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Market Wrap

Opex Shenanigans At Its Finest

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That's what's making the news tonight. But shhh, don't tell anyone that no one else followed the DOW higher today. Well, the S&P 500 was also up but only a fraction of the DOW's climb today but it too is making 5-year highs. Too bad the small caps and tech stocks didn't participate since it looks suspiciously like a handoff from the riskier high-beta stocks to the large caps. And the DOW is so easily manipulated now that it has truly lost its value as a market indicator. General Motors (GM 22.64 +2.07) was up 10% today and was enough to lift the DOW an equivalent of 50 DOW points higher than the S&P 500.

While we're on GM, it reported a Q1 loss of $323M, or -57 cents per share, which was less than the $1.3B loss, or -$2.22 per share, a year ago. That and its sales increase of 14% is what got investors excited about this fabulous deal. A pig in lipstick is still a pig. It was GM's best day since 1987. The "good" news on GM was that it's hemorrhaging at a slower rate and that its revenues were up 14%, both of which eased concern about GM heading for bankruptcy. It looked like a little short covering in that stock today (I think it set up an excellent short play today as it hit the top of its sideways triangle pattern playing out since its December low).

I've recently discussed a theory as to why the mega banks have done so well in their trading departments which is basically due to all the money they control (with the help of the Fed's money making it into the monetary system). They have declared that they can trade the market with relatively little risk (well, duh, I could too if I controlled the market) and have been making obscene profits lately. It's a good thing too since their regular banking business hasn't been doing so hot. At any rate, I read some reports this week that the Boyz were buying gobs of cheap April calls on Monday and then suddenly look where the market is after Monday's low. Amazing how that happens.

So the market was jammed higher for opex, a worse manipulation than we usually see but unfortunately becoming more common. Their arrogance in doing this will likely come back and bite them big time but for now they're quite successful in moving the market where they want. So now that we're coming to the end of opex, it will be interesting to see what happens on Friday and especially next week. If this week was false buying, next week could be payback. However, the market rallying this week makes the price pattern look better from an Elliott Wave perspective. Ideally we'll see a pullback to correct this week's rally and then another push higher to finish off the entire bull market rally. We'll see how it plays out as we review the charts, but that's what I'm anticipating. The bottom line is that even though we have market manipulation, the Boyz appear to playing right into the hands of a higher market order.

After Tuesday's ramp job, Wednesday's consolidation and then this morning's ramp to new highs, it appeared we were well on our way to busting loose to the upside. But then we saw all kinds of selling hit the market. Commodities sold off sharply this morning, especially the metals. Oil sold off but then bounced back up to its high for the day before selling off into the close. As I'll show in the charts for gold and silver, it's looking like a significant high might have been made yesterday. Bonds chopped around today, keeping yields near recent highs. The fact that the 30-year bond yield has broken its long term downtrend line (from January 2000), and holding above that line, is not bullish for the economy because of the brakes it's applying to growth. The 10-year yield, at 5.04%, is at its highest level since June 2002.


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Also indicating a potential slow down in the economy was the Leading Economic Indicators report today. The index fell -0.1% in March making it the 2nd month after February's revised -0.5% decline (from the originally report -0.2%). This two-month drop is the first time we've seen this since February-March 2001. Economists, trying to put a positive spin on this, said this should prompt the Fed to halt its rate increases earlier. Whatever. Sometimes I think the economists work for the government PR machine. When the Fed stops raising rates it will be because the data is telling them that the economy is slowing down. By then it's too late and the stock market will have already sniffed it out and be heading down. It's also why the stock market is consistently down 6 and 12 months out from the time the Fed stops raising rates. Why the market is excited about the Fed stopping is beyond me. Look at the data--when the Fed hints they're ready to stop, sell all of your stock holdings.

The March index had been expected to remain unchanged so it came in a little worse than expected. The biggest negative impact to the index came from the drop in building permits as the home market has slowed down. In fact D.R. Horton, the largest home builder, reported their earnings rose at the slowest pace in the past 5 years. They're still doing well with net income up 20% to $352.8M but the pace is slowing down. The biggest positive impact to the LEI came from stock and commodity prices. But stock and commodity prices have shown themselves to be a lagging indicator and really shouldn't be part of the LEI components.

Jobless claims data showed initial claims fell 10K to 303K, a little better than the 308K that was expected. The 4-week average dropped 2,250 to 305,250. Continuing jobless claims dropped by 6K from last week's revised number to 2.44M in the past week, which is the lowest level since February 2001, a month before the country slipped into a recession (which wasn't recognized until months later).

