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Market Wrap

Opex Push To the Rescue

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I had mentioned in the weekend Wrap that a down Thursday prior to opex week has often been followed by a strong push higher during opex. The mega-banks' trading teams load up on cheap front month call options which pay off handsomely by the end of the week. Not only did they have that opportunity but this morning as well. After futures were much higher coming into this morning's trading we had a big sell off which broke below Monday afternoon's lows and sucked in some bear fuel while stopping out longs. After the Boyz loaded up on call options (SPY November 139 calls were the most active today) this morning they proceeded to push the market higher.

This afternoon the rally was languishing so the Boyz stepped in and jammed it higher. As of today's close it doesn't look like they're finished. We should see a continuation higher although we may see some consolidation tomorrow first. Another potential reason for today's jam to the upside was the IPO for Kellogg, Brown and Root (KBR), a spin off from Haliburton (HAL). Several of the mega banks have a big stake in the outcome of this important IPO and it was in their best interest to see the market higher for its debut. They have the ability to shove this market around where they want it and they want it higher.

Interestingly the price pattern is starting to come together for a potential high this week. I've mentioned several times in recent weeks that November is a potential turn month for the market. There are several cycle studies and Fibonacci time projections that show November to be a turn month, with November 3-17 as a particularly good turn window. Considering November 17th is opex Friday I've thought that this week would be an excellent time to see a market high. Time will tell.

But that's the possibility. For now we still have a bullish market. All uptrend lines continue to hold this market up and the 10 and 20-dma's continue to be good intraday support. The bulls are clearly in control and we need to stay with that trend. I'll mention potential turning windows and upside projections to help you protect profits and perhaps even try a short play if you dare. For now though, especially this week with an obvious attempt to jam the market higher again, we should be looking to buy the dips, including tomorrow's.


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One of the negatives that I continue to see in the market has to do with that old theory devised by Mr. Dow. With the DOW making new all-time highs where are the Trannies? In fact the Transports were negative on the day. From a DOW Theory perspective that's just not right. Interestingly I'm seeing a few articles pop up lately about how the DOW Theory is no longer a valid theory, that (you ready?) it's different this time. Oh gag me with a spoon. How many times do we need to learn this lesson? Because we want the rally to go on forever we tend to turn a blind eye towards whatever doesn't support the picture we want to see. Well, ignore that bearish non-confirmation at your own peril.

The economic news this morning was lousy for the stock market, or so one would think if you try to think logically. But therein lies the problem. For engineers like me, the stock market is a picture of illogic. In a nutshell we have slowing retail sales and slowing inflation. Slowing retail sales is indicative of a consumer that is tapped out, in debt up to his eyeballs, and no more easy access to money from their favorite piggy--home equity. But slowing inflation means we might (emphasis might) have a Fed who will consider reducing interest rates sometime in the far future.

Behind door #1 we have immediate evidence of a slowing economy (the consumer drives two thirds of GDP). Behind door #2 we have a Fed who might reduce interest rates. Behind door #3 is anyone's guess. Hmm, I think I'll bet everything I have and go with door #2. Logical? Of course not but that's the market we have and I must say the spinmeisters are doing a superb job at convincing the public that now's the best time to invest your money in the stock market.

A lot of reasons we're hearing why now is a great time to invest has to do with the calendar. Never mind hard evidence that the market is probably not a good place to try to capture more upside, close your eyes and throw more money into stocks. Throwing logic aside that's not difficult to comprehend. After all, those who are chasing momentum can easily drive the market much higher.

Many are proclaiming now is a good time to invest so that you can catch the best months of the year--November and December. Take a look at the following chart:

S&P 500 stock returns by month

As you can see, since 1950 the best months have been November through January. Based on this the odds say you should be fully invested now and then perhaps start lightening up in January. And of course we've all heard sell in May and go away. But this year has been out of synch. This has not been a typical year and the gains in September and October were certainly better than typical. Could it be that the gains for November and December were already achieved? I'm thinking yes. But this is what the market is looking at and damn the torpedoes, full speed ahead.

The other thing we're not sure about is what the Fed and Treasury are doing with money supply and if the Fed is worried about the economy slowing too much they could be continuing to pump huge amounts of money into the monetary system through their primary dealers who can easily buy this market up. I'm pretty sure this morning's decline was engineered by them so that they could load up on their cheap call options. They have the money to then buy up the market so why not? They can even justify by saying they bought the market with the Fed's money at a good price.

As a sign of the times, the boasting by the mega banks is starting to come out. This was found in siliconinvestor.com (thanks to Joe for sending me the link) and as stated by them, "Apparently the ability to perform insider trading is now something to brag about."

Bill Winters, co-chief executive of JPMorgan's investment banking business, said the bank has unique insight into the hedge fund industry because it has broad relationships with firms that have some $1 trillion in assets under management.

