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Daily Newsletter, Thursday, 09/07/2006

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Table of Contents

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

Market Wrap

The End of the Beach Party

It was a relatively quiet day for economic reports but even before the reports came out the equity futures were down pretty hard and the reports did not have much of an impact on prices. The weekly unemployment numbers were released and showed new claims dropped by 9K to 310K and the 4-week average dropped by 3K to 315,250. But continuing claims increased by 15K to 2.49M and the 4-week average rose to its highest level since February--also up to 2.49M. It's a mixed bag of information but it appears that the job market is slowing down in its hiring, which of course is another sign of a slowing economy.

The amount of press that the housing market is now getting is reaching a fevered pitch. Business Week had something on their front cover. Just about every major economic and business publication is now talking about the elephant in the living room. They got tired of looking over and around it and are now addressing the problem of how to move this elephant. An oft-mentioned piece of information related to the housing industry is the number of jobs that have been created by this industry, from building homes to equipping them to buying and selling them. It is estimated that 1 out of every 3 jobs in the past several years were created to support the housing market. With the collapse of this market we can only imagine what the future employment numbers will look like.

Wholesale inventories numbers were released which rose 0.8%, the same as June. Sales at the wholesale level rose 0.4%, the lowest level since February. Helping the overall number was a gain in durable goods inventories. While these numbers help economists tweak their numbers for the GDP estimates, it's relatively old data and doesn't tend to influence the market.

Crude inventories were released today at 10:30 AM, a day later than usual due to the Monday holiday. Crude supplies fell by 2.2M barrels vs. being up by nearly 2.5M barrels the previous week. But gasoline inventories rose unexpectedly for the 3rd week in a row. Hmm, maybe people are doing more car-pooling and bicycle riding after all and demand has dropped. I can tell you that from my vantage point up on the St. Lawrence River this summer where I can watch the recreational boat traffic that people have not been using their boats nearly as much as prior years. I can see it in the marinas and when I talk with boat shop and gas supply businesses I get reports that business is half of last year's.

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There was a sharp increase in distillate supplies. Natural gas supplies also increased as expected. Rakesh Shankar, an economist at Moody's Economy.com, said "The surprise build in gasoline, and the sharp increase in distillate inventories in particular offer compelling evidence that our energy markets remain well supplied for now. The significant drop in gasoline prices over the past month--down more than 56 cents from above 2.20 per gallon wholesale--speaks volumes for the drop in demand. Gasoline price, at 1.64 for the October contract, is at a level not seen since February and it too has broken well below its 200-dma. Crude prices are down over 4% (-in the past 4 days) and also now below its 200-dma. That's a big move for oil.

Natural gas closed at its lowest level ($5.71 for the October contract) in almost 2 years. I don't see any bullish divergences on the daily chart that tells me we've seen the lows yet. At least it's helping cash-strapped homeowners who are getting slapped with higher mortgage and home equity payments as their cheap loans ratchet up to higher interest rates.

As I mentioned earlier, the equity futures market was already down this morning and these reports did not cause much of a reaction. The Boyz came back from their beach homes while letting their underlings keep bidding the market higher so that they could sell at higher prices. I've read several rumors about fear of the 5-year anniversary of 9/11 (this coming Monday) and what the crazy virgin-hungry idiots out there might do. That is of course untradeable but it does add an element of fear and as we all know fearful traders are sellers not buyers. Once we get through that day without any blow-ups we could then see a relief rally.

This week we had a full moon (today actually) and next week we have opex. There are always any number of things that could affect the market. The only thing I know how to do is read the charts. While they often give me false information I can at least see when I have to zig when I should have zagged. Reacting to forces outside the market is not something I'm capable of doing. Most should already be priced into the chart patterns. Even when we see a big reaction (positive or negative) to a surprise we can often see the chart pattern was set up for it. So let's see what we've got cooking in the charts this week.

