there's a good chance the banks will find support at its October uptrend line, currently near 104. Its 50-dma at 104.55 could also hold this one up. Selling is not hitting the banks yet which is still a bit mystifying considering what's happening with yields (inversion).

BKX banking index, 30-min chart

Supporting a turn back up tomorrow is this 30-min chart of the banks. After breaking its downtrend from the February high, price came back down for a potential test and kiss goodbye. If the banks rally tomorrow, the rest of the market might follow.

With the increase in bond yields in the past week I thought it would be an opportune time to revisit the housing market and what it means to our economy and therefore stock market. Just about everything I study in our economy is with an eye towards what the impact will be to the stock market. The effect on the stock market is most often a result of the impact on traders' emotions. Therefore looking ahead to see what changes are coming and evaluating what those changes may do to investor mood can often give you a heads up before the market reacts.

Rising interest rates, especially the 10 and 30-year, obviously have an effect on mortgage rates. Many adjustable rate mortgages are based on the 10-year rate. This week the 10-year rate hit a high not seen since June 2004. The Fed has made it clear they will continue to raise rates until they see evidence that the inflation rate monster has been beat into submission. Usually by the time they have the numbers to show this, they've gone too far. As it looks now the Fed is headed down that path again. The Fed's actions remind me of the saying "insanity is defined as doing the same thing over and over again and expecting different results". The impact on housing could be problematic for our economy.

The danger from rising interest rates is two-fold. One, it will bring to a halt the refinancing of existing mortgages. That will in turn stop home equity extraction from the refinanced mortgages. Two, the adjustable rate mortgages are going to start seeing higher monthly payments and that's going to knock some people out of the homeowner's club. RealtyTrac (www.realtytrac.com) is an organization that tracks property foreclosures and their latest report for January 2006 is not encouraging. Foreclosures were up +27% from December (don't forget, minimum payments on credit cards increased effective January 2006) and they increased +45% from January 2005. This is a huge increase and it's being reported with little fanfare. Let's not frighten the sheep. The foreclosure rate has been going up every quarter since 2005 and is now at a rate of 1 out of every 1,117 U.S. households. And this is before mortgage rates tick up more than the approximate one percentage point we've seen over the past year. And some adjustable rate mortgages are just now starting to feel the impact.

As the housing boom took off, banks became more aggressive in getting a piece of the mortgage pie. Today the banks are more heavily exposed to mortgages than at any other time in history--about 62% of bank earning assets are mortgage-related. But many of the mortgage portfolios are to sub-prime borrowers and made up of many riskier types of loans such as interest only and reverse mortgage. All of this has been done while the rate of return is at near historic lows. This is the very definition of complacency--taking higher risks but accepting lower rates of returns for those risks is a recipe for disappointment (that goes for investors in the stock market too by the way).

And speaking of complacency. An article was recently forwarded to me (thanks John) from the L.A. Iimes, written March 8, 2006, in which was discussed a poll conducted by L.A. Times and Bloomberg nationwide to discern peoples' attitude about the housing market. If this article didn't define a bubble, I don't know what does. Think about the attitude of investors during the height of the stock market and internet bubble. Investors just couldn't fathom a steep price correction and felt the good times would just continue because we were in a new world order. To have told someone in the spring of 2000 that the Nasdaq-100 would lose 90% of it value in the next 18 months would have been enough to get you committed to the funny farm.


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Today we have homeowners who are living in Lalaville with all the same reasons why housing won't correct this time. The poll results show that only 5% of the people expected housing values to not increase over the next 3 years. 75% expected houses to continue to increase in value, with a third of those expecting increases of 16% of more. And those areas where we've seen the largest increase in housing prices (the Real bubble) had the highest number of bubble-headed optimists out there. In the West, 43% predicted a price increase in the next 6 months. In the Midwest, this was 29%.

About 15% of the homeowners said they had an adjustable rate mortgage (about 25% in the West, the land of forever rising home values according to the poll). These are likely relatively new mortgages that enabled the buyers to qualify for loans they otherwise would not have been able to obtain. With rates ticking up every quarter it's no surprise to hear about the foreclosure rate increasing right along with it. That's not likely to slow down. Of the homeowners who had an adjustable rate mortgage, a little more than 20% said they were "not too confident" about making their payments if they adjusted higher. Another 5% said they were "not at all confident". So we've got about a quarter of the adjustable rate mortgage holders feeling like they're not going to be able to make the payments. That means we have 15% of the new mortgages as adjustable rate and 25% of those are headed for foreclosure, which gives us a 3.7% failure rate around the corner.

I mentioned above that the foreclosure rate is now running 1 out of every 1,117 homes. Considering just the impact from these weak adjustable rate holders, that rate could quickly jump to about 37 out of 1,117. This is just huge. And it doesn't consider the added risk from a slowing economy, job losses and higher energy costs that may force other homeowners into foreclosure. The market could be hit with extra inventory from bank foreclosures and the banks have only one desire--sell it and sell it fast. The last thing they want is to be a homeowner. And we have builders building extra inventory while buyers are slowing down. It's going to be all about supply and those who believe it's different this time will wake up and smell the coffee and it'll be dj vu all over again for many.

