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InvestmentHouse Weekend Update:

http://www.investmenthouse.com/1weekendmarketsummary.htm

- Market unable to push Thursday rebound into the weekend.
- Bernanke orders study to improve ‘dialogue’ with markets. Shutting up would help.
- Companies buying back stock as investors take money from domestic and foreign markets: bullish signal?
- Stocks try to set up another rebound, but face growing obstacles in Fed and options scandal in addition to the same problems dogging the market this year and last.

Summer Friday doldrums stalls early bounce, takes stocks lower on the close.

Futures held their upside bias through the morning trade gap report that saw the gap narrow but import prices rise (as oil rose during the month). Those prices were cited as another sign of inflation, but frankly, prices have failed to show an advance that comes remotely close to matching the hype. Instead investors appeared to favor the positive TXN comments regarding the future, pushing chips and stocks generally higher pre-market. Indeed, the chip sector received an upgrade across the board based upon purportedly the lowest inventory level since 2004.

That got stocks higher out of the gate, continuing the Thursday rebound from that big dip lower during the morning. That got SP500 back up to the 200 day SMA just after the first hour, but that was the extent of it. The market faded through lunch, tried an early afternoon bounce, then tailed off in the last hour to close with losses that were very even across the board (roughly -0.5%). That completed another ugly shellacking for the market with SP500 down 35 points for the week, NASDAQ off 85 points, and DJ30 down 355 points.

Once more the market could not hold an early gain, starting high only to close low, something it managed three out of the five sessions for the week. The other two sessions saw reversals and that helped keep SP500 and NASDAQ roughly in their ranges of the past three weeks after that initial May meltdown. Indeed, the big reversal Thursday indicates that the indices want to try another rebound as they did 2.5 weeks back when they reversed sharply intraday as well. Overall, however, the range shifted slightly lower; Thursday saw a deeper intraday low, but the indices also experienced lower closing prices as well. Even as it tries to set up another rebound, it is losing ground, closing below key support levels breached earlier in the week (the up trendline for NASDAQ, the 200 day SMA for SP500). SP600 remained a ‘bright’ spot, undercutting its 200 day SMA Thursday, but recovering and then holding that level Friday. Wow.

The market was weighed down all week, and again on Friday, by the omnipresent Fed and its recent Al Gore-like makeover to something similar to band of Teddy Roosevelt’s roughriders. There was plenty more Fed-speak during the week, and it was all the ‘tough guy’ type, tough enough to continue pushing the yield curve to flat and then inverted. The week closed out with the 2 year yield at 5% versus the 10 year yield at 4.98% (the 30 year bond moved to 5.02% on the close), and as noted Thursday, this is not driven by foreign treasury buyers but a fear the Fed is going to repeat 2000 and hike too far.

That leaves the market trying to rebound after another big reversal, this time on Thursday. Whether it can make that move is a question for next week with the CPI on Wednesday garnering a lot of the attention. With the Fed talking tough and the market disapproving of same, even a tame CPI won’t change the course. The June FOMC announcement is way out on June 29, and frankly, the Fed appears to be in its same old mode of raising rates until it sees slowing, and by that time it almost always too late to avoid economic trouble. That is why the bond market is inverting right now.

THE ECONOMY

Bernanke appoints Kohn to study how to improve transparency.

Sure wish I could get the contract to conduct this study. I could do it in half of a day then charge for 6 months of intense research, forecasting, etc. First, set the official channels of communications. Clearly establish how Fed policy will be disseminated and then stick to it. Stop all of the sound bite opportunities the Fed heads have come to thrive upon over the past 10 years. Used to be you didn’t see the FOMC members out on the lecture circuit offering daily quips about the economy. Now there are 5 speeches a week at various gatherings. Speeches are no problem; it is when they start talking about Fed policy that the trouble starts. Too many loose canons rolling around on the Federal Reserve’s decks. The markets have to know what the official channels are and that there won’t be any leaks to other sources. Thus no competition among the news services to scoop the others a la the CNBC Steve Liesman interview with Moskow or the now infamous Maria Bartiromo debacle with Bernanke that, finally, has been roundly criticized by the likes of former Fed governor Lyle Gramley and others.

Second, don’t be some damn cryptic with what the Fed’s plans are. The Fed plays this cloak and dagger game about what it is thinking, where it views rates should be at the present, etc. It tries to hide the ball, just showing you what it thinks you should know. We have always advocated that the Fed has a very good idea when it starts raising rates what it thinks the Fed funds rate should be given the economic conditions. The Fed should tell the markets this is what we think it should be and this is where we are going unless there is significant change and of course we will tell you when we think there is such change. That would allow the market to adjust and businesses to plan for the future. The Chinese water torture game of indefinite hikes keeps business planning on hold to a certain extent. Whether the Fed would raise rates all at once to that level or just heads that way in a ‘measured’ manner is open for debate. If it says that is where it is going, the bond market is likely going to start pricing it in, so likely the faster it acts the better. This is not targeting; targeting deals with setting a so-called inflation rate that is acceptable. This is setting the policy for the Fed Funds rate up front based on what is known, and THEN adjusting as necessary. Sure would make the statement a lot easier to write and understand.

