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Market Wrap

Take a Breath

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Most indices violated short-term consolidation patterns established just this week, plunging to heart-stopping levels while the VIX, the CBOE Market Volatility Index, soared up to levels not seen since last October. Many retail traders must have been holding their breath. Bulls dumped positions, leading to trading curbs being established on the NYSE. Dismal breadth indicators coupled with strong volume looked scary. It's time to take a breath and assess the damage.

Clearly some damage was done, but matters had looked much more positive heading into the trading day. Early beneficial influences on the market consisted of positive reactions to Hewlett-Packard's (HPQ) earnings and supposedly also to Applied Materials' (AMAT) earnings, strong performances on Asian bourses and hope for tame CPI inflation data. In addition, some chart characteristics suggested that it was time for a bounce attempt. Some concern was expressed over rising commodity prices, including crude, a sinking dollar, and European bourses that struggled to hold onto gains.

However, an hour before the cash markets opened, economists were proven wrong in their predictions for tame inflation data, with both the core and headline Consumer Price Index numbers stronger than expected. That data transformed that number into an early negative influence on the markets from which the markets never recovered. The reaction sent futures into retests of lows hit in overnight trading Sunday night, and those lows ultimately would not hold. Bonds declined and yields bounced. Interest-rate-sensitive financials were to take a hit when the cash markets opened. They led indices lower.

The end-of-day news reports deplored the Dow's more-than-200-point drop, the worst decline since March 2003; the Nasdaq's erasing of 2006 gains; and the SPX's four-month low. Taking that deep breath, let's also take a longer-term look at the SPX, as seen on its weekly chart.

Annotated Weekly Chart of the SPX

The bounce potential for tomorrow would have looked stronger if the SPX had bounced more from today's low. Strong volume on a decline coupled with a strong bounce off an intraday low often indicates that big-money people are using the decline to accumulate positions. Momentum can still carry prices much lower than most of the rest of us would want to follow, but that accumulation can be important to spot when it occurs. However, the bounce wasn't conclusive enough, and intraday nested Keltner channels show that the SPX ended the day without improving its outlook Keltner-wise. All day, it had closed 15-minute periods below a diving-lower line currently at 1274.36 on 15-minute closes. It needs to close above that line and then retest it before bulls will have much confidence. Still, the support being tested suggests a bounce or steadying attempt might not be impossible.

Annotated Daily Chart of the Dow

Before the bell but after the CPI number, techs were expected to hold up better than other sectors, but fear of tomorrow's Dell earnings and semi book-to-bill numbers helped to create some nasty chart characteristics on the Nasdaq.

Annotated Daily Chart of the Nasdaq

According to almost any measure, the selling on the Nasdaq's stocks has been overdone. Candlestick theory uses a measure that counts the number of record days, or days with a lower low than the previous day, and that theory would suggest that a steadying or oversold bounce should be in the works soon, but it doesn't promise it tomorrow. The Nasdaq's bounce off its low was minimal, even though the Nasdaq was testing important 2190-ish support, and that doesn't look good. Like other indices, the Nasdaq hadn't managed to create a hint of a bounce in the works on intraday nested Keltner channels, either, by the close, with the Nasdaq closing each 15-minute period below a diving-lower Keltner line at 2213.55. These lines are dynamic and so will shift up and down a little as prices do, but the Nasdaq bulls' first task will be to close a 15-minute period above that line and then successfully retest it. That daily chart gives absolutely no hint of a bounce or steadying in the making, but I wouldn't be surprised to see it, with opex activities providing the wildcard.

One index that did show an attempt to steady today was the SOX, with the SOX's intraday nested Keltner support beginning to show tentative signs of firming. The SOX needs to close a 15-minute period above the line at 489.14, however, before it even begins to change its tenor.

Annotated Daily Chart of the SOX:

After the NAHB/Wells Fargo Housing Market Index fell to 45, an 11-year low, and below the 50 boom-or-bust benchmark, in May, industry watchers wanted to see what the Mortgage Bankers Association would have to say about mortgage applications when it released the numbers. The NAHB's chief economist was still talking about an "orderly cooling-down process" when he was quoted in a Reuters article earlier in the week. Unfortunately, the MBAA's site did not post information on last week's data. The DJUSHB, the Dow Jones U.S. Home Construction Index, continued its cascading fall today, but the CPI data offered plenty of reasons for that interest-rate sensitive index to dive without mortgage application volume contributions.

