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Market Wrap

Santa's Late

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And the natives are getting restless. The eggnog is gone and the spiked punch bowl is now being used as a hat by one of the guests. Everyone's been at the party for quite a while now and they've been waiting for Santa to arrive so as to sprinkle some pixie dust on their stock portfolios and make them fabulously wealthy. Santa is conspicuously absent and the guests are starting to get rowdy and some are leaving.

The DOW, which has been one of the more bullish indices, has broken some potentially important support which I'll get into later. The techs are looking very weak and it appears to be a classic case of rotation out of techs into the big caps. But the big caps does not include the tech big caps--last week the NDX (Nasdaq 100) broke out of a sideways coil that was building since the end of November but only managed to test the November high before dropping back below that sideways coil this week. That is a clear sell signal in the techs.

But the DOW and SPX have been holding up much better. The NYSE has also been holding up well. But the NYSE, a very good proxy for the general market, has been warning of a top and again I'll discuss that more with its chart later. When you watch the intraday action there's been clear evidence of distribution. The market gets quietly pushed higher, with an occasional buy program, and then gets hit to the downside, rinse and repeat.

By holding the market up smart money has been able to transfer ownership in stocks. The sheeple believe, as Wall Street and CNBC want them to believe, that we've got much higher highs ahead. The Santa Claus rally, the January effect, strong stock performance expectations through May, the third year of the presidential cycle, you name it and all we hear are reasons the stock market will rally. And the historically low VIX reading confirm the level of complacency about this. There is no wall of worry for the market to climb because there is no worry. Bulls should be worried.

Also the manipulation of the DOW to multiple new record closing highs over the past several weeks does wonders for the bullish crowd. The DOW, still the most widely reported index for the news outlets, makes it appear as though the market continues to rocket higher. All these record highs! I must be making a fortune in my portfolio. This feeling is especially true for those who don't even look at their monthly statements but instead listen to the news and feel the bull market will just continue forever. And that of course is what smart money wants the public to believe for how else will the Boyz keep the sheeple interested in buying their inventory. This is a game as old as the stock market and it keeps working because of mass psychology.

One example of smart money is to follow insiders. Insider trading is often a good clue for what's coming since corporate leaders usually have a pretty good sense about what's coming down the pike for their companies. Insider selling has been running better than 100 to 1. For every $1 of stock being bought by insiders they're selling $100. We haven't seen this kind of disparity since 2000. Without looking at a single chart or looking at anything else that statistic alone should have the bulls running for the hills.

Interestingly one of the sectors seeing the most insider selling is the finance sector. If you look at the charts of the banks you'll see very strong looking charts. The insider selling in this sector says the corporate heads don't believe it's sustainable. Nothing like a little greed to give away how they really feel and never mind what they're saying publicly. The other sectors seeing heavy inside selling are health and consumer discretionary. These 3 sectors accounted for 57% of all insider selling in November. Wall Street is claiming "this time it's different" (hmm, when did I hear that phrase last used?) and they're encouraging their clients to buy buy buy. In the meantime they're dumping stock as fast as they can. I'd follow their lead.

All the bad economic news hasn't blunted the bullish enthusiasm. Did you tally up the amount of bad news this week? Building permits for homes dropped 3%, PPI was higher than expected and risks putting the Fed on a rate increase watch and not decrease, GDP came in lower than expected and the Philly Fed index came in much lower than expected (it was negative). Everything is pointing to stagflation and if the market were listening it would be down several hundred points from the high. Instead it's basically flat on the week.

I've said it many times before--the market is dumber than a rock and is driven by human emotion and mass psychology. News is for nannies since clearly all the negative news we've received lately has been totally disregarded by the market. People are in a cheerful bullish mood and that puts them in a buying mood. Wall Street pounding the table about what a wonderful buying opportunity this is helps stoke those bullish fires. Constant new record highs for the DOW keeps people wanting more. People are hearing, and acting upon, all the bullish hype. It's really that simple. When the people start to turn fearful, angry and frustrated they'll start selling and the pundits will start to voice their concern that the market is selling off on good news.

Helping to keep the market up is our dear Fed. While they continue to jawbone the market about the risk of inflation and how they might have to raise interest rates to fight it (which I think is a likely possibility) they're cranking out dollars like it's free money. Oh, it is free money (except for the few electrons who gave their all for it). But the consequences of all that liquidity now sloshing around in the system is of great concern to me. Inflation is a real concern when I look at how much money they continue to pump into our economy.

M3 money supply, calculated, courtesy nowandfutures.com

This is the same chart I've been showing and is updated as of last Friday. The light blue line, the annualized rate of change, continues to spike higher and is now approaching 11%. This is why I say the Fed is creating money at a hyperinflationary rate. The M3 curve continues to increase at a parabolic rate. Does this look like another bubble to you and is it any wonder they wanted to stop reporting M3 last April? They knew what they were about to do and didn't want any questions. Well I'm certainly questioning what the heck they're doing. They are clearly afraid of the economy and primarily because of the housing market.

