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InvestmentHouse Weekend Update:

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

- Earnings trump Fed in an up then down week.
- Growth sectors take their toll on market.
- Earnings, leading indicators point to slowing, Fed futures point to pause
- Market still seeking a floor in light of future economic concerns.

Tech earnings guidance pushes market lower Friday.

In real estate it is location, location, location. In the market its earnings, earnings, earnings. After a Tuesday reversal session the market jumped higher Wednesday when Fed chairman Bernanke gave the market the trigger it was looking for. Though his words were not much different from prior comments and speeches, the market was oversold and looking for a reason to rebound. When Bernanke didn’t come out with fire and brimstone the market took it as a sign from above and bolted higher.

It was expiration week, however, and that often means volatility during the week and on Friday as well. It is also peak earnings season, and while the Fed can undoubtedly influence earnings, this far into the rate hiking cycle the Fed’s action is baked into the cake and earnings are forming up with respect to that action as well as the economic cycle and the other factors in the mix. Earnings as of last week were coming in relatively solid at 65% beating, 22% meeting and 13% missing; at this stage last quarter, 19% had missed.

The market never cares much about what earnings have done lately, however, looking more to the future. Starting midweek investors suffered from future shock as INTC, AMD, DELL and other techs warned the future was not bright enough to require shades. There were bright spots as well as MOT and AAPL posted strong results and guidance, and the ‘industrial’ sectors enjoyed strong earnings and forecast more to come (e.g. UTX, CAT, SLB, NUE). Tech, however, is very much prisoner to economic growth, and as we have reported the past several months, the economy is slowing, showing typical weakening signs after 3.5 years of expansion. Yes inflation has heated up of late, but that is also typical as inflation lags, coming in hotter even as the economy slows, only to dissipate as the cycle progresses.

Fed professes ignorance.

And therein lies the rub. As half of its mandate, the Fed is to maintain price stability, and when the economy slows and inflation peaks the Fed comes under pressure to further increase rates. It should be concerned just with drying up liquidity, but in common parlance raising rates is considered how that is done. Rates certainly have an impact, but really it is a matter of removing excess money, and the best way to do that is simply sell treasuries. After all, when the Fed wants to increase liquidity rapidly it buys treasuries and ‘prints’ money as it exchanges money for treasuries. It will also cut rates, but that as we know is an indirect method and it lags for months to a year in effect. Thus with rate hikes you get that uncomfortable no man’s land that we are in now where the Fed has done its work, but inflation continues higher as the economy waits for the rate hikes to fully take effect. Problem is, with inflation still heating up the common view is the Fed’s work is not done, and thus you get the indecision financial markets despise. If the Fed had focused on drying up the liquidity earlier in the cycle we would not have this issue now. Water under the bridge at this juncture, but that underscores even more the need to dry up liquidity to directly impact inflation versus the literal guesswork of rate hikes.

Guesswork you say? Of course. Just look at the FOMC minutes released Thursday afternoon. At the June meeting the Fed was simply uncertain whether the current level of monetary policy is restrictive, neutral, or accommodative. As we noted Thursday, after two years of hikes, clear economic signals, and most recently slowing earnings guidance, the market found that lack of insight by the body charged with maintaining price stability at maximum economic growth unacceptable. Maybe it now knows it is time to stop with the rate hikes, but Bernanke’s comments Wednesday and Thursday did not really provide that kind of insight even if the market bounced Wednesday (and of course immediately sold off Thursday and Friday).

Growth sectors hammered.

The combination of weakening earnings guidance from growth sectors and the expressed ignorance as to the current state of monetary policy was enough to scuttle midweek gains, and it had a massively negative impact on the growth indices such as NASDAQ, SP600, and SOX. They closed at new lows for the year, undercutting the June and July lows with SP600 and NASDAQ likely turning over any chance for a double bottom to take shape.

The internals all week were big, favoring the direction of the market that day. For example, Wednesday NYSE breadth was 6:1, but all week they were at the 2:1 or better level, either up or down depending upon the market direction. Friday NASDAQ was -2.8:1 as it and SOX sold off. That is quite negative even if it was less than other readings for the week.

