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Market Wrap

Sunny in the Morning, but Storms Rolling in by Afternoon

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Our markets have been treated to a number of days over the last few weeks when an early sunny outlook was to darken by afternoon. This morning, our Central Texas skies might have been gloomy, but the financial skies appeared to be bright with promise as dawn arrived across the world. Asian and European markets gained. Citigroup upgraded Cisco (CSCO) to a buy rating, sending its shares higher in Germany. Cisco might shine like the sun on the several indices in which it was a component stock, the move suggested.

Some clouds, barely noticed, had already gathered on the horizon, however. The bond insurers were back in the news, with MBIA (MBI) rejecting what was called the "Ackman" plan to split up insurers. As you may remember from last Thursday's Wrap, William A. Ackman of Pershing Square Management, LP, wrote an article detailing the losses he anticipates in MBI. MBI said that Ackman, a short seller of the stock, was only attempting to benefit his own short positions. Many hearings were going on last Thursday, and MBI wanted Congress to take action to curtail the influence of shorts. However, it was Eric Dinallo, superintendent of the New York State Insurance Department, who had first announced this time last week that the department was considering splitting the municipal-bond units from the more troubled structured-finance units.

The department's plan involved making the municipal bond insurance units a direct subsidiary of the main holding company. Yesterday Ackman submitted a new plan for splitting the bond insurers. Ackman's plan is complicated but would involve splitting off the muni bond insurance units into a separate entity, while the old business units would be left to pay any claims on the structured-finance securities. The old business units would continue paying until the policies expire or until the units went into liquidation, whichever came first. Let's guess which would come first if this subprime crisis isn't resolved.

Dinallo reportedly said the department was concerned that the Ackman plan would result in a significant downgrade on the structured side, a result that would hurt banks. Criticism of the department's "lame brained" plan last week centered around the same concerns, however, so it's difficult to evaluate from this vantage point whether either plan lessens the potential damage to banks. I'm looking forward to what Jim Brown has to say about it this weekend.

The Federal Reserve's weekly figures on outstanding commercial paper suggested that another gathering storm cloud, of the credit-crunch variety, might still threaten our skies, too. Four out of the last five weeks, outstanding commercial paper has fallen, suggesting that companies are having difficulty placing this paper and obtaining short-term funding by this method.

Soaring crude costs darkened the horizons, too. Boone Pickens appeared on CNBC this morning, confirming that he is shorting crude-related securities. However, he also said that, barring a worldwide recession, crude would reach $150 a barrel if steps weren't taken soon to harness other forms of energy. Citigroup must have agreed with Pickens' short-term outlook. The firm downgraded British Petroleum (BP). BP has a strategy day planned for next Wednesday.

Bearish economic reports swept those gathering storm clouds across the sky. The Philly Fed survey proved shocking, and the usually little noticed Conference Board's Leading Indicators served to confirm the Philly Fed's information. The economy appears to have weakened quickly, the Philly Fed results indicated.

At first, it appeared that market participants would ignore the storm clouds, but the heavy atmosphere soon sent them scurrying for cover. Let's look at what damage was done, if any.


Annotated Daily Chart of the SPX:

The SPX's weekly 200-ema and -sma's are at 1322.71 and 1296.84, respectively, lending some validity to the possibility of support in the 1320-1324 area. Next support appears to be in the 1296-1306 area, but you know that if the markets are cascading lower, prices plow through supposed support levels.

The possibility of a loss of the triangle support exists of course, and you should spend some time tonight planning how you'll react if that happens. However, such a loss of support is not a given, as should be proven by the alternating up-and-down candles over the last week or two.

Market participants don't know quite how to position their portfolios when it's unclear yet what will be done with the bond insurers, what the result will be of those decisions, and how the banks will ultimately fare. For those who don't know, the U.K. had to take action to nationalize lender Northern Rock this week to keep its troubles from hitting its banking sector. That happened while we were closed for a holiday, so we heard little news about it.


