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Market Wrap

Bad News Bulls

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The early morning economic reports were not bullish for our economy and therefore were not bullish for the stock market. Unemployment claims jumped more than any week in the past year, retail sales are coming in lower than forecast, the Chicago PMI came in at 49.9 (vs. 54.4 expected) which indicates a contraction rather than growth, and the Personal Consumption Expenditure (PCE) level was above the Fed's liking (meaning higher risk for inflation). The market gapped down and ran lower until about 10:30 AM and then it was almost a collective "wait a minute, what are we doing, we're the bad news bulls and when things are bad we buy!" So with bad news meaning good news (I've yet to figure out how it could be spun as good news but that's what we apparently had) the buyers stepped in and the market rallied to new highs for the day. SPX came close to rallying above last week's high of 1407.89 and did beat the closing high of 1406.24 on November 22nd by 0.06 before pulling back into the close. Looks like there might have been just a few computers programmed to sell at that level.

As the numbers in the table above show, the internals were actually a little stronger than what was reflected by the closing prices. The total volume was a very respectable 5.7B shares and the up volume was double the down volume. Advancing issues beat declining issues by about 3:2. New 52-week highs swamped new lows. So what happened to the indices? The DOW and COMP closed marginally down and SPX and RUT closed marginally up. Today was clearly a day of churning and while some sectors did well others did not and the result for the major indices was a flat day.

Speaking of sectors, the oil sector has been on fire lately and that has helped SPX handily beat the DOW the past few days. SPX is challenging last week's high while the DOW is struggling with its 62% retracement of the decline from last week's high. The rally continues to look tired though and bearish divergences are showing up in more places. As I'll show below I think we could finally be in the last push higher, forming some small ascending wedges as we go. Even the housing index, which had a banner day today, has pushed right up into potentially strong resistance. The oil index is challenging its previous high in August but it too is looking like it could be topping out here.

In other sector action, today the gold stocks got a big boost--XAU was up 3.6% and the yellow metal was up almost $13 or nearly 2%. But believe it or not, even gold is up against potentially strong resistance as I'll show below. Gold stocks are at the top of a parallel up-channel and look ready for a pullback. But oil looks like it's finally breaking out of its down trend and should have more to go on the upside. What that does for oil stocks, and SPX, remains to be seen. Other strong sectors today were healthcare (that's usually a defensive play), internet stocks and even the SOX was finally able to outshine the broader market and techs in general.

But scooting along the bottom today were the brokers and banks and bulls don't want to see these two as the tail of the snake as Jeff would like to say. Airlines, transports and retailers were also the ones holding the market back today.


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Retail Sales
Retailers reported today that sales are not going as well as they had hoped. November came in weaker than most had been predicting and is obviously a result of consumers not spending as freely as retailers would like. The warm weather was blamed (these people kill me)--it was too warm to interest people in buying coats, mittens and boots. Give me a break. If it was too cold then the excuse would have been that people stayed home. What truly amazes me is how many people say this stuff on TV with a straight face!

I have to admit though that it is rather amusing. Ignore that elephant in the living room and keep looking for other reasons consumers are slowing down their spending. We don't want to have to admit that our piggy banks are empty and that the home equity refilling machine has an "out of order" sign on it. By the way, if it takes cold weather to pump up the sales volume then Washington State should have a banner sales period--it's colder than a ..., well, it's been downright cold here in Seattle the past few days. And this city locks up tighter than a drum when the roads get snow and ice on them. Come to think of it, that will hurt retail sales so never mind.

Wal-Mart, as the largest retailer, disappointed many by reporting same-store sales were down -0.1%. Without WMT the total retail sales number was better but the 3-month trend shows a slowing when comparing year-over-year. With 48 of 56 major retailers reporting their results, 54% are below expectations and that obviously raises some concerns about what the holiday shopping period will be like. If December's sales do not show much improvement then it begins to call into question the soft landing for the economy. Unless it gets cold. Then everyone will go out and buy their mittens and life will be good.

Initial Claims and Help Wanted Index
Initial jobless claims spiked up 34K to 357K for the past week, making it the highest jump in more than a year, since October 8, 2005. The shutdown during the Thanksgiving break was blamed for the big jump so we should see a reversal of that number next week if true. Depending on how many part-time employees are put to work in retail we could see a further improvement in the unemployment picture. Overall the unemployment picture is hard to read as we enter the holiday period.

The 4-week average of initial claims also jumped up 7,250 to 325K. Continuing unemployment claims rose by 45K to 2.48M while the 4-week average rose 18,750 to 2.45M. This represents the difficulty in finding a new job and obviously a rising number will reflect a tighter job market.

