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Market Wrap

Watching Paint Dry

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The major indexes struggled on low volume to close at new highs but Friday's market action was similar to watching paint dry. After the opening bounce on slowing job growth and the Microsoft/Yahoo news the indexes spent time on both sides of zero and the outcome was always in doubt. An end of day short covering spurt helped push the indexes just hard enough to close at new highs.

Dow Chart - Daily

Nasdaq Chart - Daily

The big economic news on Friday was the Non-Farm Payroll shocker. Only 88,000 jobs were created in April compared to consensus estimates for a gain of +115,000. The shock came when the prior two months were revised down by -26,000. That was the first downward revision in years. The trend has always been upward revisions indicating a better employment picture than previously reported. This report was a shock to many and the markets did not know how to react. Some thought it was a positive indicating the weakening job market would keep the Fed on the sidelines longer. Others thought it was a negative, especially after the downward revisions that suggest the economy is weakening more than prior estimates. The third group thought the +88K gain was right in the sweet spot, not too hot and not too cold. That became the market view by days end.

Payroll Chart

The unemployment rate rose to 4.5% and average hourly earnings rose only +0.2% and less than the 0.3% analysts had expected. Hours worked fell -0.3% indicating slowing activity. The biggest job loss came from the retail sector with a drop of -26,000 jobs. This appears to be a Goldilocks report and continued job growth in the 75K to 100K range will eventually reduce inflation and build a base for a future economic rebound.

The week was a mix of economic results with the ISM breaking out of the pack and spiking to 54.7 instead of the expected minor move to 51.1. This was the largest jump since Sept-2005 and the highest level since April 2006. After a stutter step in March it appears the manufacturing sector has regained traction and could be projecting the end of our period of economic weakness. This would have been Fed negative were it not balanced by the Fed positive payroll report. Considering all the weak regional reports this was a bullish surprise for investors.


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Next week there are few market moving reports but the FOMC meets again on Wednesday. Nobody expects any change in the interest rate but there is rapidly rising anticipation of what they will say in the statement. Are they going to continue their bipolar language from the last statement or move to a clear-cut indication of rate direction? I would bet on a continuation of language that is open to interpretation. If they lean any further to a softening bias the bond traders will push real rates lower before the Fed is ready to move. The Fed has to continue walking the tightrope and keeping traders on both sides off balance. The Fed Funds Futures are showing only a 2% chance of a rate cut at the May and June meetings. That chance rises to about 56% by the October meeting.

The other report that could be a market mover is the Producer Price Index (PPI) on Friday. Any signs of increasing inflation could compound any problems created by the Fed statement. However, the bulls have recently shown a complete lack of fear regardless of what the economics have shown. Good news produces rallies and new highs. Bad news produces minor dips that are quickly bought and followed by new highs. Even a lack of news produces continued bullish sentiment.

Economic Calendar

Yahoo gained $5.40 intraday on rumors they were in takeover talks with Microsoft. Yahoo is struggling to implement its online ad system code named Panama. Microsoft wants a vehicle to boost its paid search share and general online graphical advertising. The rumors are flying that a take out price could reach $50 billion. Many analysts expressed mixed opinions about the potential combination. Shortly before the close the WSJ said the talks were no longer active and the NY Times claimed they were talking about a partnership not a takeover and Yahoo fell back to gain only $2.80 to $31 at days end. YHOO traded 245 million shares or 25 times normal volume. Over one million option contracts were traded. Google has a 48.3% share of search revenues, Yahoo 27.5%, Microsoft 10.9%, Ask.com 5.2% and Time Warner 5.0%.

The housing sector was weak again on Friday after Hovnanian (HOV) said its Q2 loss will be larger than previously projected. HOV now expects a loss of 45-50 cents per share including charges. Excluding charges HOV now expects the loss to be 30 cents per share compared to prior projections of up to 20 cents. Orders fell -21% to 3,116 homes. The cancellation rate has improved to 32% compared to 36% in Q1. HOV said, "The adverse publicity surrounding the subprime market has further damaged home buyers' psychology." HOV lost 99 cents on the news but several other builders lost more than a buck.

