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Market Wrap

Whiff of Stagflation

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Many market participants disparage CNBC commentators, but I've never found anyone who disliked Art Cashin.

This morning, Cashin mentioned the "little whiff of stagflation" markets received in the form of economic releases during the 8:30 time slot. Three economic releases indicated surprising increases in inflation pressures coupled with surprising weakness in manufacturing. Cashin didn't appear to believe that the numbers would impact the bounce that had begun the day before, a bounce he termed a "reflexive" rally. He also didn't appear to have much faith as yet in the rally, but perhaps I'm putting words in his mouth.

He was right about the numbers not seriously hampering that rally he termed reflexive. Although gains were modest at best today, most indices did post gains. The IXK, the Nasdaq Computer Index, was one of the few declining indices I found.

Introduction

However, after an early rise, equity markets spent much of the day consolidating sideways beneath former intraday support. The last few minutes of trading saw a slight push higher, but that may have been underwater shorts covering ahead of tomorrow's important economic releases.

Ten-year yields also consolidated sideways. Bond and equity traders appeared to be waiting for tomorrow's important economic release before deciding whether all those potential bull flags produced on intraday charts today will resolve to the upside or whether equities will collapse again.

The news shouldn't have been equity friendly today. In fact, that whiff of stagflation should have been enough to fell anyone who ventured out in the markets, as frail as conviction is right now.

In addition, OPEC seems quite happy with crude prices near $60.00 and determined to keep prices somewhere in that region. The former FOMC chairman also did his part to whip up the winds of worry and stink up the market action, too. Former Fed Chairman Alan Greenspan said when speaking to a fixed-income industry group that problems in the subprime mortgage industry could spill over to other sectors, too. Although little impact has been seen on consumption as yet, that effect might occur if home prices fall, he warned. Presumably, he meant fall further.

One breath of fresher air turned out to be a Treasury Department report that noted that capital flows to the U.S. rose in January after December's first outflow since June 2005. That inflow was produced as foreign official institutions sold U.S. equities and Treasury bonds but bought a bit more government agency bonds. However, one economist was quick to point out how vulnerable the U.S. remains to global reallocations and the mood of international investors.

Charts

Annotated Daily Chart of the SPX:

Although current boundaries for the formation appear to be the 200-ema and the 72-ema, those boundaries could easily be widened to the 200-sma and 50-sma while the formation still remains a consolidation one.

Note the close at the 10-sma, at the former resistance depicted by that rising red trendline and smack in the middle of the choppy zone produced over the last couple of weeks. It may have felt better to be a bull than a bear today, but there's absolutely no commitment in direction yet, and may not be for several weeks.

The Dow's chart looks similar.

Annotated Daily Chart of the Dow:

The same widening of boundaries could occur here without the widening predicting a new breakout, so govern those stops if you're committed to a directional play.

Annotated Daily Chart of the Nasdaq:

I didn't include a SOX chart in last week's Wrap, but I'm going to do so in tonight's for a couple of reasons. One is that the SEMI Book-to-Bill number will be released tonight, a number with the potential to move the SOX, and the other is listed in the annotations.

Many of us have believed that the SOX has given up its market-leading ways, but has it?

Annotated Daily Chart of the SOX:


Annotated Daily Chart of the RUT:


Annotated Daily Chart of the TRAN:


Today's Developments

Today's slate of economic releases was full. The day started out with the weekly initial and continuing jobless claims. Initial claims fell 12,000 to 318,000, with the four-week moving average falling 10,250 to 329,250. Continuing claims were at 2.56 million, a 13-month high. The decline in initial claims could be deemed a bit hawkish, but that situation is somewhat debated by the high number of continuing claims. The insured unemployment rate rose to 2.0 percent from the previous 1.9 percent.

During the same time slot, the NY Empire Manufacturing Survey arrived on the scene. This manufacturing survey isn't as influential or predictive of the ISM as some of the other regional surveys, including the Philly Fed that was to come later in the day, but the downside surprise suggested weakness. The headline number dropped to the lowest level since May 2006, and article titles declared manufacturing activity at a standstill in the New York area.

The headline number fell to 1.9 from February's 24.4 and was well below the expected 19.0. The benchmark level measuring expansions and contractions for this survey is zero. A decline in new orders to 3.1 from the previous 18.9 contributed to that weakness, as did declining shipments and unfilled orders. However, there was an unwelcome rise in the prices-paid component to 30.2 from February's 26.9.

One of the two most important economic releases of the day arrived during that same pre-market release period, and that release temporarily pushed equity futures lower. February's Producer Price Index or PPI was expected to show a 0.5-0.6 percent increase after the prior 0.6-percent decline. Instead, the headline number jumped 1.3 percent. The ex-food-and-energy number was higher by 0.4 percent. Economists had expected only a 0.2 percent gain. Although many market watchers attach far more importance to tomorrow's Consumer Price Index or CPI, this report did not produce welcome news.

