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InvestmentHouse Weekend Update:

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

- Jobs lighter than expected, but rising wages, earnings warnings jolt a market trying to consolidate for next move.
- Jobs low, wages rising, along with fears of a slower yet inflationary economy.
- ECRI: US inflation has peaked, but Fed needs help from other countries.
- Quiet earnings pre-announcement season gets a rude start, threatens to derail prior follow through rally.

Investors get part of what they want, but the other part is what hurt.

After fears of 368K or some other high number of non-farm jobs as indicated by the private payroll and help wanted firms, jobs were a rather anemic 121K, even less than the 160K anticipated. Taking out government jobs and you get just 90K.

That lower number initially jumped futures higher; after expecting 3 times expectations (that only makes sense with respect to the stock market) investors thought they had what they wanted, i.e. another indication of a slower economy that would get the Fed out of the game. Problem is, the Fed is just about out of the game already. The third consecutive sub-par jobs growth month along with the other economic indicators showed the economy really is slowing. Employment lags, and as we have noted, the economy has been showing those slowing signs since mid-2005. A slowing economy means slowing earnings, and that is not good for the market.

That was not the real issue on Friday, however. Wages rose faster than expected while the workweek hit a 3.5 year high. That took the bloom off the lower jobs as quickly as it came on. Then at 9:00ET, MMM lowered its guidance, citing slowing in its optic film segment, the stuff used for LCD panels and televisions. As MMM cuts across many industrial sectors, however, it was easier to read more into it. One was the high price of oil pushing component prices higher; MMM specifically noted that as well. That came on top of an AMD warning about slower sales due to a price war with INTC. The song says two out of three ain’t bad, but the two were on the bad side and not the good side.

Stocks started lower across the board though NASDAQ and DJ30 took the harder hits given AMD’s implications for techs in general and MMM’s heavy impact on the Dow. As we expected, however, support held and the indices started their rebound. They fought back all morning and into lunch with SP500 turning positive. We had looked for some more selling to lead to a short covering bounce and drive things higher if the jobs report was not as strong as the private firms predicted. Problem is, those other factors suggested to investors that the Fed may still raise rates to combat the wage growth while at the same time the warnings further solidify the idea the economy is slowing.

The prospect of more Fed hikes into a slowing economy ultimately overpowered the rebound attempt. Stocks turned over and sold off into the close, finishing just off session lows. Volume rose on both NASDAQ and NYSE, though the NYSE volume was still quite modest. NASDAQ trade was more of a concern as it started to approach average (still did not make it by a sizeable margin) as NASDAQ and SOX turned over with NASDAQ diving through and closing below next support.

It was somewhat a tale of two markets. The NYSE indices finished still in decent shape with modest volume, modest breadth, and holding near support. DJ30 was whacked, but most of its drop was attributable to MMM and its 9% shellacking. Even with that the Dow held the 18 day EMA on below average trade. That leaves the NYSE stocks with their more industrial, mining, metals base in rather decent shape heading into next week. Their patterns as discussed this past week are still in shape.

NASDAQ did not finish in the same shape. It initially held its 18 day EMA and bounced, but after reaching almost flat it rolled over and dove straight down in the afternoon, taking it below the May lows, the point we wanted to see it hold and put in the bottom of its right shoulder in a potential reverse head and shoulders base. That was tossed out the window and now NASDAQ is looking for a new landing spot. Volume was still below average but it was easily the strongest of the week and matched the late June trade. Distribution as big investors got rid of some tech stocks. Breadth was back over -2.5:1. It basically was not that great.

You would have though semiconductors were dead meat. Many were hit hard such as BRCM, NVDA, XLNX, selling on higher volume. Many such as AMD itself along with INTC, NSM, AMAT, KLAC, however, sold modestly or sold off early and then rebounded nicely. That suggests that maybe, just, maybe, the chips are getting sold out after a 4 to 5 month trend lower this year. Remains to be seen, but when you see a stock warn about earnings and it basically recovers intraday while others in its sector yawn, there is not a whole lot of selling interest anymore.

