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InvestmentHouse Weekend Update:

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

- No one wanted to hold stocks ahead of the weekend.
- Some serious issues: Volatility, Frequency of the corrections, and key sector struggles (Financials, cyclicals, and transports struggling together).
- Rising volatility at market peaks is never a good sign.
- GDP solid, inflation low, consumer confident, but credit squeezes the financial markets.
- The key test for this correction is after the relief bounce to come runs its course.

Stocks try a weak rebound, get dumped late ahead of an uncertain weekend.

Futures were lower but the strong GDP coupled with low core inflation gave the pre-market a bracer, turning stocks higher on the open. Almost immediately, however, the market was sold as sellers used the bounce to move in. That rebound enjoyed a half-life of about 30 minutes. Michigan sentiment was released and it blew past the June reading, but it did not help the market. Another bounce over lunch into the last hour, another run by sellers sent the indices negative as NASDAQ peeled off 45 points from its early high, SP500 reversed 30 points, DJ30 260 points into the close.

Credit crunch fear piled on top of mortgage fears on the week, and that ignited the selling. The market held the sellers at bay even with the mortgage worries as it waited for earnings to come out better than expected. When that did not happen there was nothing to hold back the other problems from bubbling up. When the credit issues hit Wednesday and Thursday it was too much to hold back. Earnings finally came around (AMZN, AAPL, WFR, BIDU, CVX, etc.) but it was too late. The contagion fever infected the market and when that emotion laden virus hits, as with its human infecting cousins, it simply has to run its course.

A perfect selling storm.

It wasn't just credit contagion and mortgages, however. There was something of an induced unwinding of the carry trade. The New Zealand central bank raised rates with the primary goal of driving those using the NZ dollar as part of the trade out of the NZ currency. When you look at the action of the yen (the other part of the trade), treasuries, and gold, you could tell there was massive unwinding of this play. In the earlier correction this year there was a partial unwinding and that caused the market to struggle in the spring. This is a much more dramatic unwinding and it further undermined the market weakness.

That put the hammer to the market. Since the recent peaks DJ30 is down 5.3%, NASDAQ 5.9%, and SP500 6.2%. In the spring correction they fell 6.6%, 7.9%, and 6.7% respectively. The losses from the prior correction were hit on the second leg. If we get the bounce this coming week as we anticipate, we could have a very similar pattern to the spring correction in terms of the overall losses. That would also set up some great shorts for the next leg lower. How great depends upon how much of an upside rebound we get.

In the aftermath of the week we heard the usual from both sides of the fence. The bears were calling for more downside while the bulls were saying it was no time to panic. As for the bears calling for more downside, well that tells us this leg is getting close to its bottom. As for not panicking, are you supposed to wait for another 6% down and then panic? Ha! The idea was right though the delivery was less than artful. There is never a time to panic.

You always have to fight that urge, and as always, wait for the right moment and make your move. With the gaps lower last week there was not a lot you could do with some plays. Instead of bailing out on those at the bottom we are playing the percentages, i.e. looking for the rebound that typically lasts from 3 to 5 sessions. If a stock is holding a support level after this week, even a lower support level, it is likely to put in a good bounce on a market relief rally. That will at a minimum give us a better exit point, and some stocks will continue right on up, forming a good base and moving higher. That is why when we have this kind of volatile action we have seen we take interim gains on the way up. Indeed, we always like to take interim gains after a strong run, but when things are choppy there is all the more reason.

Technical issues.

Technically the action was grim once more. Volume was lower but after that huge Thursday selling spike anything seems lower. It was still well above average on both NASDAQ and NYSE. Breadth was still poor at -2:1 and better though that was way off the -13.5:1 seen intraday Thursday on NYSE. Stocks gave up a rebound attempt in the afternoon and closed at the session low. SP500 cracked the February peak as it dove lower again while SP600 broke the 200 day SMA on the close.

Beyond the session there are some disturbing features to this pullback that the prior corrections have not shown.

Volatility is rising at market peaks. After a long dormant period volatility jumped during the spring selling. No big deal there. It fell back but landed in a higher range. It rose modestly with the market as it recovered and then jumped again in the June turbulence. The market recovered and broke higher again and volatility dropped but it also moved higher with the market's gain.

