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Market Wrap

Speculators' Rally

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Speculation was running rampant today. It was all hush hush about Senator Tim Johnson, the Democrat from South Dakota, who underwent brain surgery today (which was successful) to relieve some bleeding after suffering what sounded like an aneurysm. As soon as he was rushed to the hospital yesterday the chattering started about what happens if he can't serve as SD's senator. That's when the speculation started that the Republican governor would likely appoint a Republican Senator which of course would swing control of the Senate back over to the Republicans (it would be a 50/50 Senate with V.P. Cheney as the tie breaker.

All the committee chairmanships would stay under Republican control. So, is that what the market was rallying about? That is of course just speculation. The fact that the Democratic leadership is saying there will be no change in the Senate make-up (is that just speculation?) did not thwart the stock market rally one little bit.

The early word this morning was that the market was rallying because of the very positive earnings reports out of Bear Stearns (BSC 160.02 +4.07) and Lehman Brothers (LEH 76.05 -0.29). But if that were a good reason then why didn't the market rally even harder yesterday after Goldman Sachs (GS 200.13 +1.82) announced its even bigger blow-out earnings? In fact they sold GS yesterday and they ended up selling LEH today to that turned out to be a false reason for the rally.

So what else have we got--well, there's always the Christmas rally and people were getting in ahead of the crowd. The trouble with that reason is that we've had people jumping on board this rally for quite a while now so that's not a likely reason for today's rally.

There's opex and all the related antics around that. That one's actually not a bad reason since we've seen time and again an effort to drive the market down before opex week, typically the Thursday prior, and even the first or second day of opex week, so that the mega banks' trading teams (those reporting the unbelievably high profits, which put the oil companies' profits to shame) can reap the rewards of buying cheap front-month call options.

As an example of what these guys can do, the SPX 1420 call options could be had for $1.30 on Tuesday. Today they could have been sold for $8.00 for a 6X increase. Not a bad trade, especially if you lay millions on the line knowing you have the buying power to drive the market higher to ensure you'll make a profit (this is part of their "risk-free" trading). And how is it they can be sure they'll be able to drive the market higher? You can thank your friendly Fed for that.

The Fed is stuffing money into the pipeline at a furious rate and the money is given to these primary dealers to "invest". These are the banks like GS, LEH, and BSC who are making the obscene profits and this whole system was set up for the banks back in 2002 out of fear the major banks were in severe financial trouble (JP Morgan was rumored to be close to insolvency at the time). The Fed and SEC certainly took care of that problem. If it sounds like I'm a tad annoyed at this gross redistribution of wealth (with huge bonuses being paid to these guys for being in the right place at the right time), you're right. At any rate, take a look at this chart of M3:

M3 Money Supply, calculated, courtesy nowandfutures.com

You've seen this chart before and it just keeps getting worse--this is updated as of last Friday. The bold line shows the money supply and you can see that it's increasing at a parabolic rate. Just this year we've seen an increase of one trillion dollars. That's some serious money that's making it into our economy and who knows how much of that has been coming through the primary dealers directly into our markets. The light blue line on the chart shows the annual rate of change and it has been going nearly straight up since about August. When did the monster straight-up rally in the stock market start? I report, you decide. Money is being created at a hyperinflationary rate. This can't end well. Still think the Fed is going to cut interest rates? Don't bet on it.

The Fed jawbones the market about their inflation concerns and you can see why. They're creating the problem. We've got massive bonuses being paid to guys who are playing with the Fed's money in can't-lose trading, and we have a Fed who in my opinion has lost it. They are trying to keep the economy's pump primed in hopes it will alleviate the problem with a coming housing collapse. I don't think it will work and then we'll have all this liquidity sloshing around in the system that will have to be drained at some point. And when the draining starts, especially if the economy is still slowing, our stock market will be in serious trouble and that's an understatement.

I said in today's Market Monitor and I'll say it again, I think it's criminal what the Fed is doing and we will all pay the price for their supreme arrogance. They and our major banks make Enron look like child's play. And now they're all laughing on the way to the bank to deposit their million dollar bonuses. Grrr...

OK, I've vented, thanks for listening.


