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InvestmentHouse Weekend Update:

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

- Market was holding its own into the weekend until Bear Stearns stirred the bears.
- The interesting side of this volatility.
- Will the Fed try to nip the credit problem in the bud?
- Taking the jobs report with a healthy dose of salt.
- Rollover from a modest bounce paves way for another quick test lower, but will the Fed take that action?

Relief bounce short-circuited by Bear Stearns ‘calming’ conference call.

Stocks recovered Wednesday in a big way from further selling, making the shorts scream as loud as the longs prior to that bounce. Thursday was a modest but steady rebound, continuing the bounce back from the selling that took SP500 down to test its 200 day SMA. Friday started off modestly, but it continued the upside move as well with some back and forth trade that broke to the upside ahead of lunch.

Not bad as the market had to overcome some less than solid jobs growth and a weaker than expected ISM services report. Of course the jobs report was skewed: it reported education lower (summer break?) but no one believes there are fewer teachers out there. Thus the market saw through the lower numbers and recovered. Sure the sellers took their obligatory shot, sending the decent open to negative after the economic reports, but the indices set up an intraday reverse head and shoulders and bounced out of that weakness. Good move, but we noted in a midmorning alert that it was Friday, and the key for the market was how it held into the close on a Friday in a market with an inferiority complex.

Then BSC had its conference call, the one that was going to explain the problems with now its third hedge fund gone bad. It did that, reassuring analysts and investors the company had plenty of funds to ride out a ‘perfect storm’ of bad events. When an analyst then asked whether the company would buy back some of its stock, however, the CEO hedged, saying that the company wanted to preserve liquidity. Ouch. That was interpreted by many along the lines of ‘if BSC won’t buy its own stock then why should I . . .’ It did not help that the reluctance to buy back shares was followed up with comments as to how the debt market was the worst it had been in 22 years (1985). Nice. Good job of allaying investor fears big guy.

Shockingly the market dove lower after those reassuring comments. The market had taken a lot of bad news with a lot of it coming out on Wednesday, the day the market sold but then reversed for gains. Looked as if it had taken its fill of bad news and was sold out. After Bear Stearn’s left-handed ‘assurances,’ however, the market showed it could still sell out to the highest bidder, or indeed any bidder as the indices sold off at a 45 degree down angle.

Sell programs started to hit, and with no uptick rule in place anymore (used to be you could only sell shot on an uptick in a stock or the market) the selling snowballed. The programs built on one another, feeding the downside cycle. There was already a bias to get out ahead of the weekend, and BSC was the catalyst to go ahead and just do it. Equities sold off but bonds surged with a rush to safety. That drove yields lower with the 2 year at 4.50% and the 10 year down to 4.67%. Even a further peel back by oil (75.16, -1.70, down from 78.77 earlier in the week) did nothing to slow the selling.

Technical. As noted, the market was working on a third up side session (at least it covered 3 sessions) in what we anticipated to be about a week of a bounce. Then it reversed and sold off to close at the low. Poor intraday action and with the rollover that relief bounce was dumped. The charts show the story. DJ30 rolled back down through the 90 day SMA and closed at a new low on this leg. SP500, after rebounding from its 200 day SMA Wednesday, blew that apart Friday, closing 17 points below that key level. The large caps are in the midst of a major dive lower. Not that the small caps are any better, but it is very interesting that the ‘time for the large caps’ as many are saying sees those stocks as some of the hardest hit in the market. As for NASDAQ, well it still has some stocks showing relative strength, but it was not spared Friday as it fell back from the 90 day SMA and is set to test its 200 day SMA only 19 points further down. Of course volume was up and breadth was atrocious (-5:1 NYSE) as stocks distributed and the advance/decline line continued to roll over.

The move left DJ30 down 6% from its peak while SP500 and NASDAQ are both down 8% from their recent highs. Not major corrections but much lower than the spring fling. SP500 has corrected 8% from its peak hit in mid-July. That is the extent of its correction in summer 2006. DJ30 has faded 6% from its recent high; it corrected 8.4% in the summer 2006. NASDAQ at 8% is a piker compared to the 15% it lost last summer. Ironically, NASDAQ was a leading index heading into late July and looked to give support to the rest of the market. This last week put it in the ranks of SP500, however, and that index has been the weakest of the big three.

Another look at volatility.

That raises an interesting point regarding volatility. You cannot turn on a financial station without hearing about how volatile this market is. We have discussed it as well, noting in June that day to day volatility was on the rise with large point swings up and down occurring on the heels of one another. It was also rising as the indices hit higher peaks. Those are troubling signs for the market and they led into the current selling.