The Philly Fed manufacturing index came out at 12:00 and the market barely reacted. The number was up slightly from March's 12.3 to 13.2 but that was a little lower than the market was expecting. So it ended up being a neutral number. The prices paid component rose to 29 from 17.2 and looks inflationary. But this number is not one of the "data" points that the Fed is watching.

There was another interesting little tidbit of news as reported by the Wall Street Journal that Jane posted early this morning on the Market Monitor. A survey of U.S. consumers showed that 70% of the people believe a national housing bubble will burst and that home prices will collapse within the next year. But here's the interesting part--most felt it wasn't going to happen in their neighborhood, only for the poor schmuck living somewhere else. This is a classic sign of denial. But it does show concern and that's a good thing. The bad thing for our economy is that news of housing slowing down, home prices dropping and seeing rising interest rates will all serve to make consumers wary about their own spending habits. An increase in savings rate would be good for families but bad for our economy, at least in the short term. Long term it would be a healthy correction.

This week has been hot and heavy with earnings announcements, some of which I post at the end of this report. It makes for a lengthy report so I tried to pick out the highlights for this report. Let's move on to the charts.

DOW chart, Daily

That dip below the October uptrend line and 50-dma was clearly an expertly devised bear trap. Closing below both of those support levels pulled in a lot of shorts and then the relentless buy programs on Tuesday got them scurrying. As we've seen many times, there were barely any pullbacks to let shorts out or new buyers in. Consequently each new buy program got more buyers scrambling to either cover or get in long. Even the consolidation on Wednesday barely retraced Tuesday's rally and then they hit it again this morning with more buy programs. All designed to keep the buying at a panic pace. Golf clap for the Boyz behind the mega-banks' control of this market. Opex week was an added incentive to do this because of the cheap calls they were able to buy on Monday. That's how they're raking in billions of dollars now. Post-opex could be telling. If this was all just a head fake ramp job, next week will pay the piper. But from an EW perspective it would look best with a pullback followed by another run up to the Fib target at 11464. In addition to the Fib target there, for those using the Gann Wheel (Square of Nine chart), you will see that 11470 is 360 degrees from the October low of 10156. That would make an ideal level to finish off the bull market rally.

SPX chart, Daily

An even better bear trap had been set on the SPX--it looked like a done deal that support had broken at its October uptrend line and 50-dma. Today's high tapped the top of the ascending wedge pattern that has been playing out since the January high. Like the DOW, it would look best from an EW perspective if we get a pullback followed by one last rally to a new high. There are several targets between the Fib projection at 1332 and a Gann number either side of that at 1324 and then up to 1345. If the SPX and DOW track closely the rest of the way up, DOW 11470 gives us about 1324. After pulling back first, that 1324 number would also give us just a minor throw-over above the wedge (to match the throw-under below at the last low). So it makes for a good target.

Nasdaq chart, Daily

The COMP held support at its 50-dma and looks to be in a similar pattern now as the DOW and SPX. So a little pullback followed by another high should do it for this index as well. It has a Fib target at 2382 but the top of a larger ascending wedge is now a little above 2400. If this instead turns south on us and drives below the 50-dma, that would be very bearish. Same for the DOW and SPX. The next time the 50-dma is threatened should be the next time it breaks for good.

QQQQ chart, 240-min

The Q's gave a nice head fake break of its short term uptrend line but when it left that very bullish looking hammer candlestick, followed by the gap up the next morning, that was the signal to get long. It now appears ready to roll over and at least correct some of that strong bounce so watch for about a 50% retracement of it to see if support comes back in. If the broader market is going to pull back and then rally higher so too should the Q's. Any break back below Monday's low would obviously be very bearish.

SOX index, Daily chart

The SOX has me leaning the most bearish of the indices reviewed so far. The bounce from the March low fits as an a-b-c corrective bounce and today's high came within pennies of the Fib target for equality between the two legs up (waves a and c). It also came close to the downtrend line from the January high. This looks like a correction that finished today and now it will be all downhill from here. It bears watching to see what sets up but I don't like this one from a bullish perspective.