Countrywide Financial said this week that 19% of its subprime mortgages were in default and they expected 6% of all mortgages to go to foreclosure in 2007. Companies are trying to work with the borrowers rather than get stuck with the homes in a declining market. They are extending payments, letting borrowers skip payments and generally everything they can do to keep the loans from imploding. According to industry analysts mortgage companies lose about 40% of the loan value on the average foreclosure. Having a bunch of foreclosures in the same sub division as we are seeing today can make those numbers even worse. CSFB just released a new survey showing that 40% of borrowers who had their loans adjusted by lenders still resulted in an eventual foreclosure. Looking at it from the glass half full perspective that suggests 60% of those loans in trouble were rescued successfully to the delight of all concerned. Lenders also know that eventually housing values will rebound and these borrowers could then resell their homes and escape the mortgage trap.

AAA said average unleaded gasoline prices across the US hit $3.01 last week. That was not the bad news. The bad news was their warning that gasoline could hit record levels by month end. $4 is almost guaranteed baring any unexpected surge in inventory or drop in demand. Gasoline demand hit record levels since January and is continuing to rise. Normally there is a drop in demand around March to less than nine mbpd for 6-9 days. That drop never occurred and demand grew by more than 5% instead. The higher gas prices were due to refinery problems, expensive oil and that lack of demand drop. The high prices are already causing a pullback in consumer spending in other areas. Retailers SHLD, TLB, CC, GM, F and LIZ have already warned that sales were slowing as gas prices accelerated.

Despite the rise in gasoline prices the price of oil dropped sharply all week. Starting with Monday's high of $66.60 the June futures contract closed at $61.90 on Friday. This 7% drop was blamed on strong resistance at $66-67, a lack of headlines and hedge funds rolling over to the July contract. Since that contract also fell sharply it just proves the on air "analysts" had no clue and were grasping at straws to explain the drop. I believe it was simple profit taking on a lack of headlines. That resistance at $66.50 is very strong and the June contract tried for several weeks to break it with no success. With the equity markets breaking out to new highs and oil unable to breakout over $67 it was a perfect time to take profits and shift to equities.

June Crude Oil Chart - Daily

Some of that oil money may be setting up to move into uranium futures when they open for trading on Monday. The contract will be for 250 pounds of uranium and be cash settled. The symbol will be UX plus the month codes. Uranium prices have risen over 1000% in just the last three years. The world uses 180 million pounds a year and only 100 million pounds are produced. The difference is made up by dismantling Russian nuclear weapons. The highly enriched cores are broken down and diluted with other materials to reduce it to the strength needed for reactors. That source of uranium will be exhausted over the next several years putting even more of a premium on uranium production. Over 30 reactors are under construction worldwide to add to the 452 currently in operation. 16% of global electricity is generated by nuclear plants. There is literally no chance that uranium prices will fall in the future. Hedge funds have taken control of 25% of current inventories over the last two years and that trend is not likely to slow. Uranium is one of the scarcest commodities on the planet and those funds are counting on the short squeeze to get worse. Several analysts have suggested uranium prices could double again by 2010. Cameco (CCJ) at a new high on Friday is my favorite stock pick to capitalize on this trend.

The earnings cycle is 80% over with only a few stragglers remaining. Earnings have come in at +8% growth and more than twice what some analysts predicted. This is a clear case of under promise and over deliver in action. Companies were concerned about the forecast for a slower economy and guided lower when they reported the fourth quarter results. When the slowdown was lighter than predicted these companies were rewarded with better than expected results. Now that the cycle is nearly over the focus on earnings will diminish and the Fed will return to the spotlight. Wednesday's FOMC meeting is not expected to provide any material change in posture but I would not be surprised if we see some profit taking early in the week just to be on the safe side.

The most anticipated sporting event in the last five years for wagering will occur this weekend and it is not the Kentucky Derby. The event is the De La Hoya vs Mayweather fight at the MGM in Vegas. I was at the MGM for a conference last week and when I was leaving on Friday night there were long lines of strictly male guests checking in a full week ahead of the fight. The entire hotel had an air of anticipatory excitement. The MGM said this fight had more bets than any sporting event in the last five years. Front row seats are advertised for more than $100,000 and seats further back in the 35th row are selling for $25,000 each. MGM said the tickets sold out 3 hours after they went on sale. HBO is charging $55 for the pay per view on cable and they expect over two million subscriptions. That is a very nice chunk of change. De La Hoya will receive the lions share of the fight revenue with a 70% cut vs Mayweather's 30%. Not a bad deal when you consider he was on food stamps not too many years ago. Mayweather is undefeated in 37 professional fights and is expected to stretch that string to 38. The stock price of MGM broke to a new three month low on Friday despite the major payday it will receive for hosting the bout.