Volatility has also risen as judged by the VIX. Wednesday it just over 26, topping the summer 2006 highs. It was no slouch Friday, hitting a closing high on this run and it too topped the summer 2006 highs. The VXN, the NASDAQ volatility index, however, has yet to top the summer 2006 levels and it took the Thursday intraday blast higher to top the spring selling levels.

No big deal, right? Wrong. We noted NASDAQ was the leading index in the last part of the rally before the selling started. It eventually sold off hard, but at the same time technology has some leaders that are refusing to give up much ground. While SP volatility has shot past the prior levels on this selling, NASDAQ and tech volatility is no worse than it was in the summer 2006 or in the spring. What that means is that for one of the rare times in the market the SP500 volatility is greater than technology.

It rarely happens that SP500 volatility exceeds the more speculative NASDAQ. Typically it lasts for a few sessions. This past week it was for an entire week. This is out of whack and it is being caused by the meltdown in the financial sector on the sub-prime and credit contagion fears.

What this tells us is two things. One, this is an extraordinary event, not just a market pullback associated with a long climb that needs correcting. It was, but it has morphed into a massive fear of the unknown, impacting all financials and thus the SP500.

Two, it likely won’t last. Historically these volatility events that see SP500 jump ahead of the other indices are short term. Of course you have to ask why. In some notable instances the Fed has acted as a stop gap. Why? Because the Fed is keenly aware of the financial sector of the economy, and if credit collapses the Fed knows the risk of recession triples. It also knows that you get hair-brained members of Congress trying to pass laws to ‘protect’ everyone (the most recent is Senator Schumer’s bill last week) but they only worsen the situation by locking down the housing and credit markets longer than they would be if the market is left to its own devices. We talked about this in May, and it is laughable but for it being so sad that our esteemed leaders are going to make the same mistakes they have made in the past. Thus the Fed is pressured to step in.

THE ECONOMY

Will the Fed cut or won’t it? A continuing discussion of the contagion effect.

The contagion threatens to extend further just as Congress threatens to clamp down. Thus the Fed is faced with an unpleasant choice: let the credit conditions worsen and risk a recession or cut rates and risk a dollar plunge. Some are predicting a rate cut on Monday ahead of the FOMC meeting and then use the meeting to explain the reasons. It could come Tuesday as well at the meeting.

There is a big philosophical debate ongoing as to whether the Fed should ‘bail out’ lenders that made bad loans. Unfortunately it is not that simple. That market has taken care of a lot of those that made the bad loans already. The issue is how far this spreads out beyond the initial wrongdoers. The sub-prime issue is contained. The credit contagion is not because the cat is out of the bag, the camel’s tent is under the nose, etc. It has made it out and how far it goes without being forcibly restrained is the unknown.

Thus even though there is a desire to let those that screwed up work it out themselves, the reality of a contagion situation is that it feeds on itself and spreads tendrils everywhere, even in areas that had nothing to do with it. The world runs on credit, and if it is vapor locked the world economies do likewise NO MATTER HOW FUNDAMENTALLY STRONG THEY WERE AT THE START OF THE CONTAGION. That is why one high ranking former Fed official has said that the academic argument is interesting, but reality does not allow the ‘punish the wrongdoer’ argument to play out. No one in the Fed’s position dares to test out that theory.

Still there are stupid central bankers from New Zealand (sorry goes out to my relatives there) who are taking on the carry trade that is using New Zealand dollars just for the reason they don’t like the currency being used for that reason. There is Schumer here in the US. As is always the case, the lawmakers are behind the times, indignant over the past, fighting the last battle. As with the 1929 US central bank and the 1999 Greenspan Fed, they push the wrong policies at exactly the wrong time and cause the system to break.

The question the Fed has to ask itself is whether it feels lucky. If it takes that role of the dice it will need some luck with respect to the dollar, but it may be willing to take that risk as opposed to taking potentially greater chances with the spread of this mushrooming credit issue.

THE MARKET

MARKET SENTIMENT

VIX: 25.16; +3.94. Surged back up to a new closing high, moving past the summer 2006 high and reaching those April 2003 levels again when it was on the decline after the peaks hit in late 2002 and the market was rallying out of that bear market. By recent standards it is streaking higher. By historical standards it is still low.
VXN: 24.42; +3.18
VXO: 26.42; +4.74

Put/Call Ratio (CBOE): 1.47; +0.37 Ten sessions above 1.0 on the close. As noted last week, this is at the point where it is showing extreme pessimism.

