MASTERING
THE TRADE
ORIGINAL, INTERACTIVE SEMINAR ON TRADING USING
TECHNICAL ANALYSIS 

 SEC FILINGS

After waiting all week on pins and needles for today's PPI, market participants breathed a sigh of relief when both PPI and core PPI came in below expectations.  What energy added, food taketh away, with the net result a flat core rate and a headline figure up just 0.2%.

While today's PPI numbers were benign and indicate that the economy is still chugging along merrily unburdened by its arch nemesis inflation, the numbers are unlikely to decrease the odds of a Fed tightening. While a market stricken with a short term memory naturally gravitates towards what is happening today, it is what could happen tomorrow that the Fed must concern itself with if it plans to give more than lip service to the word: pre-emptive.

The ingredients for trouble continue to work their mischief in the background: the consumer with a voracious appetite to live beyond his means, a pickup in wage growth, and an economy that is likely to reaccelerate in the coming months.

Overshadowed by today's headline numbers were a couple of figures that point to a pickup in pricing power in the coming months and a pickup in economic growth: intermediate goods prices rose at a higher than expected rate of 0.6%, and the inventory to sales ratio came in at 1.34--its lowest ever, and a figure which reaffirms our oft-stated belief that a necessary inventory rebuilding will boost GDP in the coming months.

Worrywarts that we are, we view the latest economic figures out of Germany and Japan (higher than expected retail sales, and an upward revision in GDP, respectively) as another potential road block for the U.S. market in its quest to stay inflation free.  The continued signs of building strength in the global economy spell trouble for the U.S. dollar and bond market in the months ahead as foreign money is increasingly repatriated as investors gravitate towards the markets where the risk/reward ratio is greatest: those at the beginning of their economic cycle.  Lest we forget the recent lessons of Asia: an economy with a depreciating currency and a ballooning trade deficit is an economy at risk.

Bullish analyst comments, Bargain hunters, a hostile bid for Reynolds Metals, and a benign Fed Beige Book added fuel to the rally throughout the day. Breadth picked up, with advancers outnumbering decliners by a 3 to 2 margin on the Big Board.  Equally encouraging was the ability of the S&P 500, DAX, and FTSE to hold support for a second straight day.

While the overall tone of the market improved yesterday, it is unlikely that the market will be able to sustain its rally.  Narrow leadership, rising commodity prices, and continued weakness in the transports and utilities continue to be problematic.

The leadership troika of the semiconductors, oils, and select biotechs is deeply overbought and vulnerable to a setback.  Beyond these 3 groups there is little to sustain an upward advance.  Internet stocks are enjoying their second dead cat bounce since their April peak, but the exuberance which propelled their euphoric rise is long since gone.  The small caps lagged behind the larger cap glamour issues yesterday, and are likely to continue to underperform the larger caps during rallies as investors continue to react to interest rate uncertainty with a flight to perceived quality.

Uncertainty remains the stumbling block to any sustainable rally by the major averages.  While yesterday's Beige book did not show any signs of a dramatic pickup in inflationary pressures, it did show continued labor market tightness in all regions.

While inflation has yet to show its face, the conditions continue to exist for it to emerge if action is not taken: the pace of wage growth is accelerating, productivity is declining, manufacturing has shown a pickup, and the consumer driven economy remains strong.

While today's Retail Sales ex-auto came in slightly below expectations at +0.3%, the report continued to paint a picture of a consumer whose drive to spend has been undiminished by higher interest rates.  We expect this strong demand, combined with a need to rebuild inventories, to lead to a strong pickup in third quarter GDP from its second quarter pace.

While the continued strength of the consumer fed economy is troubling, it is in the labor market where we see the greatest threat to the present low inflation environment.  Labor market tightness and the upward push to wages will continue to grow as the economy picks up speed this quarter.  Today's initial jobless claims came in below expectations at 284,000, with the four week average falling to its lowest level in a decade.

Despite the return of optimism to the street over the past two days little has changed.  The pressure remains on the Fed to be pre-emptive and to act to ease building economic imbalances. Uncertainty, the stock and bond markets greatest enemy, will continue to act as a roadblock to higher prices.  We will not see the market's jittery uncertainty ease until market participants are convinced the current Fed rate cycle is over and that the Fed has taken appropriate measures to ensure a soft landing. 

The Fed will likely need to take back last year's 3 rate hikes before the bond market is appeased and uncertainty eases.

Short term sentiment did a remarkable about face yesterday as the market bounced off its lows yesterday, with the Internet stocks leading the charge on the way up.  At the closing bell the mood change was apparent, with traders breathing a sigh of relief, their early day gloom replaced by visions of the next leg up.

The release of better than expected earnings by Cisco added to the new found optimism, an optimism that is likely to carry over into today's trading.  With the S&P futures pointing to a continuation of yesterday's last hour bounce, and NASDAQ futures suggesting that we will witness a strong recovery by the big cap techs and Internet stocks in today's trading, the question that many will be asking today is: did yesterday mark a bottom.