If the Fed truly felt the housing market was nearing a bottom, as Bernanke and Greenspan have both stated recently, then why all this money being thrown into the market? This is very worrisome since the eventual liquidity drain is going to be painful. A tightening in credit, as is happening even in the mortgage area and in the commercial real estate area, will automatically start to drain the excess liquidity. Even if the Fed doesn't do it the market will do it for the Fed. The last time we saw a big liquidity drain was in 2000 after the Fed went nuts creating excess liquidity for anticipated Y2K problems. We have a Fed that is out of control and what's really dangerous is that they think they're in control. The market will be a painful teacher, again.

The market slid back a little today but on the daily charts it looks like just another minor little pullback before pressing higher again. Certainly that's what the bulls believe. Even with the market pulling back today the VIX has stayed very low, and the choppy afternoon bounce had the VIX diving off its highs. The buy-the-dip crowd is very active. With the DOW only pulling back to its 10-dma and holding above it I'd have to say they could very well be the right play. Stick with the uptrend and use those support levels that have been working so well during this rally. Only time will tell if that works again. After all, surely Santa will help them.

But I'm on the lookout for cracks in the dam and whether or not there's anyone around to plug the leak. Today showed a few more leaks and I'm not sure there are enough pluggers. Time will tell but I saw a couple of things today that have me seriously wondering if we've seen the market high. What, no Santa Claus rally? Blasphemy! I'm thinking we saw the Santa Claus rally prior to this week. We'll see.


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Economic Reports
In the meantime the economic reports out today were not encouraging for the bulls, not that it was particularly bearish for them either. First up were the unemployment numbers. Initial claims saw an increase of 9K to 315K for the past week. The 4-week average fell 2K to 325,750. Continuing claims, after dropping 33K the previous week, rose 50K the past week to 2.52M. The 4-week average of continuing claims rose 21,250 to 2.49M which is the highest it's been since February.

Final GDP
GDP came in lower than expected, 2.0% vs. 2.2%, and raised concerns about an economy that is slowing more than most economists have been predicting. Remember, these are the same economists who consistently miss the signals that we're in a recession, even after the recession has already started. And the Fed is made up of a bunch of economists. At 2.0% this was the slowest growth since the 4th quarter of 2005 and that quarter was blamed on the hurricane damage. The economists are still rooting around in their excuse drawer for a reason for this slowdown. The collapse in the housing market is of course one of the big reasons.

Core CPI came in at +2.2% which is still above the Fed's 1%-2% target zone. Jeffrey Lacker, President of the Richmond Federal Reserve Bank, was out again saying the Fed needs to remain vigilant in fighting inflation since it's still a threat. No mention of the slowing economy, just concern about inflation. Granted he's been the lone wolf who has wanted to raise interest rates but I believe the rest of the Fed is equally concerned about inflation and will to risk growth to keep a lid on inflation. That of course takes me back to the money supply issue to remind you who is causing this inflation (and U.S. dollar devaluation).

Leading Indicators
Leading Economic Indicators (LEI) came out at +0.1% for November, in line with expectations, and is the 3rd straight increase. It was revised downward in October to +0.1% from previously reported +0.2%. Of the 10 components making up the LEI four were up--money supply (I'm shocked!), vendor performance, core capital goods orders and stock prices. So if we take out the increase in the money supply, which is likely a strong reason for the increase in stock prices that would leave two components up. That's not very encouraging. Five components dropped--jobless claims, building permits, interest rate spread (showing a higher risk for recession), factory workweek and consumer expectations. Orders for consumer goods held steady.

In a bit of profound analysis, Ken Goldstein, a labor economist for the private research group responsible for these numbers, said "The slower economy of the second half of 2006 might continue into the first half of 2007...But it may not get any slower." Hmm, OK. The stock market might go up or it might go down and if it doesn't do either then it will probably stay flat. I should get the money that guy is paid.

Philadelphia Fed Index
The Philly Fed index came out at 12:00 PM and that's what really got some selling started today. Up until noon the market had been holding up well and it was beginning to look like we'd get just another day that was held at the flat line. But it was hard to ignore the bad number--manufacturing activity contracted as the -4.3 number, being below zero, shows contraction. Economists (my favorite people if haven't figured that out) expected the number to improve slightly from November's +5.1. They missed by a mile on that one and the market reacted negatively to that little surprise.

The number was the lowest reading since April 2003. This index had been marginally below zero in September and October before getting a big bounce in November. The November reading now looks like it may have been an anomaly. This Philly number is generally a good indication of what we'll see in the next two weeks when we get the Chicago PMI (Purchasing Managers Index) next Friday and then the ISM (Institute for Supply Management) the week after next. These had also fallen into the contraction zone in November so we look to have a trend here and it's not a good one for our economy, and by extension for our stock market. But the stock market is still disconnected from that reality.