Market Risk, Part II

On Monday I introduced the concept of market risk as measured by a technique that used elements of Chaos Theory. Without getting deep into the theory, Monday's discussion was about an experiment done with sand piles and randomly dropping one grain at a time (computer simulated) which created various mounds that would collapse when they got too steep or because a neighboring hill let go. Throughout this matrix of sand piles they could identify "fingers of instability" that identified higher risk areas that were more prone to avalanches. While they couldn't predict where the next grain of sand would hit, whether it would cause an avalanche or how big the avalanche would be, they were able to identify when the "system" was reaching critical state. While the system of sand piles looked stable and quiet, it was in reality only a grain of sand away from collapse.

And that brings us to the present market. As Greenspan started warning a few years ago, and Paul McCulley with PIMCO has been writing extensively about, it is the stability of the market that sets it up for failure. Nobel laureate Hyman Minsky wrote about stability leading to instability. He stated, "the longer the period of stability, the higher the potential risk for even greater instability when market participants must change their behavior." This is due to market participants becoming more and more comfortable with greater levels of risk. It's the old story about bringing a pot of water to a boil with a frog sitting in it. The frog is comfortable in the rising temperatures and is cooked before he realizes it. "The more comfortable we get with a given condition or trend, the longer it will persist; and then when the trend fails, the more dramatic the correction is." Consumers have been so comfortable with the stable conditions that they've been willing to go deep into debt and use up their savings because they believe tomorrow will be better than today.

Back in 1997 it was tiny little Thailand that ran into trouble and the huge debt throughout Asia began to unravel. Relationships between bonds began to break down, something totally unexpected and something that had never happened before. A diversified pool of debt was suddenly no longer diversified. The fingers of instability reached into Long Term Capital Management and nearly brought down the financial world. Greenspan and the Fed pulled major international banks together and saved the day. Today we have a system that is in many respects even more vulnerable but where is that grain of sand going to come from this time? Matt Blackman at TradingEducation.com is looking at tiny little New Zealand as a potential problem that could escalate.

New Zealand, like the U.S., has become very comfortable with large trade deficits (8.9% of GDP as compared to 7% for U.S.) but now appears to be experiencing slowing growth after more than 5 years of continuous growth. Its Q4 2005 growth actually shrank -0.1% and this was after their Reserve Bank had forecast growth of 0.4% for the quarter. Oops. Their currency has experienced a drop of more than 18% in the year ending March 2006, which is typical for a country that experiences large trade deficits. Notice what's starting to happen to the U.S. dollar. But because of the U.S. dollar's status as the world's reserve currency it has been somewhat disconnected from what economic theory and history says should have already happened to the dollar--it should be depressed more than it currently is. Again, the stability of the dollar could be leading to greater instability.

There are other similarities with New Zealand. They have experienced a strong housing market--up 75% between late 2001 and 2005. Household debt has increased from 100% of income in 1999 to 150% by the end of 2005, primarily in mortgage debt. So they have soaring housing prices, huge and record trade deficits, a rapidly falling currency and yet their investors aren't worried either--their stock market is up nearly 10% this year. Talk about lala land! Could little New Zealand be the grain of sand that starts the first slide in one of the sand piles? In 1997 everyone was told not to worry about the Thai bhat. There is of course no way of knowing. It could come from an area that absolutely no one is watching. But it will be worth watching.

The markets and investment instruments are so intricately tied together now on a global scale that it's easy to see how something half way around the world in a little country could ripple through the global system. As John Mauldin states, "...everything is more connected than ever. If the Chinese and Japanese buy fewer dollars and US bonds, interest rates rise and the dollar falls which slows our economy and we can buy less of their stuff which slows them down and they buy less from Asia which slows their economies which affects the price of oil and commodities which (on and on). Everything is connected. It is a spider web of fingers of instability."

When reviewing past earnings cycles and stock prices (as measured by PE ratios), John Hussman has identified a very consistent earnings cycle. US earnings have never grown by more than 6% peak to peak since 1950. Currently we're at the very top edge of this 6% cycle. In all previous times, when earnings reached this earnings peak stock prices have already dropped in anticipation of a slowdown in earnings. Typical stock PEs in the past earning cycle peaks have been 9x (using Hussman's evaluation) but currently stocks are twice that at 18x. So unless we're in a new era (as in it's different this time) the market is dangerously over valued. Same goes for Europe by the way.

We have a stock market that is over valued, an economy that is threatening to slow down (all of the leading economic indicators except stock and commodity prices, which are not leading indicators, are pointing to a slowing economy), geopolitical risks, rising commodity prices, rising yields, a slowing housing market and a long lasting stability in the market that has produced an overly confident investor who has been seeking greater risk for better returns. We are vulnerable and there are many fingers of instability throughout the global system. A shock will likely come out of left field where no one is looking.