We've seen a relatively steep drop in the home builders and it's very likely a result of the light going off in the heads of investors who may not feel quite as optimistic as the home owners in the above mentioned survey. The chart is looking potentially ominous for the builders.

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

Yesterday I thought the 835 area might provide some short term support for the home builders but today price dropped right back through that support level. That's a little surprising and evidence of weakness. The further it drops away from this level, the more it will become resistance on a future test. When I saw daily stochastics getting into oversold I thought it might have a chance to find support here, but then I saw what it did in January after reaching oversold. The index proceeded to lose another 100 points while stochastics flattened out which indicated a downtrend in progress. I'm thinking we're going to see the same thing happen again. We should be into the strongest leg down now and it could really rip to the downside. MACD should get buried in oversold.

Oil chart, April contract, Daily

Oil is fighting to hold onto $60 which is where the H&S neckline is located. It's unlikely price will hold on long and then it should be a quick trip down to its longer uptrend line from January 2004. This is a major uptrend line and I'm sure we'll see some consolidation along the line for a number of days. But it too should give way as price heads for $50.

Oil chart, April contract, 120-min

Looking a little closer at the recent consolidation since the end of February, you can see price dropped out of the flag pattern and then popped back up to give it a test and kiss goodbye today. Whoever believes oil doesn't trade just like any other symbol needs to watch what happens next. This test and kiss goodbye today is one of the more reliable sell signals. At least if it comes rallying back up again, your stop is very close. I take these setups every time I see them and the majority are winners even if it takes a try or two (with another rally back up for another test and kiss goodbye).

Oil Index chart, Daily

It will be interesting to watch the action of the oil stocks around their 200-dma. If oil is going to drop harder, the oil stocks should forecast that with a drop through the 200-dma and uptrend line, both near 531. Any break of its new downtrend line from the January high would be a heads up that oil is or will climb with it. Until that happens though, this should keep heading south.

Transportation Index chart, Daily

Everything I see here tells me to short this index (find the weak players in the index and pick some bearish plays on them). I'd like to see a break of it October uptrend line and yesterday's 4352 low would go a long way towards calling a top in this one. A break of its 50-dma and then 4200 is needed to finish it off. Until then this sneaky little index could always make another run for it to another high. That's not what I see but I also know it doesn't listen to me.

U.S. Dollar chart, Daily

The US dollar is peeking its head above the November downtrend line. Gold has already convincingly broken its equivalent (but inverse) uptrend line so I think the dollar will make it and then it should be off to the races for the dollar as it heads up in a 3rd wave. If it instead drops back down to its 50-sma at $89.86 it likely means it will consolidate further inside its triangle pattern. That's not what I'm expecting to see.

Gold chart, April contract, Daily

Gold looks to be breaking down. As long as its Feb low of 538 holds it's possible we'll see gold consolidate sideways but I suspect it will break on its next test. Upside resistance is the broken uptrend line and 50-dma at 553 and any test and kiss goodbye there should be shorted (if you're a gold trader). If we do get the break below 538 I think it will head for $500. I could be tempted to be a buyer there since it's the location of a previous 4th wave correction which is often a support level. That would be especially true if it's hitting its uptrend line from July 2005 at the same time.

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

Tomorrow is a busy day for economic reports. The big number is the payrolls report. If too many jobs have been created it will worry the Fed that growth and inflation are getting out of hand. That would mean they would have to get more aggressive with rate increases and the market doesn't like the idea of an aggressive Fed. So good news for the economy is bad news for the stock market. If the job creation is abysmal and comes out with less than 100K the market will get spooked about a slowing economy and probably sell off. The number has to be just right for this Goldilocks market of ours.

The short term price pattern left me with the impression at the close that we could see an early morning move lower and then turn around in a rally right back up to today's highs (to give us an A-B-C bounce from yesterday's low). But this afternoon's sell off left a bearish taste in my mouth, especially knowing all the bearish internals we've been seeing this week. Price was held up while internals were awful and now price may immediately follow. So I'd be very careful about being long the market tomorrow morning.

On the other hand, because of the price pattern, and if I ignore all else, it tells me to expect another leg up to match the one from yesterday's low to this morning's early high. So I'd be very careful about being short the market tomorrow morning. How's that for commitment? Oh, I forgot one--it could go sideways tomorrow instead. If price appears to be holding near yesterday's lows, and you start to sniff out some bullish divergences at those lows, I'd be nibbling on the long side and see if it reverses back up. But if yesterday's lows give way and then become resistance I'd want to get short.

These are all very short term scalping recommendations. If you do not have the ability to watch the market intraday, I think the market is too dangerous right here for either side. I see downside potential into next week and the following week but then there's the potential to see a reversal back to the upside, and this of course means just a lot of chop on a day to day basis and may not be worth trading. Intraday trading is working if you can catch the swings and even that's been a challenge. I'll say it again--the topping process is brutal to traders and it's often times better to leave the market alone. One of Jesse Livermore's secrets to success was knowing when to leave the market, which he would do for months at a time.

For those who can trade this stuff intraday, good luck and I hope to see on the Monitor.

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