April's CPI rose 0.6 percent, with the core rate gaining 0.3 percent, with both numbers higher than anticipated. CPI numbers had been expected to rise 0.5 and 0.2 percent, respectively. A 3.9 percent rise in energy costs led to the higher headline number, and a 0.3 percent rise in shelter costs contributed to the rising core number. Other cost increases included a 2.4 percent rise in transportation costs, with a 1.6 percent increase in airline fares. Over the last 12 months, CPI has risen 3.5 percent, and the core number has climbed 2.3 percent, with both numbers representing slight increases over the 3.4 and 2.1 percent figures from March. Most interpret the core inflation rate as now being at the top of the Fed's comfort zone.


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These numbers were not cheerful ones to the market watchers hoping for a pause at the next FOMC meeting, and futures immediately dove, with the ES contract diving more than ten points within a 15-minute period after the release. Before the morning was over, Fed fund futures were predicting a more than 50 percent chance of a rate hike at the next FOMC meeting. If memory serves correctly, one week ago, just before the FOMC decision was handed down, Fed fun futures had predicted only a 36 percent chance at the next meeting, but that rose immediately when the statement was released and rose further today. Although the ten-year's yield closed well off its 5.19 percent intraday high, closing at 5.15 percent, it did bounce, and so did the thirty-year, closing at 5.27 percent. None exceeded the recent highs on their intraday bounces, however.

With sensitivity both to interest rates and to economic expectations, the TRAN dove more than a hundred points today, dropping through March and April's resistance level, all the way to its 50-sma, where it steadied. When the TRAN hit 5000 on FOMC day, this writer wondered if that level would finally be the electric fence for the TRAN, and it appears that it was. The TRAN has violated its important 30-sma, but steadied just under its even more important weekly 10-sma, currently at 4683.50. Since that average is a weekly one, it will be important to see whether the TRAN bounces from it or falls below at the week's close. The TRAN closed at 4670.97, not helped by crude's decline.

As Jim Brown mentioned in last night's Wrap, expectations for crude inventories varied, with some industry analysts having expected a build in gasoline inventories of 2.1 million barrels. The Energy Department said that crude inventories dropped 100,000 barrels, gasoline supplies rose 1.3 million barrels and distillates dropped 100,000 barrels.

Between those forecasts and the inventories release had come a lowered demand forecast from OPEC. Early Wednesday, OPEC lowered its forecast for growth in global demand. In North America, OPEX expects growth in demand to decline by 200,000 barrels a day. In China, growth is expected to rise by 500,000 barrels a day, however.

In another release, the American Petroleum Institute announced that U.S. gasoline deliveries declined 1.9 percent in April. That decline suggests that demand also decreased, with consumers likely cutting back on driving as prices moved higher. The API report also noted that April's petroleum deliveries dropped 1.5 percent from the year-ago level. While lower demand and so possible lower prices might seem to be market friendly, many worried that rising crude costs will hamper economic growth as consumers face higher prices and marshal their outing and other spending patterns.

Refinery utilization also dropped, to 87.7 percent, down from the 92.6 percent levels of last April. As those reading Jim Brown's Wraps will likely recall, the International Energy Agency had already, as of last week, trimmed its own estimates for global demand growth to 1.25 million barrels a day from the previous 1.47 million barrels.

With gasoline supplies not rising as much as some had hoped but with demand also forecast to drop, the classic supply versus demand battle was engaged. Throw in expiration concerns, and the opportunity was set for volatility in crude prices. QCharts shows a close of $68.69, well off both the day's high and day's low.

In another economic development, Treasury Secretary Snow presented testimony to the House Financial Services Committee. A portion of his testimony was reserved for dealing with China's part in "addressing global imbalances." He avowed that China's exchange rate policies remain too rigid and that the country needs to make other economic reforms related to balanced growth and financial sector modernization. China's growth is too reliant on external demand, for example.

