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Market Wrap

Pre-Election Rally

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I (Keene Little) will be filling in for Jim who is on leave for some family business. We've had one heck of a rally the past two days, one of the strongest we've seen in the rally of the past few months. It was a nice little present for the incumbents in office. As I write this (early afternoon on the west coast) preliminary results show the Democrats doing well so the Republican incumbents don't seem to have been helped much by anything the market has done. As I've seen in many articles written recently, "It's Iraq stupid."

Talk to ten different people about how well the stock market will do under various scenarios of who's in control of which house and the presidency and you'll get ten different answers. Bottom line is I don't think it matters a whole lot. Generally speaking though it seems the street likes gridlock since the government is forced to be more fiscally frugal and has a tougher time making new laws. What they're saying of course is that we the people are much better off with a do-nothing government. Some might say that's been the case for the past many years (wink).

Many investors are banking on a year-end rally though. The statistics show November/December to be generally bullish anyway. In those cases where we went from total political unity (both houses and the president from one party) to a split to total or partial gridlock (6 times since 1945), the S&P 500 rose an average of +4.8%. There seems to be no end to the bullishness we're seeing in the market these days. VIX is still near record lows although interestingly it rose today after its initial drop at this morning's open. Perhaps a little worry is creeping in here. That could be bullish (the wall of worry) or it could be a signal that the end of the run is near.

From a technical perspective we were primed and ready for the past 2-day rally. The pullback last week came right down to strong support and it looked like we should get a bounce this week. I will admit that I'm a bit surprised to look at this 2-day "bounce" since the strength of it has surprised me. But is it really strong? A look under the hood says perhaps not and we'll review some of those signals. We're also very close to achieving some important levels as we head into a potential Fibonacci turn date window. The pieces are in place for a major high to get put in but obviously price is king and we'll follow that signal above all others.

There was only one economic report today and that didn't come until the afternoon. It was Consumer Credit for September which came in at $1.2B vs. expectations for $5.5B and a significant drop from the revised $9.1B for August (which was revised higher from $2.6B). So whether it was up from the original number or down from the revised number if you average the two readings you get close to the expected $5.5B. But sticking with the $1.2B that was the most it's dropped since April 1992. Obviously retailers are hoping to see that turn around as we head into the holiday season.

Retailers have issued some less-than-rosy sales forecasts and the previous durable goods numbers also show a consumer that appears to be slowing down. With the leveling off, and dropping, of home prices, the piggy bank known as the housing ATM looks to be drying up. Without that source of "income" we will very likely find the consumer slowing their spending considerably. All eyes on holiday spending patterns since that should be a very good clue for what's coming.

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The news out of the home builders also continues to be less than rosy. Toll Brothers (TOL 28.04 -0.01) and Beazer Homes (BZH 42.07 +0.13) both reported declining numbers but today looks like much of that has been priced in. That's debatable but for now that's what it looks like. TOL, known for its McMansions, reported a 57% decline in new home contracts for Q4 as compared to a year ago. Revenues were down 10% which was more than had been expected by the street. Its backlog for new homes fell 25%. It continues to get hit by higher contract cancellations which rose to 37% from 18% in Q3, so basically a doubling of its cancellation rate.

Nearly a quarter of its cancellations are for homes in the Orlando, FL area and northern CA. Also hurting earnings are the write-downs the company is taking on land that is either owned or they had options to buy. They will be writing off between $50M and $100M for the last quarter. TOL expects to update its earnings forecast for 2007 in its conference call scheduled for December 5th which is when it will also release full Q4 results.

But TOL lowered its estimate for fiscal 2007 to a range of 6,300 and 7,300 homes, down from its previous forecast of 7,000 to 8,000 deliveries. As their Chief Executive Robert Toll said, "We continue to look for signs that a recovery is imminent but can't yet say that one is in sight." This is a significant statement by someone who should know. The market pretty much ignored his comment, or feels it's already priced in. I don't think so.

BZH reported a 44% drop in its quarterly earnings, coming in at $91.9M vs. $164.4M a year ago. But they trimmed costs/losses and were able to beat expectations for profits by reporting $2.10 a share vs. $1.89 expected. But they lowered their earnings forecast for 2007. They're citing problems getting houses sold which require deep discounting now. New orders are down 58%.

Some additional news that just warms my heart (Not!) is that the investment bankers, the ones who are raping and pillaging this market for personal gain (personal comment), will be getting 20% bonuses this year. These are the brokers for equities and asset management. The brokers for retail, fixed income and commercial will only get a paltry 5-10%. The trading by the mega banks has been condoned and supported by our Fed and SEC and I hope that some day some people get thrown in jail for the shenanigans going on. We have corruption at the highest levels of government and banking and I look forward to a good cleaning of our collective house.