The growth indices sold on strong volume Friday as did all the indices, though it was expiration day, making accurate gauging of price/volume action more difficult. Indeed, that made gauging most of the week a bit more difficult. Even with that, however, there are enough signals to give a pretty good idea as to the meaning of the week. Everyone was waiting on earnings to provide a spark. Even we noted that the market had sold into earnings in June and then the early results pushed stocks lower again, setting them up for a rebound as better earnings came out.

That came to be Tuesday and Wednesday, but it was only for Tuesday and Wednesday. The indices stalled at near resistance after the Wednesday move, unable to push higher to the ‘hump’ in the potential double bottoms on the NYSE indices before fading. They continued to fade Friday, and from the point losses and the turn lower ahead of the middle of the pattern it looks as if the potential to form a handle has been lost. That does not mean they are in a breakdown, just that the double bottom attempt is not going to work and that they will need to try and regroup and form a more lateral bottom near the June and July lows.

As for NASDAQ and SOX, as noted they blew out their prior closing lows and are still in downtrends seeking a floor. Volume and breadth were similar to the NYSE indices, positive on the up sessions, negative on the down sessions, but with the overall downtrends, the negatives won out the week. By winning the week they kept the tech indices trending lower with no bottom found yet. That drag worked to pull the NYSE indices lower as we expected, and now the latter are going to have to find their floor as well though they have one ready made at the June and July lows if they can take advantage of it. A hold and further building of a base at that level would actually be the best course of action as it would take the market out of the summer sludge and into the realm of finding a bottom in the fall that is typical for the market. Seems almost too pat, but this summer is acting like summer, with the overlay of the FOMC and slowing earnings, of course.

THE ECONOMY

Data overload the past two weeks as the picture is clearer than ever.

The past few months and more we have discussed the slowing economic picture, something normal as an expansion moves into its fourth year. With the employment report two Fridays back, Bernanke this week along with the FOMC minutes, and the earnings guidance as well, the picture continues to clarify if you want to look at the facts and history.

Problem is, with all of the data and the penchant for the financial media to pore over the minutia, the picture clouds right back up. There are a few factors to watch, and one of them was clearly out front last week, i.e. the earnings and the start of lowered guidance in many technology shares. They are cyclical, meaning they run with the economy, and with the economy slowing, their earnings growth naturally started to slow. That does not mean earnings are declining, just that the growth rate is slowing. Think of it in terms of the monthly manufacturing reports; they can be lower but still expanding just as we have seen. That means they are still growing, just at a slower pace.

ECRI shows continued slowing as well.

The best compilation of leading indicators index, ECRI, continues to show a trend lower as well. Last week its leading business cycle gauge was flat over the prior week. The growth rate rose 0.1% over the prior week, but overall it remains in its downtrend, and that continues to suggest slowing in the US economy ahead.

Okay, slowing, but as discussed above as with the earnings, that does not mean a decline or, in the common vernacular, a recession. This is key. ECRI is very good at forecasting recessions, and right now it is forecasting economic slowing but not the ‘R’ word.

As always, the caveat for this forecast is what the Fed does with rates and money supply in the future. The Fed can always overdo it as the past is littered with nice economies that were broken by a Fed fighting the prior economic cycle and its lagging inflation instead of anticipating the slowdown.

Fed Funds futures take a tumble.

This Fed with its new chairman may be more cognizant of this than its predecessors. Indeed, much of the Bernanke maligning has resulted from his more historical and indeed apparent learned view of monetary policy and economic cycles. He was even called an amateur by one of our esteemed leaders in Congress who likely, we are guessing of course, took only basic economics in college. Hell, he could have been an economics major, however, and made the same statement given that the Phillips Curve was taught as the gospel at one point.

In any event, the Fed Funds futures contract for August took a tumbled again Friday, hitting 35% on the session low before closing at 43%. They were at 67% Wednesday but then fell to 49% and now 43%. Bernanke’s testimony that slowing growth should curb inflation (hmmmm; inflation is caused by too much liquidity, right?) and some commentary in the FOMC minutes by some members about a pause after a June hike. The next meeting is on August 8, and within a couple of weeks the FFF is pretty dead on. We will have to see what next week brings and if it is below 50%, history says the Fed is likely to pause.