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Economic reports
We only had minor economic reports so we won't even speculate that they caused today's rally. The unemployment claims data shows a continuation of the spikes around the holiday period. Initial claims dropped 20K to 304K, the lowest level since mid-October, and the 4-week average dropped by 1,500 to 327,250. The initial claims are down -5% vs. year-ago levels. Continuing claims dropped 33K to 2.47M and they're down -4.5% compared to last year. The 4-week average of continuing claims were up by 9,250 to 2.47M which is the highest level since early September.

The only other report we had in the morning was import and export prices. There was nothing extraordinary or surprising in the data and it had little impact on expectations for what it meant to the Fed. Prices for imported goods rose +0.2% thanks to the drop in oil prices although oil did not experience as large a drop as the past couple of months before November. Excluding oil, import prices were up +0.7%.

Export prices were up +0.4% in November but only +0.1% if you exclude agricultural products. Agricultural products were up +4.4% after a +1.1% rise in October.

We did get one more economic report this afternoon by mistake--someone mistakenly released the NY Empire State Index at 3:00 PM today instead of its originally scheduled release for tomorrow morning. Oops. No Christmas bonus for that person. The results showed the New York slipped a little in December but not as much as had been predicted. The Manufacturing index fell to 23.1 from 26.7 in November but the expected number was 18. New orders rose to 25.2 from November's 22.4. Shipments were unchanged and inventories dropped in negative territory.

Before moving the normally scheduled charts I'd like to show what VIX is up to.

VIX chart, Daily

VIX is back down for a test of its broken downtrend line which was the top of its descending wedge, and back for a test of its previous low (slightly lower). This is very typical "price" action for the VIX if you go back and look at previous bottoms for the VIX. Notice RSI is still above its rising trend line since July (not shown but so is MACD). If this were a stock I'd be recommending a buy here with a stop not much lower than today's low. And of course if this is a good buy then perhaps it's time for a good bye to the rally. Jeff had made a comment in today's Market Monitor that he was buying a few February 12.50 calls on the VIX, at the time for $1.75. I like that play recommendation.

At the end of this report I'll cover a couple of other reasons why I like the idea of legging into a few longer term short positions. I'd be looking at least out to March for some put options and then plan on rolling out of them the first flush we get to the downside. Either that or sell some bear put spreads after the market drops (it's a great way to lower your cost basis if you do a couple of times over the life of the long put options).

Now to the charts to see what today's rally did to the patterns.

DOW chart, Daily

The DOW keeps pushing higher but it can't get back above its broken uptrend line. This is bearish price action but clearly it doesn't mean it's necessarily going to roll over now. In addition to its inability to get back above this line, currently near 12450, and keeps finding it to be resistance, RSI continues to show a bearish divergence with the new price highs. We're in opex week and I know that can skew things but I've got to tell you this chart makes me want to scream from the mountain top to get short and do it now! But I'm trying to contain myself since I've been wrong so many times in the past couple of months in calling a top.

It's clear now we're in the blow-off top and like all blow-off moves it's very difficult to figure out where it will end. It's better to wait for the break down to confirm the high is in. Right now that would be a break below 12243. If trying to pick a top I like a Fib projection that I have for this move up where it intersects the broken uptrend line at 12455 by mid-day tomorrow. How's that for picking a top? Or the top may have been made today. Or we're a long way from the top. There, I've covered all my bases.

SPX chart, Daily

One of the reasons I'm thinking today might have been a top is this SPX chart. If the move up from early November is a small ascending wedge (I drew it on the chart above) then today we got a little throw-over above the top of the wedge. If price drops back inside the pattern, with a drop below 1423.50, then it would be a sell signal by that pattern. RSI continues to warn of an impending top by not confirming the new price highs. But if this is to proceed higher then I've got some Fib projections for the next high up at 1445.

It takes a break below 1405 to tell me we've probably seen the high for the rally. In the meantime I like the odds enough to leg into some longer term short positions here. I'm using March put options to give myself enough time to get through the holidays and any bounces around then, and to limit the time bleed if this presses a little higher before coming back down in January.

Nasdaq chart, Daily

I'm having a tough time interpreting price action since the November high. On the one hand it looks like a sideways coil that looks like a continuation pattern for a move higher. Today's move up broke that coil to the upside and could be the first leg up to new price highs. Supporting this bullish interpretation is the fact that RSI has stayed above the 50 line the whole time it's been consolidating. I don't recommend a long play here because a new high could be just part of a choppy sluggish move higher before suddenly dropping. I just don't like the risk:reward parameters here.

