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InvestmentHouse Weekend Update:

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

- Market surges higher on jobs data, gives it back again, but shift to larger cap industrials remains intact.
- Fed likely to hike and say it is done given the continued rise in commodities.
- Market advance remains tenuous even after pre-FOMC rally.

Market surges then struggles on a weaker jobs report.

Thursday’s reversal from low to high set the market up for a rally on the jobs report, and when jobs came in at 113K (145K expected) and the unemployment rate jumped to 4.8% from 4.6%, it did not matter that hourly earnings rose more than expected, at least not right away.

Stocks were down pre-market on word that AAPL would delay its earnings report as it was further investigating the options scandal involving Jobs and others at the company. As we wrote in April and May, that options scandal is getting to be a problem for NASDAQ, kind of a back up negative for the threat of a slowing economy that impacts NASDAQ’s growth stocks and the small cap growth stocks. Then the employment data hit and bang . . . immediate reversal. Futures not only turned back from negative, they shot higher by 90 at the high point (versus FV) on DJ30.

The open was rip-roaring, but we said in the morning alert it had to be watched even with the solid low to high Thursday reversal. Within minutes it started to come off the early high; nothing necessarily bad about a quick test of the opening gap, but the market did something it is known for in this downtrend, i.e. it just languished the rest of the session in a steady, day-long slide.

In June the market did the same thing on the jobs numbers, but it rallied and started to sell even before the open. This time it made it into the first half hour of ‘live’ trade. After that NASDAQ flipped more than 50 points from the high to the low, SP500 20 points. Huge, huge intraday reversal. Was it the revenge of the average hourly earnings again? No, it was the Hamptons. Sure the initial surge was used to sell into, but volume was still rather modest in that it did not chalk up any huge gains on the session. What happened was a pre-Fed weekend where many fund managers and floor traders left early. After the initial round of profit taking on the first surge bids bit the dust. No one wanted to jump into a lot of new positions on the weekend ahead of the most critical FOMC meeting since June 2004, the month it started this last Quixote campaign. It had its pre-Fed run the past two weeks, and the news got to be as good as it could get before the Fed actually delivers its edict. Time to punch the ticket for the rally.

Technically not a collapse, but this is where it gets interesting.

Technically it was not great action, but it was far from a slaughter. We took some interim gain off the table on the early surge when it was pretty clear the news was as good as it gets for now. Most of our positions held up quite well even with the reversal. Some are back at the lick log, i.e. where they have to put something back in the kitty, but overall there was not much technical damage.

Indeed, that held over to the market as well (generally). DJ30 and SP500 surged higher early, and though they could not hold their gains they along with the other indices recovered in the last hour. The result was they did not damage to their technical position. Volume was lower on the NYSE: it was hard to sustain the move on lower trade, but the rollover was not a surge in selling. As noted, it was just a lack of interest after that first surge.

NASDAQ volume crept higher as it turned over so there was some distribution though volume remained below average. It too rebounded late and shaved 15 points off of its losses, basically two-thirds of its loss on the session it regained in the last hour. Of course it blew a 17 point advance that required the late recovery to saves its bacon. On the high it tapped the 50 day SMA and faded back below its trendline. It held the 18 day EMA, but it made it to the 50 day, must about where we thought it would on this trip and where it stalled in early July. Very important time for the NASDAQ right here. It has looked better the past couple of weeks, but any movement would have been grand compared to its May, June and first half of July. Now it has to put up some real numbers to show this is not just an oversold bounce to resistance in a continuing downtrend.

NYSE remains in good shape outside of the small caps, and more of late the mid-caps as well. There remains the ongoing shift from growth to large caps, e.g. industrials, financials, consumer staples and drugs. Heck, if the economy is slowing, no wonder the drug purveyors are performing better; have to get rid of those business-related headaches. As the expansion ‘matures,’ a nice way of saying slows, the growth areas lag and the large caps traditionally outperform. Now they are doing that. As you recall, the small caps were declared dead for the last two years when the economy was still expanding and thus they were as well. Now that the economy is really slowing we hear touts of small caps as well, but as a group they are likely to start to under-perform overall. If the expansion just slows they will not tank. If it picks up again they will improve once more but typically not as strong as in the first part of the economic recovery.

THE ECONOMY

What the Fed is likely to do in order to save face, avoid a stampede.

We could talk about the jobs report, tear it down and analyze the minute details, but it really did nothing to alter anyone’s view on the economy or change what the Fed thinks. Basically it was the same as last month: job growth (though not as big as some forecasts or as low as others) and a continued rise in worker earnings. Sure the unemployment rate jumped, but that is bad-mouthed so much by the Fed it has, at least on the surface, no significant impact.

