Sector Investing

[ReturntoSender]

InvestmentHouse Weekend Update:

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

- Inflation numbers add extra weight on a weary market as stocks slide lower to end a down week.
- CPI adds inflation worries to Fed woes as some energy pass-through shows up.
- Dollar has its best week against the euro in over 3 years.
- Market's near term fortunes dependent upon successful Fed auctions starting Monday as well as continued improvements in Fed targeted areas.

Inflation adds another yoke to the market.

The stock market was moving higher on the second leg of its holiday rally, rallying right up to the Tuesday afternoon FOMC monetary policy announcement. The Fed disappointed with a 25BP Fed Funds rate cut (25 on the discount rate as well) and a muddled, repetitive statement that dropped a reference to 'forestalling' an economic slowdown and still harped about inflation. Then the next morning it confused and indeed infuriated many, particularly the financial market traders, with a second day announcement that looked, based on the timing, as if it was a reaction to the market's sell off in response to the size of the rate cut. It could not have been; you cannot coordinate that many central banks in a few hours. Still, the rambling statement and the clumsy chronology of the 2-step action plan lost the financial markets' confidence.

On top of that, the second action sent the market into a temper tantrum. The Fed's second phase actions had an immediate and positive impact (LIBOR spreads narrowed and rates fell, the dollar surged, and US interest rates reversed their deflationary path). The key for the next market move is whether the Monday auction (the first of four) will show enough success to start convincing the market the Fed, despite its left-handed bungling of the action that hurt a lot of investors, at least knows what is necessary to fix the problem and only has to learn better timing.

Obviously Friday the market was not over its tantrum. Indeed, it was not going to get over it as the CPI was much hotter both in the core and overall and with the unknowns regarding the Fed auction next week. With fears that the Fed was failing to forestall, or as its statement indicated, maybe giving up attempts to forestall a slowing economy, the higher inflation reading raised the unspoken worry over stagflation. That CPI number showed why the Fed kept language about inflation worries in its monetary policy statement, but just because the Fed was right ironically provided no comfort to the market. The market is worried the Fed doesn't have a clue, yet Bernanke's tenure to this point has for the most part shown he understands economic cycles and their history. As with Alan Greenspan in his early tenure (when many called for his ouster as well), implementation of the knowledge is the shortcoming that time will help alleviate. Unfortunately, we have to live through the seasoning of another Fed chairman. You can study history all you want as Bernanke has, but the transition from theory to reality is inherently sticky.

There were positives with respect to the issues that are worries to the economy and thus the market. As noted, LIBOR rates continue lower and spreads are narrowing. The dollar surged. It was not enough to offset CPI, earnings issues (BDK reported a shortfall in its guidance), and Greenspan started talking about recession again after a 3-month hiatus (inflation chances are "clearly rising" and "economic growth is close to the stall speed"). As the market balanced out the pros and cons, the cons won again. Most everything was down: gold, oil (91.33, -0.92), financials, metals, energy - - it was widespread to the downside. But, as noted below, while down, many stocks such as the leaders we have positions again held up quite well. That shows there is an undercurrent of strength after the FOMC decision, and that shows there is some recognition out there of the positives developing despite all of the angst over what the Fed did or failed to do.

Technically the action was mixed again, but of course the overall bias was to the downside. The market started lower as the futures tanked after the CPI data came in hot. The market spent the first hour and one-half recovering, and NASDAQ actually turned positive while DJ30 and SP500 missed the green by a couple of points. Unfortunately the bids died out midmorning and stocks slid to close at the session lows. NASDAQ squandered 37 points from its high, DJ30 dumped 145 points, and SP500 frittered away 18 points off the high. There was no Wednesday or Thursday rebound off the session lows as the more bearish intraday action returned.

Internals: Breadth was pretty rotten at -3.6:1 on NYSE and -2.8:1 on NASDAQ. Of course, that included a lot of stocks that lost fractional amounts on the session as they held their near support and performed just fine despite all of the market gloom. Volume was again lower, coming in well below average ahead of the weekend. Though the market dropped to close at session lows, the volume shows the sellers were not rushing in to push it lower. It was a lack of any buyers willing to step in following the FOMC's decision and the subsequent selling Tuesday and the failed rally attempt Wednesday. If the sellers are not pushing when they have every reason and opportunity to do so, you look around to see what else is going on. The leadership as discussed below becomes very interesting in this scenario.

