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Market Wrap

Volatility Reigns

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If you like to play reversals this has been the week for you. Since Monday's close we've had a reversal of a reversal of a reversal in the DOW and S&P 500. But if you wanted to just go long the market and not be bothered by trading, you needed to by the techs and small caps. Even the large cap techs finally joined the tech party and appear ready to break out. The large cap techs, the NDX and QQQQ, have not done as well as the Nasdaq in general. While the COMP broke out to a new 5-year high yesterday, the NDX was trying to break free of its downtrend from January's high. It's still a long way from making a new 5-year high but at least it held onto yesterday's gain.

But there's a real battle going on in the blue chips and I suspect it has to do with month/quarter end. While money was rotating into the techs and small caps for show and tell in the funds' portfolios, there seemed to be an effort to hold up the DOW and SPX as best they could so as not to scare the public. This would be done if there's going to be an effort to finish unloading inventory by smart money and they don't want the bears playing in their sandbox yet. By hitting the market with large day-long buy programs it keeps the bears back on their heels and afraid to short. That keeps selling under control (their control) so that they can keep it up and sell to the retail crowd coming in on all this good news about the market being at multi-year highs.

My guess is this could continue for another week or two as we see the market pushed a little higher. We might see a little more selling over the next day or two but that should set up a good long play for traders. Longer term investors need to keep stops close by and chase this higher but I don't see enough potential reward to the upside to warrant new long positions. Hold what you've got but you should be in profit protection mode now. It's probably still a little early for the bears to get on the field.

There were a couple of economic reports this morning but none of them moved the market much. Prior to the open we got the final GDP number which was 1.7% vs. the preliminary 1.6% last month. So not much of a change and was what the market expected. The market is pinning its hopes on a strong rebound in growth for the 1st quarter of this year. The reasons cited for the weak growth in Q4 last year was weaker consumer spending for services, which was a downwardly revised 0.9% (weakest advance since early 1995).

Also down was spending on durable goods which fell -16.6%, the biggest drop since 1987. Spending was up though for non-durables and services, +5.0% and +2.6%, respectively. Another number which could be telling was business investment which was up 4.5%, with investment in equipment and software rising 5.0%, the slowest in nearly three years. As mentioned below, with record profits last year, as a percentage of GDP since 1966, one has to wonder why businesses weren't investing more of those profits.

The slight increase in GDP to 1.7% was due to an increase in business inventory. The statement that "businesses increased inventories more than originally assumed" reflects their bias. It seems not to dawn on them that inventories were higher because of weaker demand. It's all in how you state the issue. Included in the revised numbers were final sales in the economy which fell -0.2% in Q4 which was the weakest performance since the first quarter of 2002. Core consumer inflation was revised up from 2.1% to an annualized 2.4% rate which is higher than the Fed's implicit target rate of 2%. Last year's number was 2%. This backs up the Fed's concern about inflation creeping higher. Economists are predicting GDP for Q1, which ends tomorrow, will be about 4.6% which would average out Q4/Q1 to 3.2% which is the rate most are expecting for the rest of the year. We'll see.

Corporate profits did very well. Before-tax profits rose +14.4% to an annual rate of $1.48 trillion which was 11.6% of GDP. This was up from $1.29 trillion, or 10.3% of GDP, in the 3rd quarter. This makes corporate profits the largest share of GDP since Q2 1966. Profits are up 21.3% in the past year making it the fastest growth in 3 years. I'm sure the profits in the energy companies and banks had a small part in that. In fact, profits of financial corporations increased by $104.9B annualized, while profits of non-financials rose by $95.5B and profits at utilities more than doubled.

Economists feel this corporate profits picture is good news though since it provides a lot of capital for investment this year. But as mentioned above, investment in equipment was down last quarter. One thing to watch in this regard is share buy-backs. If companies start to get more aggressive about buying back their shares it will likely mean they are not as confident about the future as economists are currently feeling. Instead of spending their capital on new investments, share buy-backs would look like a defensive move so keep an eye on that activity in the future. Or they may just keep the money in the bank earning interest. Hopefully not many of them are using the capital to invest in the stock market or financial derivatives. That seems to be the game many want to play now.

