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Market Wrap

Are We There Yet?

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In ten more minutes. Anyone who has traveled with their kids knows all too well that question. It's also amazing how often the "10-min" answer worked. So to those who have asked (including myself) "have we topped yet" over the past several weeks I'm thinking of just answering "10 more points". The drive higher has been relentless, many would say unnatural. The lack of even a "normal" (I hate to use that word for this market) pullback along with continuing negative divergences against new highs has many wondering the same question--are we there yet?

The slope of the climb since July has been steadily increasing. The pullbacks are getting shallower and smaller but interestingly the space between the small flat consolidations and new highs is also getting smaller. This is of course what creates the ascending wedges that are so prevalent on the charts, in most time frames now. We also know how parabolic rises tend to end. As the steepness of a rally continues to increase it becomes increasingly difficult for new buyers to get in and for shorts to get out. Hence they both start chasing the market higher and faster until there are no more buyers/short covering left. Once that happens there's nothing left underneath to support the market and it comes crashing down.

At least that's the typical way parabolic climbs end. Will it be different this time? It certainly could be and a lot of it depends on how much money continues to pour into our markets. Money from overseas, from peoples' retirement accounts and from the Fed all contribute to the buying power. Those who think we're at the beginning, or even in the middle, of a larger bull market believe this buying power has a lot more room to run. Those who think we're at the tail end of the 4-year bull market believe we're in the throws of a blow-off top. Only in hindsight will we know the answer but I've watching several signs that point me to the side that believes we're a lot closer to the end than the beginning or middle of another bull run higher.

Certainly very few would argue that we're due a correction. Whether it's how far we've stretched above 200-dma's, bullish percents, bullish sentiment, or any other measure of "normal" ebb and flow of buying and selling, it's hard to imagine that this kind of rally can continue much longer. I recently read on Bill Fleckenstein's site of a proprietary indicator from Jason Goepfert at sentimenttrader.com. He looks at a stock-to-bond indicator that has stretched to a level that is 3 standard deviations out from the norm. As he said, this occurs only about 0.1% of the time. In simple language, what we're seeing here is very rare.

But like so many parabolic climbs we've seen in the past, it's very difficult to determine where the top might be. So, maybe another 10 points will do it. For a reminder of what happens next though, review the gold chart and see what happened after gold peaked in May after a stellar run from March. The ensuing decline is normally faster than the rise. Speaking of which, ascending and descending wedges are normally powerful chart patterns to play because the following move usually is a fast move. I showed this chart of the VIX at the end of my report last week:

VIX Daily chart

The VIX is oh-so-close to going below 10 which is what its descending wedge pattern has been suggesting for weeks (wish I had listened to this one weeks ago). Readings below 10 have always marked significant lows in the past. The other thing about this descending wedge is that it is bullish. You can see the bullish divergences building as well. This wedge should retrace faster than it took to build it. A higher VIX here would mean a stock market that is selling off. And the sell off in the stock market will likely mean a decline back to the June/July lows faster than it took to rally to the current levels. Just food for thought while we wait for this to complete.

As Jim reminded us at the end of the day on the Market Monitor, we could be seeing funds chasing performance at this point as we rush into the end of the month. Many funds chase momentum so as not to miss the party. They don't care so much about the raw number for their performance but they care greatly about how they're doing as compared to the S&P 500 and other funds. So they all end up chasing performance together. Big institutions often fall into the "retail" trader crowd because they're often late to the party along with the Moms and Pops who respond to the bullish news reports.


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The end of the month is Tuesday which means profit taking could start as early as Friday since the 3-day reconciliation means sales on Friday wouldn't be registered until Wednesday, November 1st. That just means we should be alert to the possibility that profit taking could kick in at any time. Monday and Tuesday would be most at risk in that regard.

But it's also common knowledge that the last 3-5 days of the month and the first 3-5 days of the following month tend to be bullish. It has to do with new money coming into the market. This of course puts us right into the elections and it's been debated how much influence the elections have had on the market being propped up or not.

Or the Fed may have been concerned about a slowing economy and therefore pumping money into the economy via their primary dealers. These mega banks then buy up the stock market by adding their considerable trading funds. Add all these things together and it's not hard to understand how we could have had more than the usual support under the market and a lot of buying that might disappear after this is finished. Between all this buying, and forcing shorts out of the market, it could be difficult to prop it up any further after the elections are over. That's obviously speculation on my part but it fits with what I'm seeing happening in the charts.