We talked early in the year about volatility and when it becomes an issue warranting concern. We said to watch for rising volatility as the market rises as a sign of a more significant top. With volatility on a slow rise with the market and then shooting past the spring levels we have to watch closely how this next rally and subsequent down leg play out. It will likely be a good time to go to cash on the upside and then look for downside shots if we see volatility continue its trend higher during the next upside bounce.

Frequency of corrections is another issue. There was the summer 2006 correction and then the run into the spring where there was no correction, hiccup or otherwise. Two months later the June double bottom and a convincing looking breakout just over two weeks back. Then in July a sell off that quickly reversed the breakout and in its first week is already matching the spring downside fling. The market is having a harder time making upside moves stick, and a big breakout that is reversed in short order is never a good sign.

Leadership. There are still strong stocks across the market in excellent shape even after a week of heavy market selling. It is always a good sign when there are stocks that shrug off selling and go about their business such as CELG, NVDA, BG, etc. At the same time, however, financials are in the toilet and have been for all of July; some of them longer than that. Cyclical stocks (e.g. raw materials, durables, autos) are in the tank as well, starting their selling well before the past week's downside romp. When those two sectors decline in tandem history says beware as there may be something more serious ahead even if GDP looks good. Throw in some reports we are hearing from the truckers that tonnage never really picked up through the holidays after starting to decline in late summer 2006 (as we reported at the time) and indeed that some are saying there is a freight recession over the past six months, and you have some serious issues that historically do not bode well for the economy and thus the market. And of course, the market prices it in ahead of the economic news.

That said, after this week of selling, the size of the losses to this point, and the weak, disappointing close, the downside actually looks about tapped out on this leg. Another push down Monday and that would likely bring in some covering and a relief bounce. When that runs its course after roughly a week then we need to batten down the hatches and see how these massive undercurrents swirling through the world economies and markets plays out. Of course we will play the downside on that move and if it really breaks we will be able to take the rest of the summer off and then play the upside run on the backside of the year.

THE ECONOMY

Q2 GDP as solid as expected.

At 3.4% the first iteration of the second quarter output was better than the 3.2% expected, and blew away the meager 0.6% bump higher in Q1. Fastest growth since Q1 2006, not surprising since the economy suffered that mid-cycle slowdown the second half of that year.

There was some bad news in the report, however. Personal spending slowed to 1.3%, well off the 3.7% in Q4 2006 and Q1 2007. Even that 3.7% was revised lower. Government spending jumped to 4.2% from 1% in Q1, and government spending is not really a positive for GDP growth given government spending is inefficient to begin with and is made from tax dollars that were taken from the private economy. Moreover, exports jumped and imports fell, pumping up the GDP number but also underscoring the slowing consumption at home.

Offsetting the consumer slowdown was the continued rise in business investment. After slowing to end 2006 and the start of 2007, businesses started buying again, showing an 8.1% gain in the quarter, easily topping 2.1% in Q1 and -1.4% in Q4 2006. Indeed, those Q4 and Q1 readings really look to be the outriders because before that Q4 decline business investment rose 5.1% in Q3 and 4.2% in Q2.

In addition, inflation, at least at the core level, remained under control in Q2. Indeed, it improved over Q1. In Q1 the year/year core PCE was 2.4%, well out of the Fed's 1% to 2% 'comfort zone.' That hurt. The economy was slower with its 0.6% growth rate and yet inflation jumped. Stagflation comments were heard as Phillips Curve worshippers were dazed and confused. Then Q2 with its 3.4% growth rate and the core PCE fell to 1.4% year/year. How is that possible? We have covered this before: growth resolves inflation issues because supply is humming along and it is able to meet demand where it rises. When you have a slowdown in supply as seen in Q4 and Q1, that is when inflation pressures rise. That is why it is absurd for the Fed to try and slow the economy as a way of curbing inflation.

Sentiment rises but not as much as anticipated.

Michigan sentiment (final) for July clocked in at 90.4, down from the 92.4 originally reported but still a significant improvement over June's 85.3. This is the best showing in 5 months, reflecting a 9% jump in expectations and a more modest 2% increase in the present situation measure. The improvement is attributed to a bit lower gasoline prices, a solid labor market, and a better economic outlook versus the housing market slowdown. Interestingly, expectations are holding their trend higher, resuming the move after a June slowdown. Of the two components, it is always good to have a consumer looking for better times down the road.