Jobless claims data was also released pre-market and showed initial claims fell 10K to 302K, still above the 300K number people like to see. The 4-week average fell by 1,500 to 310,750. Continuing claims rose 20K to 2.483M which is roughly equal to the 4-week average of 2.472M. These are still very good numbers and shows the economy is at least holding on. It's not robust and many feel not enough jobs are being created to fully absorb those looking for work (never mind the higher paying jobs they're losing), but these numbers continue to hold at 5-year lows. The Fed watches the continuing claims number to gauge how tight the labor market is--if it gets too tight that could create a situation where we'll see higher wage inflation. Most people now expect the Fed to raise rates another 0.25% to 5.0% at their May 10th meeting.

General Electric (GE 34.65 +0.72) got a nice lift today after Morgan Stanley blessed it with a buy rating and a call that it would likely double in price over the next 3 years. Hmm, I wonder how many shares they're trying to unload. Nah, that would be unfair of them and not playing by the rules. I wasn't watching but I'll bet Maria was just squealing with delight. GE jumped back up over its declining 200-dma, as it did 2 weeks ago, so we'll see if it does a better job holding above. It got a launch off its 50-dma and it looks like it could carry higher on some momentum but only if the rest of the market can get some upside going as well.

The rest of the DOW components didn't fare as well. Several were down more than 1% with General Motors (GM 21.06 -1.09) leading to the downside today with a 4.9% decline. Today's news on GM was that it was moving closer to selling a 51% stake in its GMAC business but it's going to have a tough time dealing with Delphi. Delphi is expected to ask a federal judge to cancel its union contracts Friday since it appears it will not be able to reach an agreement with its unions to lower wages for its 34,000 U.S. hourly workers. Cancellation of the UAW contracts could lead to a strike which would obviously hurt GM.

So the DOW didn't do so well today but it was clearly the weak link. The techs and small caps are holding up better. The inter-market divergences continue between the indices so let's see if we get a clear enough picture as to what's going on.

DOW chart, Daily

The DOW has looked weaker than the other indices recently but it's still trying to hold onto its 20-dma, currently at 11157. The DOW closed just below that today so it could be headed for its 50-dma and October uptrend line, both just above 11K. It's possible that the DOW may have already topped out but the patterns in the other indices tell me there's a new high coming after a little more pullback. Perhaps the others will make new highs without the DOW, a common occurrence at major tops, but that's just speculation at the moment. If the rest of the market is able to bounce this one should also. From a short term perspective it looks like we should see another day or two for the market to pull back before setting up another rally leg.

SPX chart, Daily

Of all the indices, this one is actually one of the cleanest. Its ascending wedge pattern would look best with one more new high (as the 5th wave in the move up from February). It's currently finding support at its October uptrend line but if the line is drawn off the March low, support is at 1286, just above its 50-dma at 1284. I wouldn't be surprised to see any pullback stay above 1290. A break below, that stays below its 50-dma would obviously be bearish and would call into question the new high as depicted on the chart.

Nasdaq chart, Daily

New 5-year highs! Break out the party hats, more champagne for the buyers--keep them buying and don't remind them that the COMP has only recovered about 30% of its 2000-2002 78% haircut. It's still down 55% from its all-time high. It's even worse of course for the large caps--NDX got an 83% haircut and is still down nearly 65%. It has barely been able to retrace 21.4% of its decline, a Fib level that is considered the minimum needed in a retracement. Pretty sad actually and I know a lot of people pinning their retirements on the recovery of this index. I've been eyeing a Fib projection at 2355 for what seems months now, which is two equal legs up from its April 2005 low. I show another Fib projection for two equal legs up from January 3rd at 2382 which is close to the top of its ascending wedge and is also a Gann level that I mention below and which I'll explain more about next Monday.

QQQQ chart, 240-min

Taking a step back on this one to get a look at the pullback from January shows price has now rallied firmly above the January downtrend line so it would appear the leg down into the March low was the end of the pullback correction (as a truncated wave-C which barely met the first Fib projection for 62% of wave-A). I've drawn a preliminary ascending wedge for the push up since the March low even though it's a bit early to draw it in. I want to show what I think could play out in this index since the rallies have been corrective--a mark of an ending diagonal if that's what we're going to get. It might not even make a new market high while the others make new highs. This index is a guess at this time because of its failure to follow through much. Caution is warranted.

