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Market Wrap

Holiday Churn

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As we count down to the Labor Day weekend volume is going to continue to slow and our trading range is likely to tighten. Support has weakened but that is probably due more to a lack of traders than an abundance of sellers. The next three days are likely to be a lot of flash but no substance. Low volume is going to make any moves meaningless because they can be reversed in a heartbeat when traders return next week.

NYSE Composite Index Chart - Daily

There were eight economic reports today but none were earth shaking. Weekly chain store sales came in a +0.2% after a +0.1% gain the prior week. Both numbers illustrate how lackluster the back to school shopping season has been.

The S&P/Case Shiller Monthly Home Price Index for June showed home prices fell -17.0% over the past year. This was actually a positive report because prices were down -16.9% in the May report. A minor -0.1% decline over the last month is not a problem in my book. Unfortunately this is a lagging report and June is still part of the spring selling season and therefore prices would have been higher. As we get the reports from later in the summer the odds are good we are going to see larger declines. Most government economists expect declines in the 20% range. Another flaw in this report is the trailing 12-month calculation. Home prices could be down 40% over the last two years and the report would only show the last 12-month decline.

TThe OFHEO Purchase-only House Price Index also held steady in June after a few of the regional markets rallied. The OFHEO index showed prices were down only 4.8% overall over the same period in 2007. The flaw in this report is it only covers FHA conforming loans. It does not include jumbo loans or Alt-A and subprime loans. As such it shows the middle range of the housing sector is still relatively ok with only a small annual decline. Of course we know the subprime sector has imploded and jumbo loans are at a standstill with million dollar and higher homes down 50% in some areas.

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New Home Sales for July improved slightly over June to 515,000 compared to 503,000 homes. The rate of sales has been in this range for four months and suggests that sector is stabilizing. The months of supply of completed homes fell to 10.1 months and the lowest level in five months. This is also a positive sign of improvement. However, the annualized decline in sales for Q2 was still -26% below Q2-2007. Sales are still slow but with builders slowing the pace of construction over the last year the industry is on the road to a recovery. Inventory has fallen -23% from July 2007 levels.

The Richmond Fed Manufacturing Survey held at -16 for August and the same level as July. This was the fourth consecutive month in contraction territory. Raw material prices increased +3.65% but that was less than the +4.41% increase in July. Shipments improved 10 points to -13 but new orders fell -5 points to -22. The six-month outlook rose +10 points to positive territory at +6. Overall the outlook for the Richmond region declined in August despite no change in the headline number.

Consumer Confidence improved to 56.9 from the earlier 51.9 reading for August. The expectations component was responsible for the gain. This was the second monthly gain suggesting the worst is over. Assessments of current labor market conditions worsened. Those planning to buy a home increased to 3.3% from 2.8% and those planning on buying an appliance rose to 31.6% from 28.6%. Falling gasoline prices are a big part of the improvement in confidence.

CConsumer Confidence

The FOMC minutes from the August 5th meeting were released today and as expected the members were concerned about the continuing risks to growth. Most expected inflation to moderate but there was still a battle between the hawks and doves on the committee. The committee did not feel the current policy of 2% Fed rates was over accommodative. Payrolls continued to fall with widespread job losses. Consumer spending picked up but members felt it was only stimulus checks being spent. They were encouraged by the slowing decline in the housing market. Business investment remained soft with a decline in spending on equipment and software. Headline inflation was expected to slow now that energy prices have moderated. There were several acknowledgements that the committee was split. In terms of prices "most meeting participants thought inflation would moderate in coming quarters." Also, "nearly all meeting participants saw continuing downside risks to growth." This was clearly a sign the tension between the inflation hawks and those who want to keep rates low. Richard Fisher has dissented at every FOMC meeting this year in favor of raising rates. The minutes expect growth to be depressed for several more quarters with it not returning to its potential until the second half of 2009. The committee also felt the credit crisis was not over and expressed concern about the continued weakness. The committee felt the next rate move would be a rate hike but agreed the timing and size of such an increase would depend on the economic circumstances. The FOMC comments suggest there will not be a change in rates for several months. Once growth finally finds some traction we can expect the Fed to raise rates aggressively.

Economic reports for Wednesday include the Mortgage Application Survey, Durable Goods and the Oil and Gas Inventories.

The quarterly FDIC problem bank report was also released and it was not pretty. The number of problem banks rose to 117 from the 90 in the first quarter. Assets of problem banks rose to $78.3 billion from $26.3 billion in Q1. $32 billion of this increase was due to the IndyMac failure. That will stay on the FDIC books until they are successful in selling those assets. The FDIC also said the insurance fund had declined to a fund to asset ratio of 1.01% and below legal requirements. The FDIC said it would have to raise additional capital to get back into compliance. The fund ratio stood at 1.32% just a couple years ago. Today at 1.01% there is $45 billion in FDIC funds insuring about $4.5 trillion in deposits at member banks. To increase this ratio the FDIC will raise fees to all FDIC banks at a time when profits are near record lows. Bank profits for all the FDIC insured banks in the U.S. fell to only $5 billion in Q2. That is a drop of -86% over the $38.6B in Q2-07. The FDIC said the credit crisis had not bottomed and loan loss reserves at member banks needed to be increased again. Corporate credit spreads widened over the past week by 17 basis points and are very close to the high set back in March. Credit is continuing to tighten and credit losses are rising. When the FDIC and the FOMC both express concern over the continuing credit crisis on the same day we should pay attention.