The American markets are hitting new highs almost every day but they are actually lagging many foreign markets. China, Brazil, Mexico, France, Germany and the UK markets are all at historic highs or multi-year highs. The American markets are playing catch up and doing so rather reluctantly. The Dow moved over light resistance at 13200 at the open on Wednesday and only managed to add +65 points by Friday's close. This is not a strong move but it has been steady. The Dow has gained in 23 of the last 26 days but only three days of the last 30 have seen strong gains. This is the strongest Dow performance in terms of positive days since 1955. Dips have been bought and somehow, regardless of the news it continues to creep slowly higher. Over the last month the Dow has averaged only +35 points per day. This lackluster rally has convinced the bears that every day could be the day the market breaks. Short interest on the NYSE is at record levels but market continues to rise. About once a week we see some event that triggers another short squeeze and the bears run to the exits. Over the next several days the lack of movement and lackluster internals convince those same bears to go short once again. It has to be very frustrating to be on the wrong side of the trade for the last 30 days. As shown by the Tuesday dip the Dow has strong support at 13050 and almost no definable overhead resistance.

The Nasdaq has moved even slower than the Dow but finally broke out to a new high as April ended. However it only managed to add +60 points from April 16th through May 3rd or barely +4 points per day. This lethargic advance saw only two days of major gains with the rest evenly distributed in random single digit moves. Current resistance is 2580 and major support at 2500. The NDX only managed a gain of +0.06 on Friday. For the week it only gained +4.64 points. This very weak performance at market high is like trolling for bears by dragging sirloin steak through the woods. The single digit advances interspersed with an equal number of declines is bear bait at its best.

S&P-500 Chart - Daily

S&P-500 Chart - Monthly

All eyes are riveted to the S&P-500 as the last major index to make new highs. The S&P is also creeping slowly higher with the historic closing high of 1527 the current price magnet. The other indexes appear to be just passing time while we wait for the S&P to reach and break that high to confirm the rally. The real question everyone wants answered is what will happen when that 1527 point is reached? Will the volume accelerate and the current stealth rally turn into a raging bull? OR, will that touch of 1527 turn into an exhaustive climax and signal the start of a summer decline? The "sell in May and go away" crowd are holding their breath today and trying to decide if they should hold any longer or run for cover.

NYSE Composite Chart - Weekly

Russell-2000 Chart - Weekly

Russell-2000 Chart - 120 min

The most bullish index continues to be the NYSE Composite with a clear historic high breakout in progress. 9600 is strong support and there is no material overhead resistance. As one of our sentiment indexes this is a very bullish sign. Unfortunately our mutual fund sentiment indicator the Russell-2000 has stalled at strong resistance around 830. For the last three weeks the Russell has failed to cross 830 and hold it for more than a few minutes. Only a bout of short covering at Friday's close managed to produce a weekly close at 832. Even more concerning was the severity of the Monday drop to 807.69. This was a -3.3% drop from the prior week's highs and much stronger than the other indexes. To its credit it did rebound back to that 830 resistance the following day but sentiment may have been damaged. When the Russell finally breaks out and sprints to new highs I will feel much better about being long this market.

Open Interest and Volume on Russell iShares (IWM)

A reader pointed out the imbalance in the volume and open interest of the Russell iShares (IWM). The May $82 and $83 puts have an open interest of nearly 320,000 contracts compared to only 260,000 calls. The daily volume was even more amazing with nearly 50,000 82/83 puts traded on Friday compared to only 18,000 calls. The June open interest on the same strikes are paired at about 66,000 each and only one fifth of the open interest for those strikes in May. Think about that a minute. There are five times as many May puts in those two strikes as in the June strikes. For all May strikes the open interest for May puts totals 2,314,767 contracts. The open interest for all May calls is 1,198,874 or nearly one million less than puts. Until the Russell loses its grip on 830 I have to maintain a bullish bias. The strong NYSE Composite helps me to overcome my concerns over the Russell weakness.

Most analysts claim the indexes are extremely overbought but I believe the slow pace has allowed for consolidation in place as the rally progressed. Is there more upside ahead? Nobody knows for sure but watch Russell 830 as a long short indicator and don't try to out think the markets.

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