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Market Wrap

Opex Push

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The buy programs were obvious this week. Once it became apparent the bears weren't going to be able to push the market lower after trying last Thursday, it's been a relentless drive higher and the shorts were bailing out left and right. This being opex week it's tough to call a market direction based on this week's action. The kind of buying we saw, driven by programs designed to make the Boyz lots of money and drive the shorts out, is not necessarily trend setting. In fact it even has the smell of a blow-off top. That's just speculation at the moment and it's probably not finished going up, but this is another one of those too much, too fast kind of rallies. We might have to wait until next week before we see whether or not we'll get some serious follow through or some serious profit taking instead.

As has been so typical of this market for quite some time now, we got a lot of divergence between indices. The S&P 500 and DOW were held up all day (their options expire at the open tomorrow) while the techs sold off. The SOX was punished today--down 3.2%, breaking back below Monday's low. Without the SOX participating, let alone the techs in general, it's hard to trust a rally in the broader market. Could be a hidden agenda out there. Nah, that's just conspiracy stuff. Speaking of conspiracies, I'll share some thoughts and concerns in a little bit about the disturbing relationship between our mega-banks, the Fed and the SEC and the control they seem to have over our market. This is not your father's market anymore. In fact it's not even the same market that you traded 5 years ago. But as I've mentioned before, a rally in the large caps while the smaller high beta stocks are selling off is a defensive posture taken by those who want to be in larger liquid stocks in case they need to get out in a hurry. That's not what you see at the start of a new bull market leg.

But first let's cover today's economic reports. This morning was busy with them, as has been true for most of this week. Leading off was the report on CPI and it juiced the futures higher pre-market and the cash market picked up the ball and ran with it after that. The core CPI, which the Fed is most interested in, was up a very tame 0.1%, lower than the expected +0.2%. The Fed is more interested in personal consumption expenditures, reported at the end of the month, for their inflation watch but they obviously watch core CPI. The higher cost of energy has not found its way into higher cost products and that's what the Fed is watching for. CPI was also up only 0.1% as prices for energy, food and clothing offset higher prices for medical care, shelter and air fares. CPI is up 3.6% in the past 12 months while core CPI is up 2.1%. Most analysts feel these numbers do not change the prospect for further rate hikes by the Fed, with at least two if not three more hikes expected this year.

Housing starts for February were down 7.9% to a 2.12M annual pace. After the strong number in January most expected to see February turn down but the number was higher than the expected 2.04M rate. Building permits also fell to a 2.15M annual rate, down 3.2%. Single family home permits fell 3% to a 1.64M rate. "Doubtless these numbers will be followed by a rash of commentary to the effect that the rumors of the death of the housing market are greatly exaggerated," said Ian Shepherdson, economist at High Frequency Economics. "That would be the wrong conclusion to draw. First, housing starts lag home sales, which are falling. And warm weather supported starts."

Basically what he's referring to is the fact that this is a supply vs. demand issue and housing starts are the supply-side of the equation. Sales is the demand side of the equation and this includes mortgage applications which have continued to slow. Without demand any excess supply will only depress home values. Interestingly, the Fed governor Donald Kohn said today in a speech prepared for delivery to a European Central Bank forum in Frankfurt, Germany, "If real estate prices begin to erode, homeowners should not expect to see all the gains of recent years preserved by monetary policy actions." He also debunked the theory of the "Greenspan put". He probably also said the sun doesn't rise in the east.

Initial claims data was reported and showed an increase of 5K to 309K, snapping the 8-week run with the total below 300K and making it the highest number this year. Continuing claims fell by 49K to 2.45M, the lowest in five years. In a separate report, the Labor Department said real hourly earnings (adjusted for inflation) increased 0.3% in February. In the past 12 months, both real hourly earnings and real weekly earnings are down 0.1% which continues the trend from 1998. It will be interesting at the end of the month to see what consumer expenditures look like. The economy is very much dependent on a strong consumer.