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As I'll show later with the Russell 2000's chart, I've become concerned over the last couple of days about the foregone conclusion that a triangle breakdown will necessarily result in cascading lower prices. While I'm firmly in the "we need to retest lows" and maybe even in the "I'm not sure they'll hold" camps, I'm not sure that the retest is a given for the immediate time period. I believe that traders ought to assess their risks if such a test occurs and if the January lows fail. I've done that. I'm not entering as many bullish credit spreads as I do bearish ones, for example, since when prices cascade lower, it's harder to adjust them, at least for me, than it is to adjust the bearish ones when prices move higher.

However, foregone conclusions have a way of proving to be contrarian indicators. I'll show you what I mean when we look at the Russell 2000's chart later. Those doubts and the propensity lately for one big down day to be followed by a bounce means that bears ought to assess their trades, planning for a possible bounce up to test triangle resistance, too, in case that happens next.

Annotated Daily Chart of the Dow:

The Dow's weekly 200-ema and -sma's are at 11741 and 11476, respectively. As with other indices, a retest of the January low can't be precluded, but neither can a bounce up through that triangle again or even an initial drop, followed by steadying at those red trendlines.

Annotated Daily Chart of the Nasdaq:

The Nasdaq closed the day--but not yet the week, of course--below its weekly 200-ema, with that average at 2311.65. The weekly 200-sma is at 2253.68, and there's vulnerability to that level if the Nasdaq does not pull it together tomorrow morning. If it instead sustains levels below yesterday's low, then it might indeed soon see a weekly 200-sma test. Those hoping to avoid a retest and maybe a violation of the January low would want to see the Nasdaq steady near 2250 if it drops because it just doesn't seem to have much protecting it from a retest if that level fails.

Spend some time tonight planning what you'll do if the Nasdaq falls out of the triangle and then doesn't hold next support. Do not close your mind to the possibility that it could instead bounce up through that triangle again. Day before yesterday, you might have been sure that yesterday was going to be a down day, for example. While inside a triangle like this, you really can't predict anything but chop and more chop.

Annotated Daily Chart of the SOX:

I've been talking about a big potential triangle setup on daily charts for the indices since the day after the last FOMC meeting, mentioning it first on the live portion of the site and then on the first Wrap I wrote after that. I like triangles. Although there can be false breakouts, you have sound boundaries on which to determine that something is going wrong with your breakout trade. Many times the breakouts are in the direction of the trade and provide good entries.

However, now everyone has discovered and begun expounding on those triangles, and the contrarian in me says "Uh, oh," because that makes me wonder if any breakdown might have a greater likelihood of being reversed or of prices just trading sideways out of the triangles. If you had lots of money you wanted to put to work and wanted to make sure first that support was going to hold, wouldn't you consider pushing prices lower and seeing if buyers jump in, when you have such nice little parameters upon which to base such tests?

The Russell 2000's daily chart confirms my fears, and I wonder if what's seen on that chart won't be seen on others.

Annotated Daily Chart of the RUT:

The RUT's weekly 200-ema and -sma's are currently being tested. The RUT closed the day beneath both. The 200-sma is at 699.54.

Usually, you would expect to see a breakdown below the triangle's support level met by a sharp decline. Perhaps after the first sharp decline, there would be a bounce to retest that trendline before another rollover, but this isn't what's happening here yet. So far, there's a sideways move out of the triangle and then a lot of chopping. That chopping around is becoming increasingly volatile, however, so there may soon be a move that either produces the sharp decline or else a strong bounce off the support level being carved out. For now, however, that sideways trading suggests the possibility that "breakouts" either direction on other indices could be met with similar sideways moves.

The RUT, then, may give us our first insight tomorrow and next week. Some other charts give a more bearish outlook than is given here. The RUT currently has a potential downside target of just under 684 on its weekly Keltner chart, a level that will remain a potential downside target until and unless the RUT produces weekly closes above about 714.

If you're trading the SPX, OEX or Dow, the TRAN might also give you particular insight. It's been stuck in its own congestion zone, and I wouldn't expect those other indices to go far in either direction unless the TRAN had broken out of its congestion zone in the same direction.

