Sector Investing

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InvestmentHouse Weekend Update 6/13/08:

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

- Stronger dollar, lower oil help investors ignore hot inflation, weak sentiment and post a week ending gain.
- Michigan sentiment keeps heading lower as gasoline keeps heading higher.
- Inflation has to slow, oil has to fall before overall market finds firm footing.
- Get your cows now: feed corn at its lowest level in 15 years.
- Playing the winning sectors upside, shorting the rest.

Volatile week yields a strong ending gain.

Ugly inflation data and weak sentiment looked to be trouble Friday, but stocks were up pre-market, rallied early, and closed strong. Unlike Thursday, oil started lower and stayed lower for the session, helping stocks fight off an afternoon pullback and close out the session with some impressive gains. For the day the Dow was the laggard but even it posted a 1.37% gain. Impressive upside.

The Friday gains helped put a better look to a weak week and even managed to close DJ30 fractionally higher. It was the only one to post a weekly gain, however. There were two big moves on the week after the prior Fridays breakdown on the heels of the NASDAQ, SP400 and SP600 breakouts. After holding flat Monday and Tuesday in something of a shell-shock state, the indices dumped lower Wednesday on rising NYSE trade, continuing the Friday breakdown. In response the indices bounced Thursday and then posted the strong Friday price gains. NYSE volume declined both sessions, indicating the buyers were not as strong as the sellers. Pretty classic relief bounce that took the indices back up to first resistance, and unless it can show something else, that is what we have to view it as.

Financials were hammered again on the week even with the Friday bounce in those stocks. While the week tested all sectors, even the 'safe sectors' where the Big 3 reside (energy, metals, agriculture), the latter still held up very well and moved higher quite nicely to end the week. Indeed we took positions as they came off the test even though it was Friday and volume was so-so. The market is struggling, managing just a relief bounce after the sharp selling, but these sectors are still getting money thrown their way and thus posted more upside after modest pullbacks.

TECHNICAL. On the week the indices were mostly lower, having continued the prior Friday's breakdown. Only the Friday bounce saves a very ugly week. Friday the intraday action was the opposite, i.e. strong to start, an intraday test, and then strong to finish as the hedge funds squared up positions ahead of the weekend. Good action on an upside day, but looking back over the week, most of the sessions were high to low or closed well off the intraday highs. Thus most of the action for the week was negative intraday.

INTERNALS: As varied as the price moves on the week. Strong to the downside Wednesday. Much better to the upside Friday accompanying the strong price gains with 2.5:1 breadth. Volume was not there, however, at least significantly different volume. All week trade was above average, and all week it was mixed on the indices. In other words, one day NYSE would show lower volume but NASDAQ would show stronger volume. Then it would flip. Overall, however, volume remained elevated above average, and in the summer that is unusual. The overall market direction on that higher than normal volume? Downside. That tells you that overall the volume was more to the downside, indicating the big money players were overall unloading stocks.

CHARTS: While all technical aspects are important, this is key. Wednesday the indices renewed the downside leg on stronger NYSE volume. A breakdown the prior Friday was confirmed with that move. Thursday and Friday the indices bounced on lower NYSE volume. NASDAQ volume was up Thursday; maybe some accumulation but definitely not clearly so, particularly with all of the other sessions and their weaker action. The bounce higher did not clear resistance on the NYSE indices with DJ30, SP500 bouncing to test the 10 day EMA. NASDAQ is a bit better, clearing the 50 day EMA Friday but still at the bottom of its May to early June trading range. The mid-caps look the best with a hold at the 50 day EMA support level. The mid-caps held up, but they were not immune from the selling. There is some strength in some techs and in the usual leaders, but overall the index charts remain weak, Friday bounce or not.

LEADERSHIP: As noted, the 'safe sectors' that include the Big 3 (energy such as oil, natural gas, services, coal; metals and particularly steel; and agriculture) performed well. They pulled back during the week but they held near support and started back up. After a tough week some techs perked up nicely Friday, and those that did not sell off are setting up for some nice buys. Certain areas in medical improved nicely after a test for the week. Industrial electrical equipment and other industrial basics performed nicely as well. Basically those that have performed are still performing while the rest of the market looks pretty crappy. Even some leaders have hit the skids: transports are in serious trouble, falling from grace. Higher inflation rates, surging energy costs tend to do that to stocks.

SUM: While Friday was a nice bounce higher after the selling, the week was volatile with a sharp decline and a sharp bounce. Volatility is not a sign of a steady trend but of change. The market was moving higher off the March low. It reversed after a new breakout and started to sell. Volatility accompanied the move. That volatility on the move lower suggests that is the change taking place and that the volatility is simply the process where the market changes trends.

