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Daily Newsletter, Thursday, 07/20/2006

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

A Day of Rest

The bulls worked so hard yesterday during that sprint higher that they needed to take today off and rest a while. Actually I think the bears rested--they're the ones who were doing the scrambling yesterday to cover their shorts. The big debate today is whether yesterday's rally was just a flash in the pan, just another bear market rally, or whether it was the start of something bigger to the upside. The jury of course is still out on that question but so far it's looking like the bulls have some more upside work to do (and shorts have some more covering to do.

As I've been doing each week I'll update the SPX weekly charts at the end of this report since we had an important bounce this week. Had the market not rallied when it did the SPX would have broken down from long term support and the bears would have been slobbering all over themselves while feeding on fresh steaks. As it is the bears got pushed back by angry bulls and it's looking so far like they just might get that choppy summer rally going. I'll explain more later. I'll also explain, using the current daily chart, what the bulls need to do now otherwise we could have a very bearish setup in place.

Today's pullback looks like a typical overlapping corrective move against the Tuesday/Wednesday rally. So far that's bullish since it looks like a bull flag formed today and the prices heading into the close could be it for the pullback. If prices continue lower tomorrow then they'll probably accelerate lower (think of the looks of a waterfall and that's what price will look like if the decline continues). But if the bottoms of today's bull flags hold then we should see a continuation of the rally start tomorrow.

Fridays tend to be quiet days, especially opex Fridays and most especially opex summer Fridays. Therefore I don't expect we'll see another powerful rally like Wednesday's but we could see the market methodically work its way higher, but that's only if today's lows hold (other than perhaps a minor morning dip). The setup is there so we'll have to see if the bulls return after digesting their Wednesday meal.

There were a couple of economic reports today. The unemployment numbers showed initial claims came in at 304K, lower than the expected 320K, which was a drop of 28K from last week's revised 332K (revised down from 334K). The Labor Dept reported that the bulk of the drop was due to the auto industry after last week's increase in claims because of their annual temporary shutdown as car makers prepared for their model-year changeover. The 4-week average dropped by 1,250 to 316,750. Continuing claims rose by 85K to 2.5M.

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Leading indicators was released at 10:00 and showed June came in at +0.1% vs. forecast for +0.2%. This was the first increase in 3 months and was an improvement from May's -0.6% but is down -0.3% in the past 6 months. This is further evidence of our economy cooling off as this measure usually shows what the economy will do over the next 6 months. But not to worry, we all know that the Fed will know when to stop so as not to force us into a recession (cough).

Bernanke has been stating that the economy is slowing down and of course the market treats that as good news (in its perverse way) since that means the Fed will soon stop raising interest rates. To which I'll say it again--the facts shows that the market is consistently down 6 and 12 months AFTER the Fed stops raising rates. Why the market is excited about this I'll never know.

The Philly Fed number for July was released at 12:00 and at 6.0 was less than the expected 12.5 and less than half of June's 13.1. Any number above zero shows expansion but obviously at a slower rate in July. This averaged 12.4 for all of 2005. The Prices Paid index was 50.3 vs. June's 48.7 and Prices Received was also up, rising to 17.1 from June's 14.0. But New Orders dropped from June's 17.7 to 10.1. Employment nearly doubled from June's 6.8 to 12.8 this month.

The bigger news for the day was the FOMC minutes released at 2:00. The market went on hold and then dropped after the release (I guess there weren't enough "we'll pause next time" comments by the Fed governors. The minutes revealed that the FOMC is aware of the risk of a sharp slowdown in the housing market but they were universally concerned about the core inflation in June. They were split on the inflation outlook but most felt it was moving lower. This made for a split on whether rate policy was too restrictive vs. too loose and one member called the June rate hike a "close call".

But there was nothing in there that said a pause in rate hikes is likely. As usual they're sticking to their policy of letting the numbers tell them what to do next. Unfortunately for us their numbers are usually a day late and a dollar short. The market sniffs it out long before they do and that's why the market is consistently lower after the Fed stops raising rates. While we will probably get a big rally after the Fed pauses (maybe even surprises with a rate reduction), it will be a rally that you'll want to short for the long run.