This report revealed inflation pressures that were hotter than anticipated at the wholesale level. For the past 12 months, prices moved higher by 2.5 percent, and core prices, 1.8 percent. Many components measured increases: energy prices, 3.5 percent; food prices, 1.9 percent and capital equipment prices, 0.3 percent.

The problem is that no one wants business growth to be stymied by tightening credit. Increasing inflation pressures might force the FOMC to raise rates and tighten the money supply for businesses. A CNBC guest commented this morning that one major bank has surveyed small- and mid-cap businesses. These businesses are already noting some tightening in credit, the bank's survey concluded.

February's Risk of Recession was released at 10:00. January's risk was tagged at 15 percent. In February, that risk had risen to 22 percent according to the figure released today. Some market watchers are standing with faces lifted into the wind, already claiming that they smell the souring odor of recession.

At 10:30, the Energy Department released the weekly natural gas inventories number. The department announced a draw of 115 billion cubic feet.

Energy was also in the news due to an OPEC meeting. OPEC ministers agreed today to keep crude production at current levels, with OPEC's secretary general commenting on the stability of the market. In other words, as long as prices stay somewhere near $60.00, they're where OPEC wants them. OPEC raised its prediction for global oil demand to 85.5 million barrels a day, up about 100,000 a day over its previous prediction. OPEC will need to increase production by 180,000 a day over the next few months to meet the April-June demand, OPEC concluded.

The news might not have produced the desired effect, however, at least the effect desired by OPEC. Crude futures dropped today, closing at $57.55 according to my charting service.

The second of the important releases of the day came at noon. Most experts consider the Philly Fed Survey more important than the NY Empire Survey that had been released earlier in the morning. Predictions had hovered around a 3.3 number for the Philly Fed, up from the previous month's 0.6.

Instead, the Philly Fed echoed its less influential predecessor today. It surprised to the downside. It slipped to 0.2 for March, barely above the expansion/contraction benchmark of zero. New orders increased to 1.9, moving up from February's -0.5 reading, and shipments rose to 6.8 from 1.7, but inflationary pressures increased. The porridge turned out to be both too hot and too cold for those seeking a Goldilocks scenario, with inflation stronger than desired and growth weaker than wanted.

The component measuring prices paid rose to 21.8 from the previous 15.8, with prices received rising to 16.3 from 9.4. Manufacturers were pushing through some of their price increases to consumers.

February's Semi Book-to-Bill reading was to be released at six this evening, but I will have completed and turned in this report before that release time. The previous number had been 1.06.

Investors appear focused on economic releases, but some company-related news received buzz today. Mergers and acquisitions news included Cisco's (CSCO) announcement that the company would be paying about $3.2 billion in cash to buy WebEx Communications, an online meeting company.

ICE, IntercontinentalExchange Inc., proffered an unsolicited bid for CBOT today, offering $9.9 billion in a swap deal. CBOT has already agreed to be taken over by the CME, Chicago Mercantile Exchange Holdings Inc., with shareholders due to vote on the CBOT/CME deal in less than three weeks. CME issued a statement indicating the company's confidence in the benefits to shareholders of both companies to a CBOT/CME merger.

In addition, Blackstone Group and the Carlyle Group reportedly have asked power companies to join with them to bid on TXU Corp. (TXU). Briefing.com reported near the end of the day that takeover rumors related to Walgreen (WAG) arose again near the end of the day.

Bear Stearns (BSC) reported, and both BSC and a Goldman Sachs analyst pictured the report as reassuring to investors who were worried about spillover from the subprime market into other sectors. Of course, the reassurances of an analyst from another company drawing scrutiny for the same reason might be taken with a grain of salt.

BSC said it had low exposure to the subprime market and reported that net income rose 8 percent in the first quarter. The company earned $3.82 a share on revenue of $2.5 billion. According to Thomson Financial, analysts had expected earnings of $3.80 a share on revenue of $2.49 billion.

Pre-tax profit margins fell from 34.4 percent to 33.7 percent, however. Fixed-income business proved to be the best performing part of the company's business, rising 27 percent. However, compensation expense did cut into net revenue, pointing out the reason for all those worries we keep hearing voiced about the dangers of wage inflation.

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Tomorrow's Economic and Earnings Releases

One of tomorrow's economic releases, February's Consumer Price Index, or CPI, is also one of the most important of the week. That arrives at 8:30. For many months, we've been hearing about the fallout from the decline in the housing market, and now that fallout is beginning to be evidenced. Economists worry that the fallout might poison the mighty U.S. consumer. Greenspan pointed out the danger today from falling prices and tightening credit.

If higher prices are being pushed through to the consumers, that encourages less spending and more savings. Any hint of a need to hike rates would exacerbate the pressures on the consumer. Expectations are for an increase of 0.3 percent, after the previous 0.2 percent climb.

Other economic reports are February's Industrial Production at 9:15, March's Consumer Sentiment at 10:00 and the ECRI Weekly Leading Index at 10:30. Economists expect industrial production to increase by 0.3 percent and consumer sentiment to rise to 95.0 from the previous 91.3.

Companies reporting earnings tomorrow include retailers ANN and BNG.

