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InvestmentHouse Weekend Update:

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

- Stocks bounce as shorts cover heading into the weekend.
- Is the bond rate spike artificial as well?
- Trade deficit drops unexpectedly as strong world economy and even the weaker dollar have their impact.
- Plenty of leaders in position to bounce but the selling has not yet shown its climax.

Shorts cover after three down sessions.

We were expecting the Thursday downside momentum to continue into Friday before the shorts started to cover for fear that too much of a good thing would lure in some more of that global money. It did continue as bond yields jumped further with the ten year hitting 5.12%. That, however, was all pre-market. Before the bell futures started to recover from the start of another down session. The trade deficit was much less than expected. Oil was falling precipitously, giving back all and more of the Thursday gain (closed at 64.52, -2.36). The federal deficit was even lower than expected as tax receipts continue to spike ($152B through May versus $227B in 2006). The dollar, riding the back of bond yields, continued to improve to levels not seen for many months.

That was enough to turn futures to positive and stocks opened higher. The sellers tried to take back the open in the first hour, but that obviously failed. Energy faltered after an early bounce, and that led to the downside test, but then the market, helped by early tech strength thanks to a solid NSM earnings report, led stocks higher even without energy's participation. When rumor hit in the early afternoon that X (US Steel) might be a takeout candidate by a foreign buyer (kind of ironic, huh?), the industrials kicked in their share and stocks really started higher.

The move sent the indices to close at session highs with 1+% gains across the board. Down close to 2% Thursday, sharply bouncing Friday. When the selling dissipates in a world of money, the turns occur quickly. This bounce evoked quite a bit of relief and commentary about a 'recovery' from the selling and other 'whew' type reporting. It is true that this rally has seen only 2 to 3 day pullbacks before the money just could not stand to move back in and take charge once more, and thus the positive commentary as the action seemed 'in line' with the rest of the rally.

Of course, each rally goes through life stages just as each stock does, whether upside or downside, and just because it happened before does not mean it will happen again. As we have noted, the rally was extended, and on Wednesday DJ30 broke through its 18 day EMA for the first time since March, and it crashed its old channel on Thursday. That is not 'in line' with the rally. NASDAQ and SP500 broke their uptrends. They found support at the 50 day EMA where you would expect them to at least make a stand, but their trends had held since recovering them in April. It is pretty clear the rally is getting its comeuppance, at least near term, as is inevitably the case.

The question is always how much it will have to give back. Technically the action Friday was negative. Higher volume selling on all indices, breaking trendlines, some struggles in the leader patch. Friday the indices rebounded with SP500 and NASDAQ bouncing off their 50 day EMA where the big money moves in to support stocks if they are still interested. That was a very good indication. It was backed by some decent breadth (2+:1) as most stocks recovered from the earlier beating.

Other than that the technical indicators were not very convincing. Volume tailed off rather dramatically from the prior selling session, falling well below average on NASDAQ after three downside above volume days. NYSE trade remained just above average; not bad given the Tuesday and Wednesday downside trade was average or less, but it was still dwarfed by the Thursday downside volume. That 2:1 breadth did not stack up to the -11:1 on NYSE Thursday. It was not bad, but when you start getting these wild swings in any indicator it means there is a fight ongoing that has yet to be resolved.

About the only thing that can disprove that is an immediate and strong turn to resume the trend. That may still happen, but Friday was not the day to show it. There is still some great leadership in position to move higher once more next week, and we will be ready if they do as this is the backbone to the market. The money has to come back in and drive the action with volume, i.e. showing that strong return to the trend. Until that happens you have to proceed in accordance with the strongest moves of late, and they are to the downside. Friday was a relief to many, but it was just a relief rally.

THE ECONOMY

Adjustments in mortgage portfolios aiding in bond yield rise.

There are many reasons bond rates are rising (meaning bonds are being sold) other than just the 'I' word that was bandied about last week. As we discussed Thursday, higher rates are not necessarily a bad thing in themselves as long as they don't rocket to 5.5%; that would change the dynamics of stock values unless earnings really shot back up. To some extent they are simply catching up with leading economic indicators as to where the economy is heading longer term.

There are other factors at play. One is rising global interest rates. The ECB hiked last week and New Zealand raised unexpectedly. Yields are rising around the world and that lures some money away from US treasuries though there is always a demand for the safe, stable US bond. This is not a dominating factor, but it is a factor.