Winters stated, "We are not exposed from a credit perspective, materially, which allows us to respond quickly to opportunities when they come up. Amaranth was one obvious example of that. I imagine there will be others as we go through time where our ability to be on the inside, but not compromised, is extremely powerful."

I continue to think the downfall of those who are corrupting the system will be when they become so arrogant to think they are not only above the law but without risk. When they feel invincible is when they are most vulnerable. It's just a matter of time before they bet all their marbles and the market throws them a wicked curve ball.

Retail Sales
The retail sales figures were not good. Sales fell -0.2% in October for the 2nd month in a row. Falling gasoline prices led the decline so at first blush that's a good thing for consumers and businesses. This decline was an improvement from September's downwardly revised -0.8% (from previously reported -0.4%). That's a bit like saying GM is a great buy when they lose only hundreds of millions instead of a billion. It's all relative I guess.

Over the past 6 months retail sales have risen only twice so it says the consumer is getting tapped out. Sales are up +4.5% in the past 12 months but clearly most of that was in the first 6 months. But even a +4.5% is the weakest it's been in two years. Auto sales were stronger than expected, in dollar terms, but that's a calculation based on several factors such as after taking out improvements, adding in crash protection features, etc. In other words, subject to manipulation, er, I mean corrections. Without auto sales retail sales fell -0.4% after a -1.2% decline in September.

With retail sales representing about half of all consumer spending which represents about two thirds of GDP you can see the impact from a slowing consumer. The holiday season shopping will be very important for future growth estimates. There is an expectation for an increase in retail sales for the 4th quarter and part of that expectation is based on more money available from lower energy costs. Well, maybe. We're also heading into the heating season and that could take up the extra slack from lower gasoline purchases. As I said, listen for future spending estimates since the market might actually start to pay attention soon.

PPI and Core PPI
These are the numbers that got the market all excited this morning before the market opened. The PPI dropped sharply, down -1.6%, matching a record low set back in October 2001. The year-over-year rate on finished-prices fell to a -1.6% rate, the first time it has been below zero since September 2002.

The core PPI, which excludes food and energy prices, fell -0.9%, the biggest drop since August 1993. These numbers, if they're not outliers, was a very big change and they were not expected. One month does not a trend make but obviously if this continues then the Fed is going to be doing an about face on their rate policy very quickly. The inflation monster that they've been fighting may have suddenly evaporated. The market likes the idea of a Fed going into rate-reduction mode and hence the rally (or so we're told). I still say the evidence is stacked strongly against the stock market if things are slowing down that fast.

Excluding autos, which may be skewing the numbers because of the auto model year shift, the PPI fell -1.2% while core PPI rose +0.1%. That's quite a difference and had quite a few economists saying simply that they don't believe the numbers. Imagine that, not believing the government's numbers. Who woulda thunk.

For the past year the core PPI is up +0.6%. Excluding food and energy, intermediate prices are up +5.9% while crude goods are up +20.1%. Crude goods were down -10.5% in October which is the biggest drop since April 2003. So the numbers are all over the place and most feel the Fed will stay on rate hold. The stock market would rather believe that the Fed will move to rate reductions.

Before moving to the Business Inventories, here's a chart showing both PPI and the Inventory-to-Sales ratio:

PPI and Inventory-to-Sales Ratio, courtesy MarketWatch

The PPI chart shows quite graphically how much the rate has dropped. We'll have to wait for November to see if the number for October is an anomaly as many economists were stating today.

The chart right next to it shows the spike up in inventory as a percent of sales. The trend in 2006 is the wrong way. As inventory builds up businesses will be forced to mark down prices in order to move it (which will drop PPI numbers) or take write-downs for obsolete inventory (which will have a negative impact to the bottom line).

Business Inventories
That brings us to the inventory numbers for September which rose +0.4% as sales dropped -2.0%. It's a double whammy for a ratio that's been falling for 20 years as businesses have striven to get much better at just-in-time inventory control. The jump in the inventory-to-sales to 1.30 is the biggest one-month increase since 1996. Most of the decline in sales was for building materials, garden equipment and supplies. Sales of furniture, home furnishings and electrical and appliance store-goods also fell 0.1%. As the housing market slows down so too do sales related to housing. This shouldn't come as a surprise and yet most seemed surprised by the amount of the jump.

We have the home builders saddled with excess inventory and have been stating repeatedly and in unison that the extent of the slowdown has taken them by surprise. This slowdown is rippling through the economy and we should expect a lot more bad news like this before it bottoms. I have some more home builders updates in the section of this report with their chart.

So let's get to the charts and find out what this rally leg might be all about.

