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Market Wrap

Bernanke Battle

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The consolidation since last Thursday continued through today. Today's excuse could be written off as the market was simply waiting for Bernanke to finish his talk at the Economic Club in New York at 7:00 PM this evening. Those who have been long the market are nervously holding their positions but not wanting to add to them for fear Bernanke might say something bearish. The bears were afraid to sell the market today for fear Bernanke might say something bullish. Plus bears have had their heads handed to them the past week for even thinking about shorting this market. So Bernanke's speech was as good a reason as any to simply consolidate last week's significant gains.

The impression I have of this 3-say consolidation since Thursday morning is that it's bullish. Usually when you see a strong move followed by consolidation it means the move is going to continue in the original direction. In fact I show two charts for SPX below, one daily and the other a 120-min. The daily chart shows how the rally started in October, shot higher, consolidated and then continued higher. I wouldn't be a bit surprised to see a smaller fractal of that play out on the 120-min chart. It means we should expected a move higher but we're probably in the tail end of the move up from March 8th.

After the current leg up completes we could very close to a significant market high and therefore I would want to keep pulling stops up underneath current price action and follow this higher if that's where we're headed. But the larger price pattern, and even the fact that we're in the month of March, tells me to be careful chasing this rally much higher. I would not recommend new long positions unless you're day trading this market. The fact that we have record in-flows of money from retail investors is classic. They're always the last ones to the party and just in time to take the inventory from the Boyz who are probably beginning to sell into rallies. That may even be part of the current consolidation. The news of 4-5 year highs in the market convinces many who have been on the sidelines that it's now safe to get back in the water. Little do they realize the Boyz shot the lifeguard so he can't call out shark sightings.


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We are still facing classic topping signs such as bearish divergences at new highs and declining volume during the latest rally. Other than Friday's large-volume day we can see a downtrend in volume since the January low in the DOW. This is typical of the last leg in a rally as the buyers become scarcer. So while I see the potential higher prices at least early in the week, I think we're close to putting in a more significant high. I don't know yet whether it will be the high for the year or just for a few weeks but the risk will be clearly for those who are long the market.

We had only one major economic report this morning and it was leading economic indicators (LEI). The number fell 0.2% in February which ended the 4-month streak of increases each month. This was a little less than the -0.3% that was expected. January's +1.1% was revised down to +0.5%. Economists see the -0.2% as an indication that growth is slowing but that the economy will continue to expand more slowly. Well of course they do. Five of the 10 indicators declined in February, with the 3 largest declines in vendor performance, consumer expectations and jobless claims. The biggest gainers were core capital-equipment orders, money supply and the average factory workweek. The coincident index rose 0.3% in February, and the lagging index was up 0.1%. This report was essentially ignored by the market, as it usually is, and doesn't tend to have much of an effect on the Fed either.

Individual stock news was relatively quiet today. Wal-Mart (WMT 47.75 +1.07) bounced to their highest level for the year, although still below their downtrend line from November 2004 (48.72), after their announcement that they will expand into China. For some reason that concept reminds me of Guppies eating their young. At least they won't have to incur the costs of shipping all those Chinese products to the U.S. before selling them. WMT currently employs about 30,000 people in 56 stores in China and they're planning to open an additional 15 to 20 stores this year and will be looking to hire another 150,000. At the rate they're going they will go from the largest employer in the world to the mega-employer of the world. WMT helped hold the DOW up today, with its +2.3% gain today, the best of the DOW components.

Microsoft (MSFT 27.89 +0.39) was the 2nd leading stock in the DOW components but holding the DOW back to finish slightly in the red today were General Motors (GM 20.85 -0.28), McDonalds (MCD 34.73 -0.37) and Alcoa (29.80 -0.31), each down a little more than 1% today. There was no particular theme in the losers and like the broader averages today the DOW was simply consolidating today with no direction apparent.

DOW chart, Daily

I have depicted on this chart a high soon that will be followed by a pullback and then another run to a new high. That's one possibility. The other possibility is that we're putting in a more lasting high with this leg up and for that reason I urge caution if you're long the market and don't chase this higher with new long positions. While the DOW could rally another 1% or so, I see higher risk without the reward in taking new positions. The risk for those who want to short the market are obvious--last week's rally, with practically no pullbacks, was not kind to shorts. The fact that many are loading up on puts as the market rallies higher is actually bullish as they could be forced to cover positions with an additional rally and that would just add buying pressure. So it's too early to be thinking short but I just don't like the reward potential for new positions. Hold 'em if you got 'em but don't be bashful about folding 'em either to take your money off the table.

