Sector Investing

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InvestmentHouse Weekend Update:

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

- Nice rebound to end the week with low overall volume, but strong volume in key sectors.
- Core PPI is in the sweet spot and looking for the CPI to get earnest about following it.
- Retail sales weaker just as everyone expected but no one cares to mention.
- The market is still extended in many respects with some iffy price/volume action of late, but the prior leaders are starting to move up again and with solid volume.

Friday doesn’t put the pullback to rest, but there were definite bright spots.

The disappointing but expectedly so same store sales presaged weaker than expected April retail sales, and the actual numbers bore that out with sales overall down 0.2% (0.4% expected), flat when you took out massively weak auto prices. Based on some of the reactions to the report you would have thought unemployment was at 10%. The wholesale inflation data (PPI), however, dovetailed nicely with the sackcloth and ashes donned after this week’s retail numbers. Core producer prices were flat month over month and fell to 1.5% annually. Many reasoned that if the CPI follows suit that will give the Fed the cover it needs to cut rates and stave off a potentially heinous slowdown (even, of course, as the more recent leading data suggests the economy is already picking up steam again).

That combination was enough to spark up futures a bit, though they were waffling heading into the open. The biggest fear among traders was that an early bounce would turn into another Thursday high to low sell off. Stocks rallied nicely up to midmorning and then the inevitable test came. The pullback held with moderate losses through lunch, then started back up. Just as the move higher got underway a story hit that terrorists had planned to attack US interests (soldiers, etc.) in Germany. That put the rebound on hold, but it did not lead to a sell off. In the last hour stocks sprinted higher into the close as some of that liquidity, seeing the market handled the bad news and was holding its gains, moved in to pick up stocks after that Thursday price thumping.

Nice price gains, good breadth and good leadership, but the volume was light. The move was dismissed by many because of the light trade, but there were some really good underpinnings. The volume was light, but it was concentrated in some of the rally’s early leaders that spent the last run higher testing back to support. They took off on Friday. Energy, metals, industrials and chemicals enjoyed some great bounces on some serious volume. We were looking for these to rebound and on Friday they were doing just that, giving us some great buys, not to mention pushing many of our existing positions sharply higher as they continued their uptrends.

Technically the action was mixed as you would surmise from the above discussion. Nice intraday low to high action that fought off a mid-session negative in the German news story. It was a good answer to the Thursday selling, bouncing up off support levels and reclaiming some lost support with respect to NASDAQ and SP600. Breadth was excellent in response to the very negative downside breadth Thursday. The boogey man is that low overall volume. NASDAQ volume was excellent moving into the Thursday selling, then showed some distribution Thursday and a light trade rebound Friday. Not great action, but one distribution session in a run is not the end of the run. NYSE volume has been more questionable as it was overall low on the last run higher. It was lower on the Thursday selling as well, however, so at least it is consistent, i.e. not leaning one way or the other.

Despite the volume, we have to lean back on the good leadership that showed up Friday from sectors that had led early and tested and rested while the rest of the market posted the latest round of gains. Those strong early leaders are important. Their resurgence here shows money continuing to rotate around the market AND moving back into these stocks in a big way with very selective buys. You have to like that kind of money movement and its focus on specific sectors as it shows smart money is still in the market, still ready to buy and even at some higher prices.

Thus while overall trade was light and leaves the market subject to an additional pullback, some key early leaders were leading once again. That bodes well for the rally as it shows that money is still moving in, rotating to different sectors that are considered ripe for the buy after a pullback to consolidate. These early leaders can make moves higher while the rest of the market continues the pullback, making us money until the market pullback is done and other sectors are ready to make their moves again. Based on this action in these early leaders, it looks as if the market rally is not ready to go into a much deeper test at this juncture.

THE ECONOMY

Is the PPI a precursor to a lower CPI?

The overall PPI was pushed higher by energy prices this time around as food prices posted their weakest gain in five months. Gasoline prices jumped 8% while food rose 0.4%, well off the 1.4%, 1.9%, 1.2%, etc. gains in the prior months. With gasoline jumping the overall PPI rose 0.7%, pretty much in line with the 0.6% forecast but below the 1.0% rise in March.

The core was, as always, the key. It was flat versus the 0.2% rise expected. That kept it flat for the second month and on a steady downtrend. Flat the past two months, a 0.4% February outrider, preceded by a 0.3% and 0.1% rise. That pulled the year over year rise down to 1.5% from 1.7%, matching the October 2006 level. Compare that to the 2.8% rise in core back in July 2005 that marked the decade high. Didn’t we say pressures on prices peaked in October 2005? Go back and check; we sure did.