Third, don’t stay on the Fed so long as did Alan Greenspan. Eighteen years is much too long. It seems FOMC members don’t gain a lot more wisdom with time, they just get more set in their ways. Fresh ideas are always good for a body, particularly one that wields so much power over our lives but that acts in relative secrecy even with its increased openness the past several years. The Fed is basically autonomous, only meeting with Congress twice a year to dodge questions about policy. Such a powerful force with basically no accountability. There is something inherently wrong with that in our society, particularly when our central bank starts working with other central banks to bring about policies that might help the world order but are not necessarily beneficial to us here in the US. As of now there is no checks or balances on the Fed’s activities with the rest of the world.

That last part got a bit far off the discussion but we have studied the history of the Fed and the US central bank, and its autonomy has not helped it avoid the same mistakes again and again. In 1929 the Fed was convinced the roaring twenties and strong stock market would inevitably lead to inflation. The country was prosperous, consumers were flush, businesses were expanding rapidly in the industrial revolution; inflation had to result. The Fed took on the stock market with a series of rate hikes. The market continued to advance and the Fed increased the intensity until it finally hit the market with a full 100BP rate hike. That finally stopped the advance and played a major role in ushering the Great Depression into the US.

On several other occasions it managed to save us from prosperity and send us into recession, the most recent being Greenspan’s 2000 disaster that some still think was a good result. No inflation in sight, but rates raised and the money supply drained to a point where the financial markets seized up, the economy fell from 10% growth to negative growth in just three quarters, investment capital and business investment went dormant, and we consequently lost millions of jobs and trillions in retirement accounts. Great record there. Perhaps, just perhaps, real, concrete openness would help all of us to raise more hell when the Fed got out of line.

Companies buying back stock as investors flee.

Last week it was reported that since early May, 162 companies had announced the buyback of $70B worth of stock. At the same time, individual investors have moved hundreds of billions of dollars out of mutual funds. Given that the crowd is often heading in the wrong direction at the wrong time, some view this as a market positive. From June 2002 to February 2003, individuals withdrew $120B from mutual funds as companies bought a net $30B of their shares. The market bottomed in October 2002. That is cited as another positive for the market.

This obviously can be part of the formation of a bottom if the right circumstances are present. In 2002 we were writing about how the economy was showing signs of recovering, and after the sharp ugly decline that sent stock prices to historic lows for many techs, the improvements in economic signals likely did foster some buying at these very low prices.

Typically, however, companies are wrong about economic forecasts. CEO’s are too negative at bottoms and too positive at tops. Current business strength does not equal future orders. Given that the economic expansion has run for over 3.5 years and stock prices are just coming off post 2002 highs, it is less likely this buying shows any particular insight into the companies’ fortunes ahead. Housing CEO’s were exuberant well into 2005 even as the housing market was starting its top. This year they were slapped with harsh reality and had to continually lower forecasts.

Perhaps the companies see Q2 orders as strong and want to buy during this sell off in anticipation of those earnings in order to enjoy a rebound ahead of and maybe through the numbers. Not a bad plan if that is the case. If, however, the bond market is forecasting as it historically has, then there is economic slowing further down the road and that would make long term buys by companies at this stage of the economic run not such a great investment.

THE MARKET

MARKET SENTIMENT

This past week saw continued climbs in the sentiment indicators with the VIX spiking to 22.59 on the Thursday high with VXN hitting 27.29, almost matching the August 2004 highs. The CBOE put/call ratio scored several closes above 1.0. The overall put/call ratio added three 1+ closes itself. Not to be left out, the bulls/bears reading was positive with bulls falling below the 2005 levels that sparked rallies and bears climbing close to the 33% in March.

Volatility can be a double edged sword after solid market rallies. Rising volatility after a run higher can indicate a peak. Back in 2000 volatility started to run higher as the market made its final run. The VXN rallied from the low 40’s in November 1999 to 60 just before the market started to heave. In other words, volatility rose before stocks started to sell. On this recent run volatility basically stayed in its range until the selling started. At that point it started running higher. Thus it does not have the same characteristics of the volatility rises that accompany tops.

VIX: 18.12; -0.23
VXN: 23.22; -1.39
VXO: 17.48; +0.04

Put/Call Ratio (CBOE): 1.02; -0.34. Fifteenth close above 1.0 in seventeen sessions. The overall put/call ratio closed above 1.0 three times last week as well.