New orders also remained below zero, coming in at -2.4 , for the 2nd straight month. The index for unfilled orders nosedived to -20.7 from -3.9 in November. Shipments were higher, rising from 6.5 to 19 but without new orders coming in that probably won't last long. The outlook index dropped to 6.7 from 12.4 indicating a little less optimism as the reporting firms peer into their crystal balls.

And now onto a review of today's charts:

DOW chart, Daily

So far this looks like just a dip that should be bought. The DOW pulled back to its 10-dma and the buyers stepped back in. We're clearly in an uptrend and support is holding. If you still feel bullish about the market, even if it's only for a little bit higher, then buying today's dip made a lot of sense. But as I mentioned above I'm seeing some cracks in the dam and water is starting to leak out. If you've ever watched a small leak suddenly and explosively develop into a dam buster you'll understand why I'm looking for the small leaks.

The daily chart shows how price has moved steadily higher even after breaking its uptrend line from July. On the one hand this is bullish but it has been worrisome why the DOW hasn't been able to get back above that downtrend line. There's been just enough buying pressure to elevate it slightly most days (to get that "new record high" in the news) but the bearish divergences at the new highs is a warning flag here. Another crack in the dam showed up today which I'll show on this 60-min chart:

DOW chart, 60-min

The upper trend line on this chart is the uptrend line from July. You can see how price keeps trying to get back above the line but hasn't been able to stay there. In the meantime the push higher since the break of that trend line, has its own uptrend line from December 1st. Today price broke that uptrend line as well. It's only a small break so it might not mean much yet so it's only a small leak. But after breaking below that uptrend line this afternoon's bounce found resistance there, currently at 12440. This bears watching tomorrow since this afternoon's bounce looks like a small bear flag. If it drops lower again it should be ready for a larger bounce but if the bounce continues to find resistance at the December uptrend line then the leak gets bigger. A drop below 12350 could be an unstoppable leak.

SPX chart, Daily

SPX looks very similar to the DOW with bearish divergences at new highs since October. It has been a little more bullish in that it's been able to stay within its up-channel, breaking its uptrend line from July only briefly at the end of November. Price closed on that uptrend line today. Bearishly it looks like it has broken below a small ascending wedge for price action since the October high. That ascending wedge, with the confirming bearish divergences, and the price break below the wedge is another one of those leaks in the dam that I talked about above.

Nasdaq chart, Daily

The techs have been in a very choppy pattern for the past couple of weeks and it looks very much like a distribution pattern--push it up, sell into it, push it up, sell into it. The December high left a very clear bearish divergence and the drop has now caused RSI to drop below its 50 line. This combination is normally a very good sell signal. The 50-dma at 2400 should support the COMP for at least a bounce.

NYSE chart, Daily

Keeping an eye on the broader market index here should be helpful in identifying a broader trend in the market. As I showed last week, the NYSE reached a level, and an EW count and Fib projection, that made me think we could be topping. The daily oscillators are rolling over so watch for a continuation lower. Support is layered with the 20-dma at 9032, uptrend line from July near 9000 and 59-dma at 8871. As I had shown last week, the weekly chart is also ready for a rollover and the last time we had seen weekly RSI as high as it is now was in May, which is the last time it touched the top of its parallel up-channel. Another repeat performance as May/June of this year.

SMH semiconductor holders, Daily chart

The semiconductor stocks have been relatively weak for quite a while now and it called into question any rally that we were seeing in techs. A tech rally without the semis has always been a warning. The semis still look weaker and now a break below the uptrend line from July and below the 50 and 200-dma's can't make anyone feel bullish about this sector. The EW count is setup for a potential swift decline so be careful if long and hoping for a recovery.

BIX banking index, Daily chart

While the price pattern certainly looks bullish for the banks, and there are no bearish divergences to warn of impending failure, it looks vulnerable to a pullback here if not a top. Price has rallied up to the trend line along the highs since August and oscillators are into overbought. While it could certainly continue higher this is a good place to consider shorting the banks since you can place your stop close by.

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

The housing index is giving some mixed signals at the moment. Bullishly I see the fast drop in stochastics while price has dropped much less as as a setup for another bounce. With price holding above the 200-dma and top of its parallel down-channel this looks like a bullish setup. This would turn more bearish with a drop below its 200-dma and then 50-dma.

Oil chart, January contract, Daily

Oil has been chopping around but working its way higher. Even if it were to drop back down near the low you can visualize an expanding triangle pattern from October. These are typically reversal patterns so it should bounce higher directly from here or after another pullback.