SPX chart, Daily

SPX has a similar looking chart to the DOW but not quite as strong. I see upside potential anywhere between about 1313 and 1320 which again is not enough to warrant new long positions. If we get a rally tomorrow I'd think about raising my stop to just below the lows of the recent 3-day consolidation. We're getting into trend line congestion near the current price level so it's a natural place to consolidate. A break above 1320 could actually light a fire under the short positions and we could see a bottle rocket blast higher. If that were to happen (too much too fast) I would want to exit most of my long positions and take the profit (sell into the rally so as to avoid any potential fast retracement).

SPX chart, 120-min

Looking a little closer at the move up from the February low I'm watching to see if we get just a 3-wave move for the 5th wave (as part of the ending diagonal or ascending wedge pattern). We might get a little larger pullback first and then finish the move to the upside--it's risky either way at the moment. One thing that could continue to give the market a boost is the amount of money coming into the market through the Federal Reserves money operations. As I've stated several times recently, M-3, which reports the activities of the Fed, will no longer be reported after this week so they'll be free to print as much as they want. That liquidity could easily keep the market higher and it's a caution for any who would like to short the market. Here's a graph of M-3 over the 16 years.

M-3 Money Supply, 1990-2005, courtesy economagic.com

As you can see, the Fed has been a busy little beaver since the mid-1990s, just when our stock market went on a parabolic path upwards. At the time much of the liquidity was for Y2K concerns but it did not abate after 2000. Obviously they can't stop bear markets, like 2000-2002 but the extreme volatility of that period may have been a result of the Fed's money being used in an attempt to stop the decline. As I'll discuss below, to wrap up my discussion on the banks, program trading along with a lot of money can do some strange things to our market.

Nasdaq chart, Daily

The COMP continues to act confused. It can barely make any headway while the large caps rally to new annual highs. But the pattern since January looks like a bull flag and looks ready to rally. Then I look at the MACD and think the top its flag, the downtrend line from January, is probably a good place to short this. If it manages to rally out of this mess I see upside targets at 2355 and then the top of its wedge pattern up near 2400. The 50-dma seems to have lost its usefulness so watch for resistance above or support at its uptrend line near 2260.

QQQQ chart, 120-min

QQQQ is very close to making a decision here--it will either be held back by its January downtrend line, which is essentially where it closed today, or it will make a break for it to the upside, I'm not sure it will make much progress to the upside but it may be enough to pull in more new bulls. The pattern of the leg up from March 8th and the broader market make me question the upside potential on this one. Be careful and don't get suckered in on a new high. By the same token it might be a tad early to short this.

SOX index, Daily chart

The SOX just can't get off the mat. What was support at 500 has now become resistance. But interestingly, while I see nearby resistance for the broader market I see nearby support for this one. Just one more reason to be cautious about where we are right now. Support for the SOX should be in the 478-480 area but I'm also seeing some short term bullish divergences setting up so I would not want to establish new short positions in the semis and pull your stops down on any short positions you might currently have. I'm wondering if the SOX is going to break support and pull the broader market down or if the broader market is going to break all kinds of resistance and pull the SOX up with it.

BKX banking index, Daily chart

The banks continue to struggle with resistance at its trend line along the highs from November. Daily stochastics is reaching overbought while MACD threatens to leave bearish divergence if it rolls over here. I see the banks topping soon and it's too early to tell whether this will be a lasting high or if instead we'll see a pullback and another rally later (April?) inside its ascending wedge pattern. That ascending wedge pattern is bearish so we'll have to see how it plays out inside the pattern.

On Thursday I started the discussion about the mega-banks and their enormous profits derived from trading their own capital with small teams of traders using proprietary trading systems. After the SEC issued a white paper in 2002 outlining concern about a potential failure of a large bank (and everyone knew they were talking about JPM at the time), we've seen more than a doubling of program trading and an enormous increase in trading profits for the mega-banks. These banks are also the primary dealers for the Fed's monetary activities. We know there is a Working Group (dubbed the PPT) that was created nearly 20 years ago and the members of this group include the Federal Reserve Chairman, chairman of the SEC, chairman of the Commodity Futures Trading Commission and the heads of the large banks.