I've referred to Fibonacci timing windows in the past and they've proven very effective at alerting us to potential turn dates. We usually don't know the direction of the turn until we're approaching the date but as the date window approaches we usually have a pretty good idea as to whether or not we should be looking for a high or low. The Fib turn dates that I'm using here are based off the DOW's January 14, 2000 high and then the subsequent turn dates since then. By making Fib projections from previous turn dates, based on the relationship between the number of days from 1/14/00, we can get an idea as to where the next turn date could occur. While the market may seem chaotic and subject to the whim of traders' emotions, it actually seeks order and it's why we often see symmetry in the market. Using the Fib projection and some other tools, I'm looking for a potential market turn during the 1st or 2nd week of April. We'll have to see what the market is doing into that time frame in order to determine the direction of the turn.

A recent example of a turn date that was "predicted" based on these Fib turn date ratios was December 30, 2005. This was 1500 trading days from 1/14/00. As we were heading into December 2005 I was looking for a turn date that would give a projection in December/January to see what might be coming. I found that April 29, 2002, which was 573 trading days from 1/14/00, gave us the end of December 2005 as a heads up for a trend change. This 573 trading days divided .382 gives us 1500 and adding 1500 trading days to 1/14/00 gave us December 30th. The closing low was December 30th and then a new intraday low was the next trading day on January 3rd.

After April 29, 2002 there was another turn on May 17, 2002 which was 585 days from 1/14/00. Dividing 585 by .382 = 1532 and adding that to 1/14/00 gave us February 21, 2006. February's high was on the 22nd. Depending on your charting software these days can be "counted" off on the chart by using your cursor, e.g. clicking on the start date resets the counter to zero and then moving the cursor to a new date shows the number of trading days. Due to the larger number of days we're getting as we get further away from January 14, 2000, and the error induced by these calculations, using +/- 3 days gives us a Fib turn date window and certainly February 22nd was within that window.


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So now we're looking for the next potential Fib turn date. We go back to look for previous market turns and the number of days from 1/14/00 and divide those days by .382 (or .618 if the date is closer to today's date) to give us potential future turn dates. The next potential turn date that is close is April 10, 2006, +/- 3 trading days. We get this from the turn date on November 21, 2003 which was 968 trading days from 1/14/00, dividing it by .618 this time which gives us 1567, and then adding 1567 to 1/14/00 gives us April 11th. We don't know whether that will be a high or low (or if it will in fact be a turn date) but if we're rallying into that date window, we should be watchful for a potential high.

There's also an interesting correlation with a cluster of Fibonacci days since recent turn dates. As a reminder, Fibonacci numbers are 1, 2, 3, 5, 8, 13, 21, 34... each number derived by adding the two previous numbers. And the ratio of each of the two last numbers gets closer and closer to .618 (the golden ratio) as the numbers get larger. It's common to see the market turn on these Fibonacci numbers whether it's hourly bars, daily or weekly. April 5th is a Fibonacci 89 trading days from November 25th, 2005's high. April 7th is 144 trading days from September 12th, 2005's high. April 11th is 233 trading days from May 9th, 2005's top, and it's also 34 trading days from February 22nd, 2006's high. So we have a cluster of dates pointing to April 5-11 based on the number of Fibonacci days from recent turn dates. And by the method of using Fib ratios from 1/14/00 we have a turn window of April 6-13.

If I can pull something together by next Monday I'll try to introduce the concept of the Gann Square of Nine chart since I think it does an uncanny job at pointing out where we should look for certain price levels and/or dates to be potential support/resistance levels and market turns. I won't get into it here since I can't do it justice but I will say this particular tool is looking at April 13th as a potentially important turn date (it is 180 degrees from the October 13, 2005 low). Also based on the low last October, DOW 11470 and S&P 500 1324 (360 degrees and 360 + 90 degrees, resp.) have the potential to be highs for the market. I'll try to explain this Gann chart a little more next Monday. I find it more than a little interesting that the Gann Square of Nine chart is pointing to the same turn window and to a price level not far above current market levels. The Gann projection for the COMP is about 2382 which is also an important Fib projection (two equal legs up from its January 3rd low). Again, I'll try to cover those projections a little more thoroughly on Monday but I wanted to mention the possibility that that's where the market could be headed next week.

