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InvestmentHouse Weekend Update:

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

- Market slides into the weekend status quo as no one wants to commit.
- July retail sales solid, raise fear of FOMC stepping back in.
- Dog days of summer, but expiration week could bring some sharp swings once more.
- A week where the market and leadership has to put something together upside.

Lack of a bid lets market slide lower into the weekend.

Thursday stocks showed some fortitude in the face of a terror threat but Friday they continued the familiar theme of the week: unable to find traction for both the large cap industrials and as well as technology and the small caps, the former at support, the latter at downtrend resistance. It was a tough week for stocks with the FOMC meeting on Tuesday, the terror threat on Thursday, oil surging, and scattered economic reports. Investors waited for the FOMC meeting, got a pause, but then could not decide if that was good or bad as some economic data was stronger while other data and events (terror threat) suggested weakness. The market could not make up its mind, so as we pretty much expected, it punted on Friday, ending a down week with a low volume loss.

Friday started weak, got weaker, and then managed a modest afternoon rebound to cut some losses. Volume was very low. There was no real selling Friday, just a lack of any bids. No one wanted to make any commitments ahead of a weekend when a terror plot was just thwarted and expiration in the week ahead.

Retail sales were stronger but even with the Fed on pause and in all reality very unlikely to hike again, the market took it as bad news and an indication the Fed might have to go active once more. Goodness. With the Fed on the sidelines for now and with worries about a slowing economy, good economic news should be received as just that. The fact that the market still cannot accept good news as a positive indicates the market has more work to do before it will really be ready to put together a sustained upside move.

Technically the market remained bifurcated to an extent even though all indices were lower on the week. SP500 and DJ30 both managed to hang onto support, still trying to set up a breakout, but they both had a harder time maintaining their patterns. DJ30 was particularly hard-pressed when the large cap cyclicals were sold Wednesday after the FOMC meeting was in the books and the transports were hammered Wednesday and Friday. NASDAQ remained in its downtrend as did SP600, but both also held above support on the Friday close. Small details but for reasons stated below, they may turn out to be important.

There was distribution during the week on both NASDAQ and NYSE, showing some institutional selling after the FOMC meeting. On the week as a whole, however, volume was lower on both NASDAQ and NYSE. Thus while the week showed individual distribution sessions, overall the trade was low. Indeed when you look at NYSE in July and August there is only one distribution week. There is only one accumulation week, but SP500 and DJ30 are making a test of their pattern, so lower volume is usually better. NASDAQ shows two distribution weeks thus far in Q3, indicative of its downtrend. As NASDAQ slipped lower this past week, however, the lower trade is a good indication.

While still technically challenged (or at least technically mixed between large cap industrials and growth indices), the market had a lot thrown at it last week and it sold lower. It did not, however, implode to the downside when given every chance and reason to do so. It took most news as bad (e.g. the FOMC pause, retail sales), but even with that ‘the world s**ks’ attitude it did not engage in a sell-a-thon. As we said Thursday, it showed some character. It is building in some toughness (meaning it is getting pretty sold out). It has yet, however, to change its character and alter the status quo (NASDAQ, SP600 in downtrends). SOX is showing promise, NASDAQ is holding its newfound support, and SP500 and DJ30 are still in their handles to the bases. We have been here before during this selling. Now that the Fed is on the sidelines and the market has had a chance to digest that fact, maybe we will see a character change this week. It is in the ‘show me’ phase again.

ECONOMY

Solid news on the retail front gets a cold shoulder, but it should have satisfied all sides.

Retail sales in July rose 1.4%, beating the 0.8% expected and reversing the June losses (-0.4%, revised from -0.1%). It was the best gain since January’s 3% spike. Ex-autos were strong as well at 1% versus the 0.5% expected (and -0.1% in June). It was not all gas either. Yes gasoline sales rose 2.5% (due to higher prices versus a surge in gallons consumed), but they were not the lion’s share of the gains. Durables, down in the Q2 GDP numbers, jumped back in July. Electrical appliances rose 1.9%. Building materials and equipment rose 1.8%. You always like to see the consumer willing to go forth with the big ticket items as it shows some continuing confidence in what lies ahead.

The return of strength from June should have been viewed as a positive given all of the mixed signals the economy has shown this year, mixed enough for the Fed to properly conclude it needed to sit the August meeting out. Instead the market seemed to view it as a problem with respect to the Fed, figuring if the economic data turns strong the Fed will once again turn on the market.