What we really need to talk about is where the economy is going based on what the leading accurate indicators say, specifically the financial markets.

First, a look at commodities. Back in 1999 the Fed was hot on the trail of inflation. It hadn’t shown up, but with the expansion lasting so long the Fed was sure it had to be just around the corner. Greenspan forgot is ‘follow the markets’ philosophy and started ‘fine tuning’ the economy in order to prevent the non-existent inflation from showing up. At the time we wrote extensively about the commodities market and what that meant for the economy. Indeed, we were in the middle of a terrible drought and crop yields were literally withering. Corn, bean, wheat, cattle, chickens: they were all dropping around the world. Why, we asked, was the Fed so set on inflation when the commodities were showing more deflationary action? As it turned out, the Fed kept hiking, and when the economy broke one of the main concerns became, not surprisingly, deflation. Commodities were talking but the Fed was not listening.

Now we have commodities running higher and higher, not the sign of deflation, but typically inflation. Oil just hit a new high recently, and while many commodities are off their May highs, after that initial blow off they have recovered and are holding up quite well. Two years into the rate hikes after an extended period of too-easy money, however, the Fed is ready to end the hikes with commodities still very strong. The Fed feels the economy is going to slow and thus commodity prices will fall. As we know, however, a slow economy does not necessarily equal lower inflation. It is a monetary thing; if you have too much money even in a slow economy you still have inflation. As we have written for years: ECONOMIC GROWTH HAS NOTHING TO DO WITH INFLATION. You can have a recession yet have inflation if you have too much liquidity. Commodities are suggesting there is lower liquidity (the hard post-May fall), but still too much in the system.

What about bonds?

Second, the bond market. Bonds have rallied ahead of the FOMC meeting, driving rates for both the 2 year and the 10 year below the 5.25% Fed Funds rate, indeed well below it by a full rate hike. Until last week the curve was slightly inverted again after straightening out in July. This week it ended modestly inverted again with yields at 4.90% on the 2 year and 4.89% on the 10 year. Bond yields are below the Fed Funds rate just as they were in 2000 when the Fed hiked into an inverted curve. When this happens bonds are saying the demand for money longer term will be lower. Indeed, right now bonds are saying the Fed is not going to raise rates but that it needs to cut them in order to try and keep the economy moving forward.

Wow, cut rates. Well, that is not going to happen. At best it is going to pause. Who is right? Is the bond market wrong here in the short term, overreacting to what the Fed may or may not do, or are bonds really saying that the economy is going to fade?

How do you reconcile the bond market with the commodities? Well, the bond market may be overreacting, but it also may be completely in line with reality, saying the higher commodities prices are going to put an end to the world economic expansion given the added strain of higher interest rates. Liquidity may still be a bit high, but rates don’t need to be.

How the Fed will likely do it?

Fed funds futures are back below 40%, and within a couple of days of an FOMC meeting, that historically is a dead-on indicator. Cannot believe I am writing this, but this time it may not be right. The Fed feels there is a slowdown coming, and has suggested that will slow inflation. Inflation is hardly out of control, but 1970’s refugees still fear it a lot; deflation is terrible but inflation is not picnic.

As we have said, inflation is not dependent upon economic activity. The Fed, however, still has to appear tough on inflation despite Bernanke’s closet desires (at least they are now after getting slapped around when he voiced them at the beginning of his term) to stop with the rate hikes and let the economy run. Thus the Fed is likely to hike rates 25BP and say it is done unless things turn around sharply, blah, blah, blah.

What the Fed really needs to do is buy back some treasuries and take money out of the system. That is the surest way to reduce liquidity, and it is very manageable unlike rate hikes. It is the quiet method because the rate hikes get all of the press, but that does not render it ineffective.

But wait a minute. What happens when the Fed buys back bonds? Prices rise and yields fall. What are prices and yields doing? Rising and falling. Hmmmm. The Fed is trying to dry up liquidity behind the scenes of rate hikes, and thus Bernanke is correctly not so gung ho about more hikes. He has been ridiculed in public, even called an ‘amateur’ by a rather preposterous figure of a Congressman. To us he is showing a very real and rather accurate understanding of the economy, though he still talks of inflation targets. Hey, nobody is perfect, and we feel his actions show you don’t have to play to the common but misguided conventional wisdom in order to do the right thing. Even with that, however, it is a toss-up as to whether he raises rates for the final time on Tuesday given this is his first fight with inflation as a new Fed chairman.

THE MARKET

MARKET SENTIMENT

VIX: 14.34; -0.12
VXN: 21.63; +0.51
VXO: 14; -0.01

Put/Call Ratio (CBOE): 1.17; +0.28. Reversals typically rile the options market as short term options players have to close positions, roll out of positions, etc. to keep from getting hammered. Thus the spike in put activity on the surge and then reversal.