Annotated Daily Chart of the TRAN:

Some subscribers who are new might wonder why I follow the TRAN. I do because the TRAN is sensitive to both crude costs and economic concerns. It serves as a good barometer. Often, too, its direction tends to lead the SPX, OEX and Dow. When it doesn't, the divergence can be important and can alert traders that something might be wrong with their SPX, OEX or Dow trade. I don't use the TRAN as a trading vehicle, of course, and it's not always great on market timing, so just use it as you would an indicator on a chart: a warning that must be corroborated by price action.

Today's Developments

Today's pre-market release of the weekly jobless claims revealed figures that proved misleading. Reports touted the 9,000 drop in initial claims, but that 9,000 drop was from a revised higher figure from the previous week. The previous week's 9,000 drop was revised to a climb of 1,000. So, although articles touted the drop of 9,000 in initial claims, the 349,000 initial claims was actually higher than the previously reported 348,000 claims from last week's report. It was also higher than the anticipated 340,000-345,000. In addition, a holiday in California may have meant that fewer were able to file claims and that next week's claims might be higher.

The four-week moving average rose 10,750 to 360,500. Continuing claims rose 48,000. The four-week moving average of continuing claims climbed 28,750.

February's Philly Fed Survey, one of the most important of the Fed District surveys in predicting the ISM's report on manufacturing in the country, proved shockingly weak. The diffusion index fell to -24 from the previous -20.9. Zero is the benchmark that measures contraction versus expansion. Any negative number indicates contraction, and the larger the negative number, the sharper the contraction.

Economists had predicted that the index would rise to -10, so the sharper decline proved a disappointment. In addition, the component that measures the outlook for the future dropped to a more-than-decade low, to -16.9 from the previous +5.2. Components for future employment and shipping dropped.

Some components showed glimmers of light. New orders rose and the prices-paid index saw a welcome drop from 49.8 to 46.6. Also, despite the fears about future employment, the employment index rose to +2.5 from its previous -1.5.

The Conference Board also released its January Leading Indicators during the same 10:00 am ET period. This number does not usually move the markets. Coming at the same time as the Philly Fed, it wasn't likely to garner too much attention, either, other than as a corroboration of the weakness shown by the Philly Fed. It was expected to ease by 0.1 percent, and it did exactly that. Five component indices dropped.

This was the fourth straight month of declines in this number, and the sharpest six-month decline since early 2001, a Marketwatch.com article noted. Moreover, the Conference Board's economist believes that February's number will also likely decline, perhaps sharply.

Clouds might have been moving in, but glimmers of sunlight showed through, too, as transient as they were to turn out to be. The coincident economic indicator, the component that measures where the economy was at the time of the index was calculated, rose 0.1 percent. The Conference Board's labor economist purportedly concluded on the basis of the coincident index that the economy was not recessionary in January.

The EIA, the U.S. Energy Information Administration, released the weekly crude and natural gas inventories at 10:30. The crude inventories had been delayed a day due to Monday's federal holiday. Crude inventories rose 4.2 million barrels. While one article noted that industry watchers had expected a rise of 3.2 million barrels, a guest commentator on CNBC had mentioned that he had expected 5.0 million barrels. Gasoline supplies rose 1.1 million barrels, about in line with expectations, and distillates dropped 4.2 million barrels. Refinery capacity dropped to 84.9 percent.

Natural gas inventories were also released. Those dropped 1.72 billion cubic feet.

Crude has of course drawn much attention with its first-ever close above $100 earlier this week. Jim Brown has been pointing out the likely expiration-related effect, sending shorts scurrying to cover when the about-to-expire contract did not retreat as expected. After today's reports, crude, now with the new contract, dropped, closing the regular trading session at $98.23 a barrel.