Regardless of what we said, the trend is lower even with intermediate and crude goods showing big gains year over year. These are not making it into finished goods. Auto prices are falling even as the input prices rise. They cannot pass the cost of the product onto the buyer. Boat manufacturers are trying to pass the costs along but as the forecasts earlier in the year show, buyers are not paying up and a weak 2007 is forecast, forcing boat makers to lower their prices.

This failure to pass along the price increases is a theme that recurs in every expansion. There is the ever-present worry that prices will be foisted upon buyers. The fear in the 1980’s was a pass through. The fear in the 1990’s was a pass through. It never happened. We always look for pass through when the economy is strong but it doesn’t appear. McTeer and Laffer are absolutely correct: when an economy is growing and creating goods, services, jobs . . . the indicia of prosperity . . . supply meets demand. When DID we see pass through? In the 1970’s when the economy was in malaise with no goods, services or jobs. Too much money without any supply creation exploded inflation as demand well in excess of supply allowed producers to pass on costs. Of course the money was worth less because of the rampant inflation, but the costs were passed on. Right now even with low pricing power in another expansion, companies are flush with cash. Now if the Bush administration would get off promoting a weak dollar those dollars would be worth a lot more. At least there is low inflation and thus the dollars we make are not being eaten up by inflation gains.

So does that means CPI will be lower? We believe so. It won’t be at the 1.5% shown by PPI; consumer prices are not as low to start with and they have not fallen off the table. That said, prices are starting to fall at a faster pace, at least overall. No one month tells the entire tale, but as with PPI, CPI is on the trend lower. Inflation is still pesky, but inflation pressures continue to decline.

Leading indicators hit a 3 year high.

The economic recovery officially started in 2003 though we were writing of the robins on the lawn in late 2002 with respect to the economy turning the corner. The signs were there in the leading indicators but many were still talking about the woeful economic conditions. More recently the economy experienced a slowdown that started second half 2006. Of late, however, the economic indicators point to a recovery beginning to take hold even as many are still putting forth doomsday scenarios relating to the housing industry, a tapped out consumer, etc. Even with the solid turn up in the data, however, the pessimism remains.

Last week ECRI, the best man-made leading indicator, showed a solid increase, keeping the string of steady gains alive and well. This week the annualized growth rate rose to 5.2%, a three year high, leaping from 4.4%. Impressive. It also makes sense. After the surge in 2003 that saw GDP gain 7.4% in Q3 of that year, the expansion naturally slowed over the next two years though it was still expanding nicely. In 2006, three years into the recovery, it hit a slow spot. After that it is starting to come back. As it does, growth rates jump again. Thus the best leading indication in three years. With inflation falling (no doubt helped by the growing economic strength) this is a very positive outlook for the economy and thus the market. Why has the market been rallying? Because it was sniffing out this recovery.

THE MARKET

MARKET SENTIMENT

It was a week where there was a lot of sentiment action though you could not measure it via the VIX. There was the ‘this time it is different’ on Wednesday that led to the immediate butt thumping gut punch on Thursday. As we said Thursday, the new rule of thumb: when you hear ‘this time it is different’ expect things to turn on a dime. In any event, there is still the feeling the market is extended among professionals and the so-called ‘retail’ investor as measured by the AAIA. It is extended without doubt, but even with the pessimism we saw money, serious money, moving into energy, metals, chemicals, industrials. Wall of worry, baby. The market is due for a pullback, but it is also showing rotation into areas that led but already made their pullback.

VIX: 12.95; -0.65
VXN: 16.09; -1.29
VXO: 12.91; -1.09

Put/Call Ratio (CBOE): 0.94; -0.17

Bulls versus Bears:

Bulls: 53.5%, up from 51.7% and close to the 55% considered bearish. Seems the market beat it to the punch and sold before 55. It was 45.5% six weeks back. It has not topped its recent high at 53.3% but is well off the 60% hit in December 2006. For reference it bottomed in the summer 2006 near 36%.

Bears: 20.0%. Plunged from 24.7% in the most telling move of the two indicators. This is the level considered bearish, and of course the market was careening lower on Thursday. Quite a drop from the 27.5% hit 5 weeks back. The rally has taken the bears down from the recent highs near 29 (28.4% and 28.9%). It is now matching its January and February lows. For reference, it hit a post-2002 high in that late June 2006 move (hit near 36%), 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: +28.48 points (+1.12%) to close at 2562.22
Volume: 1.802B (-22.76%). That is a significant drop in volume as NASDAQ price/volume action the past couple of sessions was not for spit. Some distribution Thursday and a weak bounce Friday. NASDAQ tried to show some leadership qualities the prior week but gave up on the effort last week. Don’t want to see it collapse, but it was not in the sights of the buyers on Friday, and there were some serious buyers out there based upon the volumes seen in those sectors highlighted above.