There is also the adjustment factor with respect to portfolios. Recall the Greenspan 'conundrum' as to why rates were so low given good economic underpinnings and how he attributed some unknown quantity of this to world demand for US treasuries? The rest of the world economies were improving and providing excess cash (trade imbalances with the US) and surging oil prices left producing countries awash with cash. Some of that additional cash was being recycled into US treasuries, helping tamp down rates.

The sharp drop in treasuries last week (and the commensurate rise in rates) rattled the markets on many levels. Were foreign countries pulling out of the US after years of talk? Was inflation surging? Would this crimp the ability of private equity to borrow to make all of the acquisitions that help drive the market (an IMF official stated something to this effect Friday)?

As with the low rate conundrum, these probably all played a factor to some extent. The sharp drop in bond prices, however, suggests that something else was at work last week. Just as the low rates were somewhat artificially maintained through heavy foreign buying, the quick spike in rates last week was somewhat artificial as well. If you look, most of the rise was on the long end as the yield curve reverted rather nicely to 5.00% versus 5.12%. Still a flat curve but the gains were 2:1 or better at the long end. There are many huge mortgage funds and pools that maintain certain allocations of short and long term bonds as well as certain dollar amounts of bonds. When bonds start to rise or fall they have to adjust the allocations and their holdings. Last week there was something of a perfect storm of factors that turned some normal selling and adjustments into heavy selling. As bonds sold further the need to adjust increased and a snowball effect ensued.

Thus we are likely to see some moderation in this action. Typically when any security breaks a key resistance or support point the immediate push is to further the breach as required reallocations are made. Once the initial reallocation is completed, however, there is a rebound toward the mean. It may not get back there, but the action after the break tells you more abut the true move. Thus the spike will be tested as the pressures from the week balance out. Then we see the true move for treasuries. There is no question, however, that rates are a bit higher because the economy is solid and the bond market is projecting that future expansion.

Trade gap declines more than expected as oil demand offsets some price increase.

April's trade gap clocked in at $58.5B, down from $62.4B in March. Compared to the $63.5B expected, not bad. March was revised lower as well. Oil import prices were higher for the month by 8.1% but a 3% drop in oil consumption lowered the amount imported, dropping the value of imports by about $1B.

Exports rose 0.2%, moving higher now for 10 of the past 12 months, hitting record highs all the way. That is a positive for US businesses of course, and we want to sell as many goods as possible around the world. The weaker dollar is helping along with the overall stronger world economy, but we should not sacrifice our dollar and its attractiveness as an investment vehicle in order to up some overseas sales. A happy balance as with everything else is the answer, but the problem is no one agrees upon what that happy medium is.

THE MARKET

MARKET SENTIMENT

As fast as volatility jumped higher Thursday (+2.19), it gave it back Friday as stocks rebounded. Volatility suggests anxiety is rising, but it is well off the 21.25 hit in March. But face it; volatility is volatile. In February and March when it spiked on that selling it swung up and down in rapid succession.

With volatility it is the trend that is the key. For months and months (since August 2006) the trend was lower to flat as the market rallied off last summer's selling. It spiked in February and March, then settled back down as the rally resumed. Now just a couple of months later it is at it again. It is just a few sessions into this new move so there is no trend established with respect to this specific move.

As for the bigger picture, however, we see two jumps higher in relative short succession after a long dry and quiet spell. This is an indication that the overall market character in this long rally is trying to change as the move is not as steady. Just as a stock turns more volatile as it nears the end of a run, the same can be said with respect to indices. Thus this latest jump, if it continues, is not only an indication of a current increase in worry, but also potentially a bigger problem for the market as it heads into summer.

VIX: 14.84; -2.22.
VXN: 17.12; -2.18
VXO: 14.73; -2.28

Put/Call Ratio (CBOE): 1.12; -0.12

Bulls versus Bears:

Bulls: 52.2%. Down from 53.8% last week and 54.3% the week before. That was last week, however, and the downdraft this week will likely make a significant inroads into this but it won't push it down to 40ish where it needs to be. Of course given the indices were hitting new all-time highs, bulls are at a level you would expect. Still well off the 60% hit in December 2006. For reference it bottomed in the summer 2006 near 36%.

Bears: 22.8%. Good jump higher from 21.5% as it continues off the 20.7% hit two weeks back after spending some time below the 20% level considered bearish (19.6% the prior week). It is still well off the 27.5% hit 2 months back. The rally has taken the bears down from the recent highs near 29 (28.4% and 28.9%), 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: +32.16 points (+1.27%) to close at 2573.54
Volume: 1.988B (-18.48%). Volume did not match the price gain, fading to below average and well below the Tuesday through Thursday selling volume. NASDAQ bounced, but there were far fewer participants.