Personal Income and Spending
Employee compensation increased +0.6% for the 2nd straight month which should help consumers spend and/or save a little more. Real (inflation-adjusted) after-tax incomes were up +0.6% while employment benefits were up +0.5%. Spending was up a little less than that at +0.4% in October. The increase in income over spending improved the savings rate to -0.6%, still disturbing in that it's a negative savings rate but it's the highest it's been since last March. It's been negative for 19 months now which means consumers have been borrowing or selling assets in order to support their spending habits.

The core inflation rate rose slightly faster than expected at +0.2%, keeping the year-over-year gain in the core personal consumption expenditure (PCE) price index at 2.4%, well above the Federal Reserve's comfort zone of 1%-2%. The Fed keeps a very close eye on this PCE number and as long as it remains above 2% they're not going to be in any hurry to lower interest rates. Helping in that regard is the fact that consumer prices are up only +1.5% for the past year, thanks to dropping gasoline prices. This gives us the lowest inflation rate in 4 years. The bond market reflected that in today's rally.

Chicago PMI
This is a measure of business activity and a reading above 50 indicates expansion (growing economy) and a reading below 50 indicates contraction (slowing economy). The reading for November came in at 49.9 vs. an expectation for 54.4 and below October's reading of 53.5. It surprised economists that it had dropped below October's level which itself had seen a bigger drop than had been expected. This made it the lowest reading in 3 years and follows 42 straight months of expansion. The drop over the past 2 months is the sharpest drop in 26 years, since the summer of 1980. Now I ask you, is that reason to rally the market? Apparently so when you see what happened 30 minutes after this number was released. When the music stops though, be sure you've got your eye on the chair you want.

This of course raises concerns about a coming slow down in our economy. The fact that these slowdowns in PMI for the past two months are catching economists by surprise should give us a heads up warning that the economists will probably also miss the mark, again, on predicting a recession. The Chicago PMI is of course for a small section of the country so it's only one piece of the puzzle. The ISM Index and Construction Spending numbers, both of which will be released tomorrow morning at 10:00 AM, will be more telling in this regard so keep a close eye on that tomorrow. Of course if it's a bad number then it will be time to buy (wink).

If the ISM comes out better than the expected 52.0 (up from October's 51.2) then there could be relief that the Chicago PMI is just a regional problem (due to the slowdown in the auto industry). The last time the ISM was below 50 was a 4-month period in February-May 2003 as the Iraq war began. A slowdown now would not have a handy excuse to explain it away.

The Market
There was a real battle going on today and it appears we might be finishing the final move up. Some markets may make a new high while others could fall short of last week's high (for a truncated finish). Part of the battle going on is that we've got a market that is clearly overbought by just about any measure you'd like to use. Bullish sentiment is through the roof which is bearish from a contrarian perspective. On the other side we've got many people who believe in the end-of-year rally and that next year will be a good year. November and December are typically your two best months, by far, of the year to be invested. Many people continue to buy the market expecting the rally to keep pressing higher.

Since 1926 the 3rd year of the Presidential term has been the strongest for the US stock market, delivering bullish returns 18 out of 20 times. Of those 18 bullish years 16 were double digit returns. Therefore many people are trying to position for the statistically bullish period and year ahead of us. But during a mid term election period the months of September and October have statistically been very bearish months and yet we saw just the opposite. This year continues the "opposites" in that we're seeing the opposite of what typically happens. So what does that mean for December? Only time will tell. Oh, and just recently "Barrons" magazine cover speculated on a new bull market run to DOW 13000. That cover happens to be one of the best contrarian indicators out there.

Now let's take a look at the charts.

DOW chart, Daily

On Monday the DOW broke below its uptrend line from July. It has spent the past two days testing that line but unable to get back above it. It looks like a perfect kiss goodbye on this chart. After failing to recapture its broken uptrend line on RSI, even after achieving new price highs, the resulting sell off was quick. Now price is struggling with its own broken uptrend line. The selling from this test could be equally quick. The bounce over the past 3 days has failed to turn stochastics around.

DOW chart, 30-min

Moving in closer to look at the bounce this week shows a potential ascending wedge forming, the top of which is the broken uptrend line from July. Based on some more bullish things happening in the SPX and even the NYSE, I'm thinking this ascending wedge will get a pullback and then another final push higher. This is a very typical pattern for the last leg of the rally which I believe this to be. I think the market is setting up for a down December.

SPX chart, Daily

Thanks to a few strong sectors, such as the oil stocks, the SPX has outperformed the DOW this week. SPX is testing last week's high and has a good chance of doing it if it's in the same ascending wedge pattern as shown for the DOW. With price pressed up against the top of its long term parallel channel, negative divergences at recent highs, and continuing, we could see this top out tomorrow.