In the end the action left techs looking weak, anticipating more earnings warnings in the week ahead. At the same time, the action in some of the big chips suggests they are finally approaching a sold out status after declining most of this year. The NYSE indices are still holding their patterns, still setting up for an upside break despite the Friday action. The Fed, despite the Friday numbers, is still just about done. Short interest is still high; there was no rush to sell off the entire market. Techs remain a worry; they have to find some footing this week.

Friday was likely an overreaction to data that was not expected on either side of the coin. NASDAQ is going to have to show some staying power and not fade into another meltdown. It is definitely set up for some upside earnings after the AMD warning, and indeed, the reaction of AMD and its brethren suggest it was not totally unanticipated. There is still more work to do as the dog days of summer drag on. It is always tough going at this time of the year to get an established upside move. The NYSE indices are setting up such an attempt, however, and NASDAQ is likely to get some upside earnings projections this week. Until then we still see many industrial-type stocks in good position as well as some healthcare/medical issues. That is a bit defensive but it also suggests continued strength in the energy, materials, metals that point to no immediate meltdown in the world economy.

THE ECONOMY

Despite the jobs report, US inflation has peaked.

We have often argued that prosperity and jobs are not inflation. When you look in any economics textbook you won’t find the definition of inflation as jobs growth, economic growth, wage growth, etc. Because workers make more money it does not necessarily follow that inflation appears. If someone makes more money they may feel wealthier and indeed they may spend more money. That is good; the economy needs people to consume and thus require the manufacture of more goods and services. It only can lead to inflation, however, if there are not enough goods and services to meet the demand. That would mean there are either constraints on supply and demand through government policies (taxes too high or too many regulations that artificially divert capital from where it is economically needed) or there is too much liquidity fostered by central banks. It is often a combination of the two, but as central banks can do nothing about fiscal or regulatory policy, the focus typically falls onto monetary policy.

Thus when you see all of the hand-wringing and angst over higher wages (+0.5% in June, +3.9% year over year) and an increased workweek (3.5 year high) you have to wonder if the analysts really have their eye on the ball. If wages rise that does not mean inflation is driving them higher; as an economy recovers, skilled workers are in more demand. Further, if workers spend more because they make more, that does not mean prices necessarily rise. The issue is why prices for everything are rising. If there is no increase in supply or demand (or basically no constraints on supply) but you have rising prices, you have too much liquidity in the system. You have to get to the root of the problem which is excess money. Taking action to forestall wages, i.e. slowing the economy, does nothing to solve inflation. As the seventies showed us, you can have a slow economy and high inflation. You have to get rid of the excess liquidity.

Friday there was some renewed worry that the US was falling into something of a 1970’s cycle of higher inflation with slower economic growth. That is about the worst environment imaginable for stocks, and that is why the market took a hit Friday. The Greenspan Fed left rates too low and money supply too high for too long after it killed the bull market and sent us into recession just before 9-11. That was the root of the inflation we see today, exacerbated by fiscal policies that spurred demand over supply during the first part of the Bush presidency. Gold prices, though lower after the blow off top, are stabilizing once more and trying to move higher. Gold is a sign of inflation, like it or not. Yes there are influences from new demand in China and India, but as the recent action has shown us, gold still acts like gold in a technical sense, and it is suggesting inflation fears still exist in the world.

Is it the US or the rest of the world?

And that leads us to a very important point we have to address here in the US. As we have argued the past several months, inflation in the US has peaked. ECRI, the best and most accurate leading indicator of economic activity, continues to show declining inflation pressures in the US. In the US inflation peaked in October 2005. In May ECRI’s future inflation gauge (FIG) growth rate fell to 0.5% from 2.4%. ECRI says the data suggests inflation remains in a gradual easing trend after that 5 year high in October. The US economy was out in front of the rest of the world, and despite the Greenspan Fed keeping rates too low and money supply too high for too long, its remedial action appears to have done the trick in the US. Of course, the Fed can go too far, pushing inflation control above sustained economic growth in its dual mandate, and that is what the Bernanke Fed is grappling with today.