A grain of sand will start a small slide somewhere which in turn will end up taking down the whole mountain. Ben Bernanke and his team will be called to action. Maybe it will be a small blip that lasts a day or a couple of weeks, or maybe it will end up being much more severe that lasts for months or years. We simply don't know. But what we do know is that the risks are actually greater now than they've been in a very long time; certainly greater than they were even in 2000. Keep your capital safe and protected. Getting greedy at this point could come back and bite you big time.

But don't tell that to the current bulls in this market. The blinders are on and it's buy buy buy! Maybe they'll make another 10% on their investments or maybe they'll be saying bye bye to their money. As we look at the banks, we see they did a Hail Mary pass from deep in the end zone (beneath the broken October uptrend line) and made some significant yardage. Now we'll get to see if they can make a touchdown with a new high.

BKX banking index, Daily chart

The banks too got a stick save by snapping back above its October uptrend line and 50-dma. The new high today was soundly rejected (leaving a tall shadow above the body of its candle making it look like a shooting star reversal candlestick). Any pullback needs to hold above the 50-dma in order to have a chance for a rally to the top of its wedge pattern and a test of the December 31, 2004 high.

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

After bouncing off support at its uptrend line from March 2003 and its H&S neckline, both near 850, the home building index found resistance at the broken trend line that marked the previous consolidation. This could be a kiss goodbye. Today's close was just below its 50-dma at 882.21. I'm not real sure here whether it will get a bigger bounce, perhaps up to its 200-dma at 939 (and coming down) or if the bounce is over and it will head for new lows. Obviously a break of layered support down through 800 would be very bearish. The corrective pattern from its March low says this will head lower, be it from here or after a further bounce. I certainly don't like this index from a bullish perspective.

Oil chart, June contract, Daily

Note that we have switched over to the June contract today. Oil sold off this morning with the other commodities but then recovered to its high before selling off again into the end of the day. The added volatility may have been a result of rolling over from the May contract to the new front month of June. I've changed the type of pattern that appears to be playing out here--from a sideways consolidation to more of a parallel up-channel. This pattern still calls for a pullback to its longer term uptrend line and 200-dma so that's what I've depicted on the chart.

Oil Index chart, Daily

The oil stocks could get one more small push higher to tag the trend line across the highs since last September but this, like oil, should pull back soon. I show a pullback to the uptrend line and 200-dma and then a new rally leg. As per the EW labels, the pullback should complete a 4th wave correction which would set up a rally in wave-5 but I'm starting to think this index may already be well into the 5th wave as an ending diagonal (ascending wedge). That interpretation doesn't change the price path as depicted on this chart so it stays short term bearish, intermediate term bullish. But the next leg up after the pullback would be relatively short and it would finish off the bull market in oil stocks. It's too early to make that call but it's something I'll be watching carefully over the next several weeks as this plays out.

Transportation Index chart, Daily

Record high oil levels and record high Transport levels. Am I the only one that fails to see why this is rallying? Once again, do not trade this market based on funnymentals. It will drive you to drink. The Trannies came oh so close to that Fib target at 4771.50 and the top of its channel that price has been in since the January low. Stochastics and MACD have a long way to go to catch up to that price move and if they don't then they'll leave a huge negative divergence against the new high, which is what I'm guessing will happen. There is now a 9-wave move up from the January low, which is impulsive (5 waves and then multiples of 4 after that, just as a 3, 7, or 11-wave move is corrective) and therefore the wave pattern is at a point where the rally can be called complete here. There could be a little bit left to this leg up from April 17th, but this one could finally (really) be finishing up its rally here.

U.S. Dollar chart, Daily

The US dollar broke down through support--first its uptrend line from March 2005 and then the bottom of a potential sideways triangle from September 2005. It found support at its previous low in January at $87.83 which is also at the bottom of its steeper parallel down-channel but that will probably only be good for a bounce before it continues lower. By playing with channels it looks like the dollar could be headed to a confluence of support around $86 by the beginning of June. Theoretically, a drop in the dollar to that level should be bullish for commodities. The small bounce in the dollar today was "credited" with the drop in gold and oil but I think not. Something else triggered the sale in the metals.