Before getting to the charts, let's review today's reports.

Exxon-Mobil earnings

Before the bell we had an earnings report from Exxon-Mobil (XOM 71.55 +0.61) which made a new all-time high today. It made a profit of $10.49B, its second highest total ever, for a $1.77 a share. This was its second highest profit, beat out only by its $10.71B profit in last year's 4th quarter (following the Katrina oil spike). Despite a slight decline in revenue to $99.59B from a year-ago $100.72B it managed to improve its profitability by lower its costs.

Durable Goods orders
The big headline for durable goods orders was the surge in orders to a 6-year high, up 7.8% in September, which was much higher than the expected +2.9%. Orders for new aircraft, primarily for Boeing (BA 79.12 -1.72), accounted for nearly all of the increase. They received orders for 175 aircraft compared to 30 in August. The sell off in BA's stock the past two days must mean those orders were already priced in and there is perhaps concern about how dry next month could be. There is often a big push to get orders in before the end of September, both by the customer (the end of their fiscal year) as well as by Boeing.

Transportation orders rose a whopping 27.6% which is also the biggest increase in 6 years. Civilian aircraft orders were up 183% but orders for motor vehicles dropped -6.10%. Demand from the Pentagon for defense capital goods also helped. But remove the transportation component of durable goods and the number of new orders was up only +0.1%. That's still the first increase in 3 months but barely.

Core capital-equipment orders, considered a good gauge of business health and investment, increased by 1.1%, making it the largest increase since May. It's nice to see all those record profits being put to good use in growing and investing in their companies. But this may have been a correction to slow orders in past months--shipments of core capital-equipment fell -2.1% after rising +1.0% in August. The bigger picture unfortunately suggests business investment has been weaker than expected in the third quarter even after a very weak 2nd quarter. This capital-equipment spending is important for the goldilocks soft-landing scenario.

Shipments of durable goods fell -2.8%. This will have a negative impact on GDP which will be reported on Friday. Expectations for GDP are for growth to have moderated to a 2% annual pace for the third quarter, a drop from 2.6% for the second quarter.

Inventories increased 1% which is the eighth increase out of the past nine months. While building inventory increases the GDP number it's not good for businesses since they may be forced to lower prices in order to shed excess inventory. See what's happening in the new home sales? The shipment/inventory ratio tends to be more forward-looking and it rose to a 14-month high of 1.39. This is not what we want to see and is likely the result of a slowing economy.

Unemployment claims
Unemployment numbers showed an increase of initial claims by 8K to 308K. The previous week was 300K and the week before that was 309K. Since July the average has been 315K. The current 4-week average is fell by 2,750 to 305,250 and that makes for the lowest level since late February. Continuing claims rose by 3K to 2.45M while the 4-week average was up by 4K to 2.44M. The numbers have been very steady for a number of months. The help-wanted index has remained steady for September but it had dropped in the past 3 months. There is concern that the concern about inflation combined with slowing consumption and investment growth will mean new hiring will remain sluggish.

New Home Sales
There was good and bad news on the housing front. The good news is that the sales of new home unexpectedly rose by +5.3% in September. The bad news is that the builders had to heavily discount prices to get those sales. As we've been hearing and reading lately in the home builders' earnings reports, cancellations on new home sales is now nearing 50%. With the heavy incentives offered by the builders, the average sales price of a new home dropped by -9.7% to $217,100 which is the lowest price in two years. The rate at which prices are dropping is the fastest drop in 36 years, since 1970. If you'll recall, 1970 was at the beginning of a nasty and prolonged period of stagflation for this country.

Sales of new homes came in at annual rate of 1.075M for a +5.3% increase, which is the most in three months and well above the expected 1.05M run rate. But sales for the previous three months of June, July and August were revised lower by 67K annualized. August was revised lower to 1.021M from its originally reported 1.05M. Therefore the 5.3% increase was really only a +2.4% increase for September. The revision lower in past numbers has been a pattern lately.