Charts: The week shows a lot for the indices. They rallied up to resistance into the FOMC decision and failed right there when the Fed disappointed. They tried to hold up to finish the week what with the two rebounds off the lows on Wednesday and Thursday, but after the Friday close they are teetering on the edge of another downside leg after the dump on the FOMC decision. DJ30 will try to make a higher low at the 200 day SMA or 13,250, but the patterns for the US indices are again more bearish than bullish after failing at resistance on the FOMC decision.

Leadership: There were not a lot of surges higher on such a down session, but going down the list of plays and stocks that we are watching for opportunities to buy, there are a lot of stocks that are in surprisingly spry shape after the negative four sessions (both in price and in sentiment) in the US indices. That was a continuing theme this week that we discussed every session. May have seemed as if we were beating a dead horse, but their action in the face of the negative sentiment is very important. The leaders showed rubber band action, i.e. stretching down to near support but not breaking. As noted earlier in the week, if you did not hear all of the negative stories about the market and the Fed or see the action in the major indices, you would be pretty excited about the opportunity to move into some great stocks.

Of course you can never forget about or disregard the overall market if it is struggling. But with the split in the global economies, opportunities remain, and quite a few as we can see from the list of strong leaders in good position to move higher. To us that indicates there is a continuing undercurrent of support for these stocks, and if there is improvement in the areas the Fed's second phase approach targets, an oversold market can make a bounce, and these stocks are primed to jump back up, e.g. AAPL, BIDU, CMED, FCX, SNDA, VIP, etc.

THE ECONOMY

CPI heats up, injects stagflation fears.

Consumer prices popped 0.8% (0.6% expected), and the core topped expectations as well (0.3% versus 0.2%). Year over year prices surged 4.3%, 2.3% on the core. That growth rate doubles that in August (2%) before energy prices spiked. This is the highest annual core rate since the 2.9% reading in September 2006.

Gasoline/energy was the biggest component with a 5.7% gain, up 21% year over year. Ouch. Food rose 0.3%, up 5% over last year. Thank you ethanol for pushing up corn prices, the very basis of our diet here in the US. Drugs rose 0.8% for the month, same with apparel. Airline fares spiked 2.6%, and some are saying that is the long-awaited pass through from energy prices.

That looks to be a real problem ahead. Energy prices are up 21% over last year, and they have remained very high for a very long time. As noted earlier last week, the impact of energy prices is cumulative. If they remain high they keep banging into prices and eventually they break through in areas. Airlines have tried to pass on price hikes for several years but have failed miserably. If this one sticks that marks a turning point for prices.

What can the Fed do about that? Can it lower energy prices? No, at least not directly. It can slow the US economy until we all cut back on fuel so much we are living as we did pre-1940's. That may impact the price of oil, but frankly with China, Brazil, India, etc. growing so ravenously, it would not be enough to push oil back into the 40's or 50's. The Fed definitely doesn't want to lower our standard of living in such a manner, but it is torn by the inflation it was worried about on Tuesday in its statement where it emphasized the slowing economy but could not let go of the inflation worries. Then you throw in food inflation on top of that, something driven by the Executive's side of the government thanks to its energy initiative, and the Fed is sweating it out.

Problem is, the Fed cannot accomplish anything if it tries to play both sides of the fence. It has to either attack inflation or attack the slowdown. As we have written over the past year, and as many economic heavyweights such as Bob McTeer are saying, the slowdown and credit issues are the primary concern. You keep inflation in mind, but you solve the credit problems first to get the economy expanding again as that will help alleviate the inflation issues: growth does act as a cure all in most cases.

That takes us back to the disappointment with the Fed action this past week. It has something of this two-faced approach and its statement on Tuesday only underscored the appearance of indecision as to what to attack. That more than anything in our opinion is what really rattled the market. The Fed holds much too much power over our economy and our lives, and thus any appearance of confusion or uncertainty is devastating to investors.

Dollar enjoys a big week.