Lastly we got the Philly Fed survey at noon and it showed manufacturing expanded at a slower pace this month. Orders and shipments improved while prices paid for raw materials rose at the slowest pace in more than 2 years, which is a good combination. New orders were at 20.8 vs. 12.5 in February while prices paid was down to 17.2 from February's 30.5. The Business Index dropped slightly to 12.3 vs. 15.4 in February. After the release of the report the market didn't react much to the data.

Individual stock news was relatively quiet. Bear Stearns (BSC 133.26 -0.94) followed in the foot steps of Goldman Sachs and Lehman Brothers this week in reporting blowout earnings. Earlier in the week MarketWatch reported Goldman Sachs' net income rose 64%, leaving analysts "searching for superlatives to describe the biggest profit in the history of the industry and setting the bar high for rivals reporting this week." But today it looked like BSC's earnings was old news and we saw some profit taking in that sector today after an early high. As for the chart on BSC, it left an outside down candle (bearish engulfing) and doesn't look good for a continuation of its rally. The banks in general (as I'll show in the chart) left a bearish dragonfly doji (bearish version of the shooting star).

Tonight, and then finishing up on Monday, I'll get into a little bit about these mega-banks and their earnings, the Fed and SEC and program trading and hopefully tie it all together showing our market is not quite as "free" as we'd like to believe.

This has been a bullish week and the buyers were busy--the major indices got pushed up hard with barely a pullback, an indication that the buy programs were relentless. It seems there was a desire to flush out a lot of short call positions and let most of the long put positions expire worthless. We've seen a few resistance levels get smashed along the way so let's see what happened in the charts.

DOW chart, Daily

The DOW has punched up through resistance at the top of its ascending wedge formed since its October low, and at the trend line across the highs since January 2004. The ascending wedge pattern is important. If price drops back below 11200 now it will mark that high as an over-throw, a very common occurrence in these wedges, and the drop back inside the pattern would be a sell signal. It's possible that we'll get a pullback and then one last hurrah of a rally to finish off the rally from October but the way this is pushing higher here has me thinking this one could be it. The negative divergences on MACD and RSI continue to support the idea that we're finishing something here rather than starting a new leg up.

SPX chart, Daily

There's a Fib projection, based on the internal wave pattern of the rally from October, at 1312.72. Two equal legs up from the February low is at 1312.38 so there's some nice Fib correlation at that level where the SPX may find stiff resistance. Like the DOW, the negative divergences on this daily chart do not inspire bullish feelings in me. This looks like an ending pattern to the upside (bearish ascending wedge) and it's a matter of finding the top. I would not want to chase this higher here and I would protect long positions that I might have. It might be a little early to get short the market but that's what I'm thinking is setting up here.

Nasdaq chart, Daily

This is one confused index and has been since January. On the one hand this consolidation looks bullish--like one big bull flag. But action like today makes it look like it can't punch its way out of a wet paper bag. Even today's daily candle looks like an outside down day, or a bearish engulfing candle, and that was after it ran into resistance at the top of its flag. The daily chart here says I should be thinking bullishly but action like today makes me think I should be selling my techs. We need a better signal to trade the techs as I don't like the setup yet on the COMP. However, QQQQ gave us a sell signal today.

QQQQ chart, 120-min

Continuing our coverage of the QQQQ, this week's rally shot this stock a lot higher than I thought it would go and it looked on the verge of a breakout today. But then it fell back under the downtrend from January and by so doing gave us a sell signal. Now we'll just have to see if there's follow-through to the downside. One look at the SOX and it says yes, look for more selling.

SOX index, Daily chart

While the rest of the market was rallying this week, the SOX gave it its best shot but failed. That's a big bearish engulfing candlestick left on today's chart, and it broke Monday's low doing it. There's layered support from 486 down to 478--its 50% retracement at 486, Aug-Sep 2005 highs and January low at about 480 and then its 200-dma at 478. Below that there's the 62% retracement at 469. MACD shows this index is as oversold as it was in October and therefore warrants caution if you're short the semis. We of course know the oscillators can go flat which indicates a trend in progress so don't go by those alone but understand the risk. Watch your shorter term charts' moving averages for some early clues about any potential reversal to the upside. In the meantime, the bears control this one.