Today's internals were a reversal of yesterdays but not to the same extreme. Total volume was normal but lighter which is what bulls want to see for a correction of yesterday's rally. Down volume was nearly 4:1 over up volume while declining issues were a little more than twice the advancing issues. New 52-week lows outnumbered new highs again, almost by a 2.5:1 ratio.

Speaking of new highs vs. new lows, I came across this chart today in a newsletter put out by bigtrends.com which I thought was very interesting and worth passing along.

SPX vs. NYSE New Highs and New Lows chart, Weekly, courtesy BigTrends.com

The chart says NASDAQ new highs and lows but it should state NYSE new highs and new lows. The point of the chart is that when we see new highs drop to 15 or fewer and new lows increase to 200 or more, it's signaling that the market is oversold and watch out for a reversal. Based on this chart and a double-bottom at the June lows we could say the market is ripe for a rally. The short term pattern is also set up that way so it's for the bulls to lose at this point.

DOW chart, Daily

The DOW looks reasonably bullish here, having left a bullish divergence at a double-bottom against the June low. This is a reliable signal to try the long side. At least you know where your stop belongs--just below this week's low. Obviously the DOW needs to recapture its 50-dma in order to allow the bulls to breathe a little easier.

SPX chart, Daily

The SPX also sports the potential to make this a double-bottom, right cheek up. But it clearly needs to recapture its 50-dma and 200-dma, both of which acted as resistance to yesterday's rally. Another push above today's high should set off more short covering. Until that happens I've got a very bearish EW count developing on this chart. It's labeled currently as a 1-2, (i)-(ii), i-ii which means the bottom is getting ready to drop away. This count says we're about to enter the 3rd of a 3rd of a 3rd wave down and those are screamers. This is a low odds scenario so I'm reluctant to trust it but if it follows through this way we could be looking at a mini market crash coming up. The season is not right for this and that's another reason not to trust this count. But I'll leave it on there until the July 3rd high is taken out thus negating this count. In the meantime realize the potential for a wicked sell off from here. (But I'm actually leaning bullishly here).

Nasdaq chart, Daily

Same for the COMP as for SPX--if this week's low is taken out then the selling flood gates could open up. But the bullish divergences at the new lows, along with the test of the October 2005 low, tell me that long is the place to be. Certainly I'd try a long here and then stop and reverse if price drops below 2012.

QQQQ chart, Daily

More bullish divergences at new lows. It doesn't mean we can't see more new lows but I would expect the bullish divergences to continue and I'd be reluctant to chase this chart lower. I'm thinking we'll the Q's bounce back up to at least 39 over the next month or two.

QQQQ chart, Weekly

Following up on last week's weekly chart of the Q's we can see the importance of 36 holding. If it breaks we could see the 200-weekly average at 35 and then a 38% Fib retracement at 34.68 come into play but I'd be careful chasing this one to the short side.

SMH index, Weekly chart

The semiconductors looks ready for a bounce also. Between reaching the January and April 2005 lows and a Fib projection for the leg down from this past April, I'm thinking the semis are ready for a bounce.

BIX banking index, Daily chart

The banks look like they might have hit their ceiling but the short term pattern would look better with another push higher. The pullback from the December 2004 high looks to be just some profit taking.

Securities brokers index, Daily chart

The banks look potentially bullish but the securities broker index looks potentially bearish. Each test of support-turned-resistance has resulted in further selling. With the 50-dma about to come down and cross through the 200-dma, and the index pulling back from the a test of the 200-dma, one has to wonder if this will result in another sell off. Each failed test, and subsequent sell off in this index has been followed by the broader market. Watch this one.

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

The home builders should finally be nearing some stronger support which should result in a larger bounce to correct the hard decline in this index. Watch the 500-530 area for support.