THE ECONOMY

At what point does the lack of cost 'pass through' not matter?

There is the overall CPI reading that includes most everything we buy regularly, and there is the core that strips out food and energy. The reason for the core is that food and energy are typically volatile and as they bounce month to month they can skew the data. Further, given energy tends to rise first and faster and impacts many areas of services and manufactured goods, it is good practice to strip it out and see whether it is raising other prices or not.

May prices rose 0.6% overall (0.5% expected and 0.2% prior. That puts inflation at 4.2% annually. Whopping. The core rose 0.2%, inline with expectations and remained flat at 2.3% annually. Overall inflation rose while the core remained flat. Sure looks as if inflation is not passing through even though energy rose 4.4% and gasoline 5.7%.

What does this matter? After all, whether energy and food are passing through to other areas doesn't mean we don't pay for food and energy. And indeed we are paying for them as food spikes higher helped by ethanol using our edible corn and our feed corn as well. Feed corn stocks are at a 15 year low; the real price climbs in food are not here yet. Ranchers are putting their cattle to auction early for slaughter and are still telling us that as a result beef prices are going to scream higher after the summer. I have purchased some cattle cheap at auction and using a combination of range and supplement feeding I can provide cheaper beef than what will be in the store later this year.

But I digress. First, at some point energy and food get too expensive and whether there is pass through or not, they dampen other sectors because they eat up more discretionary income. Thus even without pass through of these costs to other areas such that they cost more because of higher energy or food costs, the economy can slow under the burden.

The second point deals more with history and how prices reacted to similar times of surging energy prices. There are comparisons to the seventies right now given the surge in oil prices and the rise in interest rates and inflation coupled with a slowing economy. Stagflation is once again on the financial stations though it is not the buzz topic it was six months ago.

The reason to compare to the seventies is due to the actual pass through of costs in the seventies. You can track the overall and core CPI during that time and you see the two tracking one another move for move and without the spread seen today. This is very important because what we had back then was insidious inflation that choked consumers and businesses every step of the way. It confounded economists using the Phillips Curve because even as the economy slowed and GDP fell, unemployment and inflation, both overall and core, rose.

While higher energy prices subtract from discretionary income, if there is no pass through to other prices you avoid that extra drain that occurs when energy prices start showing up in other goods and services. It helps keep inflation expectations low and that keeps consumers and businesses consuming and producing. In that manner they can work through the rise in inflation, improve supply, and beat back inflation.

As noted all week, however, it will take lower energy prices to bring that inflation down. The jump in inflation may not be passing through much, but at the rate it is rising stocks historically don't perform that well. Energy has to fall and relieve some of the pressure on prices or else the market is going to slog around. If energy does not fall, it ultimately doesn't matter if the costs pass through to other areas or not as the drain from other areas of consumption will eventually take its toll.

ECRI: improving from lows but showing recession levels.

It is no secret that despite the positive GDP results the US economy is in recession. The financial stocks and their contracting business show the recession. ECRI, the best man-made leading indicator, reflects this recession-like slowdown. Its annualized growth index hit near a record low in late March at -11.1%, predicting further slowing that the stock market has started to show the past month. The past week the growth index held at -6.2% for the second week. That is still considered recessionary. The ECRI leading index rose 0.1, the first gain in 5 weeks. A start, but by itself it doesn't suggest a turn in progress; have to see more improvement over the next few weeks. With oil hanging in there at high levels, it will have a hard time showing that kind of improvement.

THE MARKET

MARKET SENTIMENT

VIX: 21.22; -2.11
VXN: 25.3; -2.1
VXO: 22.21; -2.64

Put/Call Ratio (CBOE): 0.91; -0.05

Bulls versus Bears:

This is a reading of the number of bullish investment advisors versus bearish advisors. The reason you look at this is that it gives you an idea of how bullish investors are. If they are too bullish then everyone is in the market and it is heading for a top: if everyone wants to be in the market then all the money is in and there is no more new cash to drive it higher. On the other side of the spectrum if there are a lot of bears then there is a lot of cash on the sideline, and as the market rallies it drags that cash in as the bears give in. That cash provides the market the fuel to move higher. If bears are low it is the same as a lot of bulls: everyone is in and the market doesn't have the cash to drive it higher.