BKX banking index, Daily chart

The banks had a good week and probably had a lot to do with this week's rally (in more ways than one which I'll explain below). The big banks--Goldman Sachs, Lehman Brothers and Bear Stearns--had blowout earnings this week and much of that came from record profits from their trading groups. It's nice to be able to control the market. Today there was some profit taking after the early high and now the daily candle is a potential reversal pattern in the making. It's a dragonfly doji which is a more bearish version of the shooting star. That tail above the small body is a sign that the highs were soundly rejected, and it was done at resistance by the trend line along the highs from November. Confirmation of the sell signal would be a red candle tomorrow. If it rolled over here it would leave a negative divergence on MACD.

One of the things I've enjoyed immensely while writing for OIN is the input from readers. I feel I've learned more from readers than any knowledge I may have imparted to you. I received a couple of emails from Joe with some observations and research that got me to doing a little more research and I thought I'd pass it along. It's right in line with some of the things I've been harping about with the Fed and their money and the amount of manipulation going on in the market. We're supposed to have free markets but with the Fed apparently more active (printing money and inserting it into the money supply through the markets) and the mega-large banks in control, this information may shed some light on what's happening to our market and what you need to be more cautious about in your trading.

We know that program trading has been increasing each year and its foot print is pretty obvious--we get these selling and buying spikes that are typically followed by a small consolidation and then perhaps another one or two program trades that seem to move the market quickly with little if any corrections. We often describe the market as getting "jammed". Prior to 2000 program trading was running less than 20% of total volume. In early 2002 it had increased to just over 25%. Today it is ticking over 60%. This is just huge and tells us that our job as traders has been made enormously more difficult because of these programmed moves that many times come out of the blue. This is a chart of price action over the past week on the S&P 500.

S&P 500 Index, 15-min chart

I've highlighted in yellow the buying spikes that were very likely the result of buy programs. If you knew those buy programs were about to hit do you think you could make a ton of money? Remember that question because I'll be coming back to it.

In May of 2002, partly as a result of concerns stemming from the 9/11 attack, the SEC issued a white paper titled "Interagency White Paper on Structural Change in the Settlement of Government Securities: Issues and Options". You can read it in full at http://www.sec.gov/rules/concept/34-45879.htm. Essentially there was concern about the fact that there were only two major banks that provided settlement services for government securities--JPM and Bank of NY. The SEC issued the paper to address a concern about what would happen, and what would be the remedy, if one of these banks became insolvent. At the time there was a lot of concern about JPM's health because of its high derivatives exposure. At the same time the co-head of JPM's investment bank left the firm on May 23, 2002. There was a lot of market speculation at the time about JPM and their stock price started to suffer.


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The SEC was concerned about a sudden banking crisis if JPM were to default on its massive derivatives exposure. It's hard to find information as to what transpired between the banks, the Fed and the SEC but the outcome of all this is rather striking and it smells of collusion. It would appear that the Fed and SEC hatched a plan to shore up the major banks by enabling them to improve their profitability through their proprietary trading units. As described in the article above (see link), these banks were suffering losses due to the shrinkage in M&A activity and other "normal" banking functions. Trading in the market was a way to pump up their profits. But the question was how to do that while lowering their risk to ensure their trading operations were profitable.

The SEC and Fed would have to turn a blind eye toward what the banks were about to do. In fact if anything the Fed is an eager participant in the money-making scheme because it's a way for the Fed to inject massive quantities of money into the banking system. And once they stop reporting M-3 this month they'll be able to do it on a scale never before seen. The banks would be allowed to collude in their trading efforts to manipulate the market, and the SEC and Fed would look the other way with the understanding that it would "decrease the volatility of the market". In other words, control the wild swings from happening again (look at the chart of 2000 and 2001 and you can see where they were coming from). Joe mentioned to me that he contacted the SEC to complain about the potential for free market corruption through massive program trading in a few hands, to which they replied that they felt it was a good thing because it leveled out volatility. The regulatory agency had decided that they didn't want to regulate the banks' trading activities.