And now off my soapbox. Boeing (BA 84.85 +4.37) got a big boost today on news that FedEx (FDX 115.03 +1.07) said it would buy 15 jets from BA, with an option to buy 15 more, after canceling A380 orders to Airbus, citing delays in deliveries. The news gave the Trannies a little lift as well.

I had shown a chart of calculated M3 money supply last Thursday because I felt it did a pretty good job at showing us what's been happening in the money-creation department. The spike up in money added to the monetary system, especially since August, has been dramatic. As has our stock market gone parabolic in its climb, so too has the money supply. Think there might be a link? I certainly do. So I was curious to see what happened on that chart last week considering the sell off we had in the stock market.

M3 Money Supply, calculated, Weekly chart, courtesy nowandfutures.com

As you can see there was quite a dip in the rate of change (light blue line) last week. The amount of M3 actually dropped last week. And the stock market sold off as well. Still don't think there's a link between the two? The mega banks get the money from the Fed and buy up the market with it, adding their own considerable trading capital to it now. And then they get fat 20% bonuses for their efforts. I only wish we could see this calculated M3 reported on a daily basis (but the numbers from the Fed for this are only reported weekly). I'd be willing to bet there was quite a bit of Fed money pouring into the markets yesterday and today.

Let's move onto the other charts to see if we just might be getting close to putting in some kind of top here.

DOW chart, Daily

The DOW got a nice bounce off the bottom of its steep up-channel (after doing a little head fake break below it). We got a minor new high today, just in time for all the good people going to the polls today. It probably won't matter but it was a good effort by the Manipulators. Price stalled at the mid line of the up-channel and this is quite common to see for the last leg up in the pattern. It remains to be seen if this is the last leg up but any break now below last week's low would be a confirmed sell signal--it would be a break of its uptrend confirmed with a break of its last low. Until that happens stay with the trend but keep that exit door blocked open in case there's a mad rush for it.

From a weekly perspective, something I've been showing each Thursday for SPX, I thought I'd review the DOW's weekly chart. We're hitting some potentially important Fibonacci levels.

DOW chart, Weekly

Using Fib projections off the internal waves since the October 2002 bottom I get a first Fib target at 12198.2. This is where the 2nd leg up in the 2002-2006 rally is equal to 62% of the 1st leg up, a very common relationship, particularly when the 2nd leg up is losing momentum as we've seen for a long time in the rally this year.

The other Fib projection (hard to see since it blends in with the other one) is for the move up from October 2005. That shows 12197.1 for an upside target based on two equal legs up from that October low. Today's high was 12196. Close enough? Time will tell.

SPX chart, Daily

Like the DOW, SPX bounced off the bottom of its steep up-channel at last week's low and hit potential resistance at the channels mid line. As I had mentioned last week, the break in the rising bottoms of its MACD and RSI is a big heads up that we probably have a trend change in the making. I had mentioned we could get another price high and that it would likely be associated with more bearish divergences. This is very apparent on all charts. This can still rally higher but keep that exit door propped open.

Nasdaq chart, Daily

The COMP is once again testing its high near 2375. It actually made a new high but couldn't hold it. Like the others it too found resistance at the mid line of its steep up-channel. Also like the others this one is sporting all kinds of bearish divergences at this high. It needs to keep going otherwise we'll recognize in hindsight the strong sell signal here. But it takes a break below last week's low to confirm a breakdown.

SMH semiconductor holder, Daily chart

The semis continue to show relative weakness over the past couple of months and that continues to be a heads up that something is not right with the rally we've seen. A lot of money is going into big caps (driving the major indices higher) but the lack of participation in the semis is never a good sign. In the meantime it's looking like SMH is forming a H&S over the past couple of months. Today's rally failed to touch its 200-dma and closed below its 50-dma where it's been struggling since mid October.

BIX banking index, Daily chart

I had mentioned last week that the short term pattern would look better with another leg up (for its 5th wave in the move up from August) and it appears we're getting it. It doesn't necessarily have to make a new high (5th waves often truncate) but it will manage a new high if it can tag its Fib projection target at 401.38. If the bulls can keep this going then the top of its up-channel near 405 is upside potential. But with the continuation in the bearish divergences I'm not so sure we're going to see much more here. I know, you've heard that before.