Of course if the housing market was the drag in July, it will be a drag in August as well given the market worries related to it. On top of that the credit issues will be on consumers' minds. Not in the sense they understand that there is a worldwide credit squeeze right now, but more in the general sense that the stock market is selling as a result of that issue. That creates uncertainty in the consumer, and as with the investor, uncertainty tends to discourage buying.

THE MARKET

MARKET SENTIMENT

VIX: 24.17; +3.43. Volatility has now topped the March level just over 21. In one move it also bested the June 2006 peak at 23.81. Still in the first leg of the selling and already topping the level hit on the initial low in June. Now that brings up to key points. First, often the highs in volatility are hit on the initial selling as the subsequent bounce to test and the relieves some of the pressure that sent VIX higher and thus the second dip does not see as high a level. That happened in last summer's selling. It also happened in 2002 and 2003 when the early correction in 2003 off the late 2002 recovery jacked volatility back up. Thus with the percentage losses almost equaling those last summer and volatility topping that level, you could surmise this leg is almost spent and ready for a relief bounce.

Second, volatility started at a higher level on this run than it did back then. As discussed above, volatility is rising along with the market peaks. Thus it started from a relatively higher level and thus it could go higher here given its higher start. Not a big point, but it does put things in a bit more perspective.
VXN: 23.18; +3.68
VXO: 25.09; +3.32

Put/Call Ratio (CBOE): 1.38; -0.15. Fourth session above 1.0 on the close and again, well past 1.0 at that. Lots of put activity in S&P futures and on the SPY as well with 300% of the normal put volume Friday on the latter. Lots of bets on the downside from both the retail investor and the big money. With volatility spiking as well, this is helping gel a bottom.

Bulls: 53.9%. Rose last week from 52.3%, continuing the move higher from 49.5% and 49.4%, but it is going to change quite a bit after this past week. Hit 56.7% 7 seven weeks back. The 55% level is considered bearish, and it topped that level on this last run. Still off the 60% hit in December 2006 but getting closer. For reference it bottomed in the summer 2006 near 36%.

Bears: 18.0%. Right at the lows for the past two months, falling sharply from 19.3%. That is what that breakout did. Dow below the 20% threshold level considered bearish. Spent a month at 18%, well off the 30% hit in March. Well off the 27.5% hit in April. 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: -37.1 points (-1.43%) to close at 2562.24
Volume: 2.778B (-20.66%). Hey, volume was lower on the selling. Big deal. After record volume Thursday anything would be lower, and yet volume was still way above average, topping the prior month's trade outside of Thursday. No let up in the selling yet.

Up Volume: 508M (+74M)
Down Volume: 2.18B (-876M)

A/D and Hi/Lo: Decliners led 2.46 to 1. A rather calm reading after the flogging the A/D line took for the week.
Previous Session: Decliners led 4.69 to 1

New Highs: 65 (+1)
New Lows: 297 (-76)

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

Another dive lower to the 90 day SMA, closing just below that level and breaking a bit lower than the Thursday low. About all you can say about the close is that it managed to hold above the lows in the May to June range. What a victory. NASDAQ was pounded, though this weekly loss was not as bad as in March. It is all relative as they say. NASDAQ is down but it also started at a better position than the other indices so it is still well above its early year highs. Nonetheless, it has given up its breakout and is struggling just as hard as the other indices. Despite that, there are technology stocks that are holding their own and that look good even in the selling (e.g. HPQ, NVDA).

SOX (-2.01%). Okay. Another try at the breakout gone bad. SOX looked invincible on this move, but nothing like 5 down sessions out of 6 to break up a nice run. SOX returned all of the early July gain, about 45 points, on the Friday close, and it fell below the May highs. Now it has to rebuild from the rubble.

SP500/NYSE

Stats: -23.71 points (-1.6%) to close at 1458.95
NYSE Volume: 2.233B (-19.84%). Volume was lower on NYSE as well but also the strongest in over a month ex-Thursday. A lot of distribution on the week, and likely a crescendo on Thursday with that record trade.