The dollar advanced the most against the euro since August 2004 on Friday. Indeed, it gained against 14 of the 16 most actively traded currencies. That is on top of a strong week overall that saw the dollar gain 1.6% versus the euro, the largest weekly increase since June 2006. The move got underway in earnest as the dollar broke the $1.4650 resistance level against the euro. The dollar is now down 8.5% versus the euro for the year.

The drivers are two-fold. First, the dollar was down too far, too fast as it moved to the $1.50 level versus the euro. It had to snap back. Moreover, the dollar has been trending lower for an extended period, and we all know that leads to relief moves or even a key reversal that changes the game.

That leads to the second driver: the Fed action. The Fed's rate cut didn't hurt the dollar as many currency traders feared a 50BP move and thus the dollar actually started strengthening on the Fed action. Then the announcement of the swaps and auctions jumped the currency higher as it enjoyed its strongest session in weeks. Then the CPI reduced, at least in currency traders' minds, the likelihood of further Fed rate cuts. That combination of events started by the Fed directly targeting the credit logjam really turned the currency. Add to that the long downtrend and you see a spring that was wound pretty tight.

As a result we could see the dollar at sub-$1.40 by year end. The rally could be just getting started there, however, as the dollar has been underwater a long time and when these moves start to reverse the recovery can be lengthy. If the Fed auction on Monday is a success, then we will see the dollar continue higher and even increase the speed of its gains. Already we are hearing stories of European visitors wondering if they need to think about cutting their stays here in the US shorter. That is how dramatic a move this was in the currency this week. Cannot complain about that, and frankly, despite the market angst over the Fed's actions, this is some pretty excellent news.

THE MARKET

MARKET SENTIMENT

VIX: 23.27; +0.71. The VIX is not reflecting it, but sentiment sure is gloomy in the market and on the financial stations.
VXN: 25.91; +0.39
VXO: 25.52; +1.41

Put/Call Ratio (CBOE): 1.06; -0.01. Another session over 1.0 on the close making it three of four. The clock is on again. When it gets to 9 of 10 or so then it will be interesting.

Bulls: 53.3%. Uncool. Up from 49.4% as bulls continued their run higher, bouncing before it got to 45% as we wanted (hit 40.6% on the low for the last round of selling). It spent 5 weeks above the threshold 55% on the last spike higher. You have to go through the process of wringing out the bulls with a decline of significance, a.k.a. a move into the lower 40's. The theory is that when too many investors or advisors are bullish then most of the money is in the market and there is nothing ready to come in off the sidelines to drive prices higher. On a steady climb from a low of 40.6%, the low for this round. Never made the thirties. Hit 56.7% in June and now it has blown past that. The market peaked about a month later. For reference it bottomed in the summer 2006 near 36%, and 35% is considered bullish.

Bears: 25.6%. Also uncool, falling from 27.6%. That is down from 29.0% after one week at a higher level, jumping from 26.6% the week prior. Up from 22.2% 5 weeks back after bouncing up and down over 20 for several weeks. It is still significantly above the threshold 20% considered bearish. Fell to a low of 19.6% on this round. Bearishness peaked at 37.4% on this move and it fell to 18% in August. It topped the June 2006 peak (36%) on this run. That June peak eclipsed 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: -32.75 points (-1.23%) to close at 2635.74
Volume: 1.961B (-8.66%). The lower volume discussed above, coming in well below average. Not so much the sellers as a lack of dad-blamed buyers.

Up Volume: 583.899M (-323.694M)
Down Volume: 1.354B (+123.006M)

A/D and Hi/Lo: Decliners led 2.82 to 1. Not pretty with the large cap NASDAQ 100 (-1.08%) barely outperforming.
Previous Session: Decliners led 1.43 to 1

New Highs: 62 (-1)
New Lows: 251 (+54). Getting there but about 200 to 250 off a level that would be more indicative of a bottom.

NASDAQ CHART: Click to view the chart

Gapped lower, recovered smartly to positive. It stalled just below the 50 day EMA (2675), however, and then slid lower from midmorning to the close. That move popped the Thursday intraday low, leaving NASDAQ just above the mid-June peak (2635). Might try to hold there and make a higher low on this leg lower, but it will have to show something it didn't have on Friday, or else a test lower to the 200 day SMA at 2600 takes it below the early December low. That would mean a lower low and open up more negative action. If it cannot hold here it will likely try to set up a double bottom at the November low.

