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Market Wrap

The Market Recasts Its Vote

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The stories today started casting doubt on what the control of both Houses of Congress would mean to the market. Everything from worry about supporting our troops (and what it would mean to defense stocks) to worry about taxing oil companies to worry about minimum wage increases and what it means to the bottom lines of companies (and to inflation worries). So the jubilation in the market at the thought of a split between the White House and Congress is now turning into a little more of an unknown. And the market hates uncertainty.

The selling today was by no means strong and in fact the numbers in the table above show that it was tilted toward the sell side but not in a lopsided kind of way. Total volume was brisk so there were certainly a lot of traders who wanted to buy this market. We still have a lot more new highs than lows. Therefore I wouldn't necessarily take anything away from today's price action has having any particular meaning yet.

Today's decline could easily be interpreted as simply part of the pullback correction to the Monday/Tuesday rally. Linda commented on this last night--we've consistently seen these strong buying spikes followed by days of consolidation. If that's what we currently have going on then we should see a reversal back up tomorrow. If we have something more bearish starting, which I see as a distinct possibility (and will show in the charts), then we should see only a small bounce followed by more lows tomorrow.

After getting "thumped" (to use Bush's term) by this market I too have been humbled and need to listen. Mind you, taken individually each of the times I've been stopped out of my short position it's not been too painful but cumulatively I got thumped. Let's just say I've now moved to Missouri and the market now has to show me that it has topped. I'll continue to attempt to pick a top because I use that as my starting point when I watch declines to see how it's forming. The current decline is inconclusive so far and therefore I'm letting price show me the way. As of tonight I could easily call a market top based on some longer term signals. Even some short term Fibonacci upside targets were met this week. Now I'm letting price prove it to me. Then I'll get aggressive again and will use bounces to get short.

I continue to keep a close eye on the VIX since it could be close to giving us an all-clear buy signal. That would of course be bearish for the market if the VIX rallies. After breaking out of its descending wedge it came back down to test the downtrend line that formed the top of the wedge. It got a bounce back up today after testing it. A rally from here back above 12, getting it above the high on November 2nd, would be confirmation of the break out. At that point I suspect we'd be seeing the stock market breaking uptrend lines.

Adding to some of the angst felt by the market today were some comments by our ex-Fed head, Allen Greenspan. In what I interpreted as a dig at the Democrats, whether it was meant that way or not, Greenspan had said that he would be surprised if the Democratic congressional wins led to major economic policy changes, adding "you'd be hard pressed to find out what the Democratic agenda is." Zing! OK Madame Speaker, the gloves are off.

Before the market opened we got news from The Bank of England saying they had raised their key interest rate to the highest level in more than 5 years. As they said, it was a pre-emptive strike on wage inflation and rapidly climbing home prices. This raised their rate from 4.75% to 5%. It's that wage inflation thing that has our own Fed spooked.

Trade Balance and Import/Export Prices
The trade (im)balance numbers came out today and showed a slight improvement in September vs. August, coming in at -$64.3B vs. the prior -$69.0B. This was also slightly less than the market expected. With it down -6.8% that made for a trade gap that is at its lowest level since April. We had rising exports (even though export prices were down -0.5%) to a new record high while imports declined 2%, making it two months in a row for a drop and it matched the largest drop in the past 3 years.

Import prices dropped -0.6% and are down -0.1% over the past year, thanks largely to the price of oil. This is the first year-over-year decline since September 2002. The good news is no price inflation pressure from imports but the potential bad news is that the reduction in imports could be a signal of slowing demand for products in general (as part of a slowing economy).

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And then there's China--our trade imbalance with them continued to widen to a record $23.0B vs. $20.1B in October a year ago. Many say we shouldn't worry about this exchange with China since our dollars to them simply return to us in the form of treasury purchases. That of course doesnt wash well considering the fact that we owe China the money they're lending us. Of course if the Fed is successful in monetizing the debt at least we'll buy back all that debt with cheaper dollars.

Speaking of China and their treasury purchases, they've indicated they want to diversify their holdings. I didn't see much of a reaction from anyone, except gold, to this news which I found interesting. If foreigners start "diversifying" what they're really saying is that they don't trust their holdings in US dollars. That could further depress the value of the dollar and the treasuries. A drop in the value of treasuries of course means higher interest rates.

Gold however did take notice of that announcement by China. At least that was one explanation for the spike up in gold prices today. While it's not new information, the Bank of China Governor Zhou Xiaochuan reiterated China's desire to diversify its currency reserves, currently more than $1 trillion which includes gold and oil. Tony Crescenzi, chief bond market strategist at Miller Tabak & Co, pointed out that central banks worldwide have been diversifying reserves since 2001 and that "The news is bullish for gold, but not really new."