Bulls: 47.2%. Quite a plunge from 53.9% last week, just short of the peak of the recent run higher in positive sentiment 56.7% hit two months back). Getting there but still needs to drop below 40% to really show the kind of dent in optimism that stronger runs are built upon. 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: 26.4%. The bears came out bawling, blasting higher from 18.0% last week and just over 1 point off of the 27.5% in April and the quickly closing in on the 30% hit in March. Amazing what contagion fears will do to investors. 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: -64.73 points (-2.51%) to close at 2511.25
Volume: 2.535B (+3.15%). Renewed the plunge lower on rising and continued above average volume.

Up Volume: 274M (-1.328B)
Down Volume: 2.146B (+1.339B). -8:1 down over up volume.

A/D and Hi/Lo: Decliners led 4.26 to 1. Very heavy downside breadth as the techs were slaughtered along with the financials and other SP stocks.
Previous Session: Advancers led 1.29 to 1

New Highs: 78 (-5)
New Lows: 394 (+198)

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

SP500/NYSE

Stats: -39.14 points (-2.66%) to close at 1433.06
NYSE Volume: 2.057B (+4.04%). Volume jacked higher on NYSE as well as SP500 and SP600 tanked through important support. More massive dumping after a modest bounce higher.

Up Volume: 116.59M (-1.097B)
Down Volume: 1.936B (+1.203B). Truly impressive downside trade. Truly impressive. As with the volatility, you just don’t see these levels often.

A/D and Hi/Lo: Decliners led 4.97 to 1. Pretty amazing as well.
Previous Session: Advancers led 1.89 to 1

New Highs: 50 (+1)
New Lows: 390 (+170)

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

Held the 200 day SMA (1443) on the Wednesday test but then gave it up like a bad habit Friday, blowing out that support on another jump in volume, a strong jump. There is some support at 1425, but as noted last week, with this kind of vicious selling in the financials each potential support level is just a possible bounce point.

The small cap SP600 (-3.48%) was bombed Friday, failing a test of the 200 day SMA breach rather miserably. The small caps are now in the midrange of the November to January range. The small caps are in freefall, becoming even smaller caps with each session.

DJ30

Recovered the 90 day SMA Wednesday and Thursday just to fail at the 50 day EMA and roll over on Friday with some high volume selling. While the blue chips closed at a new low on this leg they are still above the intraday low (13,132) hit intraday Wednesday. The Dow has formed a head and shoulders and this rollover at the 50 day EMA makes for a lower right shoulder and thus a weaker pattern. It is holding up better than the other indices, but it is on the verge of playing catch-up rather quickly with this break, once more, below the May to July lows. It has thus far refused to head through the door down to the 200 day SMA (12,692), but this could be the move that does it though after a break of support there is typically a flurry of selling followed by a rebound to test.

Stats: -281.42 points (-2.09%) to close at 13181.91
Volume: 301M shares Friday versus 264M shares Thursday.

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

MONDAY

The bulk of S&P earnings are out, but August does not bring much of a slowdown in results. Anyway, results have been pretty solid after that initial hot and cold run, and the market has exploded lower all the same. As we noted before, the market had its chance to continue the rally if earnings had come out strong from the get go. They did not and the contagion got its foot in the door. Now it is in bed with the market. After interest rates hit 5.33% in June and scared many to death that inflation was around the corner, the contagion hit and rates are at 4.67% with everyone scared that deflation is around the corner. Ironic. The market was worried high priced money would kill of deal making. Now money is cheaper that before but no one wants to place the deals despite cheap money. When things get to a tipping point they tend to move quickly.

There is more economic data out in addition to earnings, but the focus is on the FOMC meeting Tuesday and what changes the Fed will make. With the credit issues throwing in with the sub-prime the Fed has to change its bias to neutral. That may have some ceremonial value, but it is not going to stop the contagion from spreading. Will the Fed cut rates? There is precedent, but it is unlikely Bernanke is ready to make that move. The Bush administration trots out its 4 economic horsemen after the GDP report a week back and they tout the strong economy and their control over the sub-prime housing market. The Fed can go ahead and cut, claiming this accelerated quickly and they want to nip it in the bud, but it would have to get with the administration and other central banks to put the proper spin on it and be able to sell it to the financial markets. Of course they could be doing that this weekend.

If the Fed acts then all bets are off. The market could very well act adversely to the news, figuring the Fed was either overreacting or saw something truly heinous coming. After that the market would rebound because Fed rate cuts when the fundamentals remain in good shape are ultimately treated with upside. Thus after any downside it would be time to cover shorts and look for the upside.

That is a lot of speculation. It would be interesting, but I doubt the Fed will cut yet. With the rollover Friday on continued fears that means more downside but after a further blow off following SP500’s undercut of the 200 day SMA and NASDAQ’s likely test of the same early on in the week, another rebound is in order. Just as with the upside, it is not a straight line up or down. The rebound we were looking for only made it two full sessions before more bad news drove it lower. With very little upside bounce to test, there is more downside before the market finds its bottom. In addition, the fact that the BSC news had such a deleterious effect tells you the market has not yet priced in all of the contagion impacts.