And this brings us back to the increase in program trading that we're seeing. It started to accelerate higher right after this SEC white paper was published in May 2002 where they were concerned about a major bank failure. Coincidence? Probably not. We're now almost 4 years later and the amount of program trading has more than doubled. If you're interested in following the stats on program trading, here's the link: http://www.nyse.com/Frameset.html?displayPage=/marketinfo/ProgramTrading.html. The scary part is how much money the banks are making now from their trading, far more than from their other banking operations.

If we look at the earnings reports of the NYSE member banks we can see a huge swing in where the money is coming from. I'll use Goldman Sachs' numbers, just released on Tuesday, to make my point but first it's interesting to go back a couple of years to get a little history. In November 2003 there was a report in Reuters that Citigroup had made plans to use its own capital to bet on stocks, bonds, derivatives and currencies. This came 5 years after Chairman Sanford Weill had sharply reduced the amount of trading of their own capital because he saw it as "too volatile and unpredictable". But by 2003 Goldman Sachs (GS), Lehman Brothers (LEH) and Morgan Stanley (MWD) were reporting huge profits from proprietary trading in recent quarters. Something had fundamentally changed to get all these banks to suddenly feel it was no longer too risky to trade their own capital.

About a year after the SEC white paper, the bank that everyone was worried about, JPM, was doing very well. The Wall Street Journal reported concerns that JPM was making a lot of money in the "risky" business of trading their own capital. They said, "Profits have been increasing recently due to a small and low profile group of traders making big bets with the firm's money. Apparently, an eight man New York team has pulled in more than $100M of trading profit with the company suggesting it is a result of better market conditions and not greater risk." As you'll soon see, that $100M is now chump change. In June 2003 Bloomberg reported that GS and MWD, the two top merger advisors and equity underwriters were now making twice as much money from trading than from investment banking. All of this was happening at a time when banks were suffering the biggest loss of jobs since the Great Depression because of the slump in their business. These mega-banks were in trouble and it seems trading their own capital, at lower risk mind you, came just in time to save them.

This is already getting too long for the newsletter so I'll wrap this discussion up on Monday. I'm sure you can see where I'm headed with this and it's disturbing to think about the "cooperation" between the big banks, the SEC and the Fed in the name of protecting banks and "reducing volatility". I'll review actual numbers to show the astounding profits being made by the banks' trading departments. The huge increase in program trading along with the efforts by the Fed to inject large quantities of money into the banking system (which they do through their primary banks) has created a fool proof way for the banks to make money. Market manipulation is an understatement for what's happening now and of course it has a huge impact on traders and investors. To be continued...

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

Today's housing starts and permits was credited with the rally in the home builders and by the chart you can see price rallied above its downtrend line from January. It managed to make it up to its broken uptrend line from October 2004 before pulling back. This index will stay bullish if it can now hold above its downtrend line on any pullback for a retest. Resistance is just overhead at its 50-dma at 916 but if it can successfully challenge that level there's the possibility we're going to see the home builders consolidate in the larger sideways triangle. The bearish setup here, if it drops back below its downtrend line, and certainly if it breaks back below 835, is that the EW pattern is set up for a strong 3rd of a 3rd wave down. It would not be pretty for the home builders if that's what's coming.

Oil chart, April contract, Daily

Oil is at an important inflection point. If it rallies much further above $64 there's a chance we'll see head back up a lot higher. But so far it's bumping its head against its broken uptrend line and 50-dma, both just under $64 and the consolidation could be just part of the development of the right shoulder of a potential H&S as shown on the chart. A closer view of the bounce from February also shows why this would be a logical place for oil to roll back over.

Oil chart, April contract, 30-min

This chart shows the bounce from its February low and I've got it labeled as an A-B-C upward correction. The rally from the last low on March 8th needs to be a 5-wave move, which today's leg completed, and wave-C = wave-A at $63.90. The high today was $63.90. If this is the correct pattern we'll see the selling start again from here.

The EIA reported natural gas inventories today and working gas in storage was down 55 Bcf to 1,832 Bcf last week. Stocks were 439 Bcf higher than last year at this time and 688 Bcf above the 5-year average. The price of NG has risen off its March 7th low of $6.58 and closed today at $7.26.