Also helping gold today was more talk about what a new Congress will mean for the U.S. There was talk that the gold market thinks there will be potential damage to the U.S. as a result in the shift to a Democratic Congress. One fear is of inflationary pressures caused by actions in the new Congress, such as an increase in minimum wage. As Ned Schmidt, editor of the Value View Gold Report, said, "U.S. voters wanted a resolution of Iraq, but what they got is a new Speaker of the House." I'm not going to get into a political discussion because quite frankly I'm sick to death of it all, but this kind of statement notches up the uncertainty level in the market and investors then run away from stocks and into things like gold. Gold closed up + $18.50 to $636.80 which was a 2-month high. It may not stay there as I'll review in the charts.

Initial Claims
The initial unemployment claims dropped back down to its recent range by declining 20K to 308K. We can probably tell the Labor Dept they don't need to fudge the numbers anymore--the election is over (wink). The 4-week average fell slightly by 250 to 311,250. Continuing claims rose by 43K to 2.45M and the 4-week average rose to 2.44M. This may be an indication that it's starting to become more difficult to find a job.

The big drop in the unemployment rate, down to 4.4% that was announced with much fanfare earlier in the week, may be as much of an indication that many people are simply dropping off the list after their 26-weeks have been used up.

An interesting point should be made about the unemployment rate and the attempt by some to point out that it means good things are ahead of us. First of all it's a lagging indicator which means forget about using it as a gauge for what's ahead, duh. As proof of that, one only needs to look at what the unemployment rate was as we entered the last recession. The unemployment rate was 4.4% in April 2001 and bottomed at 4.3% in May 2001. The recession had started in March 2001 (which is never identified except in hindsight). Which gets us back to hindsight trading--I'm still working on it and I will let you know when I've achieved some success with it. I've got the hindsight thing down solid but I'm struggling with the application of that knowledge.

Michigan Consumer Sentiment
Consumer sentiment was down in November. Now there's a shocker. All we heard for the last month was the amount of trouble our country is in, what crappy leaders we have, how much the world hates and why we should vote in someone we have no clue about. Boy, dish me some more of that. So sentiment dropped from 93.6 in October to 92.3. Considering everything that's going on I'd say that was darned good. Americans really are an optimistic lot. It's hard to get us down. Take away my house ATM though and I might start to get a little testy. But that'll happen later.

Wholesale inventories were down from October's 1.2% to 0.8%. This was a little higher than expected but nothing major here. All in all, the market didn't pay much attention to any of the reports. It was a very listless morning and then by the afternoon the market just seemed to sink from its own weight. We'll have to see if the hangover lifts tomorrow.

DOW chart, Daily

After getting a hard bounce off the bottom of its channel, with a strong rally on Monday and Tuesday, the DOW has now stalled at its previous high on October 26th. It made a new high but hasn't been able to hold it. It also stalled at the mid line of its steep up-channel which is common when the rally is running out of steam. Whether it runs out here or a little higher first is not clear yet. The uptrend clearly dominates and holds.

In Tuesday's Wrap I showed a weekly chart of the DOW to point out some Fib projections based on the internal wave structure of the rally from October 2002. There were two projections that pointed to 12197-12198 as a potential top to the rally. This week we came within a point of that level and essentially doing a retest of the October 26th high (12167). I had commented that the high of 12196 on Tuesday might have been close enough. Looking a little closer (same daily chart as above but a little more expanded and showing RSI) shows another interesting development here.

DOW chart with RSI, Daily

The Fib projection at 12197 is the one where we have two equal legs up from October 2005. If that was the high then the next move should be a break of its uptrend line from July, currently near 12050. Today the pullback was supported by its 10-dma which is still bullish if that holds. The current pullback could simply be a correction of the Monday/Tuesday rally in preparation for another run higher. As we head into opex week that's entirely possible and the technical indicators might just have to wait for opex to end.

I had mentioned in last week's Wrap that the break of the uptrend line from June for RSI was a potentially strong signal that the rally is on its last legs, if not finished. I had said it doesn't preclude another run higher but it was giving us a heads up for a potential trend change. Also I said watch for a bearish divergence if we get another run higher. Now look at the test of the broken uptrend line on RSI--this is one of the best sell signals you'll ever see. And it shows a huge bearish divergence at Tuesday's high vs. the October 26th high. Will it work this time? We've seen so many sell signals in the past couple of months fail miserably. But this one could be real. We'll soon find out.

SPX chart, Daily

SPX looks like the DOW--hard bounce off the bottom of its up-channel and a stall at its mid line. It has not bested its October 26th high but came very close. Double-top? A very bearish divergence at this week's high will be a good indication of that if price now drops back below last week's low.