It won’t do that, and there are a few reasons it won’t. First, the Fed is simply not going to reverse course over the span of one meeting and go from a pause to a hike. The Fed paused to let the existing rate hikes show their impact upon the economy. The economic indicators are already mixed, and when they turn from solidly positive to spotty that is always a warning to tread cautiously. Aside from that logical reason, the Fed simply cannot afford to be labeled a flip-flopper. Once you wear that tag it is hard to shake. Just ask John Kerry. You can ask him before he votes for something or after he votes against it.

Second, and this one relates to the retail sales report more directly, retail sales were not all roses in July. Yes they were up more than expected for the month, but you have to look at the trend. As with many economic reports, the trend has weakened. Department store sales fell 0.4% as general merchandise rose only 0.3%. Year over year the signs of a shift in retail spending are changing, something we noted back in the spring would happen as gasoline moved to $3/gallon in the summer drive. Indeed, the year over year gain is just 3.2%.

Consumers are spending less in most all retail categories compared to same time last year as they have to allocate more and more funds to gasoline. It is not just a one-time pop in gasoline prices as it was post-Katrina and Rita, but a sustained rise in prices that forces consumers to adjust. Wages are rising moderately, but it is not enough to wholly offset the rise in energy prices. Thus the shift in consumers’ discretionary spending, something the Fed has no doubt noted and thus is no doubt looking past this report.

In sum, a critical view of the report should satisfy both sides of the growth picture. Well, not satisfy. Both sides can find solace and angst in the report and thus it is likely a very good indication the Fed is doing the right thing. There is a definite slowing in the trend of growth as consumers are forced to spend more on energy and have to adjust as to what discretionary items are bought and how much of those items are bought. At the same time the consumer is not dead, clearly still out there spending. With the continued housing fade that consumption fortitude will be put to the test. The US consumer rarely backs off from consuming, but these gasoline prices are a challenge, and with natural gas rising again, the winter is not going to be a picnic if these levels hold. Again, the Fed did the right thing by backing off, but in the current mindset of the country, polarized views are not that common.

Leading indicators turn lower, indicating continued economic slowing.

ECRI indicators have been showing slower growth in the future, but last week one of its indicators, the 4-week annualized growth rate, turned negative for the first time in 14 months. The index hit an interim peak in January and has trended lower since. This negative reading projects a continued slowing of economic growth for the next few quarters. At this level it is not forecasting a recession, and indeed it would need to fall much, much lower than the current reading to forecast a recession. Again, it looks as if the Fed got off the brake in time, at least we hope so. The index will continue to degrade as the additional rate hikes hit. That is why we also watch the market’s action as a leading indicator.

THE MARKET

MARKET SENTIMENT

VIX: 14.3; -0.16
VXN: 20.06; -0.8
VXO: 14.25; +0.24

Put/Call Ratio (CBOE): 0.93; -0.01

Bulls versus Bears:

Bulls: 40.2%. Down significantly from 41.5% the week before, continuing the retreat toward 38.7% five weeks 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: 37.1%. Up nicely once more, rising from 36.2% and 34.5% the week before. This is the highest level in this entire cycle, easily clearing the 34.4% hit 5 weeks back when bulls and bears kissed, just missing a crossover. 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: -14.03 points (-0.68%) to close at 2057.71
Volume: 1.464B (-18.69%). Volume tanked on the session as no one wanted to buy and the sellers were not really active as well. Just a very low volume session that held support once more as NASDAQ fights to keep the lateral move alive. Fights may be a bit strong. Toils? More like struggles.

Up Volume: 393M (-698M)
Down Volume: 1.048B (+390M)

A/D and Hi/Lo: Decliners led 2.03 to 1. Volume was light and with the lack of bids stocks simply faded most of the session.
Previous Session: Advancers led 1.36 to 1

New Highs: 38 (+1)
New Lows: 148 (-54)

The Chart: (Click to view the chart)

NASDAQ was down from the open as Thursday’s mock show of strength was rather quickly rooted out. Another lower close made it four out of five for the week, but with all of the selling NASDAQ still managed to hold above 2050, the bottom of its three week lateral move between this support and 2100 on the upside resistance. Unfortunately, that keeps NASDAQ in its downtrend (2077), getting pushed down from above as that resistance descends. That leaves NASDAQ in a pretty interesting position this week. It is going to have to fish or cut bait with the trendline, or as Bull said on ‘Armageddon,’ it’s time to see who’s gonna’ dance.