Oil chart, August contract, Daily

Bernanke has stated that he sees a lessening in demand for oil and this chart says we could see a significant lessening of demand (and a consequent drop in the price of oil). This would be telling us that the economy is slowing significantly. While these ascending wedges can go on and on, there is the possibility that we just saw the last high in oil for quite a while. The negative divergence at the last high fits against the 5th wave in this pattern. That interpretation says the ascending wedge is finished and when these wedges finish they usually correct quickly back down to the beginning of the wedge. That would be a drop back down to near $60 in relatively short order (a few months perhaps). But first it needs to get through its 50-dma at 73.25 and then its uptrend line near 71.40.

Oil Index chart, Daily

While oil looks like it has topped I'm thinking the oil stocks haven't quite hit their high yet and that could forecast another push higher for oil too. If this index pushes up near 660 I'd consider lightening up on my oil stocks and put some money in the bank. As for oil, a new high could be the last one for quite a while, especially if the broader market looks to be losing it.

Transportation Index chart, TRAN, Daily

The Trannies were leaders to the downside today and even took out yesterday's low. The bulls are hoping this index is not leading the way. This index looks headed for a quick test of its 200-dma and a first Fib projection target near 4375.

U.S. Dollar chart, Daily

Such a glutten. The US dollar loves to get slapped. It liked it so much at the last test of the broken uptrend line that it had to go for another. And the result was the same--a quick pullback after touching it. I didn't expect another push higher in the dollar and I'm wondering if it will continue to push a little higher along that uptrend line. But if it rolls back over here it will leave a negative divergence in its wake. I'll then continue to look for a drop to the $83 area.

Gold chart, August contract, Daily

The test is on for the gold bulls. After retracing a perfect 62% of the May-June drop, gold sold off sharply. But it's finding support at its old uptrend line and around its 50-dma. With daily oscillators in full dive mode though, it doesn't look like that will hold. At that point I'd watch for a Fib retracement of the bounce to see if we're going to get another leg up otherwise we may be looking at the start of another leg down to match the May-June decline. In that case we're probably looking at $495 as the first downside target.

Results of today's economic reports (no major reports tomorrow):

It will be a quiet day tomorrow morning as far as economic reports go. The market will be more concerned with the reaction to Microsoft's (MSFT 22.87 -0.55) earnings which were strong--record Q4 revenue of $11.8B for a 16% increase over prior year. Operating income was up 30% over year-ago $2.99B, coming in at $3.88B, with a net income of $2.83B for a diluted EPS of 28 cents per share, down from 34 cents a year ago. Mr. Softee also announced that it had completed a $30B share buy-back. MSFT's price jumped on the news, closing at 24.11 after hours, for a gain of 1.24 from its 4:00 close. We'll have to see how that translates to tomorrow's open.

Google (GOOG 387.23 -11.88) also reported earnings for Q2 and at $721.1M on revenue of $2.46B it beat analysts' expectations. But the stock barely registered a reaction and closed up only $1.67 in after hours.

Looking at sector action for the day, most of my list was red today. QCharts is still not updating the Philly index sectors so I'm not sure where they fit in today. But substituting SMH for SOX and HUI for XAU I see that both of these were leaders to the downside today along with the Trannies, airlines, cyclicals and networkers. Computer hardware and pharmaceuticals were the green sectors today.

Let's review the big picture with the SPX weekly charts. The uptrend line from August 2004, which is the bottom of an ascending wedge, held the latest test, at least for now. At about 1240 SPX has very little wiggle room here. Any drop back below this week's low could be nasty for the bulls.

SPX chart, Weekly, More Immediately Bearish

As I had shown on the daily chart at the beginning of this report, the EW count is potentially very bearish here. That's why a break below this week's low would likely trigger a flood of selling. If we're in a 3rd of a 3rd wave down, we're about to enter the strongest leg of it to the downside. I would not want to be long any stocks if that happens. Get short and wait for the April 2005 low (near 1140) to take your money off the table. That would be a 1000 point drop in the DOW and it's likely it would happen by September.