I've been saying for quite some time that the PPT seems to be getting much more active in the market in what appears to be an effort to hold the market up. But it may not be the PPT at all since it could be simply the Fed looking for a way to get their freshly printed, electron-created money into the system. The big banks take the capital provided by the Fed, add their own trading capital to it and kick in the program trades that we're seeing. When the Fed needs to pull money out of the market, the banks sell right along with them. Guaranteed results. This is why the banks have stated they are using their "proprietary trading system" with lowered risk. Well, I should say so. Even if the Fed isn't involved, it's not a stretch to think that the small trading teams of these large banks are "connected" and can ensure they're not fighting one another. That's how you can get the billions of dollars needed to move the market. You can read last Thursday's report for more information introducing this topic that I'll try to wrap up tonight.

When looking at these large banks, the 15 member firms of the NYSE, and their program trading statistics, it's interesting to see what categories it falls under. When program trading first started years ago most of it fell into the index arbitrage category which is basically simultaneous trading of futures and stocks to take advantage of very small differences between the two. Today index arbitrage program trading is about 7% of the total. The vast majority of the trading is done in their own accounts. Additional information about these program trades can be found at this link: http://www.nyse.com/Frameset.html?displayPage=/marketinfo/ProgramTrading.html The 15 firms accounted for 94% of all the program trades that occurred. The 6 top firms accounted for 65% of the total and some of these do virtually no index arbitrage trading and do mostly trading in just their own accounts. UBS Securities, Morgan Stanley, Goldman Sachs, Lehman Brothers, Merrill Lynch and Deutsche Bank Securities are the top 6 banks doing this and just these 6 banks program traded 38% of all the trading done in a recent week. It's relatively easy to understand the clout these banks have over the market especially if there is any coordinated effort between them (I'm trying to refrain from using the term collusion).

To give you a visual of how program trading has been on the increase, check out this chart. Jane had posted this chart earlier today on the Market Monitor and she had downloaded it from etfdigest.com.

Program Trading, 1999-2005, courtesy etfdigest.com

This is a measure of program trading on the NYSE so it's against a large universe of stocks. If we assume most of the baskets of stocks that are actively traded via program trading are on the DOW and SPX, we can assume the percentages of stocks traded on the SPX is a much higher percentage. We could easily be seeing 80% and higher for program trading on the S&P 500.

There have been reports written by others who watch tick charts and they've noticed some interesting correlation between large jumps in the tick charts when program trades kick in. If the market starts to settle, instead of waiting for it to pull back so that they can buy stock for their clients at a reduced price and then sell it higher, they immediately bump the price up and buy it higher. The conclusion is that it appears there is more of an effort to hold the market up than to buy stock at the best price for their clients. It's more important to keep the market up to entice more money into managed accounts than it is to make money for their clients.

If this is true they are violating their fiduciary responsibility. This is criminal and yet the SEC looks the other way. The only way this can work is if the directive and protection is coming from the top. If the banks were not working together on this, the program trading would create more volatility not less. The fact that volatility has decreased is highly suspicious and yet we hear of no investigations into this. It is sanctioned stealing from the public in the name of bank stability and lowered volatility. When the banks pull in hundreds of billions of dollars into their own accounts, where do you think that money is coming from? How is it they can make that kind of money and yet managed accounts for the most part have been flat for years?

For long term investors who like to dollar cost average into their positions over time, reduced volatility actually hurts them. The market hasn't moved much over the years and their accounts haven't made much money. But the banks take their fees for trading their accounts they're making all the money. And if 6 member banks account for 38% of all shares traded on any given day, I suggest they have a pretty good control over the market. Why else would these major banks suddenly declare the market as less risky? They're continuing to increase their exposure to proprietary trading due to "less risk". The only way for the market to become less risky for them is to have more control over their trades and to have some kind of advantage over the next trader. With almost guaranteed results it seems logical that they would pour even more money into their trades and make even more from them.

So, how much money are we talking about? Let's use Goldman Sachs' earnings statement released early last week which is representative of the big banks. Here's a segment of their report:

$ in millions

Three Months Ended % Change From
-------------------------- -----------------
Feb. 24, Nov. 25, Feb. 25, Nov. 25, Feb. 25,
2006 2005 2005 2005 2005
-------- -------- -------- -------- --------
Investment Banking
Financial Advisory $ 736 $ 546 $ 414 35 % 78 %
Equity underwriting 283 205 186 38 52
Debt underwriting 452 197 293 129 54
-------- -------- -------- -------- --------
Total Underwriting 735 402 479 83 53
-------- -------- -------- -------- --------
Total Investment Banking 1,471 948 893 55 65
-------- -------- -------- -------- --------
Trading and Principal
FICC 3,740 1,850 2,489 102 50
Equities trading 1,607 602 829 167 94
Equities commissions 842 800 721 5 17
-------- -------- -------- -------- --------
Total Equities 2,449 1,402 1,550 75 58