NASDAQ 100 (-1.08%) sold but it did not take out the Thursday low and held above the 90 day SMA as well. As in November when NASDAQ, SP500, and DJ 30 looked to be basket cases but NASDAQ 100 was holding the line moving laterally, it is attempting the same thing here. Very interesting.

NASDAQ 100 CHART: Click to view the chart

SP500/NYSE

Stats: -20.46 points (-1.37%) to close at 1467.95
NYSE Volume: 1.305B (-10.76%). Volume finally broke below average for the week, at least since Tuesday. As discussed with NASDAQ, that shows the sellers were not running away with the session but that buyers wanted nothing to do with NYSE stocks, particularly the financials and the small caps. Gee, nothing new there what with the credit issues for the financials and a weaker economy for the small caps. That is the lifeblood of both indices.

Up Volume: 182.505M (-347.056M)
Down Volume: 1.111B (+188.331M)

A/D and Hi/Lo: Decliners led 3.62 to 1. Pretty ugly negative breadth, but as noted above, there were not a lot of big gainers, just modest losses at support.
Previous Session: Decliners led 1.97 to 1

New Highs: 48 (+15)
New Lows: 242 (+32)

SP500 CHART: Click to view the chart

Failed to hold the 200 day SMA (1486) and undercut the Wednesday and Thursday intraday lows where the index rebounded those sessions. The financials are killing SP500 still. It is not going to turn things around until they are finished bleeding out. GS announces earnings next week, and the mood around the sector is still foul enough that even blowout won't be enough because blowout is expected from this sector leader. If all the others could post similar numbers in the face of the credit and mortgage issues then things would change. For now there is still that big question mark. It does not have to be totally resolved before the market moves; such issues never are when the market bottoms. It is not yet, however, at that point. It has the look of a lower test to 1450 to 1445 on the next leg, but unless the news re the Fed action really turns this week it has 1425 down to 1400 in its sights thanks to those financials.

SP600 (-2.10%) was pelted as usual, thumping to some support at 300. Probably just a rest area, however, before heading to the November closing low at 382.60.

SP600 CHART: Click to view the chart

DJ30

Managed to close above the Wednesday low though it did close on the session low. That kept it above the 200 day SMA (13,298) and some support at 13,250 where it will likely attempt to make some kind of stand. That will be the telling point on this move as the larger picture over the past 6 months is a head and shoulders pattern with this test of 13,5700 the past week and the turn back down forming the peak of the right shoulder. Not the best picture, and a lot riding on this test.

Stats: -178.11 points (-1.32%) to close at 13339.85
Volume: 245M shares Friday versus 248M shares Thursday. At least the volume lightened up as it dumped lower, but not significantly.

DJ30 CHART: Click to view the chart

THIS WEEK

Lots of economic data with some regional manufacturing reports, GDP final revision, income and spending, and sentiment. There are some earnings reports from GS and RIMM, both leaders in their sectors. In addition, there is the first of the Fed's auctions where many different types of collateral will be accepted for loans. The auction platform allows the market to set the prices for the collateral and the loans. No one really knows how this is going to be received. It is a very interesting approach and helped unclog some of the credit roadblocks even upon its announcement. There is reason to be hopeful, but we all know about hope in the market. Results are what matters.

If it goes well the market might try to stem the selling and at least attempt a relief move to test the strength of the post-Fed selling. The market's tantrum was justified in part, not in part. Investors need to see that the Fed actions, while handled less than artfully, are having the desired effect. The early data suggests it started things moving in the right direction, but now the next phase has to prove successful, preferably beyond expectations.

A lot is riding on that first auction given the major indices look like road kill with financials and small caps still under attack from all sides. On the other hand you have a slew of individual stocks across many sectors tied more to the global economies that look very nice, poised to move higher if they get some catalyst. Again, a successful auction would prove quite beneficial. These stocks weathered a lot of negative sentiment last week and even the Friday selling in the major indices. They did not surge higher, but they showed excellent strength; NASDAQ 100 again showed relative strength as well. There is support for these stocks as there was in November, but they will also need another catalyst to send them higher. The second leg of the holiday rally had Kohn and Bernanke. These stocks need a better than expected response to the auction.