Unfortunately, the rest of the world’s central banks have not been as clear and decisive in fending off inflation, once again leaving the heavy lifting to the US. Ironically, the ECB which supposedly targets inflation, is having the worst time. Of course its antiquated polices and regulations with respect to its economies typically leaves supply and demand in imbalance, and thus it is continually faced with inflation pressures and is staving off economic growth before it can get started.

This time they are not doing enough. UK inflation is, according to ECRI and most analysts, in a cyclical upturn, churning along at a 5.5 year high according to ECRI’s FIG. Overall European inflation pressures continue to rise with its growth rate at an astonishing 7.2%, rising six consecutive months.

The US inflation cycle has peaked. The Fed has done its job, and now we just hope it does not overdo it and send us into recession. With the ECRI US leading economic index (the 4 week annualized index) down 0.9%, growth levels have hit their lowest level in more than a year. The very real danger facing the US is not inflation, but that the Fed feels it has to make up for the other central banks that are not doing their jobs, i.e. keeping inflation in check while they balance that with economic growth. Instead they are focusing on economic growth and letting the US fight inflation. The problem with that is we cannot make that kind of impact on the world inflation front unless we go into recession. That will certainly take the world with it because so much of the world survives by selling their goods to the US. Thus Bernanke not only has to sell his policies to the US markets, but he also has to convince the other central banks to tighten up. Greenspan has left Bernanke in a most unenviable position. Nice parting gift to Bernanke and all of us.

THE MARKET

As noted the prior two weeks, sentiment hit levels that often indicate a market turn. The only caveat is that the market did not turn and rally well at VIX levels that sent the market on sustained runs during the post-2002 rally. When bullish and bearish sentiment touched two weeks back that was a new extreme in that indicator during the post-2002 rally and suggested a bottom may have been put in. Thus far the market is trying to sustain the move after that reading, but it is struggling as is often the case in summer. Leaders are holding but they had a difficult end to last week. Stocks can continue to work on their bases after a follow through session, and what looks like a struggle is part of the build toward a stronger move later in the summer. That looks to be the case now.

MARKET SENTIMENT

Short interest remains high, one of the last touches on the sentiment watch. It is not necessarily a timing mechanism, but it is at a point for a sustainable bounce.

VIX: 13.97; +0.32
VXN: 20.17; +0.37
VXO: 13.48; +0.77

Put/Call Ratio (CBOE): 0.89; +0.09

Bulls versus Bears:

Bulls: 38.7%. With the Thursday advance investment advisors turned more bullish, up from 37.4% and 35.6% the week before. After a decline from 53.2% at the April peak bulls are on the rise once more. On this pullback, however, they hit the lows for this rally, i.e. since 2003. That put it below the 42.3% hit on the last low and the May and October 2005 readings that preceded new upside runs.

Bears: 34.4%. After kissing bulls two weeks back the bears are on the decline this week, down from 36.3% the week before. Just missed crossing over with the bulls, but that in itself is not a bad indication for the upside. That prior week put Bears at a new post-2002 high, eclipsing the March 2006 high (33%) and well above the 2005 highs that spawned new rallies (30% in May 2005, 29.2% in October 2005).

NASDAQ

Stats: -25.03 points (-1.16%) to close at 2130.06
Volume: 1.802B (+9.23%). Trade picked up on NASDAQ as AMD and MMM (LCD component sales slowing) both suggested tech growth may not be what was expected. This was a clear distribution session, and after a follow through two Thursday’s back, you want accumulation as opposed to distribution.

