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Market Wrap

Santa Didn't Disappoint

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Today marked the conclusion of the period known for the Santa Claus rally (the 4-day period between Christmas and New Year's and the first two days of January). The results for this 6-day period (from the December 22nd closing prices) were as follows:

INDU -- +137, +1.1%
SPX -- +7.6, +0.5%
OEX -- +4.8, +0.7%
COMP -- +62, +2.6%
NDX -- +44.3, +2.50%
RUT -- +9.1, +1.2%

Other than the DOW being held up, actually driven up, at the all-time highs, the techs got the most buying interest. It's a bit unusual to see the techs getting a lot of attention without the small caps and makes the move up a little suspicious looking. As one reader commented to me (thanks John), "Today was clearly an example of massive rotation out of big caps and oil and into techs. It's my opinion (fwiw) that the big boyz are setting up the newly arrived retailers so they can distribute this inventory to them at the appropriate time. The big cap techs [NDX, Nasdaq100] were the ones getting the greatest attention today. In a 'normal' year (whatever that is) one would expect to see gravitation into small caps in January. RUT was red all day until the very end vaulting over 800 again looks like a struggle."

This is a very astute observation and shows the importance of watching several different indices to try to get a bigger picture. We sometimes focus too closely (whether it's an intraday chart and forget about the daily and weekly charts, or one index/stock to the exclusion of other indices) and can no longer see the forest for the trees. We like to study the tea leaves but it's important every now and then to back out and look at the tree/bush it's attached to. And look around the tree to see if there's a bear charging your way.

The bottom line though for the Santa Claus Rally was that we had one. So now bears can go back in their caves since that's a sure sign we'll have not only a positive January but also a positive year. Certainly if you listen to the talking heads on CNBC, including the "experts" they haul in front of the cameras, you can only believe that you'd be nuts not to throw every dime you have into the market. In fact you should mortgage everything you have and buy more stocks! That was said tongue-in-cheek so please don't go and do that.

I happen to feel just the opposite (I know, that comes as such a shock to those of you who have been reading my writings for a while now). I think we're in topping action and it's just a matter of time (a short time I believe) that we'll top out and see a long decline back down. It's the job of the Boyz (smart money) to distribute their stock to the masses at the top and the last thing they want to do is scare the sheeple away when they need them most. Not having Santa show up would have had too many investors leaving the party early. Now they'll be encouraged to take the inventory handoff.

Today left me in a bit of a quandary about what this market is going to do short term and I'll address that more in the charts below. But, as I was last week and over the weekend, I'm still leaning towards a little more upside before we see a top to this market. Yesterday's spike down certainly has me doubting that scenario as it looks bearish and today's bounce didn't do much to erase that bearish feeling. The fact that SPX has been unable to recapture its broken uptrend line from July could be a major sell signal.

I try to go more with chart patterns than gut feel but I have a gut feeling about what's happening here. There are too many traders expecting a January pullback. There are a lot of profits to be taken, (which were held off in December to avoid capital gains taxes), the economic reports are heading south, the Fed keeps talking more about inflation than a slowing economy (thereby decreasing expectations for a rate cut, which has been the underpinning for the stock market rally) and the market is clearly overbought.

But with so many expecting a pullback (even if they're longer term bullish) I've been thinking the market will fool them and rally a little longer first. Just when most start to believe we might not get that pullback after all, which is what they want the public to believe, that's when we're set up for a decline. As I'll discuss with the SPX charts, I'm leaning towards another push higher, but not much higher, before the market tops out (really really). As John observed above, getting the public excited about those sexy tech stocks keeps them motivated to continue buying and who will view all dips as wonderful buying opportunities.

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Economic Reports
The economic reports this morning were not market moving but they continue to point towards a continuing trend of slowing in the economy. We've seen an uptick in some of the numbers but the trend over the past several months has been very clear. Well, clear enough even though the stock market has had its blinders on.

Unemployment data showed an increase in initial claims by 10K to 329K for the latest week. The previous week was revised higher to 319K from its previous 317K so in actuality the past week's number was 12K higher. The 4-week average rose by 1,250 to 317,500. Continuing claims fell by 76K to 2.44M which was the lowest level since November 11. The 4-week average also fell, down 16K to 2.48M, to its lowest level since December 2.

Tomorrow we get the jobs numbers and nonfarm payrolls is expected to grow by 103K, down from November's gain of 132K. This follows yesterday's report by ADP which said private-sector employment dropped by 40K, the first decline in nearly 4 years. Adding in an estimated 15K in government jobs has ADP estimating payrolls to fall by 25K. This differs sharply from the government's +103K estimate, and probably had some traders nervous as we headed into today's close.