Oil prices continued their extreme volatility ahead of tomorrow's inventory report. Crude fell overnight to $112.36 and then rallied to $117.89 on news that tropical storm Gustav had been upgraded to a category one hurricane and is expected to enter the gulf on Sunday as a possible category four storm. The volatility has been huge in the crude contract with more than a $10 range over the last week. Fay finally evaporated after nearly two weeks of wandering around the eastern gulf and away from the oil patch. Unfortunately Gustav appears to be aiming for a direct hit on the oil patch and New Orleans. Winds are already at 90 mph and it should hit the oil patch about 5PM on Sunday. Of course the leading winds will start battering those oil platforms early Sunday morning. This suggests traders will be getting long before the weekend or at least covering their shorts. I believe traders are going to wait until after the weekly inventory report Wednesday morning before changing positions. There are three more storm systems heading for the Caribbean about a week behind Gustav. Odds are good at least one will turn into a storm named Hannah.

CCrude Oil Chart

Storm Plot Chart for Gustav

This is a holiday week with many traders already away from the market and enjoying the last week of the summer at their favorite vacation spot. Volume has been falling for the last week and that favors the bears rather than the bulls. However, the markets tend to ramp into a holiday. The Stock Traders Almanac suggests there are several conflicting trends heading into the weekend. The last four days of August have been up the last four years but the next to the last day (Thursday) has been down 10 of the last 11 years. This is seen as the last real trading day before the holiday even though the market is open on Friday. Analysts view this decline as short covering before the holiday and preparation for the normal September decline. September is historically the worst month of the year for the markets. Fund managers tend to come back from the Labor Day holiday and begin cleaning house as they approach year-end. They unload losers and then cash out on some winners to offset the losses. The cash they generate they reinvest into the next set of hopefuls for 2009. The day after Labor Day has been up 11 of the last 13 years but then the markets begin to fade with the September triple witching week the worst week of the month. br>
MMarket Internals Table Showing Decreasing Volume

With volume slowing and market support eroding I would be very skeptical of any rallies the rest of the week. The Dow has not declined to initial support at 11300 but came close at 11350 on Tuesday. The Friday short squeeze has been erased and were it not for a buy program late Tuesday we could have easily closed on that 11300 level. A break under 11300 should retest 11000. With the worst month of the year ahead I think we have a very good chance of seeing that 11000 level. Remember, the Dow and the S&P has a very high beta to the financial sector. With the OMC minutes and the FDIC report both claiming the credit crisis is worsening again the banks are probably not going to be moving higher. The FDIC assets at risk doubled without counting the IndyMac failure. The worries over Fannie and Freddie are continuing and nationalism continues to be discussed. Without any strength in banks the Dow and S&P will continue to be weak. The XLF closed just over support at $20 and a break there could easily test the July lows. The S&P bounced off support at 1265 for a minor +6 point rebound. A break there could test 1250 and then 1210.

DDow Chart - Daily

Financial Sector SPDR XLF Chart - Daily

S&P-500 Chart - Daily

The Nasdaq hit support at 2350 today and saw some immediate buying interest with AAPL, RIMM, CSCO and INTC returning to positive territory before the close. Unfortunately it was not enough buying to return the Nasdaq to positive territory. The tech sector and small caps were the only things moving the markets higher over the last month. Without this supporting cast the path of least resistance is down. The next support level for the Nasdaq is around 2275 followed by 2200.

Nasdaq Composite Chart - Daily

Russell-2000 Chart - Daily

The Russell tested support at 720 on Monday and then broke that level at 2:PM this afternoon to trade as low as 716. The end of day buy program took it back to 722.77 and technically over support but it appears very week. The asdaq and Russell both hit new two-week lows today. The tide has turned and until the internals and volume improve significantly I would not buy these dips for anything but a short-term trade. The next support level on the Russell is 700 followed by 660.

I hope I have painted a picture of a change in market sentiment to negative as we head into September. Just remember there could be some trading bounces heading into the holiday and early next week. I would not view them as a positive change in sentiment but as potential short squeezes. There is a market axiom that says, "Don't short a dull market." I have given back tens of thousands of dollars over the years ignoring that axiom. Dull markets on low volume can be pushed around like Gustav would push a sailboat. The smallest of buy programs can cause very sharp spikes triggering trailing stops only to see prices return to the lows shortly thereafter. This is not a week where professional traders are in the markets. They know to avoid the quicksand and the traps hidden under it. I would strongly suggest everyone trade the next three days with only the risk capital you can afford to lose and definitely take profits early. The herd is starting to lean to the downside and that is a risky position in a dull market.

I would like to invite everyone to attend the 2008 Peak Oil Conference with me on Sept 21-23 in Sacramento. About 20 Option Investor subscribers and myself will be attending and it will definitely be fun and entertaining. There are dozens of speakers and all the presentations will have reams of data on Peak Oil and its impact. It is not specifically on investing for Peak Oil although there are presentations on that in the schedule.

The conference will convince anyone that peak oil is real and give you a countdown calendar for its arrival. I have dozens of people email me every week asking questions about peak oil. This is where to get your answers. The first day is the story and all aspects of the coming problem will be presented. The second day covers the impact. What role will coal play? What is the future for aviation? How will governments react to the changes? What hardships will ordinary people be forced to endure? What is the future of transportation?

AAll the Option Investor attendees will sit together so we can talk about the presentations during the breaks. I will be holding an evening session just for OI attendees and it will be Q&A and a general discussion about what we heard that day and how to profit from it. I strongly suggest anyone concerned about their future not miss this opportunity.

Go here to register: http://www.aspo-usa.org/aspousa4/

On the third page of the registration put my name in the "How did you hear" box. That way I can track the registrations and send you emails about meeting times and places. I guarantee you will not be disappointed with what you learn.

See you in Sacramento!

Jim Brown
 

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