Snow didn't stop with China. He also said that the International Monetary Fund needed to do a better job of watching over exchange rate policies, as well as reforming its own policies and governances. He wants growth in emerging economies to be better represented. Snow wants a limited ad-hoc increase for the members most under-represented, but said that he would support it only if fundamental reforms would follow.

The U.S. has to do its part in addressing global imbalances, too, he asserted. Snow claims that fiscal 2006's deficit will "come in well below the estimate of $423 billion." He believes the U.S. remains on track to cut the deficit by a half by 2009, a goal proposed by the Bush administration while some still doubt its achievability.

Treasury Secretary Snow also addressed trade issues, mentioning the Doha round of trade negotiations that had begun in 2001. He believes that the negotiations may have reached an impasse and that the European Union bears the burden of moving the negotiations forward again. Negotiations over agricultural issues have proven particularly prickly.

Altogether, the day stunned some into breath-holding episodes. HPQ helped keep the Dow's losses from being deeper than they were, with the company reporting earnings yesterday. AMAT's earnings report, viewed positively by some during the pre-market period, didn't please those analysts concerned about the company's outlook and decelerating bookings. The stock fell 5 percent in today's trading. Other corporate developments included an appeals court decision to order a new trial for Philip Morris, a unit of Altria Group (MO). A jury had awarded the estate of Michelle Schwarz $150 million in punitive damages, but a Multnomah County Circuit judge decided the award was excessive and reduced it to $100 million. The appeals court ordered the judge to reinstate the full amount.

After-hours developments don't give a strong sense of direction for tomorrow. Intuit announced declining profits, although the company blamed options expensing and tax rates. Napster said sales rose more than 50 percent and that its loss had narrowed. Retailer Hot Topic posted a loss..

Economic reports for tomorrow include initial claims for the week ending May 13, reported at 8:30; April's Leading Indicators, reported at 10:00: natural-gas inventories at 10:30, and May's Philly Fed number, reported at noon. Most expect a 12.5 reading for the Philly Fed, down from the previous 13.2 reading. Later in the day, the semi book-to-bill number will be released.

Earnings for tomorrow include ARO, BKS, BRCD, CLE, CPWM, DELL's after-the-market report, GPS, LTD, MRVL, SHLD, and PLCE, with many of those reporting companies being retailers.

Throw in tomorrow's after-hours Dell report, the semi book-to-bill report, option expiration and the recent stunning declines, and many walking wounded may be stumbling around tomorrow, undecided. It's probably best to move into a sell-the-rally mode, but the extent of the decline urge bears to protect profits by aggressively moving stops lower and bulls to show some patience or else deep pockets if guessing at bottoms.

While charts don't suggest rally quite yet, that possibility exists and the possibility for a steadying certainly does. As you have been advised many Wednesday's now, watch the TRAN for guidance on the SPX, OEX and Dow, and the SOX and RUT for guidance on the Nasdaq.

Early in the Wrap, I mentioned that the VIX had soared up to levels not seen since last October. Perhaps you remember what happened last October: on October 13, the VIX hit an intraday high of 17.19 and the SPX hit an intraday low of 1168.20, and then the SPX churned around for a few more days and began climbing. It usually doesn't work that cleanly, and I'm certainly not suggesting that it will this time, either. The VIX did not pull back from today's intraday high the way it did on October 13, but the VIX did hit 240-minute Keltner resistance at 15.96. Another chart suggests a possible upside of 18.28 for the VIX as long as it maintains daily closes above 14.93, so the evidence is mixed. Taken together, however, this evidence suggests that a bounce or steadying could be possible, too, with option expiration throwing in a major wild card for the VIX. Bears, protect those profits. Bulls, either have deep pockets or very small positions, and be willing to be wrong. Momentum is currently to the downside.

Don't hold onto a losing position, particularly if it's a losing bullish one. Another and more dire possibility is a further cascading fall. Conservative traders might stay out of the markets entirely with opex shenanigans, Dell's earnings and the semi book-to-bill number all potentially playing havoc with the markets.

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