Bulls: 43.0%. Fading as the rally rolls over, down from 44.8%. Bulls dropped sharply to 37.9% before that bounce back up. That followed a string of steady gains: 44.4%, 40.9%, 39.1% and 37.8% where it held for a few weeks. Fell to 30.9% in mid-March as the low. The indicator did its job with the dive below 35% and the crossover with the bears. The bulls and bears were eye to eye in mid-February and have crossed. A move into the lower 40's is a decline of significance. A move to 35% is a bullish indicator. This is smashing that. For reference it bottomed in the summer 2006, the last major round of selling ahead of this 2007 top, near 36%, and 35% is considered bullish.

Bears: 32.6%. Bears gained ground, up from 31.1%. Bears rose during the last part of the market move higher, somewhat of a contrary move, but they had reason to doubt the move. As with the bulls the jump in bears did its job after hitting 44.7% in the third week of March that was up from an already freakishly strong 43.3% the week before. That was a surge from an already high 36.6% the prior week. Up sharply from a low of 19.6% on the last rally. It is over 30% and indeed over 35% the prior week, meaning it has blown past the range that means business. Big move after falling to a low of 19.6% on this round. Bearishness peaked at 37.4% in September 2007. It topped the June 2006 peak (36%) on that 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). This is a huge turn, unlike any seen in recent history.

NASDAQ

Stats: +50.15 points (+2.09%) to close at 2454.5
Volume: 2.113B (-5.94%).

Up Volume: 1.64B (+320.111M)
Down Volume: 461.61M (-443.888M)

A/D and Hi/Lo: Advancers led 2.52 to 1
Previous Session: Advancers led 1.19 to 1

New Highs: 54 (+11)
New Lows: 174 (-9)

NASDAQ CHART: Click to view the chart

Gapped higher Friday, moved through the 50 day EMA and closed just below the 10 day EMA. Has moved back up to the bottom of its 6 week range where NASDAQ formed its double top. Lower volume on the bounce and NASDAQ has now hit the point where it either fails and heads lower once more or continues higher to try and break up that double top at 2550.

NASDAQ 100 (2.17%) rallied up to close just over the 200 day SMA (1963). As with NASDAQ overall, the large caps are up to the bottom of the range where it formed its double top.

NASDAQ 100 CHART: Click to view the chart

SOX CHART: Click to view the chart

SP500/NYSE

Stats: +20.16 points (+1.5%) to close at 1360.03
NYSE Volume: 1.225B (-8.04%)

Up Volume: 971.678M (+200.467M)
Down Volume: 240.894M (-306.095M)

A/D and Hi/Lo: Advancers led 2.69 to 1
Previous Session: Advancers led 1.04 to 1

New Highs: 42 (+10)
New Lows: 159 (-38)

SP500 CHART: Click to view the chart

A rally Friday after SP500 held at the old trendline on Wednesday and Thursday. Held where it had to after resuming the breakdown on Wednesday. It has now bounced back up to the 90 day SMA and the 10 day EMA (1362 and 1363) but on lower, below average volume Friday. Don't expect SP500 to blast back up through that level without oil tanking.

The small cap SP600 (1.84%) gapped higher and bounced up to close at the session high as well. After breaking below its 50 day EMA Wednesday it recovered it with ease Friday. Closed just below the 10 day EMA. Still a shaky pattern and needs to get through the 200 day SMA at 390.56 to turn its pattern back to positive.

SP600 Chart: Click to view the chart

SP400 CHART: Click to view the chart

DJ30

After renewing the breakdown on Wednesday, DJ30 bounced Friday, posting a triple digit gain but still lagging the rest of the market. The move was on lighter though still above average volume, and it took DJ30 to within spitting distance of the 10 day EMA. But it is just the 10 day EMA, the first level of resistance on a rebound. That is not the picture of strength and we are not expecting more upside from DJ30 before it turns back down from this low volume bounce to near resistance.

Stats: +165.77 points (+1.37%) to close at 12307.35
Volume: 247M shares Friday versus 260M shares Thursday.

DJ30 CHART: Click to view the chart

MONDAY

Lots of data out next week with some regional manufacturing reports, PPI, housing starts for May, production. These are important as they will help gauge the impact of the high oil. Much of the improved data seen of late was before this last spike to 135 and more. How the economic data reacts with higher prices will provide some late though interesting comments on the economic condition. As seen the past month on DJ30, the market is already pricing in slower economic data again. NASDAQ is not so bad, but its selling is no less real given the sharp break lower after attempting a new breakout.

The data will also influence short term direction. Friday the news was not that great but stocks still managed to rally for other reasons, namely some pre-weekend short covering and oil selling harder once more (134.86, -2.09). While the economic data has a near term impact, Friday shows that oil as well as the dollar with how it reacts to or influences oil, are the longer term influences on price.