Nasdaq chart, Daily

The COMP at least looks stronger here than the DOW or SPX since it did not break its uptrend line from August. However, with oscillators in full dive mode, price bouncing only back up to the mid line of its steep up-channel and with it bumping up against the top of its longer term parallel up-channel from 2004, I don't see any reason to buy it here. In fact, like the DOW and SPX, I'd be looking at adding to my longer term short position on this bounce.

SOX semiconductor index, Daily chart

The SOX was actually relatively bullish today in that at least it was green while most of the other sectors, including tech, were in the red. But the daily chart doesn't inspire me to be a buyer here. The consolidation over the past few days looks like a continuation pattern, in this case down. The positive thing for the SOX is the fact that it's consolidating on top of its 20-dma which is above its 200-dma. I can't quite figure out if it's testing its broken downtrend line (bullish if it is) or if it is instead finding that line to be resistance (in which case it's bearish). It's got a lot of support between here and 460.

BIX banking index, Daily chart

It was a predictable bounce off its uptrend line from October 2005 and now I'm trying to determine the form of the bounce. So far it looks like a correction to the decline and that spells trouble for the banks. If it's just a correction, which looks like it could bounce up to its 50-dma at 396.50, then the next move after that will be a break of its uptrend line. And if the banks break down then the broader market won't be far behind.

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

Last week's consolidation led to the move higher this week just as I thought and hoped it would. Now it brings the index right up to the top of its bear flag pattern and the top of its parallel down-channel for price action this year. A Fib projection, showing a measured move inside its bear flag, at 732.73 was met today. Not shown but a 38% retracement of the decline from January at 734.57 was also met (today's high was 736.77). While the short term pattern supports the idea we could see a small pullback and a minor new high after that I like the setup here to go short. Pick on your favorite (weakest) housing stock and look for some good short plays on it. I wouldn't want to see this index get above 765 otherwise something more bullish is going on and therefore I'd use something just above there for a stop level.

Oil chart, December contract, Daily

Oil finally came rallying out of that choppy mess. By looking at some Fib projections for the current bounce I'm looking for a rally up to just under $65 before getting a larger pullback. We should see a choppy rally into the new year as depicted on the chart.

Oil Index chart, Daily

The rally in oil certainly helped the oil stocks, but they've basically been predicting the rally in oil for the past couple of months. Yes, they were a tad early but benefited from the general bullishness in the broader market. The question now is whether or not the bounce in oil is already priced in and whether a decline in the broader market, if we get it, will drag the oil stocks down with it. I'm thinking it will, that oil stocks are topping here. I've got a Fib projection that was met today at 658.93 and potentially gave us a small throw-over above the top of an ascending wedge (not sure about the wedge idea). If the oil stocks remain bullish then I can see the potential for a rally up to the top of its two parallel up-channels near 689. The weekly chart shows these stocks to be overbought now and if it rolls back over here it will leave a negative divergence against the August high. If I've got the longer term wave count correct we should see a strong sell off in this index as the next big move. That's just a caution at this point since clearly we'll need to see how a pullback progresses.

Transportation Index chart, TRAN, Daily

The break of the uptrend line from September suggests the rally has topped. Whether it goes into a consolidation pattern above its 200-dma is too hard to say. By my wave count the next big move is down towards new lows for the year. We'll first have to see how it handles support at its 50 and 200-dma's.

U.S. Dollar chart, Daily

The US dollar was not able to hold support at its May low and that gives the price pattern a bearish look right now. If we see a small bounce fail at that May low and head for a new low then we'd get an impulsive move down from its October high. That would then be followed by a bigger bounce, depicted on the chart, but importantly it would tell us we've started a new down trend.

Gold chart, December contract, Daily

While the US dollar and gold tend to move counter cyclically you obviously can't tell how much it will move. The dollar's break down hasn't exactly turned into a breakout, yet, for gold. Its broken uptrend line from August 2005 continues to act as resistance and now with the daily chart back into overbought as it struggles under this trend line it looks ready for another pullback. But the move up from October now looks impulsive and that suggests we have a new uptrend underway. Therefore, assuming we'll get a pullback to around its 50-dma, that should set up a very good buying opportunity for gold. Its next move after that should be a strong rally to challenge its previous high and ultimately break that high.

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

As discussed briefly above, we have some potential market movers tomorrow. The only problem is guessing which way it will move. If the ISM, out at 10:00 AM, confirms today's Chicago PMI, then that will be bearish for the economy. Does that mean it will be bullish for the stock market? Lately, yes. Will that continue to be the case? Very definitely no.