Two releases during the day related at least obliquely to the subprime and credit crunch worries. One was the weekly Freddie Mac survey of mortgage rates. Thirty-year fixed-rate mortgages averaged rates of 6.04 percent, much higher than last week's 5.72 percent. It's still lower than the year-ago rate of 6.22 percent, Freddie Mac pointed out. Many had hoped that a Fed easing would result in lower mortgage rates, helping those who were transitioning out of ARMs and into more traditional loans to afford those more traditional loan rates. Instead, Freddie Mac's chief economist believes that the widening spread in rates for long-term fixed-rate mortgages and ARMs might lead ARMs to become more popular again than they have been recently.

The other release related to the credit crunch. The Federal Reserve released its weekly figures on outstanding commercial paper, a measure of how well companies and other entities are succeeding in placing the commercial paper they use to fund their operations. During the worst of the credit crunch, outstanding paper was falling sharply every week, and last week, it had continued and even sharpened a decline from the previous week.

Unfortunately, that trend continued. For the third week in a row and the fourth out of the last five weeks, outstanding commercial paper has fallen. Moreover, the drop has been steepening. This week, outstanding commercial paper fell by 17.8 billion. In the previous two weeks, it had fallen 8.6 and then 13.3 billion. Asset-backed paper dropped 11.3 billion.

For those not familiar with commercial paper, here's the Fed's definition: "Commercial paper consists of short-term [30-270 days], promissory notes issued primarily by corporations." The money the corporations garner provides an alternative to bank loans and is used for current transactions.

Microsoft (MSFT) starred in company-related articles. The company announced technology and business changes that will benefit developers, customers, partners and competitors, too. The company said that the changes will enhance interoperability and openness. The European Union apparently wasn't impressed and reportedly will continue with its antitrust suit against MSFT.

Research in Motion (RIMM) also had its time in the sunshine today. The company raised its guidance for net subscribers. It also reaffirmed revenue and EPS guidance for the fourth-quarter.

Tomorrow's Economic and Earnings Releases

Only one release appears for tomorrow: the ECRI Weekly Leading Index. That number does not usually prove market moving.

What about Tomorrow?

Annotated 30-Minute Chart of the SPX:

What if the SPX bounces immediately or after dropping to that trendline? Where is resistance? Look for potential resistance from 1346-1347.50 first. If the SPX can't get past that, the likelihood increases that it will roll down and retest the support again, if not break through it.

Annotated 30-Minute Chart of the Dow:

If the Dow bounces immediately or after dropping to test that Keltner and trendline support, watch for rollover potential in the 12300-12330 zone. If the Dow rises but can't sustain values above that zone, then the potential increases that it will roll down to test support again.

Annotated 30-Minute Chart of the Nasdaq:

If the Nasdaq bounces immediately or after testing that trendline support, watch for rollover potential at the descending 9-ema on the 15-minute and 30-minute charts. They're at about 2305.25 and 2309.25 currently, but will have changed a little tomorrow, depending on the price action. If the Nasdaq can't sustain values above them, it's more likely to roll back down to test support.

Annotated 30-Minute Chart of the Russell 2000:

The RUT is the index closest to 30-minute Keltner support. It may be our first guide for tomorrow as to whether the approaching support will hold or be broken. If it bounces tomorrow, watch for rollover potential from 698-700. If it can't sustain values above that, it's more likely to roll back down to test support again.

So what's it going to be for tomorrow? Will indices bounce immediately, drop down through the current potential support zones but then bounce or just cave?

That's the trouble with triangles. Prices chop around inside them, turning around on a dime. Days that see closes on the low of the day, indicating that not all sellers were able to get out, are followed by days of gains instead of days where there's some follow-through to the selling. The thing to do with triangles is to try not to anticipate or think you know the next action.

However, if these were normal times, which they are not, the most likely or best-guess action tomorrow morning would be retreat further through the support zones detailed earlier, followed by a bounce attempt. If the day is moderately bullish, a doji-type day might be produced or indices might even bounce back to the top of their recent congestion zones. If they're not at all bullish, any bounce attempt would be met by selling and the indices would roll down again, either to produce a doji that closes on support again or into a real breakdown.

These are not normal times, so use any best-guess scenario only as a test against which to measure initial action, not as a prediction of what will happen..


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