Up Volume: 361M (-389M)
Down Volume: 1.431B (+551M)

A/D and Hi/Lo: Decliners led 2.56 to 1. Decliners were strong. It was not just some selling in the big names as NASDAQ 100 matched NASDAQ in the decline.
Previous Session: Advancers led 1.13 to 1

New Highs: 50 (-30)
New Lows: 103 (+43)

The Chart: (Click to view the chart)

From looking well positioned to rally off of its May low and 18 day EMA near 2150, NASDAQ turned over after a midday recovery attempt to close near the session lows. It is now in its June range and unless it makes a quick recovery it looks to be at best heading for a test of the June low (2072 closing) and a potential double bottom. On this last bounce it was able to beat the 18 day EMA that stalled it in early June, rising to the 50 day EMA (2184). It could not take out that resistance at this juncture, and now it has to regroup. Earnings may come to the rescue, but the concern is not what the Q2 results are but the guidance ahead, and MMM and AMD did not provide the kind of outlook that suggests tech growth.

SOX (-1.52%) was again the loss leader as that index undercut its May closing low, continuing its decline since March. The pace accelerated in May, and since that time SOX has been unable to break back through the 18 day EMA (446) on four attempts, the sign of a rather entrenched downtrend. Given it has made four tries at the 18 day EMA, however, it sill be ripe for a move higher to test the 50 day EMA up at 464 after this current leg lower sells itself out. As AMD, INTC, AMAT and other big names did not really budge Friday on the AMD news, this selling could burn out rather quickly. With all of the short interest in semiconductors we could see a sharp rally in SOX in the next week or so, and that would coincide with the general short covering bounce we expect the market to show.

SP500/NYSE

Stats: -8.6 points (-0.67%) to close at 1265.48
NYSE Volume: 1.427B (+1.23%). Volume rose but it was still paltry, well below average. Hard to categorize this as distribution either. Indeed, we still like the way SP500 and SP600 are setting up with this test of the 200 day SMA.

A/D and Hi/Lo: Decliners led 1.61 to 1. Very modest breadth as the indices pulled back.
Previous Session: Advancers led 1.62 to 1

New Highs: 80 (0)
New Lows: 77 (+11)

The Chart: (Click to view the chart)

SP500 managed to turn positive midday but then rolled over with the rest of the market, undercutting the 50 day EMA (1268) that held on the first downdraft of the session. By the close it had tapped the 200 day SMA (1263) and bounced modestly. That still keeps SP500 in its attempt to form a reverse head and shoulders base using the 200 day SMA and 1260 as support. The key for SP500 was its move back above 1260 on the follow through two Thursdays back, recovering the May low. Unlike NASDAQ, SP500 is still holding that level and still set up to break higher from here. Maybe some OEX and SPY calls up off of this level. Indeed, the OEX held the 50 day EMA on its Friday low and is sitting pretty for a rebound here.

SP600 (-1.43%) undercut its 50 day EMA (373.47) that was acting as support for the nice test lower last week. It dropped to the 18 day EMA (369), just below the May low (371.34). Still in shape to bounce and try to form the right shoulder to its 8 week attempt at a reverse head and shoulders base.

DJ30

MMM was a huge drag on the Dow, accounting for the lion’s share of the decline as heavyweight MMM lost 9%. DJ30 fell through its 50 day EMA (11,112) but after undercutting the 18 day EMA (11,084) it rebounded to close at that level. That keeps it right at the May lows and thus still with the potential to form the right shoulder to its 8 week attempt at a reverse head and shoulders base. The selling was an overreaction to the MMM warning. Looking for a bounce this week.

Stats: -134.63 points (-1.2%) to close at 11090.67
Volume: 253M shares Friday versus 224M shares Thursday. Despite the selling in MMM volume was still well below average.

The Chart: (Click to view the chart)

MONDAY

Another week with a lot of economic data, but with the Fed decision in the bank and the jobs report history, the market is not going to be overly moved by this week’s economic data. Earnings pre-announcements and warnings will take front stage along with the early earnings reports. As always investors will look toward what the future holds as opposed to what just transpired; strong results with strong guidance always wins out.