I think the choppy price rise we're seeing this week is a result of more distribution of stock to the masses and therefore the market is being manipulated higher in order to accomplish this. I also think there's plenty of Fed money coming into the market so that extra liquidity from the Fed can keep the economic pump primed. The price they pay for that is inflation but they'll keep fighting that with interest rates remaining where they are, or higher if they have to.

At any rate, be careful of potential price gyrations around these economic numbers. I wouldn't be surprised to see a rally follow the reports and then top out sometime tomorrow. We could see selling take hold before the weekend.

SPX chart, Weekly, More Immediately Bearish

I zoomed in a little closer on this weekly chart only because I wanted to more clearly show the doji candlesticks that are forming--last week's and so far this week's. Last week warned of a potential trend change. This week's more bearish dragonfly doji continues to warn of a potential trend change. As I mentioned last week, a red candle following the doji is needed in order to confirm the reversal signal so it's still a bit early to go off this signal. But it's a good enough warning, especially with price up against the top of its long term up-channel and weekly oscillators overbought, for me to suggest adding to your long term short position. You may want to wait for confirmation of a break down if you've already started legging into a short position since basically we don't have a change from last week.

Adding to my bearish assessment here is the fact that we've entered a potentially important turn window. Many previous market turns have resulted at a Fibonacci number of days from previous turn dates. The Fibonacci sequence is 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, etc. (keep adding the two previous numbers to derive the next). The further out you go the closer you get to the perfect golden mean ratio of .618 when you divide a number by the following number in the sequence. We find these Fibonacci numbers and ratios throughout nature and they're abundantly present in our stock market (we humans react unconsciously to the ratios).

So, with that brief explanation, here are some interesting Fib dates:
November 29, 2006 is a Fib 987 trading days from the December 27, 2002 bottom.
November 30, 2006 is a Fib 377 trading days from the June 2, 2005.
December 5, 2006 is a Fib 144 trading days from the May 10, 2006 top.
December 5, 2006 is a Fib 233 trading days from the December 30, 2005 bottom.

The Bradley Model shows a major turn window of November 28, 2006 +/- 3 days. That gives us November 27 through December 5, 2006 and pulls in the dates above.

One other point I'd like to make and it's not designed to scare but to inform. Many market participants feel as if the market is like the latest model car with radar warning, front and side air bags, a roll cage and whatever else can keep us safe in the event of a crash. The Greenspan put grew out of the desire to feel safe in the market. We have oodles of circuit protectors, when program trading must cease, the uptick rule, etc. We feel safe within our well-engineered car.

There's one thing that could make a sell off worse than anything we've experienced before--ETFs. I was reading, but have not confirmed, that there's now more money in ETFs than in regular mutual funds (perhaps many hedge funds are using ETFs as well). And we know hedge funds have exploded in popularity in the past few years. Hedge funds can use tactics such as buying put options and selling call options instead of shorting individual stocks.

What does all this mean for the market? It could exacerbate any sell off and it could get ugly real fast if things get carried away. Selling ETFs does not require an uptick in the market. Buying puts or selling calls does not require an uptick. Short selling of stocks requires you to sell on an uptick. That means if the market gets into free fall you can't short more stock. You can however sell ETFs and do all the option plays you want.

This makes the market a lot more vulnerable to a rapid sell off than we've ever seen before. We still have the normal circuit breakers that stop program trading, or stop trading all together, at certain levels, but by that point we will have already seen a lot of damage. And the stopping of program trading doesn't stop hedge funds or ordinary traders from continuing to sell ETFs and buy puts. Both of these actions would continue to put a lot of downward pressure on a market that's already hard down.

Again, I'm not predicting something like this will happen. Think of it as a public service reminder to wear protection at all times.

For tomorrow, as shown in the short term chart for the DOW, the pattern would look best with a small pullback in the morning followed by another push higher. This is if the ascending wedge idea is in play. If the rally gets strong then clearly we're not in small ascending wedges. But if this is the final rally leg, a rally off the 10:00 AM reports fits the pattern nicely. But then a minor new high should be met with bearish divergences and I'd try the short side.

If we rally strong and you don't see bearish divergences do not try to short the market. We'll have December money coming into the market and who knows how much of a factor that will be. On the other hand if we see immediate selling take hold tomorrow morning I would look to short the bounces. Just realize the bounces could be small ones, just the opposite of how the rallies have progressed. As above, so below. Good luck tomorrow and I'll be on the Market Monitor tomorrow and back here next Thursday.

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