Bulls versus Bears:

Bulls: 40.2%, continuing the slide from 53.2% at the April peak. This is down from 42.6% the prior week, 43.8% the week before, and 46.3% hit before that. It has surpassed the 42.3% hit on the last low. The current level puts it below the May and October 2005 readings that saw new upside runs.

Bears: 31.5%. Still climbing, up from 29.8% the prior week (27.6%, 25.3% before). Still just below the March high at 33% but above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005). The 20% level and below is considered bearish. It started this move just above 20%, the threshold level.

NASDAQ

Stats: -10.26 points (-0.48%) to close at 2135.06
Volume: 1.81B (-40.41%). Volume fell off well below average after the huge Thursday spike on the rebound. Plenty of low volume selling last week but it did not stop the slide. May help in its attempts to hit a bottom as no blowout downside trade, but it has to show it.

Up Volume: 643M (-107M)
Down Volume: 1.155B (+1.155B)

A/D and Hi/Lo: Decliners led 1.44 to 1. NASDAQ was not able to turn close to positive breadth though NASDAQ was close to positive until the late drop.
Previous Session: Decliners led 1.53 to 1

New Highs: 62 (+7)
New Lows: 71 (-123)

The Chart: (Click to view the chart)

NASDAQ was positive early in the day but then slid lower through lunch. Managed a rebound up to the last hour before once more fading and dumping hard late to close negative. Lots getting out of the way ahead of the weekend. Volume was summer Friday low, and thus the index continued its trend for the week, i.e. lower. NASDAQ fell below its August 2004 up trendline, hitting a new closing low for this selling. It still has an outside chance to pull off a double bottom, but the character will have to change. The Thursday rebound suggested that is possible, but it will have to show it this coming week.

SOX (-0.58%) received an early boost from TXN and NSM but it only managed to wave at its 10 day EMA (457.91) before turning over and closing near the session low. Looks to be continuing its downtrend even before it made it back to the 18 day EMA. Pretty much sums up the market of late: could not make any use of good news.

SP500/NYSE

Stats: -5.63 points (-0.45%) to close at 1252.3
NYSE Volume: 1.595B (-37.3%). Volume fell below average as well, but it is still relative stronger than NASDAQ, i.e. it is closer to average.

A/D and Hi/Lo: Decliners led 1.15 to 1
Previous Session: Decliners led 1.3 to 1

New Highs: 32 (+5)
New Lows: 62 (-140)

The Chart: (Click to view the chart)

SP500 tried to recapture the 200 day SMA (1260.55) but after that morning flurry spent the rest of the day lower other than the afternoon rebound attempt that failed late. The losses looked worse than they were as most of the lost was hung back on the wall in the last 10 minutes. Volume was low but SP500 closed at a new low for this leg lower. As with NASDAQ, still has those double bottom possibilities after that big reach lower Thursday and rebound though they are dwindling.

SP600 (-0.49%) tried the 10 day EMA (372.72) on the high but then faded as well, managing to hold above the 200 day SMA (365.48) where it bottomed intraday two weeks back. Lick log time for the small caps.

DJ30

The Dow sold back but managed to hold the 200 day SMA (10.875) on the close. This comes after falling through the neckline of its 10 week head and shoulders base. This is where it should bounce to test that breakdown from 11,100.

Stats: -46.9 points (-0.43%) to close at 10891.92
Volume: 279M shares Friday versus 442M shares Thursday. Big volume on the reversal Thursday and lower on the Friday selling. Not bad to end the week but has to show the rebound.

The Chart: (Click to view the chart)

MONDAY

Now we see if the market can make something of the Thursday reversal as it tried to do out of the reversal three weeks back. That one bounced but failed to deliver serious upside. If Friday was any indication this attempt may not be better; it may be worse. Friday, however, many just wanted to get out of week alive to fight again.

The PPI is out Tuesday and the CPI Wednesday. Those are the main agenda items of the week as the market continues its day to day inflation worry. That worry has translated into the 210 point decline on NASDAQ (8%), the 74 point decline on SP500 (5.6%), and the 39 point SP600 fall (10%). It also turned a 10 year yield at 5.19% to a 4.98% return, now inverted below the 2 year at 5%.

Thus far the inflation worry has trumped rising sentiment indicators on this drop, sentiment indicators that sent other sell offs back up in the continuing rally. As of Friday the indices still have a chance of making that rebound, though anemic and scattered leadership has left the market without a guide. Many of the strong growth stocks are down more than the market, typical when the growth train slows. Healthcare and biotechs tried to stake out a bit of the leadership role the past week but they still need more work. Unless some leadership emerges even if the market does once more rebound as it did three weeks back following that reversal, the result will likely be the same.

