Option Investor
Market Wrap

Where's the Beef?

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A good trader friend, John, has been asking me that question lately. Every time we get a rally we don't seem to get much follow through. The internals of the rallies are either "too much too fast" and flame out quickly (a mark of short covering rallies in a bear market) or they lack punch with less than normal volume and less than inspiring internals. Last week's rally from the low on Thursday is a good example. We saw very strong internals if you looked at advancing volume vs. declining volume. Too strong really--in excess of 10:1. And sure enough there's been no follow through since the high put in on Friday morning. We had an opening pop on Friday morning as follow through to Thursday's rally and then nothing.

Today we had the makings of a break to the upside but the downtrend held. This morning's rally was turned around and the bulls gave up everything they gained. Actually the DOW at least kept some of its gain but the S&P 500, COMP and RUT gave it all back plus a little extra since they ended marginally in the red. Are we seeing rotation into the bluest of the blue chips again? If so we know how well that turned out for the market last time that happened (the DOW lead the way to the highs in May).

If I put on my rose-colored glasses though (that would be the bullish pair), I see the possibility that we have simply been consolidating the past three days. Perhaps we'll have a little more consolidating to do before the next leg up. The DOW, naturally, gives me the strongest bullish feeling in this regard. We had a strong impulsive rally off last week's low and now we're just motoring sideways. This sideways consolidation should lead to further upside. Therefore, while the other indices are looking more bearish, I have a feeling we haven't seen the last of the buying. From a short term perspective though, it's hard to determine whether or not we're going to see a further dip before the buyers step back in (or shorts are forced to cover again). We'll see what we can glean from the charts.


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We'll spend most of the time in this report looking at charts because frankly there's not much else going on. It's been a light economic week, including today, and even the news rooms seemed to be slow.

As a reminder for the week, so you'll know who's writing which Market Wrap when this week, I (Keene Little) am writing tonight in place of Jim who will be writing Wednesday's Wrap. I will be writing Thursday's and then we'll be back to a normal schedule.

The two economic reports today were Building Permits and Housing Starts, both of which came out at 8:30 AM. Equity futures rallied a little off the news but whenever I see futures make a move before the cash open it always makes me suspect. The futures are moved a lot easier than the cash market and many times it seems some of the bigger houses try to move futures one way so that they have the ability to trade against that move when cash opens. So this morning's move up would be a good time for the Boyz to sell into it if that was their intention. After this morning's open we did in fact see a little bit of a settle as the futures, with cash following, dropped back near the point where price was before the 8:30 reports. But then the market reversed and headed higher into the afternoon. Too bad it couldn't continue.

Back to the reports, new construction of U.S. houses increased 5% in May after three months of declines. While confidence among builders continues to weaken, housing starts rose to a seasonally adjusted annual rate of 1.96M in May, a 5% increase and stronger than the expected 1.86M. Starts of single-family houses rose 2.1% to 1.59M in May, while starts of large apartment units rose 19.7% to 371,000. With fewer and fewer people able to buy homes, especially as banks rein in aggressive lending practices, there will probably be more pressure on rentals. That might explain some of the emphasis on large apartment buildings. On the down side, building permits, a leading indicator of housing construction, fell 2.1% to a seasonally adjusted annual rate of 1.93M from 1.97M in April.

Analysts attributed the increase in construction to an unusually dry spring in many parts of the country which allowed builders to start work on more new homes. But this may have been a 1-month shot in the arm for this construction industry as the analysts cautioned that a slowing housing market (feeling the impact of higher mortgage rates) could see a further slide in construction activity. The drop in building permits backs up that expectation.

The builders sense a further slow down as well. The sentiment among U.S. home builders fell in June making it the 6th month in a row and it has now dropped to an 11-year low. The housing market index dropped four points to 42, the lowest since April 1995. May's reading was revised up to 46 from 45. Readings over 50 indicate most builders think business conditions are good or fair. The index was at 68 in October and peaked at 72 in June. It has fallen in eight of the past nine months. If you look at the chart of the Home Construction Index you will see that investors started selling off about this time.

The index declined in all four regions of the nation in June, but the West is still feeling a stronger demand and their index remains positive at 61. I can see it in Seattle where home prices and sales are still relatively strong. But even here realtors tell me it's starting to slow faster than they expected. The other three areas of the country declined in June. The U.S. index has declined in 10 of the past 12 months, falling by a total of 30 points, matching the largest year-over-year plunge in the 21-year history of the index. We knew this was coming (you did, right?) and it's only a question of how bad the correction will be--shallow longer term correction or swift and steeper decline. I'm thinking relatively shallow this year (although it's been pretty steep the past few months) but then the decline will kick into gear next year.

Overall the price patterns are leaving me guessing about the short term direction. I'm getting a bearish sense looking at some of the major indices which makes me think we'll immediately head for new lows below the June lows. But the current pullbacks lead me to believe we'll see at least another leg up first. Looking at the charts we can see a similarity between the indices

DOW chart, Daily

A strong bounce off the June low took the DOW up to its 20-dma. As the center of the Bollinger Band this is an important moving average that shows the intermediate trend. If the 20-dma, currently at 11027, can not be recaptured, the bears will continue to rule. The 200-dma at 10893 is even more important for the bulls to hold so we've got a tight range to help us determine where the market will head next. I think a drop below 10800 would be bearish.