Up Volume: 1.631B (+1.31B)
Down Volume: 331M (-1.773B)

A/D and Hi/Lo: Advancers led 2.12 to 1. Respectable breadth as NASDAQ 100 and NASDAQ matched their pace higher. Even with the -3.5:1 Thursday, the breadth was good enough. As noted, however, volume was not.
Previous Session: Decliners led 3.55 to 1

New Highs: 72 (-15)
New Lows: 61 (-30)

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

NASDAQ held where it had to, tapping the 50 day SMA on the session low and bouncing to post a solid price gain. The move took it back to the 18 day EMA (2574) and back through the July/August 2006 up trendline. All in all a good move for the session and a good response to the selling. Bigger picture NASDAQ is in the process of building a head and shoulder; how this bounce plays out will tell more of that story. Suffice it to say that NASDAQ is very choppy the past three weeks. It was okay after that last pullback but this one was a little harsh and left it vulnerable. NASDAQ typically does not perform all that well in summer, and after this past week the pattern turned even more questionable.

SOX (+3.10%) enjoyed a super session as the NSM earnings bounced it right back up to the top of its range, the same one it broke out of in late April and then gave back. Despite this move we are not looking for SOX to provide any real leadership having failed that breakout. Indeed, if it fails at the top of its range again (493) we are looking to short it.

SP500/NYSE

Stats: +16.95 points (+1.14%) to close at 1507.67
NYSE Volume: 1.564B (-18.03%). Volume fell back, coming in just above average on a session that saw SP500 and SP600 rebound. It was not a bad volume session. Trade on the Tuesday and Wednesday selling was lower than the Friday rebound volume. Thus it was a bit better than NASDAQ as there has not been as much distribution and more buying on the rebound.

Up Volume: 1.342B (+1.238B)
Down Volume: 196.555M (-1.595B)

A/D and Hi/Lo: Advancers led 2.28 to 1. On any other day the 2.2:1 breadth would have been a solid performance. On the heels of an 11:1 drubbing it was rather anemic. As noted Thursday, that session's breadth was what you expect when you get extreme readings at the bottom of a sell off. That it occurred in the initial stages of some selling is less of an indicator, but we are not going to ignore that extreme, particularly as volume was not that horrible on NYSE as it sold back.
Previous Session: Decliners led 11 to 1

New Highs: 37 (-3)
New Lows: 97 (-7)

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

The large cap index surged back up off the 50 day SMA (1489) test. As with NASDAQ, that is what you would expect it to do if there was any life at all left in the index. The move took it up to the November/February trendline, the next important resistance point if the large caps are to continue the recovery. The Thursday selling was extremely harsh in many ways, but the overall move to that point was primarily positive. While SP500 is arguably due for a more sustained pullback after that long run higher from last August and just a 5 week base in the spring, you can also argue that following the breakout from that base the large caps put in a normal move up the 18 day EMA and are now making the deeper test to the 50 day EMA that sets up the next run higher. Its pattern in that respect is a bit better than NASDAQ, but it will have to show a break of the trendline on rising trade to be back in the upside game.

SP600 (+1.05%) bounced off its 50 day EMA as well, and that level is coincident with the September/January trendline, a nice double layer of ice as we noted Thursday night. That gave it the upward push that kept it in the channel on that lower but slightly above average volume. After breaking out of its channel the prior week, gravity set in. at this stage, however, it is still holding its trend, and how it reacts this week will be key for the rest of the market as the small caps assumed some leadership the past few weeks.

DJ30

DJ30 held some support at 13,250 and bounced cleanly, clearing its upper channel line once again. It did not even make the 90 point dip to test the 50 day EMA before making this rebound. Maybe it can continue this move upside after this test; it has landed on its feet more times than a cat. The pattern sure has turned heavy with last week's sell off, but as with SP500, after a run up the 10 day EMA following the April breakout from its short base, a deeper test at this juncture is a normal set up for a continued run higher. The severity of the selling on DJ30 as well as the other indices, however, warrants a does of caution this week as the indices fight out their issues.

Stats: +157.66 points (+1.19%) to close at 13424.39
Volume: 242M shares Friday versus the big 298M shares Thursday on that harsh selling. Volume remained above average, however, and stronger than the Wednesday trade. Thus Friday was no shrinking violet.