The wild card remains the Fed and the economy down the road. The Fed is likely close to being through but there are clear indications the economy is slowing as the Fed continues to try and stamp out residual inflation even though inflation appears for the most part to have peaked. Makes sense as noted last week: inflation is lagging, it is still quite tame historically, and according to the leading indicators that are accurate, it peaked at the start of Q4 2005. The Fed wants to stop but we are going to have to wait until August to see if it does. By then it will have a lot more data, including another jobs report, to make its decision.

NASDAQ is weak as is SOX. SOX led lower Friday, taking NASDAQ with it. SOX has already tested the 18 day EMA and failed four times on this trend lower; after a bit more downside it will be ready to try a more sustained move higher. The issue in the interim is whether SOX and NASDAQ take the NYSE lower with them.

The latter are in position for a nice bounce given the patterns, the short interest, etc. Their earnings are likely to be strong as well, and the outlooks based on what we have heard still look solid. We were looking at more upside from those indices Friday, and we are going to continue doing so to start this week. Though a lot of stocks were hit Friday, many solid stocks are still in their patterns, testing their recent moves higher. We are going to continue attacking with those but still not going whole hog. It is a volatile time of the year, and with earnings coming it will be even more so on an individual stock basis as well as for the overall market. Summer is a tough time but the NYSE indices continue to show some upside strength that we are going to continue to play as it builds.

Support and Resistance

NASDAQ: Closed at 2130.06
Resistance:
The 18 day EMA at 2146
2162 to 2155 from December 2005 and September 2006
2163 is the August 2004/April 2005 up trendline.
2177 is the December 2004 high.
2185 to 2182 is the September 2005 peak and interim high from November 2005.
The 50 day EMA at 2184
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 2228
2234 is the early June high
2240 is closing low in February range.

Support:
2100 from the early and mid-2005 peaks
2072 is the June closing low
2063 is modest, soft support
2050 from the summer 2005 lateral range lows.
2045-47 from June and October 2005 lows and June 2004 highs

S&P 500: Closed at 1265.48
Resistance:
1272 to 1268 is the November and December 2005 closing highs and March 2006 closing low
The 50 day SMA at 1273
1280 is the recent July peak.
The late January peak at 1285
The early June high at 1288
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:
The 200 day EMA at 1263
The 18 day EMA at 1261
1248 is an old trendline from the August 2003/August 2004/October 2005 lows.
1225 from the March 2005 high
1213 from December 2004 high to 1215
1205 from the August lows

Dow: Closed at 11,090.67
Resistance:
11,097 to 11,137 is the last peak from the February top.
The 50 day EMA at 11,112
The 50 day SMA at 11,175
11,279 is the late May high
The March 2006 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

Support:
The 18 day EMA at 11,084
11,044 is the January high.
10,965 from Q4 2000
10,931 is the November 2005 high
The 200 day SMA at 10,921
10,890 is the December 2005 closing high.
10, 737 to 10,730 from December and February lows
10,705 – 10,965 from July/August 2005 range top to bottom
10,678 to 10,665

Economic Calendar

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

July 10
- Wholesale inventories, May (8:30): 33.8 expected, 33.8 prior
- Consumer Credit, May (3:00): $3.2B expected, $10.6B prior

July 12
- Trade balance, May (8:30): -$65B expected, -$63.4B prior
- Crude oil inventories (10:30)

July 13
- Initial jobless claims (8:30): 313K prior
- Treasury Budget, June (2:00): $20.0B expected, $22.9B prior

July 14
- Retail sales, June (8:30): 0.4% expected, 0.1% prior
- Retail sales ex-auto, June (8:30): 0.5% expected, 0.5% prior
- Michigan sentiment, preliminary, July (9:45): 85.3 expected, 84.9 prior
- Business inventories, May (10:00): 0.4% expected, 0.4% prior