SPX chart, Weekly, Intermediate Bullish

Until that lower trend line breaks, with a drop back below this week's low, the bulls have a good chance of getting their summer rally. Certainly from a risk:reward standpoint this is an excellent place to try a swing play to the long side. Keep your stop below this week's low, give yourself a few months for the rally to materialize (it will be choppy and take a while) and then take profits at the top of the wedge pattern, up near 1350.

We're dancing on the edge right here and for those of you who are long without stop orders in or put protection, you're on the high wire without a net below you. If you're short and stayed short through yesterday's bounce you could be facing another strong rally leg tomorrow or next week. This market is teetering and either way it goes it could go quickly as the other side scrambles to cover. Maybe a strangle play?

Tomorrow being Friday it could be a real snoozer. The price pattern is set up for another rally leg and that's the way I called it for an end-of-day play in the Market Monitor. But any further break down tomorrow could result in some quick selling and that would then endanger yesterday's rally (and make it look like yet another bear market rally that was Fed induced to help their main man in front of Congress). Whichever direction you're playing right now, keep your stops tight. A rally above today's high or a drop through this week's low will then allow you to relax your stop and then let it run because it should have a good run in that direction. Good luck and I'll see you on the Monitor or back here next week.
 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
Strangle Options Plays
None MAN None
  UNP  

New Calls

None today.
 

New Puts

Manpower Inc. - MAN - close: 59.42 chg: -2.41 stop: 62.25

Company Description:
Manpower Inc. is a world leader in the employment services industry; creating and delivering services that enable its clients to win in the changing world of work. The $16 billion company offers employers a range of services for the entire employment and business cycle including permanent, temporary and contract recruitment; employee assessment and selection; training; outplacement; outsourcing and consulting. Manpower's worldwide network of 4,400 offices in 72 countries and territories enables the company to meet the needs of its 400,000 clients per year, including small and medium size enterprises in all industry sectors, as well as the world's largest multinational corporations. (source: company press release or website)

Why We Like It:
In the last two days MAN has produced a failed rally under its 50-dma and a breakdown under support at the $60.00 level. Both events occurred on big volume. The early strength on Wednesday was probably fueled by MAN's recent earnings report, which came in better than expected. Unfortunately, the buying spree was short lived. Now he stock is breaking down and the next level of support looks like the $55.00 region with its rising 200-dma (54.77). We are suggesting that readers buy puts with MAN under $60.00. Our target is the $55.50-55.00 range. The Point & Figure chart currently points to a $52 target.

Suggested Options:
We are suggesting the August and September puts. You choose which month and strike best suits your trading style. (currently there are no August 55 puts available)

BUY PUT AUG 60.00 MAN-TL open interest=115 current ask $2.80

BUY PUT SEP 60.00 MAN-UL open interest=173 current ask $3.30
BUY PUT SEP 55.00 MAN-UK open interest= 96 current ask $1.35

Picked on July 20 at $ 59.42
Change since picked: + 0.00
Earnings Date 07/19/06 (confirmed)
Average Daily Volume = 1.0 million

---

Union Pacific - UNP - close: 84.01 chg: -3.39 stop: 87.01

Company Description:
Union Pacific Corporation owns one of America's leading transportation companies. Its principal operating company, Union Pacific Railroad, links 23 states in the western two-thirds of the country and serves the fastest-growing U.S. population centers. (source: company press release or website)

Why We Like It:
The gap higher in shares of UNP this morning was probably due to the company's earnings report. UNP reported earnings that came in 11 cents above analysts' estimates. Yet the rally reversed right at the $90.00 level and under its 50-dma. The selling continued throughout the session and UNP eventually broke down under technical support at its 200-dma with volume coming in way above the average. Today's move also produced a failed rally, a breakdown of support, and a new sell signal on the P&F chart, which now points to a $74 target. Normally you want to see some confirmation or follow through after a stock produces a big bearish engulfing candlestick pattern like UNP did today. That's why we're suggesting a trigger to buy puts at $83.75, which is underneath the June low. If triggered we're suggesting two targets. Our conservative target will be the $80.10 level. Our more aggressive target will be the $77.65 mark.