Oil Index chart, Daily

The oil stocks look a little more bullish than oil itself since they've rallied back above the 50-dma. Of course it's been cycling up and down and all around its 50-dma and therefore it's hard to tell if it has broken resistance or not. The stocks may have also been lifted with the broader market this week. Based on the clearer pattern I see in oil I would say be cautious if you're long this sector. If on the other hand this sector is leading the way, it says oil will keep rallying with it.

Transportation Index chart, Daily

Yes, another high in the Trannies. They hit it at the open and then it was downhill from there for the rest of the day. It's too early to tell by the short term charts whether the current pullback will lead to yet another high, but the daily chart says this may be it, again. The Transports have now rallied up to the top of a long term parallel up-channel for price action since the March 2003 low. That will likely be significant resistance all by itself. But at the same place is the trend line along the highs since last November which marks the top of a potential ascending wedge (just another of many that are showing up across the board). The internal pattern of the rally leg from March 8th supports the idea that this leg up is the very last one and once again I'd pick on the weaker stocks in this index. As I depict on the chart, it's possible we'll see a pullback and then a final push higher to about 4650 but we won't know that until it happens. In the meantime, I really like the potential for a long term shorting opportunity presented here.

U.S. Dollar chart, Daily

The US dollar had a bad week. What looked like a breakout in progress turned around and bit dollar bulls. Once the dollar fell back below its downtrend line, that was a sell signal (just like we're now getting on QQQQ. Now we'll see if trend line support at $89 holds. Any further break down from here will likely be long term bearish for the dollar. But it's still possible that this pullback is simply part of a larger correction from the February high. If so it needs to turn back around immediately and head for new highs. The bulls are on the ropes with this chart. Oil may provide some clues as well--oil and the dollar have been counter-cyclical so if oil is ready to roll back over that could mean the dollar is bouncing.

Gold chart, April contract, Daily

With the dollar's decline this week I would have expected gold to get more of a bounce than it did, and that might be bearish for gold. If the dollar bounces back up, gold could take a hit. Right now it's pressing up against its broken uptrend line like a cat rubbing against its owner's legs. It has been held down each day by its slowly rising 50-dma. It needs to break free of $560 and keep climbing in order to get another rally leg going. Otherwise this looks like it's setting up a kiss goodbye against resistance in which case the next leg down should be swift.

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

Tomorrow finishes a busy week of economic reports and of course the remaining options and March futures expire so we'll start fresh next week. Pre market we'll get the capacity utilization and industrial production numbers and unless these are very different from expectations they should have a muted response by the market. Just after the bell, at 9:45 AM we'll get the preliminary Michigan sentiment report. Again, unless there's a surprise, this should not have much of an impact. A negative surprise though could stop the current rally in its tracks.

Sector action was mixed today with my list showing about an even split between red and green. The leaders on the green board were the energy indexes, retail, healthcare and utilities. The red sectors were led by the SOX, disk drives, high tech, computer hardware and the Trannies.

The market internals today were fair but mixed, but then so was the day. Large caps were up, techs and small caps were down. Advancers to decliners were mixed; volume was on the light side. There were lots of new highs vs. new lows though and in fact the number of new highs on the NYSE could be considered overbought. The two previous times it got this high were the two highs in January which were both followed within days by a more significant pullback. Today the NYSE stopped at its trend line along the highs from August 2005 (at 8262), the same trend line that stopped the rallies in January.

And here's a heads up from the VIX.

Volatility Index chart, Daily

It's always hard to trust the VIX during opex week, just as it is hard to trust the put/call ratio, but today we got a sell signal from the VIX--it pierced its lower Bollinger Band and then rallied off its opening low. This may have been nothing more than opex activities so use this only as a heads up that something more significant could start to the downside. When I see this kind of sell signal with the market at or only marginally above significant resistance levels, I take notice. If you're long the market, continue to chase this higher but keep your stops comfortably close by. But until proven otherwise, the bulls are running so stay out of the streets unless you're running with them. Good luck and I'll see you on the Monitor.

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