Oil Index chart, Daily

Even with oil bouncing the oil stocks have been giving up their gains. The oil stock index has now broken its uptrend line from October and it appears this will head for its 50-dma near 634. If the EW count is correct on this index then we've seen the highs (which I had thought was true for the August high) and we'll see a long slide back down from here. If the 50-dma is broken then I'd move into profit protection mode rather than buying the dips. If the broader market sells off then I don't think these stocks will be immune.

Transportation Index chart, TRAN, Daily

The Trannies have been telegraphing a problem with the DOW's rally by not confirming the new highs. There are a lot of people who have been very vocal lately that "it's different this time" and DOW Theory is no longer valid. Boy, if that doesn't sound like the "New Economy" talk we heard in 1999-2000. Any time something tried and true no longer supports an analyst's belief (in this case that we're in a new bull market), and that analyst tries to redefine the relationship because "it's different this time" run like hell the other way. Right now it looks like the Trannies might make a bee line for the uptrend line from May 2003, down below 4400.

U.S. Dollar chart, Daily

The dollar's bounce stopped at the downtrend line from October and appears ready to roll back over. The dollar should drop to a new low and it's possible we'll see it drop to the December 2004 low at 80.39 before it should bounce back up some. The dollar looks to be on a path to repeatedly new lows next year. That should be bullish for gold.

Gold chart, February contract, Daily

Gold is pulling back as expected and is finding support near its 38% retracement of the rally from October which also coincides with its 50-dma. It may start its next leg higher from here, especially if the dollar starts declining from here. If it drops a little lower first then watch for support at its 50% retracement at 611.

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

Tomorrow's economic reports have the potential to move the market. As always it's hard to figure out how the market will react. Lately bad news has been good news since the market has wanted to believe that a slowing economy is good because it could mean the Fed will start lowering interest rates. Soon, and it may be starting now, the recognition that the Fed may not act soon enough and that a slowing economy is already starting to ratchet down earnings expectations will result in a sell the bad news. After that we will selling of good news. It's a cycle you can bet on (if only we could figure out when that switch gets made). The Durable Goods number could cause a nasty reaction if the expected improvement to October's number doesn't happen.

Because price action has been so tight lately we're not seeing much happen on the weekly charts.

SPX chart, Weekly, More Immediately Bearish

We've got a red candle so far for the week but it's just a small one. The top of the parallel up-channel is near 1408 and a drop below that level would create a sell signal. The daily and shorter term charts show that a drop below 1415 would be the first heads up that the selling is getting more serious. A drop of another 10 points on this chart would probably give us some bearish crosses in the oscillators as well.

I mentioned in the beginning that I'm seeing cracks appear in the dam and water is starting to appear in more places. I've been looking for signals that the market is topping and with all the expectations for a Santa Claus rally and January rally, after a strong rally leading up to this point, one has to wonder if the market is set up for disappointment. There's no wall of worry and there's far too much complacency, as evidenced by the low VIX.

This is a setup for disappointment for the bulls. Will the Fed be able to continue to support this market? If people become fearful and start taking profits then no, the Fed will not be able to do it all by themselves, not even with the mega-banks' trading teams helping the Fed. In fact the banks' trading teams could get hurt if they try to fight a new downtrend. I'll try not to shed a tear if that happens.

As of the corrective bounce this afternoon it looks to me like we should see a continuation lower tomorrow morning. I've seen too many of these bear flag patterns bust a move to the upside so I hate to go with that pattern but that's the "normal" interpretation of this afternoon's bounce. If we get an immediate bounce out of the gates I would be reluctant to trust it. Most times we're seeing the initial move out of the gates is the move you want to fade.

If you're not watching the market intraday and you're wondering where it's headed next I wouldn't be in any hurry to make a move yet. I've been recommending getting out of long positions because I think surprises will be to the downside now. But I wouldn't be surprised to see this market supported into the end of the year. So if we get a further drop I think there's a good chance we'll get a bounce between Christmas and New Years. Remember, there's a lot of bonus money riding on the profits gained this year and that will be defended.

I like the opportunity here to add to long term short positions with some put options--low VIX and some significant resistance right here makes it a good trade. If we don't start down quickly in January simply get out with minimal loss. I'd look at least out to March if not June or December 2007. Buy more time than you need and cash them in much sooner than the expiration month. If we were to get a strong sell off into February I'd be cashing in my puts and wait for a bounce (if not play it). Leg in carefully while VIX is low now but realize you'll have plenty of opportunities to get short on bounces. I strong recommend not entering new long plays. That side is either done or very close to it--there are just way too many canaries falling off their perches here.

Good luck tomorrow and the rest of this month. I wish everyone a Merry Christmas and Happy Hanukkah and a joyous time with family and friends. There are many who will not be able to have a joyous time so be sure to keep them in your prayers. I'll be with some of you on the Market Monitor tomorrow and back here next Thursday.

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