Gold chart, June contract, Daily

I had posted a chart of the gold bug index (HUI) on the Futures Monitor on Wednesday night after the market had closed. I really liked the setup for a short on gold based on that index. The EW count and the Fibs were in perfect alignment for a top on Wednesday. But the sell off today caught me by surprise. I did not expect to see the metals get creamed the way they did, especially silver. So it now looks like we have a top and if I've got the wave count correct we should see a multi-week pullback that retraces at least to about $550 (on the June contract). Depending on how quickly it pulls back (it will probably be volatile), it could find support by its uptrend line from last July. Price will find some support at its steeper uptrend line from November but that one should break. I think it's time to short the rallies in gold until we see that kind of pullback.

Silver chart, July contract, Daily

File this one away for a reminder about why you don't want to chase something that's in a parabolic rally. Silver went truly vertical and was a screaming sell. The trouble was you couldn't tell where it would end and therefore made a short entry extremely difficult. The last steep correction in December (small by comparison now), which had followed a parabolic rise out of November (again, small by comparison), was about 30%. Today's correction was 18% so a 30% correction would take silver down to about $10.40. But the 50-dma, which is coming up fast, should provide support so perhaps above $11. The new ETF (SLV) is not out yet so I'm not sure what influence that will have. I had been thinking this wouldn't happen until after SLV started trading but no word yet on that one.

Results of today's economic reports is in the following table. There are no major economic reports tomorrow.

Market action was mixed today and that's visible in the internals as well as between indices. Decliners beat advancers and declining volume edged out advancing volume. But new highs handily beat new lows. The granddaddy of the indexes, the NYSE, had a doji day against resistance by its trend line along the highs since January. The market looks ready for a pullback but the techs actually look a little more bullish as far as room to run a little higher. But it looks like they're rotating out of techs and small caps into large caps. Confused? Welcome to topping action which I believe is what we're still in the process of doing. It's a time for greater caution in your trading because of all the swirling currents. Trying to keep your footing on the slippery rocks is a challenge. Some times it's just better to watch from the river's edge.

Sector action was also equally divided today. The leaders to the upside were healthcare, utilities, computer hardware, SOX and pharmaceutical. The red sectors were led by gold and silver, networking, airlines and energy. There's not much to derive from these sectors as I think opex had more to do with today's action than anything else. There was an effort to push the major indices, such as the DOW and SPX, up and hold them there for optionS expiration at tomorrow's open. Then we'll have to deal with options expiration for the remaining stocks and indices at the end of the day tomorrow.

Friday of opex has typically been a very slow day and I don't see anything to suggest otherwise for tomorrow. The market looks ready for a bit more of a pullback so that's the way I'm leaning. The Boyz should be done for the week and therefore I'm not expecting anymore surprise buy programs. Without the program trading I suspect we'll see slow price action as the retail crowd beats up on each other in attempt to squeeze pennies from their options positions. It's usually not a bad day to do some research and catch up on some of your studying/reading.

At the end of the day Google (GOOG 414.74 +4.50) announced its earnings. Investors were very happy with their report (short sellers got slapped silly after hours once again on this stock). The stock jumped 33.61, +8%, to close at 448.35 in after-hours trading. That will not only close its gap down on February 1st (gap close at 432.66) but will likely gap above it. So is that an island reversal with all the price action between February 1st and today as the island? Technically speaking it is but that's a bit of a stretch. I was looking for gap close to finish its bounce before heading back over. Now I'm not so sure what will play out. It might be a big head fake and give us a gap n crap so be careful if you're playing that one.

As for their earnings report, GOOG reported Q1 profit rose 60% to $592M, or $1.95 a share, up from $369M, or $1.29, a year earlier. Stock-option costs and other expenses were included in the results. Analysts had expected GOOG to earn $1.75 a share and therefore the positive surprise. Now we'll see if the after-market euphoria and short covering lasts tomorrow much past the open. GOOG's sales, excluding expenses they pay to its distribution partners, grew to $1.53B which was up 92% from last year. This number was also above expectations of $1.47B.

There were a slew of earnings reports which I won't get into here otherwise it makes the report too long and I'll miss my deadline for submittal. You all know where to find earnings reports anyway (how's that for weaseling out of them?). When the market has an agenda we know that earnings and economic reports have very little to do with the market's moves anyway. In fact the different reactions of the market to the same bit of news at different times makes it too hard to figure out. I'll stick to my EW analysis thank you. Good luck tomorrow and be careful about forcing trades. I'll see you on the Monitor.

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