DOW chart, Daily

It looks like the DOW gave us a brief throw-over above its ascending wedge pattern and then a collapse back inside. Sell signal #1. A break of the uptrend line from July (the bottom of the wedge) is sell signal #2. A bounce back up to the broken uptrend line (about 11450 on Monday) and failure there (kiss goodbye) would be sell signal #3. I'm waiting for that retest early next week to add to my short position. If I then get stopped out with a move to a new high I'll just chalk it up to yet another head fake to the downside. But you gotta test these patterns (practically my favorite since they're high-odds winners). The other bearish pattern we have is an evening star bearish candlestick pattern. A big green candle followed by a doji (or small-bodied candle) followed by a big red candle makes up the reversal pattern. These are pretty reliable signals and where it has occurred makes it even more reliable.

SPX chart, Daily

Resistance for SPX was at the downtrend line from March 2000 and the top of its ascending wedge. The break below the bottom of the wedge is bearish so now watch for a retest of the broken uptrend line (1306-1307) to act as resistance and a place to get short.

Nasdaq chart, Daily

The techs had been looking so strong there for a while but then suddenly lost steam. The COMP reached its 50% retracement of the April-July decline but could not press it higher to a 62% retracement or a test of its 200-dma. While it's still possible for the techs to turn around and head higher still that's not the way I'd play this pattern. I think the broader market has turned and the techs might lead the way down.

Speaking of the broader market, a look at the NYSE shows it too reached a nice level for shorting.

NYSE chart, Daily

This index is harder to manipulate and often gives us better signals. The bounce from July took it right up to the top of a parallel up-channel created off the June low. These "measured moves" are very common in most markets and provide great trade setups. Today's drop took it below the last low on Aug 24th and that changes the trend (it also has an impulsive wave count down). This should mean we've started the next leg down which will drop below the June low.

SMH index, Daily chart

The semis are one of the few sectors that gives me the impression there could be more upside. But the pattern of its rally off the July low is subject to interpretation and therefore I wouldn't want to base my impression of the broader market on this sector. However, the pullback will be important to help determine whether or not to expect higher prices--a sloppy corrective pullback will be bull flaggish whereas a sharp decline will look more impulsive and indicate lower prices. That downtrend line and 200-dma up near 35.50 look like powerful magnets...
Could get a H&S off 50-dma

BIX banking index, Daily chart

Based on the corrective bounce pattern off the June low I'm expecting the banks to continue lower and it looks like the high in August will stand. While the 50-dma (closed slightly below it today), the uptrend line and the 200-dma, all in the 370's, will likely provide some support I expect them all to break.

Securities broker index, Daily chart

Regardless of whether or not we get a larger sideways consolidation, the brokers look bearish. In fact I would say the most bullish possibility I see for this index is a sideways move for another couple of months before heading lower. The more bearish possibility is that it's getting ready to let go big time to the downside in a move that should quickly take out the June/July lows.

I mentioned earlier that the housing market is making the news and today Beazer hit the airways. They again cut its earnings forecast for 2006, blaming higher cancellation rates and weakening sales. BZH said net home sales for the two months ended Aug. 31st fell 49% from the year earlier as the cancellation rate rose to 50% from 26%. They said "As compared to prior years, a higher percentage of home closings are being deferred or cancelled, immediately prior to closing in many cases, due to worsening buyer sentiment and the inability of buyers to sell their existing homes." So the negative drumbeat continues.

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

The EW pattern for this index calls for a stair-stepping lower over the next several months before it's ready for a bigger bounce. The little sideways consolidation could be complete and ready for another leg down. I show a H&S price objective near 500 and that has some Fib support there as well. That will be a 50% haircut from the January high and 55% from July 2005. It's possible this index will see about 425 before any major upside correction. That would be close to a 2/3 drop in value from July 2005. There will be many housing markets that will experience similar declines. I know that's hard to believe but if history (long before we've been around) is any guide, it will happen.