Securities broker index, Daily chart

Like the banks I was thinking this could use another minor new high and we might get it. So far the brokers are finding resistance at its broken uptrend line from May 2005. Maybe it'll walk its way a little higher under this trend line.

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

The bullish thing I see for the home builders is that it's holding above its broken downtrend line and may be inching its way down for a retest of the line for support. A break back down below 600 says another rally leg is probably not going to happen. But until then there's still hope for a leg up to the 200-dma and top of its bear flag near 730.

Oil chart, December contract, 120-min chart

Oil is slowly making its way out of its downtrend but not showing a whole lot of enthusiasm yet. After breaking its downtrend line from August oil is pulling back for what should be a retest of that line. I'm expecting a higher bounce out of this. The 120-min chart here looks like it's ready to roll back over so the bulls will need to step back in now. The daily chart continues to show bullish divergence for a continuation higher. What I don't like, from a bullish perspective, is the bounce so far looks like a 3-wave corrective bounce. The bounce can easily press higher but being corrective suggests we haven't seen the lows yet.

Oil Index chart, Daily

The oil index has been predicting a bounce in the price of oil, or it's simply been participating in the exuberance of the broader stock market. At any rate the short term pattern looks good for a small press higher but then it should be ready for a larger correction. If the pullback forms a choppy sideways/down kind of move then that will be bullish. But as I depict, I'm thinking this could be the end of the correction to the August-September decline and we should see the next leg down start soon.

Transportation Index chart, TRAN, Daily

The Trannies got a bounce off the bottom of its up-channel, like the broader market, and daily MACD turning back up near the zero line looks bullish. The short term pattern supports the idea we'll see at least a retest of the October high but I'm thinking not much more than that before it rolls back over. Stick with the uptrend until it breaks and then get shorty.

U.S. Dollar chart, Daily

I can't get an updated chart from QCharts for some reason so I'm showing last Thursday's chart. There's not much of change since then anyway and I wanted to remind you of the pattern I think is playing out--an ascending triangle with support just above $85. It should make a run back up to the $87 area now before starting another big decline into 2007. Based on this interpretation I see gold doing just the opposite here.

Gold chart, December contract, Daily

Gold is stalling at its broken uptrend line from August 2005. It might even be stalling at its potential H&S neckline (blue trend line) which would be even more of a bearish setup for gold. But based on the US dollar's pattern I'm thinking gold will consolidate in the descending wedge shown with the brown trend lines. Another pullback towards $560 could set up a strong rally into 2007.

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

Economic reports are light this week. We only had the one today and only Crude Inventories on Wednesday. The rumors are that crude inventories will show an increase and that's what has prompted a bit of a sell off in oil the past couple of days. Obviously a draw down in inventories could spike the price of oil. I don't think the stock market is paying much attention to oil these days (they're too giddy drinking and asking "What, me worry? Of what?"? Wo be to the unwary. Anyway, as I commented on the oil chart above, it's ready to rally, or at least it needs to rally in order to maintain a bullish picture here. If it drops then the oil stocks could be finished with their rally as well.

Bottom line for me, after seeing the strong rally the past two days, is that we could be set up for a sell the news once the election is over. We've seen this happen time and again. If we get a sell off on Wednesday then the pundits will spin the news to match the outcome in the market. It's never the other way around. Along with the potential for a sell the news event we came very close to some important Fibonacci numbers for the DOW.

Some of the other indices and sectors could use a little higher but definitely not necessary. The bearish divergences, on long term time frames as well as short time frames, tell us to be cautious now. We're into the Fibonacci turn date window of November 3-17. The Bradley Model shows a turn at the end of November though to basically we have the month of November as a turn month. That's not very helpful for day to day trading but it does give us a heads up that we probably won't have a rally into the end of the year.

It's also a warning to continue pulling your stops up behind you as this rallies higher. If you got stopped out of any of your positions as some 20-dma's were broken last week (a head fake break to suck in the shorts needed to provide this week's rally) you may be annoyed at missing this week's rally. Don't be. You exercised sound money management rules. It's also much riskier to chase the last couple of percentage points in a rally. Jumping back in long now is way too risky in my opinion. Look to stay flat or for an opportunity to get short.

If you like playing the short side I think we've got a nice setup coming. I'd consider legging into some longer term plays such as put options. I'd go out January or even March 2007 at a minimum so that you can enjoy any drop in December (but take profits before Christmas). If you play shorter term moves then it could be better to wait for a confirmed break down and then get short on a bounce back to support-turned-resistance.

Good luck on Wednesday and don't be afraid to let the dust settle in the morning. I'll see you on the Market Monitor or back here on Thursday.
 

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