The more significant fact is the price drop and the fact that new home sales are down 14.2% year-over-year. Inventories are up by the same amount, +14.4%, but they fell to 557K which represents a 6.4-month supply at the current September sales pace. I guess if they keep dropping the price they can make it up in volume. Didn't AMZN try that once? We know how well that worked out for their stock (as a reminder their stock was over $110 in 1999 and dropped below $10 in 2001; it's now all the way back up to $38).

Bad news in the housing market was met with buying in the home builders. I'll review the chart in a bit to show why I think we're only seeing a correction to the decline but one thing to think about here. We have heard many times during a bear market rally that it's rallying (usually on bad news) because all the bad news has already been discounted by the market. Then we find the market rolls back over and heads for new lows again. Another bounce and another bad-news-is-good-news bear market rally follows. The same thing is happening in the housing market. The bad news hasn't been discounted yet, only some of it.

An example I was recently reading is in an index called the ABX index. This measures the risk of owning bonds backed by home loans to people with poor credit. This index is up 30% since August and is not declining. This is where traders place their bets on whether or not they think these loan portfolios will see less or more defaults. They've been betting huge that there will be more defaults. With the ratcheting up of ARMs and the inability for many to handle the increased payments, the foreclosure rate will likely accelerate higher, and it's already hitting record levels. We unfortunately haven't seen the worst in the housing market, imho. And a worsening housing market will not be good for the stock market. It's all tied together.

OK, let's get to the chart.

DOW chart, Daily

The DOW has reached a Fib projection where the 2nd leg up in the climb from the June low is 262% of the 1st leg up. This kind of move is common in commodities but not stock indices, except in blow-off moves. Price is also pressing against the top of its tight and steep parallel up-channel for price action from the July low.

SPX chart, Daily

Like the DOW, SPX has achieved the level where the 2nd leg up in its rally off the June low is 262% of the 1st leg up, at 1384.47. The 78.6% retracement of the 2000-2002 decline is at 1385. SPX rallied a little higher than this today and hit the top of its parallel up-channel for price action since July. S-t-r-e-t-c-h that rubber band.

Nasdaq chart, Daily

The COMP managed to break its April high and close above it. That's bullish. The top of its parallel up-channel is a little higher just above 2400 so there's a little more room to run. Short term this looks like it could be completing the leg up from early October. This might turn out to be a double top.

The tech big caps are not doing quite as well but they're close. The NDX and its representative stock, the QQQQ, is close to testing its April high (43.05) and then has one more high to deal with at its January high of 43.31. It's healthier if the generals are leading the charge and the fact that they're hanging back a little could be another heads up here that things are getting a little frothy. I have the same concern about the lack of participation by the semis.

SOX semiconductor index, Daily chart

A rally without the semiconductor stocks is normally not a healthy rally. That clearly hasn't prevented the major indices from rallying hard but where are the semis? They were rejected at the 200-dma, broken uptrend line from April through October 2005 and the broken uptrend line from July. The 475 area also marked the location of the 50% retracement of the January-July decline. To me it's looking like the semis are going to show the way lower after the current small bounce is finished.

Before looking at the banks, I wanted to review the 30-year yield chart that I've been showing the past few weeks. What yields do over the next several weeks will have an impact on the banks and could provide some important clues for the economy.

30-year Yield, Daily chart

The 30-year yield has been consolidating after hitting resistance around 4.92%. It dropped hard the past two days after the FOMC announcement and any continuation lower will bust the potential inverse H&S pattern I've shown on the chart. A drop in yields would support the notion that the Fed will stay on hold for a while longer. But a consolidation followed by a break above 4.95% would suggest the Fed is not done yet.

The other concern about yields is the yield curve. Whenever we've had a yield curve inversion (short term rates climb higher than longer term rates) it has predicted at least a slowing in the economy if not a recession. This chart is a different way of looking for an inversion in the curve.

3-month vs. 10-year yield, Weekly chart, courtesy stockcharts.com

If the 3-month yield climbs above the 10-year (inverting the curve) then the value on this chart goes above 1.00, which it recently did. Past occurrences of this happening, such as in late 2000 and early 2001, have led to recessions. So why is the stock market rallying? Because it's not listening. So much for it being a good forecaster of what's coming down the road.

BIX banking index, Daily chart

The banking index is nearing a level that could be the turning point for its climb. Two equal legs up from June is at 403.18 which is also the top of its parallel up-channel for price action since June. This channel is based on the longer term uptrend line from May 2005. You'll find that these kinds of channels do an uncanny job at identifying turning points.