THE MARKET

MARKET SENTIMENT

VIX: 17.4; +1.19. An up and down week did not let VIX really sail higher as it needs to do. Volatile action yes, but the Wednesday rebound acted as a relief valve for fear. Still well below the 23 hit in June, and again we note it really did not get any legs during the initial jump in Middle East hostilities.
VXN: 23.2; -0.02
VXO: 16.55; +1.01

Put/Call Ratio (CBOE): 1.31; +0.29. Eight out of nine sessions above 1.0 on the close indicates there is an awful lot of put activity on going, and that typically means speculation or at least expectations of further downside is reaching saturation. The overall ratio closed at 1.13, and the past month it has tickled the 1.0 level many times.

Bulls versus Bears:

Bulls: 42.1%. Ever so slight of a dip in bulls after a continued brutal market, down from 42.2%. There was a big spike higher from 38.7% two weeks back, but we hoped for more here. At this level we note it is below the levels hit on the last market sell offs. On the last pullback bulls 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: 33.7%. Up slightly from 33.3%, but still lower than the 34.4% hit three weeks back. Kissed the bulls to end June, just missing crossing over with the bulls, but that in itself is not a bad indication for the upside. Hit a new post-2002 high in that late June move, 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: -19.03 points (-0.93%) to close at 2020.39
Volume: 2.41B (+12.92%). Volume was up, matching Wednesday levels when then market was up as well. Big trade all week during expiration, so it loses some instructive value. In the bigger picture the index continued lower overall for the week and volume was up for the week. That makes it a distribution week, adding to the overall pressure on NASDAQ.

Up Volume: 636M (+243M)
Down Volume: 1.703B (-25M)

A/D and Hi/Lo: Decliners led 2.85 to 1. The negative breadth continued as NASDAQ lost ground for the second session. Very weak internals.
Previous Session: Decliners led 2.98 to 1

New Highs: 31 (-23)
New Lows: 275 (+146). New lows expanding this time after hold fairly light on the last test. Given that did not hold the market higher we are looking for a big expansion of lows on this next test lower as another indication of extremes and a flush out of the sellers. Much of finding a bottom is a matter of extremes and getting the sellers finished.

The Chart: (Click to view the chart)

NASDAQ had a tough week ending it with a new closing low for the year. Up and down with most of the market, but ending with tow down sessions on above average volume. Volume was skewed by expiration as indeed were the price moves. Above that, however, the earnings drove the action. While earnings were overall decent, some big names (INTC, AMD, NOK, DELL) failed to produce the results, failed with guidance, or warned ahead of their announcement. That was the kiss of death that scuttled the Tuesday and Wednesday rebound attempts even before NASDAQ could reach near resistance at the 18 day EMA. NASDAQ remains searching for a floor on this round of selling.

SOX (-4.76%) was hammered lower after AMD guided lower in Q3 in the wake of INTC doing the same. It crashed through the bottom of the downtrend channel as the chips have shown incredible weakness, a very good indication of a slowing economy ahead as chips are in everything now, and if prices tumble that is an indication of slowing.

SP500/NYSE

Stats: -8.84 points (-0.71%) to close at 1240.29
NYSE Volume: 1.92B (+13.35%). Volume hit the high over the past month as the NYSE indices turned lower for the second straight session. Expiration trade but selling volume cannot be discounted completely.

A/D and Hi/Lo: Decliners led 1.92 to 1. Downside breadth contracted a bit but remained strong. After the +6:1 on Wednesday everything else paled, but we also have to remember that before this week a 2:1 day was huge. Expiration really jumbled the internals.
Previous Session: Decliners led 2.08 to 1

New Highs: 43 (-24)
New Lows: 167 (+82)

The Chart: (Click to view the chart)

SP500 rallied well Wednesday and approached the 200 day SMA (1265). The next step was a move to 1280ish to test the early July high and then start to work on the handle to the double bottom base. SP500 never took that next step, turning over Thursday and then taking below its old trendline at 1250 on Friday. If this is a handle it is certainly the strangest handle ever for any cup; hard to take a drink from. No, SP500 failed the strength test below the 200 day SMA and has faded toward a test the June and July lows now (1223, 1234) where it will try and hold and continue the work on putting in a bottom. Will be watching that test to see if it tanks through those lows and consummates a potential head and shoulders the move over the last 6 weeks is setting up.