Up Volume: 406.09M (+300.227M)
Down Volume: 1.849B (-188.727M)

A/D and Hi/Lo: Decliners led 2.15 to 1. Wow. At -2:1 it was almost like a moral victory after -13.5:1 drubbing intraday. The advance/decline line has rolled over after flattening out for the past two months. Another issue confronting this selling bout, but it is not different from the summer 2006 selling when the A/D line did the same maneuver though it was not as protracted as the current flattening.
Previous Session: Decliners led 9.33 to 1

New Highs: 21 (-20)
New Lows: 400 (-343)

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

Another big downside session for SP500 capped its worst week of declines since September 2002. Dubious distinction. As we said, the selling in this first leg lower has almost matched that of the low on the second leg of last summer's sell off. A bit more virile this time around though it does have over 300 more points to play with. It was no easy slide as volume remained strong as SP500 closed on its low. Indeed, it cracked the longer term trendline that rose out of last summer's selling after tapping that level and rebounding Thursday. The move took SP500 just below its February peak (1465.30 closing), and that set off alarm bells on technical desks across the country. The 200 day SMA (1448) is just a morning's sell off away, and it seems very likely that SP500 will get there. We would not be surprised, however, to see it feint that way to start next week and then rebound ahead of it. If not, then a breach of that level that brings in more immediate selling, and then a big short covering binge.

SP600 (-1.51%) continued its clubbing as the small caps are sold off along with the rest of the market but also taking a bit more as people are looking toward large caps as the economic expansion reaches its mid-life crisis. On the close the small caps breached the 200 day SMA, the first index to do so. High praise indeed. Some support here at 410 but that is just minor support.

DJ30

The blue chips continued the downside as well, undercutting the Thursday intraday low and landing on the 90 day SMA (13,256) to close. While the cyclical and materials are selling, the technology stocks are, for the most part (e.g. IBM, HPQ), holding the line nicely. This matches the June twin lows. This is a very good point for DJ30 to try its initial bounce from this selling as the next support is the February peak at 12,786 closing. It will likely undercut the 90 day SMA early this week and then try the relief bounce to test before the next move lower.

Stats: -208.1 points (-1.54%) to close at 13265.47
Volume: 337M shares Friday, lower but no shrinking violet to end the week as the blue chips suffer selling from their cyclical and materials components.

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

MONDAY

A big week for a multitude of reasons. Earnings, earnings and more earnings. After an up and down start the earnings finally starting lighting up the scoreboard midweek, but it was too late; the window of opportunity had closed as the credit issues and missed deals as a result surfaced. The market waited and gave earnings a chance, but they were dilatory with the good results and next thing you know, 5% and 6% lower.

It is also a week of big economic news with personal income and spending, the PCE, Chicago PMI, ISM, and the employment report. Big news indeed. Of course the GDP report was huge as well and it failed to spark an oversold bounce on Friday.

The bigger near term news is the decline itself. Over the weekend all of the news stations will headline the decline, the talk shows will be slobbering over it, and the politicians will point to errant policies as leading to this correction (just as they did in March and last summer as well). Hmmm. Errant policies that led to huge growth and a resumption of the expansion after a mid-cycle slowdown. Cannot say we agree with all the policies out of Washington by a long shot, but the tax cuts were of the right type and at the right time to spur the recovery. After all, even Greenspan said so and therefore it must be true.

In any event, after all of this reporting there is often more selling to start the week as the retail investor calls his or her broker on Monday with the 'SELL!' order after hearing about all of the credit issues and the end of the M&A and buyback binge. If it is on television it must be true, and as things look to only get worse according to the reports it is time to get out while you still can. Thus some more selling and a further downside. After the news hits the local news and the non-financial talk shows, however, it is at the point of an extreme and after that final push lower a rebound can take place.

As noted above, however, we are not looking at this as the final downside leg on this selling. It is just a strong first leg to the downside, and after a relief move we look for another leg to test. As we said last summer and again in the spring selling, it sounds too pat, but human emotion tends to play out in the same manner again and again.

We will remain as calm as possible and look for the rebound. There are some stocks that have pulled back but are still in strong position. There are others that bucked the market. We will put those on the report and be ready of they show solid moves and we get a market rebound. They were strong in some heavy selling, and should shine as the market rebounds.