SOX (-2.25%) just wasn’t the leader you would want to see after a two week lateral move that included a break above its trendline just over a week back. After a couple of promising sessions Wednesday and Thursday, it tanked back down to the bottom of the range Friday as some big name chips (e.g. NSM) fell similar to stones. Despite that it held its lateral move and thus keeps tantalizing us with the possibility of a continued move off the trendline to at least test the 50 day EMA at 425.

SP500/NYSE

Stats: -5.07 points (-0.4%) to close at 1266.74
NYSE Volume: 1.333B (-16.29%). No volume. Veritable desert of volume. No selling, just no interest ahead of the weekend.

A/D and Hi/Lo: Decliners led 1.85 to 1. Not bad what with the small caps dropping close to a point.
Previous Session: Advancers led 1.51 to 1

New Highs: 42 (-8)
New Lows: 78 (-39)

The Chart: (Click to view the chart)

After trying again to make the breakout above 1280 early in the week the large caps suffered the dips as well. Held the 50 day EMA (1266) through Wednesday, but then dipped lower intraday toward the 50 day SMA (1259) Thursday and Friday. Recovered Thursday for a gain; Friday it did not, but it did manage to close near the 50 day EMA once more. Low, low discount volume, coming in well below average on the selling. The deeper tests Thursday and Friday on the lows and then the rebounds shows some shaking out. That often helps set up a move higher, but we just have to see how this one holds. It is the backbone of the market right now, though it is suffering from some downside curvature of the spine at the moment.

SP600 (-0.87%) gave back the modest upside Thursday gain, continuing its fade that started in early May. It has used the 50 day EMA (364.32) as resistance in its downtrend, most recently failing in a wild attempt to clear that level two Fridays back. It has again faded toward the June low at 350 and the July low (348.69 on the close). Looks as if it is going to test those levels again this week . . . a triple bottom? More like a descending triangle, a bearish pattern where lower and lower highs push down on a constant support level. The small caps are going to have to try and dance this week as well.

DJ30

The blue chips had one really rough session last week, the Wednesday following the FOMC decision. The cyclicals got hammered and then the as did the transports. That left DJ30 struggling to end the week, tapping at the 50 day SMA (11,037) on the Thursday and Friday lows and then rebounding to recoup some losses. As with SP500 that shows some shaking out, but DJ30 is struggling in having to deal with the dying transports. Dow theory has it that the industrials cannot hold up without the transports; the latter is more or less the leader to the industrials. With DJ20 diving lower below the 200 day SMA, the prognosis for DJ30 is not that great. On the other hand, the blue chips are still in their pattern and the selling last week was on very low volume. Seems all of the indices are at the point where they have to put up a move.

Stats: -36.34 points (-0.33%) to close at 11088.03
Volume: 166M shares Friday versus 211M shares Thursday.

The Chart: (Click to view the chart)

NEXT WEEK

There is a cease-fire agreement in the Middle East, though the hostilities may not end for a couple of weeks. That may or may not impact the market much, however, as a lot of this was anticipated.

It is expiration week, and over the past few months we have seen a lot of activity midweek as positions are rolled over. We also see activity on Friday as well. We could see some solid upside moves midweek similar to prior upside moves on expiration Friday, but those were false moves, unable to sustain themselves after expiration ran its course.

In addition the week is loaded with economic data of the Fed type, e.g. PPI, CPI, housing starts, production, leading indicators, Michigan sentiment. There is still this tug of war within the market that wants better economic data that shows the economy is not tanking while on the other hand it is afraid if the data is too solid the Fed will have to step back in. That damn idea that prosperity leads to inflation seems to be the death of all economic expansions.

Despite the rhetoric from the Fed, it looks as if this one is not as dogmatic as the prior Fed would get when it felt prosperity had gone too far. The pause says a lot; it paused when many said it shouldn’t. It is hardly ever (never?) discussed on the financial stations, but the Fed has sold treasuries, thus sopping up extra liquidity as it keeps money supply under control the past six months. Growth in money supply was 6.2% through January 2006, but just 0.5% since that time. M2 money supply growth has dropped from 10% to between 4% and 5% over the past two years.

Thus it appears as if the Fed has made the right moves at the right time. That is why inflation peaked in the US in October 2005 and remains trending lower. The Fed has been withdrawing liquidity when the other central banks were not. Now you see the Bank of England still having to hike (along with other central banks) when the US is in position to cut. The Fed is an easy target to lambaste, and may have gone too far again, but at least this time it is making better, more sensible moves.