What about Tomorrow?

First, it's important to cast any predictions for tomorrow within an overall view. I've shown you charts today that show indices that have been coiling over the last couple of weeks, but that doesn't surprise me.

On January 20, the weekend newsletter carried a Trader's Corner article I had written about the corrective fan principle, a way in which trending moves can be tracked and the end of those trends pinpointed. At that time, I set up the conditions that would need to be met for the rally from last summer to be considered concluded. A couple of weeks ago, my Trader's Corner article provided a follow-up. Those conditions had been met on Tuesday, February 27.

This weekend, I attended a trading-related seminar where participants questioned each other about likely next direction. I drew several little charts showing the corrective fan principle and discussing the implications. Several results can follow the break of the third trendline fanning out from a rally's beginning.

One result, of course, is an immediate steep decline. We did get that, but some are sure that we've seen only the beginning of such a steep decline.

Another result can be a period of disorganization, however, such as the kind that produces a wide triangle that gradually narrows in time before prices break in their final direction. Such a period can resolve overbought pressures in time rather than in a steep decline, or it could be part of the consolidation zone that often sets up midway through a steep decline. The final direction isn't known until the formation is broken. In either case, the beginning of such a consolidation period can be marked by wide swings, especially if a triangle or wedge shape is being staked out.

Right now, there's not even a formation to watch. However, I believe that it's just as possible that we're entering such a period of disorganization that will eventually set up into a triangle, wedge, or rectangular consolidation formation as it is that we're entering one in which there will be steep declines. I know all the reasons why we should have a steep decline. You've heard them, too. The steep decline may come, or, rather, may continue, but I don't see any chart evidence that tells me definitively whether we'll have prolonged consolidation or a steep decline. Uncertainty in the markets can be resolved in time rather than in declines, and I'm not going to draw conclusions yet.

If there is to be a period of disorganization, it's going to be difficult to trade until the pattern sets up definitive parameters. Those who get into bearish trades and hold on "for the big one" could be stopped out of their positions when declines reverse suddenly at some as-yet-unseen barrier that will eventually mark the boundaries of a new formation. Unless they're adept scalpers, those traders who buy the bounces could see their trades stopped, too, until those definitive boundaries set up.

Of course there's another possibility, but I think it the least likely of the three. Markets could be done with the retracements and ready to rally. Many of you know I trade credit spreads, and I worried this weekend when I met with many who were placing bear call spreads barely above recently hit highs. Those spreads may be perfectly safe and probably will be, but if markets are setting up triangles or wedges, the widest portion of the wedges will be produced over the near-term as markets swing wildly up as well as wildly down. Those wild swings higher, when shorts get trapped once again and help fuel the rise, could certainly pop markets up into retests of recent highs.

In short, I'm reserving judgment right now and being just as careful of risks to my bearish positions (call credit spreads) as of my bullish ones (put credit spreads). I just don't know yet what will happen but feel that the period of disorganization for the intermediate term should be given as careful consideration as a potential continued decline. Nothing that has happened this week has changed my mind, and the action may instead have reinforced the possibility of that period of disorganization.

That means that I would advise that you not hold on "for the big one" in any trade if it begins to go against you. You may be waiting for an options-premium-killing long time before you get that big move, and then it might be in the wrong direction.

Intraday charts show the effect of the sideways movements today, with Keltner channels flattening. The CPI tomorrow morning is likely to start markets headed one direction or the other at the cash open. Remember that Keltner lines are dynamic. If markets move strongly up or down first thing tomorrow morning, the Keltner channel lines are going to be pushed that direction, too. Remember also that their support or resistance is upon closes, not intra-period moves. Prices often pierce one of the channel lines during an intra-period move, but then close back inside it by the end of the period.

Annotated 30-Minute Chart of the SPX:


Watch the TRAN first thing tomorrow morning. During steep declines over the last couple of weeks, the TRAN has often dropped precipitously while the SPX, OEX and Dow were still rising, giving traders a heads-up that something was wrong.

Annotated 30-Minute Chart of the Dow:


Annotated 30-Minute Chart of the Nasdaq:

Watch the RUT and the SOX tomorrow morning for clues as to Nasdaq-related trades, such as those on the QQQQ's. The RUT began moving up out of the afternoon's consolidation pattern, and the 30-minute chart hints that support remains strong enough to propel the RUT into a resistance test, but tomorrow morning's CPI can change that in a heartbeat. I haven't shown the SOX's intraday chart because there's only a slight hint of stronger support than resistance, but do watch it if you're considering or are in bullish Nasdaq-related plays.

Annotated 30-Minute Chart of the RUT:

I wouldn't be surprised to see some upside follow-through tomorrow morning. Yesterday's candle was a strong one, and on each dip, I've seen some signs of accumulation. The question is, how far would such a rise take the indices? As yet, I have no confidence that it would take them very far unless markets get propelled high enough that shorts get scared and bail. Most indices ended the day squarely in the middle of recent consolidation patterns, and that's honestly no place to enter any trade except a scalping one.
 

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