After rallying this afternoon there was a pullback right at the end of the day. If tomorrow's job number comes out strong (but not too strong) we could see an immediate rally tomorrow morning. If the number is too strong then that will worry investors that the Fed will be under no pressure whatsoever to lower rates, so good for the economy, bad for the stock market. If the number is as low as ADP estimates (or lower) then we could see a quick sell off but then possibly a rally right after that (bad economy, lower rates, good for stocks). Don't try to over-analyze that statement or else you'll make yourself crazy.

There was good news from Challenger, Gray & Christmas, Inc. which announced job reductions during 2006 dropped by 22% from 2005, dropping the number below 1M and the first time it's been below 1M since 2000. Just remember, employment numbers typically reach their best levels just as the country is heading into a recession. These are very definitely lagging indicators. Corporate layoffs peaked at 1.96M in 2001.

Existing home sales continue to slow as indicated by the National Association of Realtors (NAR) in their report. Sales dipped -0.5% in November, making it the 3rd straight decline. The pending home sales index dropped marginally to 107.0 from October's 107.5. The NAR used this indicator to suggest we're seeing a bottom in the housing market. Even though the index is down -11.4% from November 2005, they feel this is "another indicator that home sales likely bottomed-out in September," according to NAR chief economist David Lereah.

On Tuesday the home builder Lennar (LEN) announced a disappointing, and surprising, revision to their earnings forecast, calling for a loss instead of a profit (big swing to a loss). Part of their loss will be due to a write-down of $500M by canceling land purchases and selling a stake in a joint company which owns a large tract of land outside Los Angeles. They said they don't see a bottom in sight and want to reduce their risk in land ownership. I applaud the decision. So, do we believe the head of Lennar, and the other home builders saying the same thing, or do we believe some economist with the NAR? I think the answer is obvious.

Factory orders for November rose +0.9% vs. +1.2% expected. The good news it was up, the bad news is that it was slower than expected, which continues to be the tune we're hearing. Excluding transportation orders the number was -0.5% and this suggests further slowing in the general manufacturing sector. Orders for durable goods rose +1.6% vs. expectations for +1.9%. Orders for non-durable goods were flat. While the ISM (Institute for Supply Management) manufacturing sentiment index that was reported yesterday rose slightly to 51.4 from November's 49.5 (the first increase since July), it doesnt break the down trend and these other manufacturing numbers show that slow down still in progress.

Inventories rose again, up +0.3%, which makes for the 10th rise in the last 11 months. This is not a good sign. Excess inventories mean fire sales later or worse, the companies take write-downs for the inventory value. Economists are still upbeat though, saying orders and shipments should improve by mid-2007 as excess inventories are worked off. I'm not sure why they feel that way other than because that's what they want to believe.

Shipments of non-defense capital goods excluding aircraft rose by 2.0% in November. The average level of shipments in October and November is 1.2% below the average for the 3rd quarter and that doesn't bode well for the numbers for the 4th quarter. Joshua Shapiro of MFR, Inc. noted that "business purchases of capital equipment and software are unlikely to contribute much if anything to growth" in the fourth quarter. And yet the stock market is at or near record highs. The market is playing dumb right now (and doing a fine job at it) and is ignoring these signs of slowing. It's hardly predicting a slow down, as many like to believe the stock market is capable of doing, so we have a disconnect. It should get all reconnected soon.

The ISM Services sectors continue to do better than the manufacturing sector and this is the one thing that most bulls hang their hats on--with our economy moving from a manufacturing base to a services base, we become immune to the normal business cycles found in the manufacturing sector. I think I just typed "it's different this time". We'll see about that. But that's not to take away from the stronger services sector. While down slightly from November's 58.9%, December's 57.1% still shows positive sentiment. This index has been above 50% for 45 straight months. New orders index fell from 57.1% to 54.4% and that becomes a little worrisome if that trend continues, especially since the order backlogs fell to 48% from 54.5%.

I smell a slowdown here also. But it certainly matters how you look at the numbers. Stephen Stanley, the chief economist for RBS Greenwich Capital, said "Even with the housing sector drag, the economy outside of the manufacturing sector continues to hold up well. With increasing straws in the wind suggesting that housing demand is trying to stabilize, the economy appears to be doing a masterful job of muddling through." A masterful job of muddling through...I guess that was a positive statement. I wonder if he said that without cracking a smile.