Nasdaq chart, Daily

The COMP looks bullish in that it climbed above its April high yesterday, made a new high and then came back down to close at the high. If this retest of the high holds then the bulls still control the ball. The bearish divergences at each of the past two highs after mid-October tell me the ball might be greased at this point and the bulls could fumble it at any time. Like the DOW and SPX, the COMP stalled at the mid line of its up-channel.

SOX semiconductor index, Daily chart

"Where in the World Are the Semis?" should be the title of this chart. The rally in the broader market, even in the techs and small caps, has not included the semis. This has been one unloved index. I'll continue to caution the bulls--a rally without the semis is like a day without sunshine. Watch the 200-dma for resistance if this can push a little higher otherwise this is in danger of falling now.

BIX banking index, Daily chart

I have two Fib projections for the banks--between 401.38 and 403.68. The top of its parallel up-channel is closer to 405. Yesterday the banks rallied to 403.20 and today's pullback is hinting no mas. The pattern looks good to be able to call the rally complete at this point and if the banks start to sell off I doubt the broader market will be far behind.

We got some more news out of the housing industry today. Pulte Homes (PHM) said it is reducing its land purchases, lowering sales volume and cutting costs as it sees a difficult road ahead yet. It's a very similar story at this point. I had warned many times in past months, in a counter-argument that home prices would fall precipitously due to over supply and would have little to do with how nice the area or houses were. Speculators were hot and heavy into the housing market (remember the flippers and I don't mean the dolphin?) and they were a larger part of the demand driving prices higher. They would be the first ones to bail en masse.

PHM CEO, Richard Dugas, said the same thing today. At a UBS-sponsored investor conference today he said cancellation rates have doubled since last year. "The market experienced a 'double impact' when speculators stopped buying homes, and also put homes up for sale to exit the hottest markets." This is driving inventories higher which is forcing builders to offer incentives and concessions to entice nervous buyers.

At the same conference, Toll Brothers (TOL) CEO, Robert Toll, said his company is seeing record cancellations now. Part of the reason is because its backlog had stretched out beyond 12 months during the boom years. As a result the speculators are now walking away and giving up their deposits as the houses are coming to completion. The last thing they need is an empty house that's taking too long to sell. Their deposit is minimal as compared to the losses they could take on an empty house.

And from the man who created the housing bubble with his easy money policy and massive liquidity injections comes this from our ex-Fed head Mr. Green-money-span: he expects the worst is over as the market makes its way through the inventory of unsold homes. He said the U.S. housing market is no longer taking away from economic growth and that "this is not the bottom, but the worst is behind us." He is supposed to be a bright man. If he sincerely believes that statement then he hasn't studied bubbles. And if he has studied bubbles then he believes it'll be different this time. Don't bet on it.

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

The home builder index hasn't liked the beating of the negative drum this weak and has settled back to the bottom of its bear flag pattern, and slightly back below its broken downtrend line. The bulls can still save the day here and drive it back up to the top of its flag. From a short term perspective I can see that happening, especially as stochastics gets into oversold while price hits support. If it were to bounce back up then a short at its 200-dma would be an ideal setup. But a break below 600 would indicate to me that the next leg down has already begun and a downside target at least to 500 should be expected before we see another consolidation.

Another chart worth showing, since it's clearly tied to what's happening in the housing market, is a chart showing how much money has been withdrawn from home equity.

Mortgage Equity Withdrawal, 1955-2006

The spike in withdrawals since 1998 is dramatic. Homeowners have had more money than they know what to do with and it was enormously helpful to our economy. Consumer spending was strong to say the least, out of control to say the most. Now we're seeing a sharp drop in equity withdrawals since the end of 2005. This sharp reversal in home equity extraction will likely continue and take this chart back to where it was pre-1998. The impact to our economy, from the lack of consumer spending (since they'll double the impact by saving instead of spending) will be significant. To those who still believe in the soft landing scenario, in housing or the economy, I say it's doubtful.

Oil chart, December contract, Daily

On Tuesday I showed an update to the 120-min chart that I had been using for the past several weeks (due to the steep and tight down-channel that price was "squished" into). I showed how it was breaking its downtrend line from August and came back down for a retest at its 58.90 low for the day. It held and has bounced about $2.30 since. So now backing out to the daily chart, I think it will probably head for a test of its 50-dma which may or may not offer much resistance. We should be at just the start of a multi-month rally to correct the July-November decline in oil.

With oil getting ready for what should be a much bigger bounce it would appear that the oil stocks were expecting this for a little while now. The question in my mind is whether it's now all priced in.