FICC is Fixed Income, Currency and Commodities revenue. Here's a link to the full report as found on yahoo.com: http://biz.yahoo.com/bw/060314/20060314005560.html?.v=1

Look at the line below FICC, which is the Equities trading, and notice that revenues were up 94% year-over-year (167% over last quarter). Fixed income, currency and commodities trading revenues were up 50% (102% over last quarter). If this trading were a result of trading OPM (other peoples' money), their commissions should be up roughly the same. But commission income was up just 17% y-o-y and a very small 5% increase over last quarter. Commissions were up only 5% while FICC and equities trading income was up 118% between the two. And compare these trading incomes with the income from their normal banking business above that--nearly double. It's no wonder the banks are doing so well and it has nothing to do with their banking business, which would be a true measure of the health of their business and the economy, and instead has everything to do with how well they're trading their own capital. With a virtual lock on the market they can't help but make money.

But the market always wants more. With the high growth rate in profits, as indicated above, how are they going to continue to match this level of performance? They will have to constantly strive to do more trading with even more capital and greed is an ever-present danger. This will make it more and more obvious what is going on and one has to wonder how much longer it will continue without being challenged. As reader Joe, who get me started on all this, commented, "Goldman and the others will have to do even better the next quarter, and the next, and the next, and... To do so the 'line' that must not be crossed will pushed out further and further and the financial markets will become even more unstable, with an eventual crisis almost guaranteed." And then Congress will get involved and make believe they didn't know any of this was happening.

So while the banks make money, which may be reason enough to buy bank stocks, it does not necessarily reflect the state of our economy. In fact it's a smoke screen for what's going on behind the curtain. I've been thinking it's the Fed and their money (which obviously helps the banks by allowing them to trade with the Fed's money) but have come to believe the problem is right in our own market. I know most of you don't have a problem believing the market can be manipulated by big money and we have the biggest bank in town (the Fed) supporting its primary dealers in a scheme that is unfair to the investing public. I suppose some day the arrogance of the players will come back and bite them in the keister and that probably will not be a good thing for the banks and by extension our entire financial system. As the banks take bigger risks (even though they don't see it as a risk anymore), the more dangerous the game becomes.

Two weeks ago JPM was accused of manipulating the market in Japan (I know, this is shocking news) as reported in the Kyodo News, March 9, 2006: "The Financial Services Agency ordered the Japan unit of J.P. Morgan Securities Asia Pte. Ltd. on Thursday to suspend part of its operations for five to 15 business days for manipulating the value of a Tokyo Stock Exchange futures index with a massive sum of "cross trades" on Nov. 4, 2004. The FSA imposed the disciplinary order in light of a recommendation by the Securities and Exchange Surveillance Commission to impose punitive measures on the brokerage. The regulatory authorities slapped the company with a similar penalty in 2003 for market manipulation. http://asia.news.yahoo.com/060309/kyodo/d8g83rqg0.html I'm sure JPM is not doing this just in Japan.

So what can we do about this? Not a whole lot really. As long as the stock market is being held up and investors aren't losing money (they are but it's in performance vs. actual losses) there won't be much interest in clamping down on this, especially when it has the support and blessing of the SEC and Fed Reserve. Why doesn't Congress become indignant about the massive sums of money the banks are making? Because it doesn't get the same attention as the profits of the energy companies. But if and when a crash occurs you can bet they'll be looking for where to pin the blame. In the meantime understanding what is occurring will help us understand what to do when we see these program buying (and selling) runs begin, like we saw during opex week. While the fundamentals or the charts may not support the kind of buying (or selling) we see at times, we need to understand that it's a momentum move and to jump aboard. Whether the move is going to be for a day, a week, or more will be the hard part. But that's always been true. The trick for us traders will be to recognize the foot prints of these massive program trades and learn to hitch a ride with them.

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

The home builders did a perfect tap of their 50-dma and pulled back fairly sharply today, down 2.5% today. If they can hold above the broken downtrend line now, near 866, and then bounce again that would look like a bullish kiss goodbye. Getting back above the 50-dma after that would likely point the home builders up to its downtrend line from last July, up near 1000. But if they drop back below 835 it will likely be a quick drop much lower.

Oil chart, May contract, Daily

Oil is either consolidating for a push higher or it's getting ready to break $60 for good (at least for a long while). The 200-dma is supporting price, as it did in the beginning of March. If oil breaks below $62 and then below $60 it should be a quick trip down to its lower uptrend line currently near $55.