Retailers have been turning in mixed reports and even within certain segments different stores are getting different results. Most believe the overall retail growth will be around +3% for stores open more than a year. Recent sales have been running lower than expected and the warmer than usual weather is getting the blame. Without customers running in to buy winter apparel I guess that had a significant impact. So now we need not just a goldilocks economy (growth but not too much, a pullback to a soft landing but not too hard) but we also need goldilocks weather (cold enough to get people to buy winter items but not too cold that keeps people indoors). Would you say this market is priced to perfection for a goldilocks scenario? Only a few disappointments along the way could quickly derail this market.

Other than the techs which got a much bigger boost today, this morning's trading started off weal but then bounced right back up to yesterday afternoon's late day bounce. From there it went dormant until the buyers returned to drive the market higher into the close, with a little pullback just before the close. The techs had a very good day and are challenging yesterday's highs so completely reversing their hard decline yesterday. But small caps didn't participate like the techs and that has me wondering what's playing out short term. On to the charts for some assistance.

DOW chart, Daily

The DOW, which has held up better than SPX, has stayed above both its 20-dma and its uptrend line from July. As long as it stays above 12400 the DOW stays bullish whereas a break below 12400 would suggest we may have seen the high. At least it would be a heads up for that possibility. The ascending wedge pattern as drawn on the chart still fits with my expectation for a very near term top. If we get another push to the top of the wedge, currently near 12600, it should be accompanied by more bearish divergences and should be the last leg up. I have a few Fib projections to the 12630 area so watch for resistance near there if we get the rally.

SPX chart, Daily

SPX has been weaker than the DOW for the past week (less public visibility as compared to the DOW) and is threatening to break its uptrend line from July. The past two days have left doji candlesticks on that trend line (which is also the location of its 20-dma just under 1418. Price is finding support at the top of its longer term parallel up-channel from 2004 and then right below that is its 50-dma coming up to 1400. A break of 1400 would be a heads up that a top could be in but it takes a break of the 1377 low on November 28th to confirm that. In the meantime, if we another leg up I've got some Fib projections pointing to 1437-1439 for a high.

Moving in a little closer I'm using a 120-min chart to identify the wave count for what I think is playing out here.

SPX chart, 120-min

This chart is a little busy with the different uptrend lines but I wanted to show the little bull flag pattern for the pullback from December's high. Two equal legs down in that A-B-C flag pattern is at 1407.89. Wednesday's low was 1407.86. I can't make this stuff up and that tells me there's a good chance yesterday's spike down was not the start of the decline but instead the end of the pullback correction from the December high.

What I don't like is the inability for SPX to get back above its broken uptrend line from July. Right now it's looking more like a bearish kiss goodbye than a resumption of its rally. Therefore any decline back below today's low would have me looking for bearish plays rather than bullish (bullish only for a short term intraday trading). The bulls need to push this back up right away tomorrow as a decline below this afternoon's low of 1412.88 would suggest we're headed lower. Perhaps tomorrow morning's job numbers will have this gapping above its trend line and running higher.

I received an email from a reader (thanks Scott) who watches the OEX and wanted to pass along his observations. He sent me a wave count on the OEX that looks exactly like the one above on SPX. He pointed out that the 5th wave (the leg up that I'm expecting) should end up near 670. As Scott pointed out, that's also where OEX would retrace 62% of the 2000-2002 decline. In my response to him, and what I posted late on the Market Monitor, is that there are more reasons to look for 670 as the target for the top of the rally. Looking at the weekly chart there is an A-B-C pattern for the 2002-2007 rally and wave-C achieves 62% of wave-A at 673 (62% being the first common relationship between these two waves). For the 5-wave move up from November, the 5th wave would equal 62% of the 1st wave (common in an ascending wedge) at 669. When I see this kind of Fib correlation (between Fib projections and retracements), I stand up and take notice. Keep an eye on that 670 level if tagged as it could be an outstanding opportunity for some longer term put plays, like OEX puts.

Nasdaq chart, Daily

The techs got a big lift today but price continues to stay trapped within a sideways consolidation. Support is near 2390, tested yesterday, and resistance is near 2470, not far above today's high. This looks like a bullish consolidation and that's the way I'd play it until proven otherwise.

SMH semiconductor holder (ETF), Daily chart

The techs got a nice lift today thanks to the semis. SMH rallied right up into the nest of moving averages just above $34 so the bulls have some work to do to punch through this, especially with the downtrend line from January just above. The whole pullback from November looks bullish but it could also be 1st wave down in a new decline. In either case it looks like the semis should make it a little higher.

BIX banking index, Daily chart

After reaching the top of its parallel up-channel and now with daily oscillators rolling over it certainly looks like this is headed lower. Short term it looks like this could consolidate or bounce a little before heading lower but it does not look like this index is due any new highs.