But an alternate interpretation is that the whole consolidation is just a correction to the initial drop from the November high. Supporting this bearish interpretation is an alternate reading of RSI here--it hasn't even come close to confirming a near test of the price highs and that's bearish. Price is also finding resistance repeatedly at the top of its longer term parallel up-channel from 2004. That again could be bullish or it could be bearish. Not much to do but wait for a break out or a break down. It takes a drop below 2400, which will probably be a break of its 50-dma at the same time, to tell us we've got a decline started.

NYSE chart, Daily

Another juicy looking bearish chart. OK, juicy because I'm bearish this market and trying to identify an opportunity to get short for what I believe will be a nice ride back down. Price made it up to the top of its parallel up-channel for price action since 2004 and the last time it did that was in May. You can see what happened following that test of the top of the channel. At the same place it has reached the top of its narrow ascending wedge for price action from July. It has also reached a Fib projection target at 9132 (next Fib target is 9336 which would be a good rally from here). RSI is negatively divergent against the new price highs.

Not shown here but the monthly chart shows an RSI level higher than it's ever been before (82.96 on my RSI(10) setting). To say that this is overbought is an understatement. But of course we all know that overbought can stay overbought for a very long time. But again, I like the odds for legging into some longer term short positions. Setups just don't get much better than this one. Gotta try it.

SOX semiconductor index, Daily chart

The semiconductors have not been supporting the latest rally and they've been a drag on the techs. After a double-top failure near 482, the 62% retracement of this year's decline (with a clear bearish divergence on RSI) the SOX is now testing its 50 and 200-dma's. Today the bounce found resistance at its downtrend line from January and I have little reason to believe the bounce will progress much, if any, further. It could of course continue to rally but that's not what I see in this chart.

The SMH (semiconductors holders) chart looks a little more bearish than the SOX which is why I'm leaning bearish on the SOX chart. SMH bounced up to its broken uptrend line from July, which is also where its 50 and 200-dma's are located (34.20-34.32). Today's close at 34.16 was below these resistance levels (as opposed to the SOX using these as support right now). Any continuation lower in the semis could see an acceleration lower.

BIX banking index, Daily chart

The banks had a bearish setup last week but quickly negated it with a continuation higher. The setup was there but anyone who shorted the banks should have immediately been stopped out with a new high for the move up. This is overbought but so what. I don't see any bearish divergences nor do I see a reason to be bearish this index. This one looks strong and is a caution to anyone thinking about shorting the market (myself included).

But where are the brokers? I don't show a chart of the broker index (XBD) but the new highs for the SPX and DOW are not being confirmed by the brokers. This negative divergence is a warning that something is amiss. In fact it reminded me of a particular stock that is worth keeping on your radar screen. As I had posted on the Market Monitor today, I had been told a long time ago to watch Mother Merrill (MER) since it often reflected what the stock market would do next. I had forgotten it over the years and was recently reminded about it again when I heard that there are many floor traders who watch it like a hawk.

If MER is not confirming the move in the broader averages they fade the move in the averages. This includes intraday moves as well. So I recently started watching MER again and right now it's telling me to fade the averages, i.e. short this rally.

Merrill Lynch (MER), Daily chart

As the DOW and SPX make new highs MER is not confirming. It hasn't even been able to get above this week's earlier high. The last time MER broke below a steep ascending wedge, as shown on the chart, was back in April, ahead of the peak in the broader averages in May. Is this another heads up for us? Obviously a break below its 50-dma, currently at 87.49, would be bearish. But until that happens this does have the potential to rally to a new high as well so keep an eye on Mother and it just might help us avoid getting caught up in the emotions of the general market, especially as the broader averages achieve new highs and all the hype around that.

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

The only question I have as I look at this chart is whether the current small pullback will lead to another push higher (which I suspect would only be a minor new high if it happens) or if it's already peaked out in its bounce and is starting back down. Right now it's bullish by being above its 200-dma and the top of a parallel down-channel for this year's decline. It takes a drop below 700 to give me a heads up that we might have seen the high and a break below 680 to confirm that. This bounced a little higher than I expected, although the 38% retracement was a natural upside target, so I'm watching the next move carefully.