We will look to catch some more downside as DJ30 breaks lower toward the 200 day SMA to play catch-up (or is it catch-down?), then button them up and see how the market rebounds. There are still upside positions in tech and other growth areas that refuse to give in to the selling. They may not all be surging higher, but they are using the selling to test and hold support or move laterally in a consolidation of prior gains. If these stocks don’t crack like a weak tour cyclist on Alp d’Huez, this market is not going to suffer a major decline. Why? Because a major decline eventually takes everything down, and growth stocks are typically the first to go.

Thus we continue to watch (and indeed own) stocks such as HPQ and CSCO as they continue to perform notably well in this weak market. If we are presented with the opportunity to own these type of stocks, i.e. an entry position where an upside move is primed to begin, we won’t pass them up, but we won’t load the boat all at once given the contagion is still an unknown quantity.

Again, if the Fed decides to cut or strongly suggests it will do so if things don’t improve rather rapidly, this will ultimately be good for stocks. Unlike 2000 and 2001 when the Fed managed to wreck the expansion, a contagion is fear driven, and with respect to credit, it can be cured with liquidity if nipped in the bud. Thus if the Fed is going to do any good it needs to act quickly before any economic fundamentals are damaged. In that situation the economy will continue it expansion based upon the still solid fundamentals and the financial market will rebound nicely. Thus our focus on the stocks that are not succumbing to this round of selling but that are using it to consolidate or otherwise test near support. Even tests of the 50 day EMA are in the game as many stocks rallied nicely up the 18 day EMA and are making deeper tests during this selling to reset the clock for another run higher. If the Fed cuts or strongly intimates it will if things don’t improve, these stocks are in position to lead higher once more.

Support and Resistance

NASDAQ: Closed at 2511.25
Resistance:
2523 was price resistance November 2000
2531.42 is the February high (post-2002 high); 2525 intraday
The 90 day SMA at 2572
2601 is the mid-May intraday peak.
2603 is the October/December trendline
The 50 day EMA at 2605
2634.60 is the June peak
2662 is the November/February up trendline
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:
2509 is the January 2007 high
The 200 day SMA at 2491
2470 to 2467 are price peaks from November and December 2006
2400 is price support

S&P 500: Closed at 1433.06
Resistance:
The 200 day SMA at 1450
1461.57 is the February 2007 high.
1469 is the July 2006/March 2007 up trendline
1475 from peaks in December 1999 and January 2000
1490.72 is the early June closing low
The 10 day EMA at 1477
The 50 day EMA at 1504
1534 is the early July high
1539 is the mid-June intraday high
1541 is the early June high.
1548 is the late November to February up trendline
1553 intraday high from March 2000 is the all-time index peak
1565 is the upper channel line from October/December 2006

Support:
1440 is the mid-January high
1427 represents some interim peaks from December 2006
1406 – 1407 from March 2007 and November 2006 interim peaks
1389 from October 2006 interim peak
1375 from March 2007 low

Dow: Closed at 13,181.91
Resistance:
The 90 day SMA at 13,304
The 50 day EMA at 13,490
The mid-May peak at 13,556
13,580 is the November/February up trendline that marks the lower channel.
13,630 is the upper channel line in the November/February channel
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
12,878 is the July 2006/March 2007 up trendline
12,796 at the February 2007 high
The 200 day SMA at 12,783

Economic Calendar

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

August 3
- Non-farm payrolls, July (8:30): 92K actual versus 135K expected, 126K prior (revised from 132K)
- Unemployment rate, July (8:30): 4.6% actual versus 4.5% expected, 4.5% prior
- Hourly Earnings, July (8:30): 0.3% actual versus 0.3% expected, 0.4% prior (revised from 0.3%)
- Average workweek, July (8:30): 33.8 actual versus 33.9 expected, 33.9 prior
- ISM Services, July (10:00): 55.8 actual versus 59.0 expected, 60.7 prior

August 7
- Preliminary productivity, Q2 (8:30): 2.0% expected, 1.0% prior
- FOMC policy statement (1:15)
- Consumer Credit, June (3:00): $7.0B expected, $12.9B prior

August 8
- Wholesale inventories, June (10:00): 0.4% expected, 0.5% prior
- Crude oil inventories (10:30): -6.49M prior

August 9
- Initial jobless claims (8:30): 307K prior

August 10
- Import prices ex-oil, July (8:30): 0.2% prior
- Export prices ex-agri, July (8:30): 0.1% prior
- Treasury budget, July (2:00): -$32.5B expected, -$33.2B prior


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