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

After Lennar's (LEN) warning this week the home builders got knocked to the downside. It has many questioning whether or not we're bottoming over the last several months or just bouncing. Bullishly I see price hanging above the 200-dma with the 50-dma just below. If this can hold above 687 then it's possible we'll see another move higher although I'm starting to have more serious doubts about that. Any break below 687 should start to accelerate lower.

Crude inventories numbers came out today and showed crude supplies fell for a 6th week, dropping 1.3M barrels to 319.7M for the week ended Dec. 29. But motor gasoline supplies rose 5.6M barrels to 209.M. Distillate stocks climbed 2M barrels to total 135.6M barrels. Whether it was crude inventories or concern about a slowing economy, the price of oil has taken a hit since December.

Oil chart, January contract, Daily

I had been expecting oil to bounce back up to the mid-$60's, maybe $70, but I've given up on those thoughts after this big drop. This drop tells me there's more downside to come now and it's possible we'll see a drop to $50 before better support is found. The one message I get from this is that oil traders are seeing a faster than expected slow down in demand. That says the global economy is going to slow further and is something I've been expecting to see. I'm just surprised how quickly it appears to registering with oil. I thought we'd see this kind of decline after a bigger bounce. While lower oil prices may be good for our economy, the message from this is not good news about our economy. Stocks will soon register that if this is the correct message to take away from this chart.

Oil Index chart, Daily

With the body slam to the mat that oil has taken it's not surprising to see the oil stocks take a sudden nosedive as well. Price sliced right through the 50-dma and appears headed for the 200-dma at 609. For now price is finding support at the 50% retracement of the Sept-Dec rally. It could be good for a bounce back up to the 50-dma but this will likely head lower still.

Transportation Index chart, TRAN, Daily

The Transports got a nice bounce in the past week and made it back above the 200-dma. Price stalled at the downtrend line from November and its 20-dma (green). Just above is its 50-dma at 4715 which is where I'd look for next resistance. If it's able to get above that then we could see the Trannies head for the downtrend line from May, currently near 4830.

U.S. Dollar chart, Daily

Along with the move in oil this is the other one that has surprised me. I expected the US dollar to continue lower and break its December low before setting up another bounce. It appears the dollar could be in a larger consolidation pattern and a move back up to near $85.20 before turning back down. The bounce in the dollar is having a negative impact on commodity prices (higher value for the dollar means fewer required to buy the commodity) including oil and gold.

Gold chart, February contract, Daily

Gold hasn't reacted nearly as negatively as other commodities but it appears it too will be heading lower. I'm now expecting to see gold pull back to its uptrend line from August 2005 near $600 before getting another bounce. Based on my current EW count I think the pullback will be a good long term buying opportunity but I'll want to see what other commodities and the dollar are doing at that time.

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

The non-farm payrolls number is the one that could move the market so watch for the pre-market reaction. The trouble of course is figuring out how the market will Really react. It's that good news is bad news and vice versa thing. We also typically have an initial move out of the gates that then gets reversed. If you're into scalp trading, try fading that initial move but you have to be quick and it's a little gutsy since you're never sure it will reverse.

This shortened week hasn't given us much price action yet and this week's candle is so far just a doji sitting on top of SPX's longer term channel. But the oscillators are threatening to turn down so we've got a heads up.

SPX chart, Weekly, More Immediately Bearish

The monthly chart is also overbought and RSI is as high as it was in 1997-1998, also threatening to turn back down. The setup is here for a very good and profitable short play. Leg into a few more of those longer term puts and I'd even be comfortable at this point selling some OTM (out of the money) bear call credit spreads. Don't go hog wild since we'll have plenty of opportunities to play the short side and add to positions. But I like the setup this week, possibly as late as early next week.

As I've been saying for a long time (this market clearly has a time frame very different, and slower, than mine), now is not the time to add to long positions. Don't get sucked into the bullish hype you're hearing on TV and reading in the papers. Smart money is distributing stock and I suggest the same. If you can watch and trade intraday we could have a long play setting up but with limited upside potential, as I currently see it, that's a risky play. Shorting it, other than some longer term option plays, is also risky at the moment. Patience is still required.

I'll see some of you tomorrow on the Market Monitor for what will hopefully not be a boring Friday. Volatility is picking up some so hopefully we'll get some good trading opportunities, in both directions. I'll be back here next Thursday with hopefully a clearer idea about where that top is (and thinking we will have already seen it by then). Good luck in your trading.
 

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