Oil chart, October contract, Daily

I was surprised to see oil didn't get much of a bounce off its 200-dma. That says things are more bearish than I suspected with oil. I've changed the EW count to an impulsive count to the downside rather than a corrective a-b-c which I had last week. This count, if correct, calls for a sideways consolidation soon and then a continuation lower. If we get that pattern then it will be proof positive that we've seen the high for oil for a very long time. That would tell us the economy is heading into a deep recession and there will be a lack of demand for oil products. For now we'll have to see if any bounce finds resistance at the 200-dma.

Oil Index chart, Daily

As expected we're starting to get the acceleration lower in the oil index. Like oil I'm expecting to see some consolidation before continuing lower. That might mean we'll see either the uptrend line (approaching 600) or the 200-dma (582) act as support for a bigger bounce. If this forms an impulsive 5-wave count, as I think it will, then we'll have the signal that the trend has turned down. Until we get that there is still the possibility that this pullback will lead to more new highs. I don't think that will happen but I'll let price tell me if I'm right or wrong. For now I'm waiting for lower support to kick in.

Transportation Index chart, TRAN, Daily

The longer the Trannies continue sideways the more bearish it becomes. It's consolidating above its uptrend line and a break below the August low would be confirmation of a longer term trend change. I've been half expecting a bounce up to the 50 and 200-dma's, which are about to bearishly cross at 4468, but that's looking less and less likely now.

U.S. Dollar chart, Daily

It looks like the US dollar is going to try again to test its downtrend line but its 50-dma may stop it here. The sideways consolidation since the August low should lead to a continuation lower.

Gold chart, December contract, Daily

We should be getting close to a resolution for gold. I show a bearish resolution to this pattern but I'm starting to get the impression that the corrective pullback from the July high is bullish. In that case the uptrend line and 200-dma, near 606-610, should provide support and the next leg up should break the downtrend line that held back the last bounce (on Tuesday). Play the break is my best recommendation on this one.

Results of today's economic reports and tomorrow's reports include the following:

There are no significant economic reports tomorrow morning and only a consumer credit report tomorrow afternoon. After this week's decline we'll probably get some consolidation tomorrow and the pattern for the decline looks like it needs a little more downside work. This fits with the notion that many are afraid of the 9/11 anniversary coming up. Assuming the market works its way a little lower, the pattern will then be set up for a correction of this week's decline. That too will fit the "relief rally" that will likely happen after Monday passes uneventfully. That bounce, which could even take up the majority of next week (opex week), to a lower high should then set up an outstanding shorting opportunity since the next leg down after this one should be a screamer.

Today's internals supported the decline and nothing jumps out at me as out of whack with the selling. Volume was on the light side but that's actually good for the bears. The bears want a sneak attack on the bulls. Whenever they get overzealous and start charging into the fields the bulls end of surrounding and slaughtering them. The bears need to sneak out quietly and surround the bulls instead and then spring the trap. So today's decline was actually more bearish than had we seen a high-volume sell off. A bounce into next week, which could be a strong one, will convince many that they were brilliant to buy the dip. But in my mind nothing could be further from the truth. You'll want to take advantage of that bounce and get yourself short.

That takes us to the weekly chart of SPX which I'm using to track the progress of the EW scenario that I believe is playing out. The 3-wave bounce from the June low looks to have completed at the high on Tuesday. The reversal candlestick pattern for the DOW this week is a strongly bearish signal. So, assuming wave-b on the following chart ended this week we're now due wave-c down and it will be a stronger move down than the May-June decline. Just in time for the annual Sept/Oct stock market bash. Notice I didn't say crash, but now that I mention it...

SPX chart, Weekly, More Immediately Bearish

Remember the housing vs. S&P 500 chart I showed last week--an 80% correlation is nothing to discount lightly. We're perched on the edge of the cliff from an EW standpoint and that housing market chart only further supports the idea that the stock market is in trouble. While the decline above doesn't look all that dramatic, this is a weekly chart and the decline back down to the October 2002 low (1168) would be an 11% correction. You can make some serious money on the short side with that kind of move. But the real money maker won't happen until early 2007 when the next big leg down hits us. So we'll continue to take this market a leg at a time and play it in both directions. The direction to play now is on the short side so look for a bounce next week to position yourself for a nice ride on the southbound train. But remember to buy yourself a ticket (a couple of December put options) so that you don't get kicked off.