Oil is so key because consumers are reacting to it at this price. Ford came out this past week and said it was not selling any trucks or SUV's, that buyers wanted the more energy efficient vehicles. Ford noted that when gas prices hit $3.50/gallon is when this started. With oil in the mid-130's, gas prices are going to stay in the $4 range, and that is without any Gulf storms. Thus our focus on the price of oil the past two weeks as a major key to the market action. While it may be late in this particular run, oil appears to be setting up for another surge higher nonetheless.

With that background we are going to continue to focus the upside on the leading sectors of the Big 3 as well as some others that are trying to emerge, e.g. medical instruments and related stocks, industrial equipment, and individual techs from chips to software that are showing improvement and can provide growth in this kind of environment. The rest of the market is open for downside as the opportunity presents. For instance the bounce back up Friday is a good start on setting up some stocks at resistance after they broke down. With the market breaking down under the strain of high oil and some inflation worries it will pay to play the downside in addition to the mix of upside with the leaders that continue to capture the money that remains in the market.

Support and Resistance

NASDAQ: Closed at 2454.50
Resistance:
The 18 day EMA at 2464
March 2008 trendline at 2495
2500 from interim August lows.
The 200 day SMA at 2511
2540 from November 2007 low
2552 is the May high
2576 represents a range of interim peaks and troughs from May 2007 into December 2007. At least 8 in that period.
2618 from a June 2207 peak.
2625 is an old trendline from summer 2004/summer 2005
2668 to 2673 from November/December 2007 interim peaks
2720 (July 2007 peak), 2724 (December 2007 peak) are key resistance points

Support:
2451 is the August closing low
The 50 day EMA at 2440
2419 is the January 2008 peak and the early February peak
2392 is the April 2008 peak
2386 is the August intraday low
2378 is the mid-February peak; 2379 from the October 2006 peak
The 90 day SMA at 2371
2370 from the April 2006 peak
2340 from the March 2007 low
2315 is the trendline from the summer 2004/July 2006 lows, Q4 2005 consolidation

S&P 500: Closed at 1360.03
Resistance:
1362 is the 90 day SMA
1370 is the August 2007 intraday low
1374 is the March 2007 closing low
The 50 day EMA at 1378
1387 is the April 2008 intraday high
1396 is the February 2008 peak
1406 is the August and November 2007 closing low
The 200 day SMA at 1421
1433 from a pair of August 2007 lows and December mid-month intraday low
1434 is a longer term trendline from the August 2003/September 2004 lows
1446 from the December low
1460 is the February 2007 peak
1481 represents several peaks and lows ranging from April 2007

Support:
1350 where it held early in the week.
1336 is an ancient trendline that held last week
1324 is the April low
1317 from the February low
1270 is the January low
1257 is the March low

Dow: Closed at 12,307.35
Resistance:
The 10 day EMA at 12,324
The 90 day SMA at 12,504
12,518 is the August intraday low
The 50 day EMA at 12,564
12,573 is the mid-February high
12,743 is the November low
12,750 to 12,768 is the February 2008 peak and a series of lows and highs from August 2007
12,786 is the February 2007 peak
12,845 is the August closing low
The 200 day SMA at 12,945
13,092 is the December 2007 intraday low
13,133 is the May 2008 high
13,250 from price points in second half of 2007
13,563 is the late December peak
13,780 is the early December 2007 peak

Support:
12,250 from late March 2007 lows
12,070 from the early February 2008 lows
12,050 from the March 2007
11,731 is the March 2008 low
11,670 is the May 2006 intraday high; 11,642 closing
11,634 is the January intraday low

Economic Calendar

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

June 16
- New York Empire State Index, June (8:30): -2.4 expected, -3.2 prior
- Net foreign purchases, April (9:00): $80.4B prior

June 17
- PPI, May (8:30): 1.0% expected, 0.2% prior
- Core PPI (8:30): 0.2% expected, 0.4% prior
- Housing Starts, May (8:30): 980K expected, 1.032M prior
- Building Permits, May (8:30): 950K expected, 978K prior
- Capacity Utilization, May (9:15): 79.7% expected, 79.7% prior
- Industrial production, May (9:15): 0.1% expected, -0.7% prior

June 18
- Crude oil inventories (10:30): -4.5M prior

June 19
- Initial jobless claims (8:30): 384K prior
- Leading Economic Indicators, May (10:00): 0.0% expected, 0.1% prior
- Philly Fed, June (10:00): -12.0 expected, -15.6 prior