DOW chart, Daily

After pulling back to its uptrend line again on Monday and today the DOW sprang off that support. Today's rally was after a big spike down this morning which doesn't show up in the daily candle except for a hard-to-see tail under the body of the candle. Price action looks bullish. But after today's new high we've got the oscillators thinking twice about this "rally". Watch for another test of the broken uptrend line for RSI. Continued testing of this resistance from underneath could spell trouble for the current rally leg. I've drawn a short term trend line along recent highs and I'm getting the impression, especially the way price is now chopping its way higher, that we might form a small ascending wedge, a very common pattern at the end of a long run. This typically happens because many of the big players (smart money) starts using all rallies to unload their inventory.

In the meantime we have bullish price action and it appears the DOW is headed for its next stair in its stair-stepping move higher. That's at about 12250. If price pulls back to its uptrend line again and gives us another marginal new high, which is accompanied by continued bearish divergences, that's when I'll be backing up two trucks and loading up on cheap put options. The pattern will be signaling a breakdown coming but obviously won't be confirmed until we get a break below its uptrend line, confirmed with a break of its previous low. Right now that low is today's 12085 low.

Speaking of low, check out the move by VIX today:

VIX chart, Daily

The VIX is taking its sweet time to play out this pattern and just shows how extended this market is. After breaking out of its descending wedge (bullish for VIX, bearish for stocks), it has been chopping its way lower on top of the broken downtrend line as if afraid to leave it. It's slowly making its way down to the historical lows in 2005. Complacency reigns supreme but a move, even if only briefly, below 10 should scare the bulls. It takes a move above 12 to say we probably have a breakdown in progress on the major indices.

SPX chart, Daily

SPX looks marginally stronger than the DOW based on its RSI at least back to its RSI's broken uptrend line. Price is attempting to push through the mid line of its up-channel whereas the DOW hasn't quite reached that level yet. But the DOW is making new all-time highs whereas SPX was having trouble breaking its October 26th high so perhaps it's all evening out. As with the DOW, we could see a pullback in SPX followed by a minor new high.

If that new high is accompanied with more bearish divergences I think it will be a good short play setup. I'm looking for a small 5-wave move up from the November 3rd low and it may be an overlapping choppy move, pretty classic for a finishing move. I have some preliminary Fib projections to about 1400 and in fact that ties in with the top of its long term up-channel from 2004. See the weekly chart at the end of this report for that chart.

Nasdaq chart, Daily

The techs have been doing a great job at catching up and now surpassing the recent climb in the DOW and SPX. Price has rallied up through its up-channel mid line and RSI is poking back above its broken uptrend line. The top of its up-channel is near 2465 so that's the upside potential I see currently. Look to protect profits and perhaps try a short up there since there's a good chance it will be its final leg up in this pattern.

SOX semiconductor index, Daily chart

Who let the dogs out in the SOX? Nice pop higher in the past few days but now comes the tough part. The broken uptrend line from April 2005 has been strong resistance each of the past 3 times it's been hit since June. Not only that but this time it has its downtrend line from January 2006 to deal with. Both of these trend lines intersect today where price stopped. Coincidence? We'll see but right now I'd say this is where you want to short the semis. SMH has a slightly different pattern and trend lines but looks similar here for a short play setup.

BIX banking index, Daily chart

I keep waiting for the banks to rally up and tag its Fib projection at 403.68 or even the top of its up-channel near 405 but the banks have been lagging. This is not what bulls want to see and the non-confirmation from the banks and Transports (see chart below) tell us that not all is well with the current rally.

Securities broker index, Daily chart

Like the banks I don't get a bullish feeling from the brokers, another index you'd like to see participating more strongly with the broader market rally. This is chopping its way higher (bearish in itself) and keeps finding resistance at its broken uptrend line from May 2005. If this continues to act as resistance and looks to top out at or below its Fib target just under 241 then I'll continue to maintain a bearish bias on this one.

DR Horton (DHI) reported earnings today and reported a 51% drop in profits from a year earlier. This is the largest home builder so they're a good representation of the home building market. They took charges for land options that it decided not to exercise. This is a strong statement by the company that they would rather take the loss on those options rather than risk sitting on land that may sit vacant for years. Their confidence level in seeing the housing market turn around next year is obviously not high enough to warrant the purchase of more land.

But because the company beat expectations for reduced earnings their stock shot higher by 7% today. Sounds like some shorts scurried for cover and took some profits off the table. These are what bear market rallies are all about. DHI reported net income of $277.7M, or 88 cents a share in their 4th quarter, which was down from $563.8M, or $1.77 a share in the year-ago period. Charges for the 4th quarter included $142M for "inventory impairments" and $57M for write-offs of deposits and pre-acquisition costs related to land-option contracts. I'm not sure but the "inventory impairment" costs sounds like deep discounts made to sell their inventory. How creative.