The small caps in the SP600 are getting even smaller capitalization after the Thursday and Friday moves. Similar to SP500, the small caps (-1.56%) turned over well below of the 200 day SMA, stalling at the 18 day and then diving lower to a new low for the year, both intraday and closing. In a quick move the small caps have formed and started the breakdown from a 6 week head and shoulders topping pattern. The break through 350 and the bearish near term pattern put this index at risk of another 10 to 15 points to the downside though after two hard sessions it is likely to try a rebound to test some before rolling over to finish the job.

DJ30

The blue chips had a lot to deal with during the week with the INTC earnings issue but countered with IBM, UTX, and CAT. It suffered the same fate as SP500, unable to clear that next resistance, the 50 day EMA (10,692) for the Dow before turning over Thursday and then crashing the 200 day SMA (10,512) Friday on very strong trade. No handle, but no devastating breakdown either as seen on say SOX. Not a lot of blues in the blue chip index just yet, but though it is not breaking down, it also bears the yoke of technology.

Stats: -59.72 points (-0.55%) to close at 10868.38
Volume: 433M shares Friday versus 330M shares Thursday. Volume jumped above average the last three sessions of the week as earnings stirred the pot with both upside and downside on the blue chip average.

The Chart: (Click to view the chart)

MONDAY

Despite the torrential flow of economic data and Fed information, there is not much slowdown this week with consumer confidence, durables orders, home sales, ECI and Q2 GDP. This is all a lead-in to the August 8 FOMC meeting where we feel the Fed will do the right thing and buck conventional wisdom with a cessation of hostilities. That could start the market on the trail of recovery and set up a bottom near the start of Q3.

Ahead of that the explosion of earnings continues. As noted, the scorecard is solid overall with fewer misses thus far than same time Q1. The issue remains with guidance, and too many big names in tech are warning. Dell’s Friday warning was just dismal. The start of earnings was slow and the second week did more damage than good. You would think things could only get better, but if things are slowing, guidance will continue sluggish.

Some post-expiration bounce, but likely won’t last with economic slowing.

Even with that, the market often bounces early in the week following expiration when expiration closed lower. Given the selling a bounce is indeed likely but it will not result in a lasting change on its own. That would have to come from a change in expectations regarding future earnings, and at this stage the warnings are holding sway, and with an economy 3.5 years into an expansion and showing all the classic signs of slowing, it would be fairly ludicrous to expect guidance to surge ahead. Economies hit slower spots within overall expansions and this is one of those. The most important factor for the next year to come (and that is what the market is worried about) is whether it is just a slow spot or is a serious slowdown pushed by the Fed, high energy prices, etc.

There is also a further escalation in the Middle East as Israel pushes into Lebanon, basically in the process of clearing a ‘fire lane’ of sorts at the border to get the Hezbollah fighters back far enough to neutralize their rocket launches. They started massing at the border late Friday, and that was part of the drag on stocks and bumped oil a bit higher (74.43, +0.16). Thus far energy continues to struggle; we will see if this escalation helps them recover but many are looking weary.

Still seeking a bottom.

Last week kept the market in the early stages of putting in a bottom. The collapse by semiconductors and small caps only made the task more difficult while the NYSE large caps did themselves no favors. The latter are still in position to hold the June and July lows and thus simply continue the basing process without losing ground, just requiring more time. NASDAQ, SOX and SP600 still have the task of defining a possible bottom having broken to new 2006 lows. That means more time to find the low on this move, rebound, and test it.

Finding a bottom is difficult when the economy is slowing. The market started to forecast this as it broke the trends in May and continued lower. Similar to other corrections during this run from late 2002, but also more virulent as the Fed comes down to where it should stop tightening. When the Fed gets off the economy’s throat that will help, but the question becomes whether it went too far with energy prices holding such high levels and the expansion being so old. It is not decrepit, but this is a long expansion in historical perspective and with everything older it is more vulnerable and takes longer to recover (just look at me after my runs. I can pull a muscle just by thinking about it and I need a team of experts to help me recover).

Thus those thinking it will spring back to life once the Fed says it is done with hikes are likely to be disappointed. Indeed, some are suggesting the Fed will be cutting rates by late 2006, early 2007. In 1994 and 1995, there was a lag after the Fed halted and the market started back up (and the market leads the economy, anticipating the move). If the Fed has not gone too far this time and stops in August, we can expect a lag here as well, and that would, what do you know, put the timing of a market rebound for the last quarter of the year.