Has it gone too far? The market has corrected since May in one of the sharpest drops since the expansion begin off the October 2002 low. Right now SP500 and DJ30 are trying to break from bases while NASDAQ, SOX and SP600 are struggling. NASDAQ and SP600 are in downtrends, trying to put up a fight with some modest lateral moves, but they are not in a position of strength. As noted above, the indices are at a point where they need to dance or give in.

Thus this week could be very interesting. The Fed is in the can. It has paused, giving the market what it should want. And let’s face it, the economic data has weakened as we have discussed for a year or more as the housing market topped (statistically in September 2005). The economy has slowed and the Fed is still slowing it further with the rate hikes yet to hit the economy (they are falling from the sky after the Fed launched them over the past 6 months or more). If the market fails in this attempt to consolidate and move higher then it is a pretty clear sign that the Fed has once again overshot even with Bernanke bucking conventional wisdom and pausing while there were still signs of inflation. Of course we know from experience that inflation lags; last week labor costs hit a level not seen since late 2000, and that immediately preceded the official recession.

Back in 2000 when the market sold off ahead of the recession there was a sharp first plunge and then a rather nice recovery through Labor Day. Then it started the selling again. The point is that we have to stay vigilant to market signals. We need to see a strong breakout from SP500. We need to see NASDAQ and SOX complete bases and then breakout as well. They have quite a bit of work to do before that. Near term they can deliver that bounce we are looking for; they are set up for that. Then they will likely test again into September. How they set up and recover from that, e.g. the market patterns and leadership, will tell us much about the economic future. Right now the market is forecasting a slowdown, but it is at a crossroads between just a slowdown in an otherwise upside economic expansion or a much deeper decline brought about by overly stringent monetary policy even as the expansion matured.

This week we are looking at energy again. It pulled back to end the week with many, many solid stocks at near support. If they are strong and going to move higher again they will use this test to spring higher. Many have set up good bases, and as with the indices, they are at a point where they need to show the move or sell some more. They have led the market and are also something of a harbinger of economic activity; prices fall if they anticipate less economic activity and thus less demand for product. If they break down through support on volume that indicates more of the downside outlook.

In addition to energy there is life in financials, scientific instruments, some telecom, and then a lot of scattered stocks from various sectors. Leadership remains a sore point for the market, and it needs energy and financials to come back strong and pull other areas with them. Another tall order, but there are still some excellent patterns set up.

Support and Resistance

NASDAQ: Closed at 2057.71
Resistance:
2072 is the June closing low
The May downtrend at 2080
2100 from the early and mid-2005 peaks
The 50 day EMA at 2111
2158 from the May 2005 low.
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:
2050 from the summer 2005 lateral range lows. It has held the past three weeks.
2045-47 from June and October 2005 lows and June 2004 highs
2037 at the October 2005 closing low
2020 is the July 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 1266.74
Resistance:
The 200 day EMA at 1271
1272 to 1268 is the November and December 2005 closing highs and March 2006 closing low
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:
The 50 day EMA at 1266
1257 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 11,088.03
Resistance:
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:
The 50 day EMA at 11,093 is trying to hold
11,044 is the January high.
The 50 day SMA at 11,036 held on the Thursday and Friday intraday lows
The 200 day SMA at 11,007
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 15
- PPI, July (8:30): 0.3% expected, 0.5% prior
- Core PPI, July (8:30): 0.2% expected, 0.2% prior
- New York Empire State Index, August (8:30): 15.0 expected, 15.6 prior
- Net foreign purchases, June (9:00): $69.6B

August 16
- CPI, July (8:30): 0.4% expected, 0.2% prior
- Core CPI, July (8:30): 0.3% expected, 0.3% prior
- Housing starts, July (8:30): 1.810M expected, 1.850M prior
- Building permits, July (8:30): 1.845M expected, 1.869M prior
- Capacity utilization, July (9:15): 82.6% expected, 82.4% prior
- Production, July (9:15): 0.5% expected, 0.8% prior
- Crude oil inventories (10:30)

August 17
- Initial jobless claims (8:30): 319K prior
- Leading Economic Indicators, July (10:00): 0.1% expected, 0.1% prior
- Philly Fed, August (12:00): 8.0 expected, 6.0 prior

August 18
- Michigan sentiment, preliminary, August (9:45): 84.0 expected, 84.7 prior