Oil Index chart, Daily

While oil was still struggling at its lows the oil stocks took off to the upside, convinced oil was going to follow. I think it will too but now I'm thinking the oil stocks may have already priced it all in. The pattern suggests to me that this index is now going to pull back. A retest of its 50-dma would be a logical place and if there are more bullish things ahead for this index then that should be solid support. What I'm not sure about is the longer term pattern from here. The 5-wave move up from September tells me we should continue higher after a pullback. A more bearish interpretation says this 5-wave move completes its rally that started back in March 2003, coinciding of course with the broader market rally. It would mean a truncated end to its rally (not making a new high above its August high). This bearish interpretation is entirely possible and I mention it in case you want to protect your positions. Jim is guiding you on these plays so I don't want to step on his recommendations but I see some potential for a reversal here.

Transportation Index chart, TRAN, Daily

While the DOW makes new highs the Trannies blow raspberries. The non-confirmation by the Transports does not bode well for the DOW rally if you agree with DOW Theory. If you think it's different this time then simply ignore what the Trannies are doing. We're close to getting a sell signal here as price pulls back again to its uptrend line. A break below last week's low would be confirmation of the break. Until that happens, follow the trend.

U.S. Dollar chart, Daily

The US dollar felt some heat today in all the talk about the negative impact to the U.S. from a Democratic Congress. Whether that's true or not doesn't matter, only what strikes fear into the hearts of traders. But I see support here for another bounce back up to the top of its consolidation pattern before we see the next big decline. But a break below $84 would suggest that break down is already in progress.

If the dollar breaks down we'll probably see gold rally from here. But just as I see a bounce in the dollar I see a pullback in gold.

Gold chart, December contract, Daily

Gold jumped up today and banged its head again on its broken uptrend line from August 2005. It's looking overbought here so it's unlikely that it will break this resistance. If it does then obviously stochastics will just flatten out in overbought indicating a strong uptrend in progress. But based on the internal wave structure I'm expecting to see this pull back to the bottom of its consolidation pattern before it's set up for a strong rally to new highs in 2007. I show the bearish potential off the H&S pattern but that's an alternate interpretation.

Getting little closer to the move up in gold, this 120-min chart shows where it might top out before pulling back.

Gold chart, December contract, 120-min chart

The leg up from October looks to be forming an ascending wedge and some internal Fib projections line up nicely at the top of its pattern tomorrow in the 643-644 area. If you like to play the gold e-mini futures (YG), that could set up a very nice short play. At least you'll be able to keep your stop tight.

Results of today's economic reports include the following (there are no major economic reports on Friday):

While today was active with economic reports, none of them were really market moving. Tomorrow there are no reports so the market will be on its own to figure out what's next. If today's pullback was part of a larger sideways consolidation that is correcting the Monday/Tuesday rally then we should expect a rally on Friday. If we've seen the high then we should be due a bounce soon but then watch for it to turn back over and head for new lows next week.

Once we get some clues that strong support lines and moving averages are breaking then we can get more aggressive in looking for bounces to get short. In the meantime the trend is still up and bears need to respect that. On top of the indecision the past couple of days we now head into opex week and that can distort any trend or non-trend. Continue to scalp if you're trying to day trade this. If you like longer swing or position trading, long is the place to be until we break support. Just be careful because we could be close now to a reversal.

We're starting to get a hint from the weekly chart that we could, might, just may be topping. The fact that we have daily, weekly and monthly charts overbought and rolling over could be a very significant long term signal here.

SPX chart, Weekly, More Immediately Bearish

The weekly oscillators are threatening to roll over, this after price reached the top of its parallel up-channel from 2004. It was also at some important Fib projections that were pointing to the 1385 area as potential resistance.

One last bit of news was from Microsoft (MSFT 29.26 +0.28) which said antitrust regulations haven't fundamentally altered key features that the company wanted to include in their new Vista operating system (which I've previewed and it's very slick). They announced they will be shipping copies to business users by the end of this month. Mr. Softee has had a very nice run from its low in June, especially considering the spanking it got at the end of April and the huge gap down.

Now MSFT is at a very interesting place and in fact I think its chart supports the idea that we're seeing a major top getting put in place in the broader market. Check out this monthly chart

Microsoft chart, Monthly

If this were a daily or 60-min, or whatever, chart would you be looking to buy this or sell it? I'd be selling and shorting it with both hands since you can place your stop very close (the top of this bear flag pattern is near 29.50 and today's high was 29.40. If the bear flag is the correct interpretation then the 2002-2006 "rally" in MSFT was simply a correction of the 2000-2002 decline. The internal wave count is also good for calling this bear flag complete with the rally leg from June. Get ready for bear market leg #2 coming up, or should I say going down.

With that I'll say good luck tomorrow and continue to be careful about a little extra volatility coming up. The topping process can be volatile anyway and now we're heading into opex week which may only aggravate that. I'll call it as I see on the Market Monitor and I'll be back here for the Market Wrap this weekend and on Tuesday as I fill in for Jim.
 

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