Good luck and trade carefully next week because of opex. Expect the unexpected and lots of stop runs. I'll see you next Thursday or on the Market Monitor tomorrow.
 

New Plays

Most Recent Plays

New Plays
Long Plays
Short Plays
None None

Play Editor's note: We strongly considered adding some new short plays to the newsletter tonight. However, the current pull back may be nothing more than just that - a pull back in the market's current up trend. What makes us cautious is that September is normally one of the worst months for stocks. Yet, the S&P 500 is still above Jim's 1290 go short or flat level. A couple of stocks we were considering as short candidates are TDW and NX.


New Long Plays

None today.
 

New Short Plays

None today.
 

Play Updates

Updates On Latest Picks

Long Play Updates

Brookfield Asset Mgt. - BAM - cls: 44.57 chg: -0.67 stop: 42.95

We told readers to expect a dip toward $44 and BAM came close to delivering. Shares slipped to an intraday low of $44.33. We're not suggesting new plays at this time. Our target is the $49.00-50.00 range.

Picked on August 22 at $44.82
Change since picked: - 0.25
Earnings Date 08/03/06 (confirmed)
Average Daily Volume: 393 thousand

---

eBay Inc. - EBAY - close: 27.53 chg: -0.68 stop: 25.95

Internet stocks took another beating on Thursday. The INX Internet index was one of the worst performing sectors. Shares of EBAY under performed its peers with a 2.4% loss. The technical picture is decaying so we're not suggesting new bullish positions at this time. Right now we're expecting a dip to $27.00 and possibly the $26.50 level. If you don't want to weather that kind of pull back consider exiting early. Our target is the $29.25-29.50 range.

Picked on August 24 at $26.25
Change since picked: + 1.28
Earnings Date 10/18/06 (unconfirmed)
Average Daily Volume: 19.6 million

---

Elk Corp. - ELK - close: 27.84 change: -0.03 stop: 25.80

ELK produced a relatively volatile session. We could not find any specific reason but shares gapped lower at the opening bell. Then ELK rallied back into the green before fading again. Overall the session has a bearish feel to it. More conservative traders may want to tighten their stop loss! We're not suggesting new plays.

Picked on August 22 at $27.10
Change since picked: + 0.74
Earnings Date 08/17/06 (confirmed)
Average Daily Volume: 245 thousand

---

Mittal Steel - MT - close: 33.50 chg: -0.41 stop: 32.49

There is no change from our previous updates on MT. We are still sitting out on the sidelines waiting for a breakout over resistance near $35.00. Our suggested trigger to go long the stock is at $35.26. If triggered our target is the $39.50-40.00 range. We do not want to hold over the early November earnings report. FYI: The Point & Figure chart is bullish with a $47 target.

Picked on September xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/01/06 (unconfirmed)
Average Daily Volume: 3.2 million

---

Maxim Integrated - MXIM - close: 29.20 chg: -0.16 stop: 27.95

There is no change from our previous updates on MXIM. The stock tried to rally but failed at the $30.00 level again. Our suggested trigger to go long the stock is at $30.15. Our target is the $33.00-34.00 range.

Picked on August xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/03/06 (unconfirmed)
Average Daily Volume: 6.0 million

---

Knight Cap. Grp - NITE - cls: 17.05 chg: -0.52 stop: 15.95

Shares of NITE continue to see strong profit taking. The stock lost almost 3% and broke down under its 10-dma. We are not suggesting new positions at this time. The only reason we're not suggesting an early exit is that NITE still has a two-month trendline of support near $16.00. Our target is the $19.85-20.00 range. Currently the P&F chart points to a $25 target.