At today's DR Horton (DHI) conference call there was the following question: "Some companies say the market is bottoming, others say it's getting worse. Which camp are you in?" The answer to the question was: "We are in the early stages of a declining market, and the decline will be longer and deeper than most people think."

This was a surprisingly candid response and one the market needs to listen very carefully to. These are the people in the trenches and know what's coming and what's not. The home builders rallied 6% today. Out of synch? Probably.

I'll touch on the following a little more in Thursday's Wrap but food for thought on this one. Since the 1940's each time the housing construction market has risen over 5.5% of GDP and then dropped 10%, we fell into a recession, every time. The latest build cycle reached 6% in 2005, the highest since the early 1950's and has since dropped over 20%. The data, which I'll show on Thursday (trying not to let this get too long), suggests we're a long way from the bottom and this is a message that's coming loud and clear from the home builder executives. But that didn't stop the short-covering rally yesterday and today.

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

From a technical perspective the pullback to the bottom of its bear flag pattern and its broken downtrend line was a good setup to buy the home builders. The rally since last Thursday's low looks pretty strong and it's still possible we'll see this bounce all the up to the top of its bear flag/200-dma near 730. But first it needs to get pat its 130-dma which has held down the previous 3 tests since the end of September. That's where price stopped today. In the meantime we see the negative divergence in MACD continuing. If this were to turn back down before exceeding the high on October 26th (689) then it's possible we'll see a very strong decline follow so bulls need to be careful with this one.

Oil chart, December contract, Daily

Oil continues to look weak when I expected more strength after breaking its downtrend line. At this point it's looking like it might drop back for a retest of its low (which should leave another bullish divergence) and its broken downtrend line. This could, and should, turn around and rally at any moment. I do not expect to see this continue lower. Maybe a minor new low but it shouldn't be much more downside here.

Oil Index chart, Daily

The oil stocks were predicting a bounce in oil and so far that hasn't happened. That might be giving traders reason to pause. Even though I expect to see a stronger rally in oil develop I don't expect to see higher in the oil index, at least not yet. This index is due a pullback and whether or not it's going to be just a pullback before proceeding higher or the start of something more serious to the downside it's too early to tell. But I think it's time to protect profits if you're long.

Transportation Index chart, TRAN, Daily

As the DOW rallies to new all-time highs the Trannies are blowing raspberries. Regardless of those who say "it's different this time" I don't think a DOW rally without the transports is a healthy rally. At this point I'm thinking the TRAN could rally to a minor new high but doesn't have to. The way this is chopping higher tells me it could be on its last leg here. It keeps threatening to break its uptrend line but so far it's holding.

U.S. Dollar chart, Daily

The US dollar bounced off its uptrend line from January 2005 and I expect to see this continue to the top of its consolidation pattern. First resistance is its 50-dma and any bounce from here followed by a break to a new low would tell me the next decline in the dollar is already underway. Therefore the uptrend line is very important to watch now.

Gold chart, December contract, Daily

Just the opposite to the US dollar, it looks like gold should be ready to drop back down to the bottom of its consolidation pattern, near $560. It found support at its 200-dma today and didn't drop much considering the significant drop in the PPI reported this morning. That suggests the gold market doesnt believe the numbers. The stock market would do well to listen. Like the dollar, if this pulls back and then rallies above 640 then there's a good chance the new rally leg in gold has already started.

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

The NY Empire Index has the potential to move the market since it will be another indication of how the economy is doing. But again it may be more a matter of how the market interprets how the Fed will react. Right now the market has its own agenda so I don't expect the reports to have much of an impact.

A look at the SPX weekly chart shows we could be oh-so-close to a high. But of course I've said that a time or two in the past several weeks.

SPX chart, Weekly, More Immediately Bearish

With weekly oscillators threatening to roll over a little bit more each week, and price pressing the top of its long term up-channel from 2004, one has to wonder if there's enough fuel to rally this much higher. These parallel channels do a remarkable job at showing where potential turns will occur. The top of this channel is at 1400, a nice round number for resistance. That might see the DOW topping at another nice round number--12300.

This is almost too tempting to load up on put options, especially with the very low VIX. Put protection/speculation has never been cheaper. I say almost too tempting because great setups have been busted so many times lately I'm beginning to think this rally will just keep going. My resignation in this respect is probably a good contrarian indicator.

As I had mentioned earlier, the fact that we're chopping higher now is telling me we're probably in an ending pattern to the up side. A pullback tomorrow would be fitting and then another final push higher would finish up the pattern, so perhaps a high on Thursday or Friday. Because it's been a choppy move higher it makes for very difficult trading and that will likely continue the rest of this week. If we do top out this week (and that's obviously a big if right now), then next week should be a lot easier to trade. Don't rush your trades right now.

Good luck and I'll see you in the Market Monitor on Tuesday and back here for the Thursday Wrap.

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