In sum, the market still has an outside chance at using the jumping sentiment indicators and the big Thursday reversal on huge volume to its upside advantage. Overall the picture has turned bleaker with the market seriously pricing in a Fed overshoot and the bond market echoing those sentiments with its yield curve inversion. On top of these issues you have the continued problem with oil, and Greenspan himself acknowledged this week that energy prices (now up 47.5% over last year at this time) are starting to impact the economy at this level. That is what we have been saying: when oil hit $75/bbl and gasoline $3/gallon, the economy slowed as demand stalled.

Add to that the rising options backdating scandal. This is flying somewhat under the radar because the ramifications are not as far reaching as the accounting scandals, but the fact is that even after Sarbanes-Oxley there are still ways executives can find to side-step the law to line their nests. Investor confidence is getting rattled by the selling (hence the mutual find withdrawals), and this is another issue piled on top.

Given the Friday failure to deliver any follow through, the lack of leadership, the prior reversal failure, the yield curve inversion, etc., the market is walking a thin line. We would like a rebound to better set up the downside, but given the Friday action and the inability to deliver anything in addition to the Thursday rebound despite some decent TXN news, we will be ready with plays for either direction this week. If the market makes another modest, low volume bounce as it did three weeks back we will use it to close the upside and then line up some downside positions. If it shows more we can go long to the upside. Again, given the Friday slog we also want to be ready with some downside from here; most expect a bounce, and that has a way of making the opposite occur.

Support and Resistance

NASDAQ: Closed at 2135.06
Resistance:
2148 is the August 2004/April 2005 up trendline.
2162 to 2155 from December 2005 and September 2006
2169 is the 10 day EMA.
2185 to 2182 is the September 2005 peak and interim high from November 2005.
The 18 day EMA at 2190
2205 is the December 2005 closing low
2218 is the August 2005 peak before the sell off through October 2005.
The 200 day SMA at 2230
2240 is closing low in February range.
The 50 day EMA at 2242

Support:
2100 from the early and mid-2005 peaks held on the Thursday low.
2045-47 from June and October 2005 lows.

S&P 500: Closed at 1252.30
Resistance:
The 200 day EMA at 1260.55
1272 to 1268 is the November and December 2005 closing highs and March 2006 closing low
1280 from the April lows
The 18 day EMA at 1271
The 50 day EMA at 1283
The late January peak at 1285
1297.57 is the recent February high.
1315 is the May and May 2001 peaks
1317, the recent intraday highs from April.
1324 to 1329 from the October 2000 lows.

Support:
1250 to 1248 from the November and December 2005 lows.
1245 from the August 2005 high & May intraday low; 1241 from the September 2005 high
1239 is an old trendline from the August 2003/August 2004/October 2005 lows.
1225 from the March 2005 high

Dow: Closed at 10,938.82
Resistance:
10,931 is the November 2005 high
10,965 from Q4 2000 and November/December 2005
10,985 is the March 2005 intraday high
11,044 is the January high.
The 10 day EMA at 11,047
11,097 to 11,137 is the last peak from the February top.
11,123 is the 18 day EMA
11,159 is the February high.
The 50 day EMA at 11,192
The March 2005 highs at 11,329 to 11,335
11,350 from the May 2001 peak
11,401 from the September 2000 peak and April 2001 highs
11,417 from the recent April highs.
11,425 from April 2000 peak
11,452 from December 1999 peak

Support:
10,890 is the December 2005 closing high.
The 200 day SMA at 10,875
10,740 – 10,750 is some support December 2005 and February 2006 lows
10,705 – 10.965 from July/August 2005

Economic Calendar

These are consensus expectations. Our expectations will vary and are discussed in the ‘Economy’ section.

June 12
- Treasury budget, May (2:00): -$36.6B expected, -$35.4B prior

June 13
- PPI, May (8:30): 0.5% expected, 0.9% prior
- Core PPI, May (8:30): 0.2% expected, 0.1% prior
- Retail sales, May (8:30): 0.1% expected, 0.5% prior
- Retail ex-auto, May (8:30): 0.5% expected, 0.7% prior
- Business inventories, April (8:30): 0.5% expected, 0.7% prior

June 14
- CPI, May (8:30): 0.4% actual, 0.6% prior
- Core CPI, May (8:30): 0.2% expected, 0.3% prior
- Crude oil inventories (10:30): 1.146M prior
- Fed Beige Book (2:00)

June 15
- Initial jobless claims (8:30): 302K prior
- NY Empire State Index (8:30): 11.4 expected, 12.4 prior
- Net foreign purchases (9:00): $69.8B prior
- Capacity utilization (9:15): 82.0% expected, 81.9% prior
- Industrial production (9:15): 0.2% expected, 0.8% prior
- Philly Fed (12:00): 11.0 expected, 14.4 prior

June 16
- Current account, Q1 (8:30): $223.4B expected, -224B prior
- Michigan sentiment, prelim, June (9:45): 79.0 expected, 79.1 prior.