Oil chart, January contract, Daily

The little pullback from the bounce high is what I expected even if a little earlier than I expected to see it. I don't see any reason yet to change how I think price will go from here--it should continue higher after this pullback.

Oil Index chart, Daily

Between a bounce in oil and the stock market there's no surprise to see the oil stocks rally as well. This "bounce" from the September low has clearly gone longer and higher than I was expecting after the drop from August. Based on how it looks now I relabeled the Elliott Wave (EW) count to count the rally from October as an impulsive count. What that means is that I'm looking for this rally to be the end of the longer term rally from March 2003. This puts it in synch with the broader averages and solves a problem I was having with calling a top in August. The present wave count has me thinking this is very close to making a high now--there's potential to see it drive up to the top of its longer term parallel up-channel near 690 but a Fib projection at 677 (came very close to it today) is a warning that this could be very close now.

Transportation Index chart, TRAN, Daily

Like the brokers the Trannies are not confirming the new price highs in the DOW or SPX. The Transports bounced back above the 50-dma today but I don't get much a bullish feeling from this chart. The one thing it has going for it is the fact that daily oscillators look ready to turn back up.

U.S. Dollar chart, Daily

If the current bounce in the US dollar continues to find resistance at its May low and 20-dma, and then turns back down, I suspect it will head for the previous lows in December 2004. That's what I'm expecting even if the bounce makes it a little higher first.

Gold chart, February contract, Daily

I've been expecting gold to pull back before continuing its rally. It would be logical for a pullback to the 610-620 area but it might bounce up a little before continuing its pullback. In other words it might stay a little choppy and make trading it more difficult for another few weeks at least.

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

The big report tomorrow is the CPI number. After October's low number it could be a shock to the market if it comes in at +0.2% or above. That would be above the Fed's target rate and it would cause the market to be worried about a Fed that will not only hold interest rates steady but might even have to raise them. If that happens you can be sure today's rally would be given up in a heartbeat. If the number comes in at +0.1% or below then we could even see a relief rally take this market even higher.

I'm not sure an early morning rally in that case would hold (possible gap n crap) but one never knows with this market. The capacity utilization and Industrial Production numbers will be potentially as important in that the Fed uses that data to judge the health of the economy and whether or not they foresee inflationary pressures. So tomorrow holds the potential to be very volatile. Be careful around the opening.

The rally this week has pushed SPX above the top of its long term parallel up-channel and that has the weekly chart looking bullish.

SPX chart, Weekly, More Immediately Bearish

At first glance the break above the channel looks bullish. There was some consolidation for a couple of weeks under the line and now a break above. That's bullish and needs to be respected by the bears. The fact that the weekly oscillators are more overbought than just about any other time in history doesnt mean a thing except continued caution by those who are in long positions.

Entering new long positions could be especially risky if this break above the channel turns right around and drops back inside the channel. That would be bearish. I gave the numbers to watch in the daily chart review. Personally I don't like the risk of chasing this higher but clearly shorting it here has its own risks. More conservative traders will wait for a confirmed break (I think 1405 would be good for a short entry) and from a weekly perspective it takes a close below 1375 to tell us a top is in.

We're in opex week and I've said many times that a big move during opex week is not necessarily trend setting. Today's move may have been nothing more than an opportunity by big money to rake in the dough from cheap December call options. There was a high open interest at SPX 1420 and by the looks of the close they were probably long calls. Those who were short those calls were forced to hedge their position by buying the market and that just added to the buying pressure.

Tomorrow could see an unwinding of today's price action. But if we get some Bullishly interpreted economic reports tomorrow morning then watch for a continuation of today's flare up. If we're into a blow-off move, which I don't always expect, this could really heat up to the upside before it flames out and comes crashing back down.

So that's my warning for tomorrow morning--it's possible we'll see a big move but which direction is up for grabs. It's also possible that we'll see an initial volatile reaction after the open and then deadsville after that. Fridays of opex week can be mind numbingly boring. If you're quick you might be able to catch a good ride tomorrow. If you can't watch the market closely I'd stand aside and let the dust settle for the week. Then things will hopefully be a little clearer to make some judgments for next week. Good luck tomorrow and next week. I'll try to clear this up a little on the Market Monitor and just maybe we'll have a clearer sense about where this market is headed by this time next week.

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