One last thing about the cluster of dates that's popping up in the April 5-11 time frame--this is also tax selling time. If you missed Linda's Traders Corner article on Sunday, March 26th you might want to read that. In it she shows some charts and discusses the selling that the market often sees as we head into April 15th. Selling of stocks (and bonds) is often done to pay for the taxes due. If we rally into this time period it will be just one more indicator that gives us a heads up that we could see a market turn coming. If on the other hand we see selling take hold after this fluffed-up end of month/quarter window dressing is finished this week, we could see the market turn back up during the turn window. That's why we'll need to wait to see which way the market is headed as the turn window approaches. At this time it's looking like it could be a high in which case it could be a very important high. We'll wait and see.

SOX index, Daily chart

The SOX is trying so hard to get up off the mat. Price is struggling to bounce while the oversold conditions get worked off and that looks bearish. This one may go sideways a little longer, or drop back down to test its 200-dma now at 482. I'm thinking we may have seen the highs in the SOX. Unless there's some serious rotation into the semis over the next couple of weeks I just don't see this one rallying to a new high. If it drops down to its 200-dma and manages to rally some, I suspect the 50-dma will hold it down.

BKX banking index, Daily chart

The banks dropped through support by its uptrend line from February and the top of its long term parallel channel. But the October uptrend line and 50-dma are not far below, just above 105 and I would expect to see support there. Its upside pattern would look best with another rally leg to a new high and that's what I've got depicted on the chart. If it drops down below 105 instead that could spell trouble for the banks and by extension, for the market.

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

The 50-dma continues to hold down the home builders. The 20-dma (light green line on the chart) is acting as support but it will probably break. Other than a sideways consolidation for a little longer, which would still be bearish, I don't see much upside for this index. If it fools me and rallies, the 200-dma at 946 will be first resistance.

With the new ETFs coming out for oil and silver (already have one for gold), there is speculation that that might be part of the reason for recent rallies. I suspect it has more to do with other things but once the new ETFs are out for both, it could be a good time to sell them after everyone climbs aboard. The one for oil will be USO and will enable you to trade this chart.

Oil chart, May contract, Daily

Oil broke above its recent consolidation and looks bullish at first glance. I'm not so sure about that. I know there's some geopolitical risk premium in there, plus the dollar has dropped in the last few days, so the rally is normal. But whether or not it can hold onto its gains is questionable in my mind. However, if it doesn't immediately turn back down, we could see oil rally back up to challenge the $70 mark again.

Oil chart, May contract, 120-min

The consolidation pattern that oil has been in has the top of its bear flag pattern (if that's what it is) at about $66.40. But there's a Fib projection for a potential A-B-C pattern at $67.35 so any failure at or below that level, and a drop back below $66 could signal a top is in. If it rallies much above $67.35 and it should be a quick trip up to $70. Watch the US dollar--as the chart below shows, it's on support and if support breaks, oil and gold should head higher.

Oil Index chart, Daily

The oil stocks were a little weaker than oil today and it's possible they're forecasting a reversal at hand. This one could tolerate a little higher before negating a bearish potential but if it turns back down below its 50-dma at 583.43 it will likely mean another test of its 200-dma and uptrend line at 538.

Transportation Index chart, Daily

The Transports could be close to giving us a firmer sell signal but it has to break below its October uptrend line at 4500 to do so. It's currently finding support at its 20-dma and then just below the uptrend line is its 50-dma at 4413 so it's got lots of support nearby. The current bounce after last week's spike down either means it's getting ready to head back down for new lows, or it's going to chop its way to new highs. Either case is bearish; it just changes the date of the top.