Bulls versus Bears: Big jump in bears even as market improved shows a good contrarian indication.

Bulls: 41.5%. Bulls got a little long in the face again, falling from 42.2% the week before. After moving in a holding pattern at 42ish, good to see a bit of a fall back toward the 38.7% level from a month back. It remains 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: 36.2%. Quite a spike from 34.5%, and the highest in this entire cycle. The past two weeks top the 34.4% hit a month back when bulls and bears kissed, just missing crossing over with the bulls. 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: -7.28 points (-0.35%) to close at 2085.05
Volume: 1.895B (+0.75%). Volume climbed closer to average as NASDAQ gapped higher and reversed. Not a big volume surge, but stronger than on the upside sessions this week, indicating once more that the sellers, despite some improvement in NASDAQ’s overall picture, remain in control of the index.

Up Volume: 773M (-348M)
Down Volume: 1.1B (+366M)

A/D and Hi/Lo: Decliners led 1.33 to 1. Quite modest, but such is a reversal session.
Previous Session: Advancers led 1.45 to 1

New Highs: 98 (+9)
New Lows: 78 (-40)

The Chart: (Click to view the chart)

NASDAQ gapped higher and rallied to the 50 day SMA (2116) on the high. That was it. A 50 point reversal from high to low (2.3%) was about as violent as big as it gets in one session. A last hour rebound that recovered 15 points held the 18 day EMA (2081) and kept the session from the ‘complete rout’ category. NASDAQ made it to the 50 day MA, just about where we felt it would rally to on this move. The close took it back below its trendline (2097) and indeed, the 50 day MA is where NASDAQ stalled in early July after a very similar looking June recovery melted away. NASDAQ made its move, showing some modest accumulation and some modest distribution, but more distribution overall. In short, it rebounded form some harsh July selling, but did not show a lot of accumulation. It hit the downtrend and turned back on Friday. It is the lick log time for NASDAQ once more, and technically it is not in a great bargaining position. We will see this week if it has drawn an inside straight.

SOX (-0.96%) rallied up to 425, an interim resistance point from the late June low, and that stalled it Friday. It gave back 13 points from high to the close (late rally helped), but it managed to hold the 18 day EMA (410.66) and the down trendline at 408 on the close. Not great technical action with the tombstone doji, but it did hold the trendline break without rolling right back over. Some promise, but it has to work with NASDAQ to recover, and both are at the point where they test this last recovery attempt to either hold and try higher toward the 50 day EMA or fold for now.

SP500/NYSE

Stats: -0.91 points (-0.07%) to close at 1279.36
NYSE Volume: 1.724B (-4.94%). Volume faded as the NYSE indices ran higher then gave it all back to close modestly lower. A lot of running up and down to get back to flat. No distribution so that is a modest positive, but there was also no accumulation on the upside run. NYSE price/volume action, however, remains more positive overall versus NASDAQ as money flows to the large caps.

A/D and Hi/Lo: Advancers led 1.32 to 1
Previous Session: Advancers led 1.51 to 1

New Highs: 179 (+62)
New Lows: 46 (-13)

The Chart: (Click to view the chart)

The large caps jumped well past 1280 and over the June high (1290.68). Looking good, at least for an hour or so. Then it faded and could not even hold the breakout over the July high. Three sessions, three tries, three failures. The pattern is not a failure, but as with baseball, the market usually gives you three tries. We will see. SP500 remains in its pattern, showing solid volume to end the week as it butts against the breakout. At the same time the 50 day EMA is coming up to test the crossover of the 200 day SMA; the repeated failures may be suggesting something with respect to that crossover. Large caps continue to get the money. Tech rallied the past two weeks, but they were playing catch-up in a relief move. SP500 has a real pattern in progress.

The small cap SP600 (-0.36%) surged through the 200 day SMA (369.17) on the high (371.29) and then it peeled back and closed again below the 50 day EMA (366.05). It is trying to break higher on toward that July high at 378, but the 200 day is where we thought it would reach and it did so only to reverse and close lower. Trying to keep a double bottom attempt together but it has a lot of work just to get back to the ‘hump’ that is the January high.

DJ30

Similar theme: early surge to a new post-May high (11,344) but it could not hold the move, giving back 104 points. Hard to be happy about that at all. DJ30 tested nicely to start the week and then started higher, making the breakout Thursday. Volume did not move with it, however, coming well below average. Then the big surge Friday and failure. May come back some more to test and set up again. Large cap industrials still getting money as the pattern indicates.