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

MONDAY

Friday allowed the market to come up for some air after three hard downside sessions in what amounted to a technical relief bounce as some shorts covered ahead of the weekend. The strength of the selling, the breaks of trendlines, and the weaker Friday rebound all make up a change in character in the move and suggest there is more to come in this round of selling. It can always simply continue back higher, shaking the week off as if it did not exist, but this move also comes relatively quickly after a sharp downside push in late May. As noted earlier, the frequency of these events tells you as much about the future action as the strength of the individual moves.

With expiration we are likely to see more volume moves on Tuesday and Wednesday as positions are squared ahead of Friday. The addition of last week's selling can exacerbate those moves as traders and funds have to make bigger adjustments. There is some important economic data such as retail sales and the Fed Beige Book on Wednesday, the PPI Thursday, and CPI, production and Michigan sentiment Friday. Thus we are not likely to see things calm down much, and given DJ30 and SP500 broke some important trends last week the action could be what you call interesting.

The start of a new week (and an expiration week) finds many tried and true leaders on the report in good position to rebound and start new moves. We are thus looking at many of those winners as potential new positions in the week ahead. If this was just a short term hiccup in the continuing move higher these stocks will provide that leadership once more as they come back up off of near support tests. If the selling resumes the Friday bounce has set up some better downside entry points; we like those where a stock breaks lower, tests, then fails that test. Basically the opposite of the first test of an upside breakout.

In sum, the market moves last week started to show a change in character from the liquidity and M&A driven rise that spurred the run from March. Interest rate issues were a cause and an excuse for sparking the selling, but after a long run higher the market was due at some point for more of a pullback than two to three days. After the initial rate scare we will see if those fears calm down and more normal action returns in the bond market. There are still many more positives than negatives for the economy and thus the stock market, and once this near term selling runs its course the longer term prospects still remain solid.

Support and Resistance

NASDAQ: Closed at 2573.54
Resistance:
2580 is the May high
2592 is the November/February up trendline
2590-95 from an April 1999 interim peaks
2613 is the top of the November/February channel
2778 from a July 1999 peak
2887 from a September 1999 peak
2920 from an October 1999 peak

Support:
The July/August trendline at 2568
The 50 day EMA at 2539
2531.42 is the February high (post-2002 high); 2525 intraday
2523 is price resistance November 2000
2509 is the January 2007 high
2471 is the December 2006 high
2468.42 is the November 2006 high
2460 is the March high

S&P 500: Closed at 1507.67
Resistance:
1510 is the late November to February up trendline
The 18 day EMA at 1515
1520 from the September 2000 peak
1528 is the March 2000 closing high
1553 high intraday from March 2000 all-time index peak
The upper trendline of the channel at 1540

Support:
1500 from April 2000 peak
The 50 day EMA at 1492
1475 from peaks in December 1999 and January 2000
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

Dow: Closed at 13,424.39
Resistance:
The 18 day EMA at 13,461
The 10 day EMA at 13,490

Support:
13,325 is the upper channel line in the November/February channel
13,240 is the November/February up trendline that marks the lower channel.
The 50 day EMA at 13,225
12,796 at the February 2007 high
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.

Economic Calendar

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

June 12
- Treasury Budget, May (2:00): -$60B expected, -$42.9B prior

June 13
- Export prices, May (8:30): 0.4% prior
- Import prices, May (8:30): 0.2%
- Retail sales, May (8:30): 0.6% expected, -0.2% prior
- Retail sales ex-Auto (8:30): 0.7% expected, 0.0% prior
- Crude oil inventories: +1.1M prior
- Fed's Beige Book (2:00)

June 14
- Initial jobless claims (8:30): 309K prior
- PPI, May (8:30): 0.5% expected, 0.7% prior
- Core Ppi, May (8:30): 0.2% expected, 0.2% prior

June 15
- Current account, Q1 (8:30): -$202.50B expected, -$195.8B prior
- CPI, May (8:30): 0.6% expected versus 0.4% prior
- Core CPI (8:30): 0.2% expected, 0.2% prior
- New York PMI, June (8:30): 10.0 expected, 8.0 prior
- Net foreign purchases, April (9:00): $67.6B prior
- Industrial production, May (9:15): 0.1% expected, 0.7% prior
- Capacity utilization, May (9:15): 81.5% actual, 81.6% prior
- Michigan sentiment, preliminary, June (10:00): 88.0 expected, 88.3 prior