Our answer: NO.

While the S&P 500 did survive its intraday test of support, as we have said many times in the past: 'one day's action doth not confirmeth a change in trend, it merely leaves the individual who acts prematurely vulnerable to whipsaws'.  If the market is able to successfully hold support over the next few days however, then the stage would be set for a short term rally.

The market's ability to close above support yesterday was the day's lone technical bright spot.  Overall, the market's technical picture continued to grow bleaker yesterday, with declining issues swamping advancers by a 3 to 1 margin, the advance decline line continuing its freefall, and new lows swamping new highs.

A lack of leadership also continues to be a major roadblock to higher prices. The leaders of the run to 11,000 long ago ceded leadership, and the only contenders for the vacant position are the semiconductors and the oils.  We would keep a close eye on Intel and the rest of the chipmakers over the next few days.  The group is overbought and is showing signs of tiring after its recent bound upwards, and a retreat by the sector would leave the oil stocks and oil services stocks as the sole heirs to the leadership throne, a scenario which is unlikely to lead the market higher.

Technicals were not the only thing deteriorating yesterday.  The IPO market also continued to show signs that it has seen its better days, with another busted dot.com IPO making its debut and the after the bell pricing of Blockbuster below its expected range adding to the woes of the IPO market. 

Narrow breadth, and a fading IPO market are the least of the market's worries however. While auction host eBay was busy grabbing headlines yesterday with another well publicized outage and a subsequent rally sparked by upgrades from analysts with conflicts of interest, the market's main nemesis continued to work quietly in the background darkening the horizon and raising the specter of higher prices.

Sentiment in the bond market has reached a crescendo of negativity as the building blocks upon which the House of the Rising New Era were built are shaken, The New Paradigm once thought to be eternal, now seen as a fleeting house of mirrors.

With bond market sentiment now at the extreme bearish end of the spectrum, and quarterly refunding around the bend, the odds of a bond rally emerging from the darkness have increased, but any rally that emerges in the coming weeks will likely endure only a limited run, with 30-year yields unable to penetrate below the roadblock that exists at 5.86%-5.89%.

After a brief bounce, and a temporary lifting of spirits, the bond market is likely to resume its slide as traders realize that the consumer remains unrattled by the dreaded 6%, and spending remains strong.

While the mood in the bond market is dark enough to spark a rally, stock market sentiment has not yet ventured far enough into the depths, and so the slide is likely to continue, interspersed with the occasional bounce here and there.

The euphoria of last month has lifted, but deep seated fear has yet to set in, the need of many to be 100% invested in the perceived only game in town still remains, and the belief in the 30% Annual Return Fairy still lingers.

Unfortunately for stock and bond investors the bottom that is in place is in the C.R.B. Index, and that spells trouble with a capital I(nflationary).  A confirmed double bottom is now in place in the C.R.B. and the index appears ready to reverse its eons long slide.  We would keep a close eye on the index this week, a move over 200 will rattle an already skittish bond market and put downward pressure on interest sensitive stocks.

There are several other fronts that bear watching this week as the stock and bond markets vacillate between joy and fear in the leadup to Thursday's Retail Sales figures and Friday's PPI.

The Transports are now in a long term downtrend after their slide on Friday, and are currently sitting 2 points above important support at 3218.  On a break of the 3218 level the Transports are likely to slide another 6%-7% and test support around 3050.

Bellwether General Electric is another source of potential trouble for the stock market this week.  The stock is sitting just 4 points above its 200 day moving average.  If GE falls below its 200 day moving average it will pull the rest of the market down with it and things are likely to turn ugly in a hurry.

The key support levels to watch on the Dow and S&P this week remain 10450 and 1280.  See the above comments on GE for what to expect if the Dow fails to hold support.  We would also keep an eye on the U.S. Dollar Index, where 98.5 remains the key support level, and on the long bond.

The 30-year treasury has broken through support this morning, with yields rising to 6.21%.

With bond yields cutting through overhead resistance like a knife cuts through butter, the sectors to avoid this week remain the interest rate sensitive and those stocks with P/E ratios that are significantly above their long term growth rates, with the Internet stocks heading the list.

While we still expect the Internet stocks to experience their second dead cat bounce before their fall resumes, we would avoid playing the bounce.  It is likely to be short lived and end without warning, with the selling on the next leg down panic-driven as investors rush for the exits.

 The sector's recent haircut changed the fundamentals for many stocks in the sector: debt financing costs will rise as companies are unable to convert convertible issues into stock and instead must pay interest to bond and noteholders, companies that fueled their growth by making acquisitions with their skyrocketing shares will find the going tougher and their growth rates lower.  With valuations in the sector still at levels that elicit the word bubble, the downside risk remains great.