Again we emphasize how much slowing continues as bearing directly on any recovery. Right now ECRI suggests just a slowdown, but that is taking a picture of the trend at the present and with the currently existing pressures. If oil jumped to $85/bbl or the Fed hikes more that could easily change. One positive to look at if you are so inclined is that the Fed, with talk of a pause, has taken the Greenspan ‘kick them in the groin’ approach of a 50 BP hike to end the campaign off of the table.

That leaves us looking at this week for a bit of a relief move form the harsh end to the week, but one that does not change the complexion much. SP500 and DJ30 are still in the hunt for a possible nearer term bottom, but last week they showed they could not withstand NASDAQ pressure and go about their own way. Indeed a rebound will likely set up some downside plays for the weaker sectors while the defensive sectors will continue to get more money thrown at them.

Now some may wonder why even bother with the defensive sectors if the economy is slowing. There is a difference between a slowing economy and one heading into recession. In a recession a bear market will typically occur and will do so ahead of the economy’s move. You could argue the market is showing this right now. If a recession is to come, then there are really no safe sectors and we are playing all downside. Don’t mind that because the money comes fast, but most people just won’t do that. Thus you look for the defensive sectors. As long as there is no recession, the defensive sectors will perform, and then as the market predicts economic firming, the money will spread elsewhere and start bringing back the growth areas.

There are plenty of strong growth sectors now that are getting money and that can make us some good money. We will use options a bit more to leverage into moves that are not anticipated to be 20% in the underlying stock. That way we can take advantage of these moves, make strong money, and yet not have to have that 15% to 20% move in the stock. Less exposure to the market is always great when it is in transition.

Thus we will continue to look for the right upside plays to be in as well as take advantage of the stocks and sectors that are getting gouged. We have some new upside and downside this weekend so we can be ready to take whatever the market gives us.

Support and Resistance

NASDAQ: Closed at 2020.39
Resistance:
2037 at the October 2005 closing low
2045-47 from June and October 2005 lows and June 2004 highs
2050 from the summer 2005 lateral range lows.
The 10 day at 2050
2072 is the June closing low
2100 from the early and mid-2005 peaks (and the 18 day EMA as well).
The 50 day EMA at 2144
2177 is the December 2004 high.
2185 to 2182 is the September 2005 peak and interim high from November 2005.
2190 is the July 2006 high

Support:
2019 is the April 2005 interim high
2008 is the January 2005 low
1971 from an October 2005 peak and 1973 from a March 2005 low.

S&P 500: Closed at 1240.29
Resistance:
1250 is an old trendline from the August 2003/August 2004/October 2005 lows.
The 18 day EMA at 1252
The 200 day EMA at 1265
1272 to 1268 is the November and December 2005 closing highs and March 2006 closing low
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:
1239 from the late June consolidation range.
1225 from the March 2005 high
1223 is the June 2006 closing low.
1213 from December 2004 high to 1215
1205 from the August lows

Dow: Closed at 10,868.38
Resistance:
10,890 is the December 2005 closing high.
10,931 is the November 2005 high
The 200 day SMA at 10,943
10,965 from Q4 2000
11,044 is the January high.
The 50 day EMA at 11,046
11,097 to 11,137 is the last peak from the February top.
11,228 is the July closing high.
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:
10,737 to 10,730 from December and February lows
10,706 is the June 2006 closing low
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 25
- Consumer Confidence, July (10:00): 104.8 expected, 105.7 prior
- Existing home sales, June (10:00): 6.60M expected, 6.67M prior

July 26
- Crude oil inventories (10:30): 151K prior

July 27
- Durable Goods orders, June (8:30): 1.7% expected, -0.2% prior
- Initial jobless claims (8:30): 304K prior
- New home sales, June (10:00): 1.175M expected, 1.234K prior

July 28
- GDP advance, Q2 (8:30): 3.1% expected, 5.6% Q1
- Chain deflator, Q2 (8:30): 3.7% expected, 3.1% Q1
- Employment cost index, Q2 (8:30): 0.6% prior
- Michigan Sentiment, final July (9:50): 83.0 expected, 83.0 prior