Oil Index chart, Daily

The oil stocks have been a little more bullish than oil itself but that may have been as much a factor of last week's market rally as anything else. My expectation, like oil, is for a continuation lower now and a break below the early March low of 533 would confirm it. Like oil, the stocks could be forming a H&S pattern with the neckline approaching 540. The downside projection is near 450 which is close to the Fib projection for the next leg down, if it's to come. Obviously we could see this turn right back around and head up to the top of the parallel up-channel. Until I see evidence of that (corrective pullback followed by another new high above 572) I'm leaning to the downside on this one. Jim has done some really good fundamental analysis on oil and oil stocks and it makes me very nervous calling something 180 out from his call. My analysis is strictly by the chart and the EW pattern and has diddly to do with funnymentals. So understand where I'm coming from on this.

Transportation Index chart, Daily

The mighty Transports are not ready to come down off the tower yet. As I suspected last week it looks like we're going to see this index continue to press a little higher. Changing the complexion of this index by outing some of the laggard airlines and adding railroad companies, and then mixing in the basket buying in program trading has done wonders for this index. But like the banks themselves it may not necessarily accurately reflect the broader market which is why we may be continuing to see the inter-market divergence between this index and the DOW. The bearish divergence continues and I think it's an accurate predictor of what's going to happen next.

U.S. Dollar chart, Daily

The US dollar needs to hold on here otherwise the bull market in the dollar could be over. With the massive creation of new money by the Fed I wouldn't be surprised to see this roll over (which would probably give oil a boost so watch this one for signals in that regard). But if the dollar can hold its uptrend line it still has a chance to continue its rally to new highs.

Gold chart, April contract, Daily

The candles are getting smaller and it's still hugging its 50-dma and uptrend line, but from underneath and that makes this look bearish. If gold can't get a rally going soon, and get back above $560, another rollover here could see a swift decline towards $500.

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

After today's lonely economic report, tomorrow is not much better--we have two reports and they could move the market if the numbers key off anything in particular that Bernanke discusses tonight. The Core CPI (the one that matters to the Fed) and PPI (the one that matters to everyone else) will be released at 8:30 AM so watch for how the futures might react to the data if they haven't already reacted to Bernanke. Other than those two reports, the only ones that could move the market are the housing numbers on Thursday and Friday.

Sector action reflected the broader market today, with losers about even with winners. The winners were led by the airlines (+3%), transports, internet, healthcare and other computer hardware. Those in the red today included the energy indices (OSX down 3%), utilities, gold and silver, disk drives, biotechs and retail.

Oracle (ORCL 13.73 +0.12) announced earnings after the bell and reported a 42% jump in net profit, almost as good as recent reports from the banks! But they didn't get the same reception. The stock sold off after the news dropping to 13.19, nearly -4$, by the close of after-hours trading. Some stocks just don't get no respect. But it's all about growth and investors were not happy with the growth prospects for ORCL. Revenue, after adjusting for prior acquisitions, was up 14% to $3.53B from $3.09B a year earlier, in line with estimates. Net income was $765M, or 14 cents, which was up from last year's $540M, or 10 cents, and slightly higher than expectations. But growth in their largest business, database software, has been sluggish. Prospects for future growth was apparently not enough for investors who proceeded to sell off the stock after the close.

If the market was on hold for the Bernanke discussion this evening, we should see a continuation of the rally tomorrow. If Bernanke says something scary (like he sees multiple non-stop rate increases until the cows come home), and Core PPI takes a big jump tomorrow morning, expect the market to tank. But then maybe not--that's when the banks will step in with Fed money, and their own, to goose the market back up and scare the bears away. Remember that little statistic about a lot of puts being purchased as the market is rallying. Bulls like to see non-believers in the rally so they get their help buying when they feel the need to cover. Trying to figure all that out is taxing on my feeble brain and it's why I stick to the charts.

And the charts are telling me to expect a rally tomorrow but don't hang around too long. If we get another 100 points out of the DOW I'd say thank you very much and pull at least some of your money out of the long side of this market. But if the market gets a nasty surprise tomorrow morning, I've seen these consolidations suddenly break down hard--it's as if too many were leaning on the long side expecting the consolidation to resolve higher (as I'm expecting). When they get a nasty surprise they all bail en masse and you don't want to buy that kind of dip. Unless the banks step in... Be careful, good luck tomorrow and this week and I'll see you on the Monitor.

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