Suggested Options:
We are suggesting the August puts. Septembers are not available yet but if you're interested Novembers are available.

BUY PUT AUG 85.00 UNP-TQ open interest=1953 current ask $3.10
BUY PUT AUG 80.00 UNP-TP open interest= 586 current ask $1.15

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/20/06 (confirmed)
Average Daily Volume = 1.7 million
 

New Strangles

None today.
 


Play Updates

In Play Updates and Reviews

Call Updates

Dominion - D - close: 77.23 change: +0.73 stop: 74.49

The U.S. markets may not have seen any follow through on Wednesday's gains but shares of D did. The stock added another 0.95% but on below average volume. We remain bullish but if the major indices continue to be weak then we would expect D to likely pull back and retest broken resistance near $76.00 as new support. Traders can use a dip to or bounce from $76 as a new entry point. Our target is the $81.00-82.00 range although more conservative types may want to exit near $80.00. Please note that we do not want to hold over D's early August earnings report.

Picked on July 17 at $ 76.05
Change since picked: + 1.18
Earnings Date 08/03/06 (confirmed)
Average Daily Volume = 1.5 million

---

Fortune Brands - FO - close: 71.68 change: -0.42 stop: 69.74

There was no follow through in shares of FO today. The stock continues to struggle with short-term resistance near $73. We're starting to noticed that the MACD and the RSI on the daily chart might be hinting at a bearish roll over soon. We would expect shares of FO to pull back toward the $71 level tomorrow and possibly the $70 region. We're not suggesting new positions at this time and more conservative traders may want to exit early to minimize any losses. Our target is the $74.75 level but FO has to push past the 50-dma first.

Picked on July 06 at $ 71.30
Change since picked: + 0.38
Earnings Date 08/01/06 (confirmed)
Average Daily Volume = 674 thousand
 

Put Updates

Alcon Inc. - ACL - close: 93.50 chg: +0.26 stop: 97.65*new*

ACL managed a decent bounces from its lows near $91.80 this morning. The move looks like a short-term bullish reversal. We would expect ACL to try and rally back toward the simple 10-dma overhead near 96.00-96.25. A failed rally anywhere under $97.50 could be used as a new entry point to buy puts but unfortunately, we're quickly running out of time. We do not want to hold over the July 24th earnings report. At this time we're planning to exit on Monday afternoon to avoid the earnings report. Please note we're adjusting our stop loss to $97.65.

Picked on July 13 at $ 95.61
Change since picked: - 2.11
Earnings Date 07/24/06 (confirmed)
Average Daily Volume = 805 thousand

---

Air Products Chem. - APD - cls: 61.72 chg: -1.75 stop: 64.01*new*

APD experienced a somewhat dramatic bearish reversal today. The stock lost 2.75% that more than erased Wednesday's gains. The close back under $62.00 and its simple 200-dma looks like a new bearish entry point. However, before you open new positions keep in mind that our target is the $59.00-58.00 range and we do not want to hold over the July 26th earnings report next week. We are going to adjust our stop loss to $64.01.

Picked on July 09 at $ 62.95
Change since picked: - 1.23
Earnings Date 07/26/06 (confirmed)
Average Daily Volume = 1.2 million

---

Apollo Group - APOL - close: 46.63 chg: -2.68 stop: 50.05 *new*

APOL also experienced a sharp reversal today. The stock lost 5.4% on above average volume. Shares have now closed under the March 2006 lows and APOL looks poised to hit our target in the $45.50-45.00 range soon. The P&F chart's bearish target has moved from $40 to $38. We are adjusting our stop loss to $50.05.