We are short SP500 in two ways (SPY puts, SDS calls) and we are short the Russell 2000 small cap index with IWM puts. That covers the really ugly aspects of the market. We are long many of the stocks showing relative strength with their excellent pullbacks. We are still looking at some more positions on those if we can get a catalyst develop and as long as they and NASDAQ 100 continue to show the same kind of relative strength that launched the market higher in November.

Thus heading into this week the keys to the market are the action in these stocks and NASDAQ 100 and how that auction turns out. That will set the scene for the other items such as the GS and RIMM earnings as well as the other economic data. Some traders have stopped for the year, but with the Fed double dose of action, many are staying in the market because of the results the two announcements caused. As for us, when we see such relative strength in a very negative sentiment environment, we keep looking for opportunity, and that is what we are going to do this week as well.

Support and Resistance

NASDAQ: Closed at 2635.74
Resistance:
2673 is the early July high
The 50 day EMA at 2675
The March up trendline at 2705
2725 is the July high
2751 is the November/December/February up trendline
2778 from a July 1999 peak
2834 is the October interim peak
2861.51 is the October peak

Support:
2634.60 is the June peak
The 200 day SMA at 2598
2550 to 2540 from May/June consolidation
2525 is the February closing high
2521 is the August 2004/April 2005/October 2005/March 2007 up trendline
2451 is the August closing low
2386 is the August intraday low

S&P 500: Closed at 1467.95
Resistance:
1475 from peaks in December 1999 and January 2000
The 200 day SMA at 1486
The 50 day EMA at 1486
1490.72 is the early June closing low and early August peak.
1530 to 1535 are the June twin peaks
1534 is the early July high
1539 is the mid-June intraday high
1541 is the early June high
1549 is the July 2006/March 2007 up trendline

Support:
1459 is the February peak
1440 - 1437 from January and March peaks
1441 is the June/July 2006 up trendline
1438 is the November low
1430 from the August interim lows
1425 is some minor support.
1406 is the August closing low
1375 is the March closing low
1370 is the August intraday low

Dow: Closed at 13,339.85
Resistance:
The 50 day EMA at 13,430
The 90 day SMA at 13,479
13,645 is the July 2006/March 2007 up trendline
The early July peak at 13,671
The early June high at 13,676 (closing), 13,692 (intraday)
The mid-June high at 13,689
The August high at 13,696
13,750
13,930 is the late October peak
The July high at 14,022
14,088 is the early October closing high
14,198 is the October intraday high.

Support:
The 200 day SMA at 13,298
12,845 is the August closing low
12,786 is the February peak
12,743 is the November low
12,518 is the August low
12,250 from late March lows
12,050 from the March 2007 low

Economic Calendar

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

December 17
- Current account, Q3 (8:30): -$183.0B expected, -$190.8B prior
- NY Empire State Index, December (8:30): 21.0 expected, 27.4 prior
- Net Foreign Purchases, October (9:00): -$26.4B prior

December 18
- Housing starts, November (8:30): 1.190M expected, 1.229M prior
- Permits, November (8:30): 1.150M expected, 1.170M prior

December 19
- Crude oil inventories (10:30): -722K prior

December 20
- GDP, Q3 final (8:30): 4.9% expected, 4.9% prior revision
- Deflator, Q3 (8:30): 0.9% expected, 0.9% prior revision
- Initial jobless claims (8:30): 333K prior
- Leading Economic Indicators, November (10:00): -0.1% expected, -0.5% prior
- Philly Fed, December (12:00): 8.0 expected, 8.2 prior

December 21
- Personal income, November (8:30): 0.5% expected, 0.2% prior
- Personal spending, November (8:30): 0.5% expected, 0.2% prior
- Core PCE Inflation, November (8:30): 0.2% expected, 0.2% prior
- Michigan sentiment, December revision (10:00): 74.3 expected, 73.5 prior