Up Volume: 1.427B (+1.113B)
Down Volume: 352M (-1.644B)

A/D and Hi/Lo: Advancers led 2.34 to 1. Not bad upside breadth at all though it fell short of the outsized downside move Thursday. It was really interesting that the large cap NASDAQ 100 led the entire market at +1.26%. Good recovery action, however, much better than what was shown on the prior upside sessions for the week.
Previous Session: Decliners led 3.59 to 1

New Highs: 125 (+7)
New Lows: 86 (-1)

NASDAQ CHART: http://www.investmenthouse.com/ihmedia/NASDAQ.jpeg

NASDAQ gapped up to the 18 day EMA and then rallied back up through the 10 day EMA and just cracked back into its old uptrend channel marked by the November to February trendline. Of course it has poked so many holes in that trendline of late that it doesn’t mean what it used to. NASDAQ struggled last week, rising on lower volume, selling on higher volume Thursday, then bouncing on low trade. It is hardly in a position of strength after the week other than where it managed to close with respect to the trendline. It did hold the break over the late February high on the Thursday thumping, the silver lining. NASDAQ has some work cut out ahead of it, and it appears the path of least resistance is lower, particularly as NASDAQ stocks were not getting the volume and money many of the industrials enjoyed.

SOX (+1.19%) enjoyed a decent gain off the 18 day EMA, but it was not leading as you would expect if the chips and indeed techs were serious about making a move here. It managed to hold the breakout from the six month range, and now it will try to extend once more, something it has had a hard time doing.

SP500/NYSE

Stats: +14.38 points (+0.96%) to close at 1505.85
NYSE Volume: 1.413B (-8.2%). Volume was lower as the NYSE indices bounced off the up trendline in its channel. Volume has been mushy at best on the last run. Good volume as it reversed off the trendline two weeks back and that showed key buying at a critical time. It faded on the rest of the move and at least it did not rise as the index faded Thursday. A good push that kicked off the next leg showed the big buyers were in, using that money. They were not bailing on Thursday. They were not out in force Friday, however.

Up Volume: 1.163B (+1.002B). 4.8:1 up to down volume Friday. Not quite the 8.4:1 downside volume Thursday, but not a bad showing.
Down Volume: 240M (-1.113B)

A/D and Hi/Lo: Advancers led 3.35 to 1. Not bad at all, matching the downside breadth Thursday. The energy and metals were showing some power again on Friday, and that pushed that breadth on up.
Previous Session: Decliners led 3.39 to 1

New Highs: 143 (-2)
New Lows: 27 (-7)

SP500 CHART: http://investmenthouse.com/ihmedia/SP500.jpeg

SP500 bounced up off the 18 day EMA and the November/February up trendline that marks the former (and now the current) channel. Like how it held that test of support, turning soft support into harder support. After a break up through a resistance level it needs a successful test to turn it into hard support. Before that it is considered soft, which is a notch above putty. Stronger volume would have been nice, but it would have been nice if I got a new wakeboard for Christmas as well. I survived just fine without it (and likely because of not getting it). Again, there was key buying in returning leaders, and that was on solid volume.

SP600 (+1.15%) rallied back through the 18 and 10 day EMA. It held the October/January up trendline that marks the bottom of its late 2006 uptrend channel on this last test, something it had to do. It has been rocky of late, dumping down to that trendline in the late April selling then early May buying, managing to hold on and continue the trend higher. It was back down at that level Thursday as energy and metals faded, but they completed their test on that move. Friday they were back up and SP600 jumped up off the trendline once more. The selling was not on high NYSE volume, and if SP600 starts to lead here as we suspect it will given the great moves in energy, metals, etc. on Friday, that is a huge boost of support for the idea the economy is strengthening.

DJ30

The blue chips held the 10 day EMA and bounced right back through the top of the uptrend channel (13,250). Volume was again below average and lower, spending the entire week below average as it continued higher. DJ30 showed some above average trade for the two weeks (straight) prior to last week. Weaker and weaker volume on the trend higher is not a sign of a rally ready to break to new highs. Hold it; we said that in April. Nonetheless it is hard to sustain such moves and the Dow still is not out of the woods after that strong run and the Thursday buck lower.

Stats: +111.09 points (+0.84%) to close at 13326.22
Volume: 210M shares Friday versus 224M shares Thursday. No dumping on the Thursday selling but no heavy buying on the Dow overall Friday. Weak volume all week though the Wednesday upside was the best volume it showed.