Picked on July 09 at $ 49.92
Change since picked: - 3.29
Earnings Date 09/19/06 (unconfirmed)
Average Daily Volume = 1.4 million

---

IDEXX Labs - IDXX - close: 74.85 chg: -0.06 stop: 76.05

There are no changes from our previous updates on IDXX. We're not suggesting new plays and we're repeating our suggestion to exit early. Our conservative target at $75.25 has already been hit and we're aiming for the $72.00 level.

Picked on June 12 at $ 77.95
Change since picked: - 3.10
Earnings Date 07/28/06 (confirmed)
Average Daily Volume = 144 thousand

---

Jacobs Engineering - JEC - cls: 71.77 chg: -2.69 stop: 76.55

JEC witnessed zero follow through on yesterday's bounce. Today's decline produces a bearish failed rally under the stock's 200-dma and 10-dma. Our short-term target is the $69.00 level but traders may want to use today's move as a new entry point to buy puts and aim lower. Just remember that JEC is due to report earnings on July 25th and we do not want to hold over the report.

Picked on July 16 at $ 73.75
Change since picked: - 1.98
Earnings Date 07/25/06 (confirmed)
Average Daily Volume = 583 thousand

---

Panera Bread - PNRA - close: 58.25 chg: -1.76 stop: 62.01

PNRA is still sinking. The stock lost another 2.9% today on strong volume, which is definitely bearish, but it's worth noting that stock does look oversold. We remain negative and continue to target the $55.50-55.00 range. We do not want to hold over the July 25th earnings report.

Picked on July 18 at $ 59.49
Change since picked: - 1.24
Earnings Date 07/25/06 (confirmed)
Average Daily Volume = 494 thousand
 

Strangle Updates

None
 

Dropped Calls

EOG Resources - EOG - close: 67.99 change: +1.11 stop: 69.90

The oil sectors were unable to trade higher in spite of a bounce in the price of crude oil today. Shares of EOG failed to see any follow through as well and the stock posted a failed rally under its simple 10-dma. It was our plan to go long at $72.55 but EOG is quite a ways off from hitting our trigger so we're dropping the stock as a bullish candidate.

Picked on July xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 08/01/06 (confirmed)
Average Daily Volume = 3.5 million

---

PetroChina - PTR - close: 108.86 chg: -1.74 stop: 107.49

Abandon ship! Our trigger to buy calls on PTR was at $111.55 and the spike higher this morning snagged our trigger before turning lower again. Thursday's failed rally has PTR headed for a drop toward the 50-dma and 100-dma near $106.50. A decline that low would stop us out at $107.49. Aggressive traders may want to widen their stops to give PTR enough room to bounce from the $106 region. The lack of follow through in the markets today and the oil stocks does not inspire any confidence in us and we do not want to widen our stop. Instead we're choosing to cut our losses and close the play early. We could re-enter later if PTR turns higher again or consider put plays if PTR trades under $106 or $105.

Picked on July 20 at $111.55
Change since picked: - 2.69
Earnings Date 08/16/06 (unconfirmed)
Average Daily Volume = 708 thousand

---

Reynolds American - RAI - close: 123.71 chg: +3.39 stop: 117.45

Target achieved. Investors may have ignored RAI during yesterday's big rally but they came back in a hurry today. The stock rallied to $124.60 this afternoon. Our target was the $124.50-125.00 range. Don't forget that RAI is due to report earnings on July 26th and due to split 2-for-1 on August 14th.

Picked on July 17 at $120.20
Change since picked: + 3.51
Earnings Date 07/26/06 (confirmed)
Average Daily Volume = 636 thousand
 

Dropped Puts

Caterpillar - CAT - close: 69.08 chg: -2.04 stop: 72.31

CAT's 2.8% decline on Thursday more than erased its gains from the big rally yesterday. The move today was fueled by above average volume and the stock looks poised to move lower. We're exiting per our plan to avoid holding over the company's earnings report, which is due out tomorrow. Wall Street's estimates are for $1.42 a share.

Picked on July 12 at $ 71.31
Change since picked: - 2.23
Earnings Date 07/21/06 (confirmed)
Average Daily Volume = 5.1 million
 

Dropped Strangles

None
 

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