U.S. Dollar chart, Daily

The US dollar is back down to its uptrend line at $89.35 and must hold here for any hope of staying bullish. A drop below $85 should usher in more selling and would likely be bullish for the commodities including gold and oil. A break above $91 is needed to put the bulls back on the field. In the meantime we could see the dollar chop sideways for a little longer.

Slightly higher inflation numbers in the final GDP report may have sparked some interest in gold as the last 5 days have seen an increase of $36 in the yellow metal boosting it to a 25-year high.

Gold chart, April contract, Daily

After just a 3-wave a-b-c pullback, gold has broken to new highs again. This actually cleans up the EW pattern from its July 2005 low and this leg up looks like it should be the final 5th wave. Finding a top in gold has been a challenge but I like this wave count. It calls for a small pullback and then another push higher to finish it off. That should then be followed by a multi-month decline to correct the rally from last July. I expect gold to get above $600 but it may not be much more than that.

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

Tomorrow we'll get some potentially market-moving economic reports starting off with the Personal Income and Spending reports before the open. With the slowing in the home market and therefore less equity extraction there is worry that the consumer is going to slow down in the spending department so that could ignite some worries on Wall Street if that takes a big plunge. If income is up less than expected that could also cause concerns for the mighty consumer. If income is too high then it will ignite more worries about wage inflation and the Fed's reaction to that.

After the open we'll get the revised Michigan Sentiment which shouldn't be a surprise but watch the reaction to the Chicago PMI and Factory Orders. Any unexpected slowing here could cause the market to sell off or just the opposite if economic growth is showing some strength through these numbers.

Today was mixed but with a negative tone, primarily because of the DOW. The DOW was down 65 points while the COMP was up 3 points. Let the tub sloshing begin--we'll probably see some rotation back to the larger caps after this week. Once the funds can show their brilliance to their customers by owning techs and small caps, they'll probably disgorge themselves of those stocks and scamper back into the safety of large caps. And who knows what the opposite reaction will be next week once the rebalancing in the S&P 500 is complete from adding Google (GOOG 388.44 -6.54) and a couple of other smaller changes.

As for sector action today, it too was evenly split. The green sectors were led by gold and silver, high tech, oil service and drugs. The leaders to the downside were the airlines, Transports, financials and retail. Some of the energy indexes, the SOX and biotechs were flat on the day.

Tomorrow being Friday and the last day of the month tends to be a bearish day. I think Stock Traders Almanac reports that the last day of March has been down 12 of the past 16. This is probably due to window "undressing" since any selling tomorrow doesn't get reflected in the funds' books until next week. Anything that was bought this week just to make their portfolios pretty will probably be reversed over the next couple of days. The price pattern in the pullback from the March high supports that view as well. It calls for a little more pullback/sideways consolidation that should then resolve to the upside. The daily charts for the DOW and S&P 500 are approaching oversold on the fast stochastics setting so that also supports the idea that we could be setting up for a stronger bounce. The stronger RUT and techs look like they could use a little more upside as well so perhaps a brief consolidation for them will also be followed by more buying. But beware profit taking in the small caps soon.

The stock market will soon begin to reflect concern over rising interest rates. While the bond market reflects this with selling in bonds which creates higher yields. But the stock market has refused to listen, so far. The concern with higher rates is that it will negatively affect valuation models and slow economic growth and corporate earnings, all of which will have a negative impact on stock prices. But that's just funnymentals. Don't distract the bulls with such nonsense. Buy buy buy is the mantra. I see an effort to hold the market up, even push it up, while bullish enthusiasm reigns. As long as investor money comes into the market the Boyz will be able to offload their inventory. They know exactly what's coming down the pike and they're methodically unloading to the retail crowd who aren't looking for the warning signs.

So I'm expecting a little more of a pullback to finish the downward correction from the March high, which could continue for another couple of days, but this pullback should be followed by another rally. If I've got the longer term pattern correct, the next rally leg to new highs should be the last one. It will be the time to exit long positions and think about shorting the market for a longer term play. I think it's a bit early for the bears so keep you powder dry while we wait for that setup. Traders should be looking for an opportunity to get long early next week for the last hurrah of a rally. As that picture changes I'll keep you posted. In the meantime good luck and I'll see you on the Monitor.

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