Picked on August 22 at $17.36
Change since picked: - 0.31
Earnings Date 07/18/06 (confirmed)
Average Daily Volume: 1.5 million

---

Steel Dynamics - STLD - close: 53.83 change: -0.67 stop: 49.99

Bingo! We suggested that readers wait and watch for a bounce near $52.50 and STLD delivered. The dip and bounce was another entry point to go long the stock. More conservative traders may want to tighten their stops toward $52. Our target is the $59.00-60.00 range. We do not want to hold over the October earnings report.

Picked on September 03 at $54.48
Change since picked: - 0.65
Earnings Date 10/19/06 (unconfirmed)
Average Daily Volume: 1.5 million
 

Short Play Updates

Black Box - BBOX - close: 36.92 change: -0.52 stop: 40.06

BBOX continues to sink hitting new relative lows. Shares lost 1.38% today but volume came in relatively low. We're not suggesting new positions at this time. Our target is the $35.25-35.00 range.

Picked on August 27 at $38.25
Change since picked: - 1.33
Earnings Date 10/31/06 (unconfirmed)
Average Daily Volume: 243 thousand

---

BCE Inc. - BCE - close: 24.63 change: +0.05 stop: 25.26

The bulls and bears seem to be fighting for every inch in shares of BCE. The stock dipped to $24.32 before bouncing back into the green. Volume on the session was very strong. The move looks like a short-term bullish reversal. We would expect the bounce to continue and hit its 10-dma near $24.90 soon. Remember, we're trying to play the trading range in BCE. Our target is not the far edge of its trading range (22.25) but what looks like intermediate support at $23.25. We'll actually use a target range of $23.35-23.25.

Picked on September 03 at $24.73
Change since picked: - 0.10
Earnings Date 11/01/06 (unconfirmed)
Average Daily Volume: 225 thousand

---

Brookefield Homes- BHS - close: 23.35 chg: +0.65 stop: 24.05*new*

Believe it or not but the homebuilders managed to rally in spite of not one but two builders issuing an earnings warning today. Shares of BHS bounced back into its $23-24 trading range with a 2.8% gain. We are not suggesting new plays and we're adjusting the stop loss to $24.05. Please note that the latest (August) data puts short interest at 27.8% (up from 20% in July) of BHS' 26.2 million-share float. That is a high degree of short interest and increases the risk of a short-squeeze!

Picked on August 25 at $22.99
Change since picked: + 0.36
Earnings Date 07/20/06 (confirmed)
Average Daily Volume: 497 thousand

---

Hormel Foods - HRL - close: 36.04 chg: -0.11 stop: 37.05 *new*

HRL is slowing sinking lower. We noticed that volume is slowly sinking lower as well. We would prefer to see strong volume on the sell-off. Today's session was rather ho-hum and shares seem to be trying to find support at its rising 100-dma. We are lowering our stop loss to $37.05. Our target is the $35.00-34.50 range.

Picked on August 31 at $36.65
Change since picked: - 0.61
Earnings Date 11/23/06 (unconfirmed)
Average Daily Volume: 331 thousand

---

Portfol.Recov.Assoc. - PRAA - cls: 39.18 chg: -0.06 stop: 41.65

We do not see any changes from our previous updates on PRAA. The drop under $40 looks like a new entry point. More conservative traders might want to adjust their stop toward $41. Currently our target is the $36.00 level.

Picked on August 24 at $39.49
Change since picked: - 0.31
Earnings Date 08/02/06 (confirmed)
Average Daily Volume: 166 thousand
 

Closed Long Plays

Stereotaxis - STXS - cls: 10.55 change: +0.01 stop: 10.29

We have been stopped out of STXS at $10.29. Last night we raised our stop loss to $10.29 and this morning the stock spikes lower, right at the open, to $10.28 and then quickly recovers. What frustrates us the most is that STXS came pretty close to hitting our target on August 23rd's high at $11.71. Our target was $11.85.

Picked on August 21 at $10.31
Change since picked: + 0.24
Earnings Date 08/09/06 (confirmed)
Average Daily Volume: 272 thousand
 

Closed Short Plays

None
 

Today's Newsletter Notes: Market Wrap by Keene H. Little and all other plays and content by the Option Investor staff.

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