Stats: -2.24 points (-0.02%) to close at 11240.35
Volume: 210M shares Friday versus 211M shares Thursday. What a competition in mediocrity. No wonder it could not hold the break higher.

The Chart: (Click to view the chart)

THIS WEEK

FOMC week, a one-day affair this time around with results Tuesday at 2:15PM. The market moved higher for two weeks ahead of the meeting where the bond market is expecting a cessation to the rate hikes. If the Fed does not hike the market may like it but not like it, i.e. it won’t satisfy all of the investors in bonds, gold, etc. and thus turmoil. Actually the best result would likely arise from a rate hike and a statement that says the Fed is done unless it really sees some trouble.

The result? The Fed Funds futures say no hike and as noted, it is typically dead b**ls on accurate at this juncture. That is one reason we feel the Fed will actually raise and then say ‘no mas.’ That would work to satisfy most everyone though it may not be what the economy needs. The economy needs no more rate hikes and a bit less liquidity. The Fed is drying up liquidity with some treasury purchases, and thus helping US inflation, inflation that still shows a peak in October 2005. It was up the past week but still has not reversed the trend lower. As we noted two weeks back, the real problem is the rest of the world; the US has been fighting inflation for everyone else. At least last week the BOE raised rates unexpectedly, thus helping the US out some. See, there are some positives regarding the world’s central banks.

As for the market, it may have had its pre-FOMC last call rally. With the meeting on Tuesday and two weeks of upside (ragged as it was) behind it, there is not a lot to be gained just ahead of the actual result. Look at how Friday turned out: good news, a surge, but then the inevitable ‘what next?’ question. With the bond market pricing in the need for the Fed to lower rates due to economic growth concerns, the market may not like the answer. After all the Fed cut rates on January 3, 2001 for the first time since it started its campaign against prosperity, and the market surged only to rollover the next month. The economy is the most powerful variable with respect to the market, and the market prices in economic moves ahead of time. If bonds are correct, the economy is slowing much more than the Fed thinks, and the need for a 25BP rate cut now may be more if things are not tended to.

Lots of stocks faded after the early move Friday, but lots of stocks held near support on lower volume. As we noted with the NYSE indices, the action was not great but it was not fatal at all with respect to those indices and their stocks. Those have to be the upside focus ahead what with NASDAQ struggling at its downtrend. NASDAQ perked up last week, but this is the key for the move now that it has moved to its trendline and has to show its stripes. We have to be careful of a pause leading to a surge that just does not last. We won’t mind at all as that will let more of our positions run toward their targets, but we will have to see how that move holds to really ramp up a lot of new buys.

Support and Resistance

NASDAQ: Closed at 2085.05
Resistance:
2100 from the early and mid-2005 peaks
The May downtrend at 2100
The 50 day EMA at 2122
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:
2072 is the June closing low
2050 from the summer 2005 lateral range lows.
2045-47 from June and October 2005 lows and June 2004 highs
2037 at the October 2005 closing low
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 1279.36
Resistance:
1280.37 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:
1272 to 1268 is the November and December 2005 closing highs and March 2006 closing low
The 200 day EMA at 1269
The 50 day EMA at 1265
1254 is an old trendline from the August 2003/August 2004/October 2005 lows.
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 11,240.35
Resistance:
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:
11,228 is the July closing high.
11,097 to 11,137 is the last peak from the February top.
The 50 day EMA at 11,084
11,044 is the January high.
The 200 day SMA at 10,987
10,965 from Q4 2000
10,931 is the November 2005 high
10,890 is the December 2005 closing high.
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.

August 4
- Non-farm payrolls, July (8:30): 113K actual versus 145K expected, 121K prior
- Unemployment rate, July: 4.8% actual versus 4.6% expected, 4.6% prior
- Hourly earnings, July (8:30): 0.4% actual versus 0.3% expected, 0.4% prior (revised from 0.5%)
- Average workweek, July (8:30): 33.9 actual versus 33.9 expected, 33.9 prior

August 7
- Consumer Credit, June (3:00): $4.0B expected, $4.4B prior

August 8
- Preliminary Productivity, Q2 (8:30): 1.1% expected, 3.7% prior
- FOMC decision (2:15)

August 9
- Wholesale inventories, June (10:00): 0.6% expected, 0.8% prior
- Crude oil inventories (10:30)

August 10
- Initial jobless claims (8:30): 315K prior
- Trade balance, June (8:30): -$64.5B expected, -$63.8B prior
- Treasury budget, July (2:00): -$47.8B expected, -$53.4B prior

August 11
- Retail sales, July (8:30): 0.6% expected, -0.1% prior
- Retail sales ex-auto (8:30): 0.5% expected, -.3% prior.
- Business inventories, June (10:00): 0.5% expected, 0.8% prior.