The big issue after that is whether the market continues higher or rolls back over. We expect a rollover but the market can always surprise you. If it continues higher, great. In the likely event it stalls out at the old trendlines or the June highs on NASDAQ or DJ30, and 1500ish on SP500 we will close up most upside positions and look to play the downside leg. That could be quick if this is just another interim correction. If those issues outlined in the summary (volatility, leadership, frequency of the corrections) are coming home to roost it could set in for a longer period. Thus we use the upside for the strong stocks that weathered the selling, close some rebounding positions on the relief move when it starts running out, then play the downside for what it is worth and see if a second bottom can form near the initial bottom.

We still view the overall picture as solid with the economy expanding nicely, but the contagion virus has found an opening and it will allow other issues in. We will see just how strong the market is as it weighs the logs in the road in the way of the expansion. Just for reference, ECRI, a very reliable economic forecaster, saw its weekly index dip modestly (143.7 versus 143.9), but its 4-week annualized growth rate moved up to 6.4%. That shows solid though not spectacular growth. The leading economic indicators are still expanding nicely, but some market indications suggest there could be a deeper problem this time around than last summer or this spring. Thus we will be a bit cautious and use the rebound to close stocks that rebound but don't blast off again and then be ready for the second downside move, the most important move if the relief bounce turns into something unexpected.

Support and Resistance

NASDAQ: Closed at 2562.24
Resistance:
2567 is the 90 day SMA.
2601 is the October/December trendline
2601 is the mid-May intraday peak.
The 50 day EMA at 2617
2634.60 is the June peak
2655 is the November/February up trendline
The 10 day EMA at 2660
2673 is the early July high
2725 is the July high
2778 from a July 1999 peak
2887 from a September 1999 peak
2920 from an October 1999 peak

Support:
2531.42 is the February high (post-2002 high); 2525 intraday
2523 was price resistance November 2000
2509 is the January 2007 high
The 200 day SMA at 2486

S&P 500: Closed at 1458.95
Resistance:
1461.57 is the February 2007 high.
1475 from peaks in December 1999 and January 2000
1490.72 is the early June closing low
The 50 day EMA at 1516
The 10 day EMA at 1522
1534 is the early July high
1539 is the mid-June intraday high
1541 is the early June high.
1542 is the late November to February up trendline
1553 intraday high from March 2000 is the all-time index peak
1562 is the upper channel line from October/December 2006

Support:
1465 is the July 2006/March 2007 up trendline
1440 is the mid-January high
The 200 day SMA at 1448
1427 represents some interim peaks from December 2006

Dow: Closed at 13,265.47
Resistance:
13,545 is the November/February up trendline that marks the lower channel.
The 50 day EMA at 13,529
13,595 is the upper channel line in the November/February channel
The mid-May peak at 13,556
The 10 day EMA at 13,667
The early July peak at 13,671
The mid-June high at 13,689
The early June high at 13,676 (closing), 13,692 (intraday)
The July high at 14,022

Support:
13,121 is minor support from the April peak
The 90 day SMA at 13,256
12,796 at the February 2007 high
The 200 day SMA at 12,749

Economic Calendar

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

July 31
- Personal income, June (8:30): 0.5% expected, 0.4% prior
- Personal spending, June (8:30): 0.1% expected, 0.5% prior
- Core PCE, June (8:30): 0.2% expected, 0.1% prior
- Employment cost index, Q2 (8:30): 1.0% expected, 0.8% prior
- Chicago PMI, July (9:45): 59.0 expected, 60.2 prior
- Construction spending, June (10:00): 0.3% expected, 0.9% prior
- Consumer confidence, July (10:00): 105.0 expected, 103.9 prior

August 1
- ISM Index, July (10:00): 55.5 expected, 56.0 prior
- Crude oil inventories (10:30)

August 2
- Initial jobless claims (8:30): 301K prior
- Factor orders, June (10:00): 1.3% expected, -0.5% prior

August 3
- Non-farm payrolls, July (8:30): 135K expected, 132K prior
- Unemployment rate, July (8:30): 4.5% expected, 4.5% prior
- Hourly Earnings, July (8:30): 0.3% expected, 0.3% prior
- Average workweek, July (8:30): 33.9 expected, 33.9 prior
- ISM Services, July (10:00): 59.5 expected, 60.7 prior