DJ30 CHART: http://www.investmenthouse.com/ihmedia/DJ30.jpeg

MONDAY

The market enters this week still extended and showing questionable price/volume action. Been there, done that on this rally, but of course, as soon as you start anticipating something as the norm it is no longer the norm. Thus you have to respect the fact the market is extended and showed some questionable action toward the end of the week. It did this two weeks back when April ended and May began; this time there is no end of month, beginning of new month to explain it. It is extended. Still, as Crash Davis (Kevin Costner) said in ‘Bull Durham,’ you have to respect the streak; the new money thus far has come in at every possible opportunity and pushed things up. Friday some serious money pushed those prior leaders higher. Real substance to that buying, not like a push-up bra. It was not very widespread, however, and that leaves the rest of the market subject to that pullback that Thursday tried to get going.

Thus we are going to keep looking for buys in those leaders that tested while the rest of the market moved higher on this last leg and be ready for those to continue higher this week. As noted, we picked up some of these Friday and will be ready for others this week. In addition, other stocks continue to work on good bases, setting up for the next breakout as the money in the market continues accumulating shares.

This may sound simplistic given all of the theories about the market heading seriously lower, the economy ready to implode, etc., but the market, like baseball, can sometimes be fairly simple. You throw the ball, you hit the ball, you catch the ball (keeping with the ‘Bull Durham’ theme). You see the good patterns, you see the volume move in, you buy the stock. Friday we saw, despite overall low volume in the market, some serious volume in some solid early leaders that were primed to move back up. That was the money moving into a ‘new’ area. It may peter out on us, but we don’t think so. When the market shows you something you need to go with what the market is showing and put all of your logical, reasoned theories aside because the market doesn’t care what you think and often does the opposite of what you consider rational. With the market on the cusp of summer and all of the other issues about the economy and the length of the current run, it only makes sense to follow what the market is showing.

Support and Resistance

NASDAQ: Closed at 2562.22
Resistance:
2563 is the November/February up trendline
2580 is the May high
2590ish is the top of the November/February channel
2590-95 from an April 1999 interim peaks
2778 from a July 1999 peak
2887 from a September 1999 peak
2920 from an October 1999 peak

Support:
The 18 day EMA at 2541
The July/August trendline at 2542
2531.42 is the February high (post-2002 high)
2523 is price resistance November 2000
2509 is the January 2007 high
The 50 day EMA at 2498
2471 is the December 2006 high
2468.42 is the November 2006 high
2460 is the March high
2405 is the ‘hump’ high
2400ish from the late November and late December 2006 lows.

S&P 500: Closed at 1505.85
Resistance:
The upper trendline of the channel at 1518
1520 from the September 2000 peak
1528 close, 1553 intraday from March 2000 all-time index peak

Support:
1500 from April 2000 peak
1496 is a peak from July 2000
The 18 day EMA at 1490
1487 is the late November to February up trendline
1475 from peaks in December 1999 and January 2000
The 50 day EMA at 1463
1461.57 is the February 2007 high.
1440 is the mid-January high
1439 is the March high
1432 is the December 2006 high
1425 is an interim high from November 1999
1410 is the ‘hump’ high
1408 is the November high

Dow: Closed at 13,326.22
Resistance:

Support:
13,255 is the upper channel line in the November/February channel
The 10 day EMA at 13,230
The 18 day EMA at 13,113
13,111 is the former up trendline that marks the lower channel.
12,796 at the February 2007 high
The 50 day EMA at 12,812
12,700 is the early February peak intraday high
12,623 is the mid-January high
12,511 is the March intraday high.
12,499 is the December intraday high.
12,361 is the November 2006 high
12,350 is the March ‘hump’ high
12,039 is the early March low.
October high is 12,167
11,986 is price support from mid-October and the early November low.
11,940 is the March low

Economic Calendar

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

May 15
- CPI, April (8:30): 0.5% expected, 0.6% prior
- Core CPI (8:30): 0.2% expected, 0.1% prior (this will likely be wrong)
- New York Empire State Index, May (8:30): 9.5 expected, 3.8 prior
- Net foreign purchases, March (9:00): $70.0B expected, $58.1B prior

May 16
- Housing starts, April (8:30): 1,48kM expected, 1.581M prior
- Building permits, April (8:30): 1.520M expected, 1.564M prior
- Industrial production, April (9:15): 0.3% expected, -0.2% prior
- Capacity utilization, April (9:15); 81.5% expected, 81.4% prior
- Crude oil inventories (10:30): 5.511M prior

May 17
- Initial jobless claims (8:30): 310K expected, 297K prior
- Philly Fed (12:00): 2.0 expected, 0.2 prior

May 18
- Michigan sentiment, May preliminary (10:00): 87.0 expected, 87.1 prior