SPX chart, Daily

SPX looks more bearish than the DOW based on its inability to get back above its 200-dma. After bouncing off the June low it failed the retest of the 200-dma--the kiss goodbye. The bulls could make a nice run if SPX can get back above 1261 otherwise a drop below 1230 would look bearish and the June lows would be at risk of breaking.

Nasdaq chart, Daily

If the DOW is relatively strong and SPX relatively weak, then the COMP is sickly. It is stuck well below its 200-dma and couldn't even make it up for a test of its 20-dma. Additionally, the 50-dma is dropping hard and is getting ready to cross its 200-dma. This would be a longer term sell signal for many managed funds. Currently price is trying to hold onto it uptrend line from August 2002.

QQQQ chart, Daily

While the COMP looks very bearish, and the QQQQ could be interpreted as just as bearish (it too couldn't get back above its 20-dma), the larger wave count supports the idea that the June low could have been the completion of a larger pullback from the January high. This would mean we should get a rally (probably choppy) through the summer that takes us to new market highs. I have to admit that scenario is not looking particularly good right now.

SOX index, Daily chart

Another bounce, another kiss goodbye. After breaking its uptrend line from April 2005 the SOX gave it a perfect retest and failed. That's a sell signal pure and simple, with a stop just above the trend line. Take those every time since your risk is minimal. It'll be interesting now to see whether or not the daily oscillators will get this turned around and headed back up.

BKX banking index, Daily chart

The banks bounced hard off the 200-dma last week but have been struggling since. Short term the current pullback gives me the impression that this will head higher again and at least give us an a-b-c bounce that might even reach for the 50-dma. Unfortunately the securities broker index gives me the opposite impression.

Securities broker index, Daily chart

The securities broker index looks downright bearish. If the 200-dma continues to hold down this index I'd get short and stay there for a while. If it manages to push back up then we'll probably see a retest of the broken uptrend line from May 2005, currently near 213.

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

The housing index remains trapped in a very tight parallel down-channel, making the decline look particularly bearish. Eventually we'll get a break of this channel which will set up a larger sideways/up correction before heading lower again. The price objective near 500 continues to look like the right one.

Oil chart, August contract, Daily

Oil's pattern is beginning to look like a descending wedge which would be bullish. The uptrend line near $68.50 or the 200-dma approaching $66.60 make for good downside targets, although the descending wedge, with a small throw-under, suggest support more in the $68 area.

Oil Index chart, Daily

If the oil index keeps heading lower then that will tell us oil will likely break its uptrend line and head south with this index. Currently flip-flopping on both sides of the 200-dma leaves us guessing which way this is going to go.

Transportation Index chart, TRAN, Daily

The Trannies almost made it up to its 50-dma today, which was more bullish than the broader market. But price hasn't quite broken its downtrend yet and looks bearish by that measure. A rally above 4700 would be bullish but until then it's questionable.

U.S. Dollar chart, Daily

The US dollar has a Fib target area of $88.36-86.64 and that's where price has been struggling. The uptrend line from January 2005 is slightly higher so this area will be strong resistance. I expect the dollar to head lower again once this is finished. That could then give us a bounce in the metals.

Gold chart, August contract, Daily

The currently bounce in gold may lead to one more drop to its uptrend line near $550, possibly even down to a Fib projection at $531. But this should be getting close to a larger bounce, potentially back up to at least $625.

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

Tomorrow is even quieter than today as far as economic reports go--only Crude Inventories at 10:30 AM. The market will be left to its own devices and worries so that could mean retail trading will rule the day and we know how choppy that can get.

Sector action was mixed today, reflecting prices which for the most part closed at the flat line. Those in the red were led by the oil service (OSX), healthcare, disk drives, biotech and the SOX. Those in the green were led by gold and silver, airlines, securities brokers and Transports. The rest were essentially flat on the day.

Market internals also reflected price action, with a slightly more bearish tone than what we saw in the prices. With decliners beating advancers and declining issues edging out advancing issues it mirrored the broader market. But new 52-week lows swamped new highs 378 to 82. When we see this coupled with the DOW holding up, it smacks of distribution and rotation into the biggest large caps so that the large funds can sell quickly if needed. Overall volume today, was low at less than 4B and that further makes it a challenge to determine where the market is heading short term.

We'll need some additional price action to help discern the short term direction of the market. Longer term traders on both sides should be a little nervous right here. I suspect any move to lows below June's will mean a hard and fast decline so be out of long positions if that were to happen. It's possible we'll see a move higher still but the way it's been going so far--either strong but short-lived shots higher or very choppy and whipsawing moves--it's been tough to play the long side. I don't see that changing. We're into summer time trading and the lower volume (as we saw today) makes it that much more difficult.

Hopefully by my Market Wrap on Thursday we'll have a few more answers as to what the market is doing. In the meantime, be careful if you're day trading this--take profits quickly and then reevaluate for the next trade. Longer term traders will need to establish their stop levels while we wait for direction here. See you Thursday. Jim will be writing tomorrow's Wrap.

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