Securities broker index, Daily chart

The parallel up-channel for the brokers happened to be just above and below the longer term uptrend line from May 2005. After dropping back below that uptrend line earlier this month it has now bounced back up to it at 236.40. Today's high was 236.54. Looking at a short term chart I see that the bounce off the low on October 11th has also reached the level (236.04) where it has two equal legs up in its bounce. Based on this it should be ready to turn back down. The one thing that has me second guessing myself here is the MACD. After returning to the zero line and now turning back up, this is normally a bullish signal.

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

I discussed reasons above about why I think the talk about all's better with housing is false. The bounce off the July low looks corrective. It looks like a bear flag and the EW count supports that view. It could bounce a little higher still, perhaps up to 720 but this should head for new lows once the consolidation is finished. There was some hard selling in the first half of this year that needs to be consolidated. If and when it turns back down the recognition that housing is in deeper trouble will likely spoil things for the rest of the stock market bulls.

Oil chart, December contract, 120-min

Oil is hammering out a bottom. Whether the last low was it or another new low is coming, it's very close to starting a larger upward correction. The expected move up is very likely what's being sniffed out by the oil stocks.

Oil Index chart, Daily

There's no question now that the bounce off the September low is correcting the decline from the August high. The big question here of course is whether or not the bounce is correcting the decline, as I've depicted here, or if instead it's the start of a new leg higher. Once we start back down, assuming of course we'll ever see selling again (wink), it'll be the pattern of the decline that will provide some clues to this question. If it meanders sideways/down (correcting this month's rally) then it'll be bullish. If we start impulsing lower again and break below the 200-dma then it'll be bearish.

Transportation Index chart, TRAN, Daily

A retest of the May high for DOW and SPX is not being accompanied by a test of the high for the TRAN. That continues the bearish non-confirmation of the DOW's rally. Obviously a continuation of the rally in this index would be bullish confirmation. But the short term pattern suggests the Trannies are topping here. The kind of decline that follows should provide some more clues as to whether or not this will be an important high.

U.S. Dollar chart, Daily

No surprises yet or changes to my opinion that the U.S. dollar will consolidate between 85 and 87 into the new year before tanking again.

Gold chart, December contract, Daily

The down-channel for gold is still holding and is fairly wide--the top is just below the 200-dma at 617 and the bottom is close to 550. Other than that I don't have a good feel for where this is going. If forced to make a bet I would say the current bounce is going to be followed by a move down towards 550.

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

GDP and Michigan Sentiment could move the market tomorrow but the only thing that seems to be moving this market is cash. With cash coming in the market goes up. Cash starts leaving, the market will sink. Now if we could only measure that cash flow.

I redrew the long term trend lines for SPX on the weekly chart I've been showing each week to conclude this report.

SPX chart, Weekly, More Immediately Bearish

Using the trend line along the lows from August 2004 and attaching a parallel line to the high in January 2004 we get a parallel channel that I believe will do a good job at identifying the end of the current run up. The top of that channel is near 1394. Obviously my guesses over the past few weeks as to where the top of this run would be haven't been even close. We've got a runaway bull on our hands. This market could easily rally above this upper trend line but these channels are remarkably good at identifying the normal swings in prices.

But therein lies the problem. The current rally is not normal. By so many different measures, especially when comparing to historical norms, this market is beyond being stretched to the upside. Therefore it's a challenge to know where it will end. Will it be a level or will it be a time? Will it rally until after the elections or will it stop prior to 1400? We will of course know in hindsight (still trying to perfect that technique for trading--it works great in my back testing but I can't it to work in real time).

We're due for a rest but I'm not telling you anything you don't already know. All it means is that if you're long keep chasing this market higher. I'd keep my stop tucked in tight, certainly no lower than the 20-dma. The 10-dma has been supporting price so depending on aggressive you want to protect profits, use that one. If you want to short the market I'd suggest waiting until we break these support levels and then look for a bounce back up to test support-turned-resistance.

I'm a masochist and I like to find tops and bottoms (turning points). I've had my head handed to me this month and missed one helluva run to the upside. Ce la vie. I'd be a rich man if I just had the trades I didnt take. I'll continue to try to call out the top on the Market Monitor so I'll see you there tomorrow. For the rest, good luck and I'll see you next week.

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