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InvestmentHouse Weekend Update:

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

- Flat lining into the weekend.
- Manufacturing is on fire.
- Market avoids selloff, posts a modestly constructive session to cap a positive week.

Market slides into weekend quietly, but action is positive.

Low volume and modest price movement overall, but the indexes closed near the highs, fighting a modest urge to sell ahead of a long weekend that faces renewed terror threats. No one really wanted to take many chances, but there were still some nice moves from some stocks sporting solid patterns. That is one thing the market has shown since the follow through on Tuesday: solid, even if few in number, breakouts.

There was some great economic news from personal income and spending, and the Chicago manufacturing index was simply blowout. Indeed, the surging manufacturing sector almost assures that jobs for May will be another very strong showing. The market mulled the news, but did not necessarily rejoice. Bonds had been rebounding, but the strong Chicago data coincided with a drop in treasuries as bond traders saw the strong construction sector simply meaning higher rates were more of a certainty.

It was a quiet session with low volume and modest breadth, but it was not a weak session. Stocks started soft but in the end overcame early selling to close near session highs. The gains and losses were modest overall, but the market fought off some attempts to sell it, and buyers were not afraid to step into some stocks that have shown good strength during the selling and that are making breakout moves. Many have denied this move has any real meaning or that it is actually a summer rally, but more stocks are breaking out. Not hoards of stocks, but a steady improvement after the follow through. Often the market will provide a follow through and then stocks will continue to form up and then provide waves of breakouts as the overall market continues to set up its pattern. Indeed, the market is trying to set up a broader double bottom pattern following the follow through to the rally that started two Tuesdays back. In other words, it is still working on building even as some early leaders start breaking out. That is how rallies typically progress. This coming week we will see if the positive shift in price/volume action turns into even stronger volume gains to show more conviction.

THE ECONOMY

Personal spending and incomes continue to show solid gains.

April spending rose 0.3% versus the 0.2% expected and 0.5% in March (0.4% originally reported. Income increased 0.6% after a 0.4% rise in March (0.5% expected), one of the few times incomes actually outpaced spending in the past six months. Incomes, despite many who argue there is no recovery, continue to expand. That does not happen without a recovery.

Inflation news was good as well as the price index contained in the spending and income report rose just 0.1% versus a 0.3% March rise. The data is mixed regarding inflation. The GDP price deflator was lower as reported Thursday, another indication that inflation is not necessarily all it is cracked up to be. What we see is not necessarily a current problem with inflation but a structural problem that can give rise to future problems, i.e., where the supply has not caught up with demand. We have discussed this in the past two weeks, and basically it is a situation where stimulus was applied to the demand side long before the supply side was pushed to expand. Indeed, the supply side until quite recently has purposefully lagged as producers have held back, still burned from the big overhand left in their laps in 2000.

Chicago PMI surges to record levels, provides some promise supply is trying to catch up.

The May Chicago regional manufacturing report surged to a 16 year high at 68.0, much better than the 62 expected. New orders hit a 20 year high at 74.4; as you recall, we have pointed out each time orders have hit 20 year highs. That is key. Even during the boom of the 1990's, the growth rates were not the supercharged levels seen now. The last time growth was this explosive was after the big supply side incentives of the early 1980's were passed in Reagan's Emergency Economic Recovery Act. The supply side incentives led us to the greatest growth ever seen during the following 20 years. Once gain we are duplicating those explosive growth rates, setting up the potential for another boom where we see low inflation coupled with strong growth based on the productivity technological gains give us.

Yet, there are still many we see on the financial stations and other news stations making bald faced assertions that there is no economic recovery. It is a case of selective recognition or denial. You can cite actual statistics about GDP growth, surging business investment, surging profits, a job market that is catching fire, growth rates in economic indicators, the already sharp decline in deficit projections and be met with statements about how the stock market has still not recovered its losses, how jobs have not been totally replaced. Ask anyone who is intellectually honest and he or she will tell you the market does not recover to those astronomical levels for years after the bust. That does not mean the market is not healthy or that the job market is not growing rapidly, it just means the boom peaks have not been hit. And, of course, if they were already hit just a few short years later, you would be right back at a top and would be ripe for another collapse. It drives you batty listening to the intellectual dishonesty being pushed to unsuspecting citizens who presume that reporters may just possibly be intellectually honest. The growth is there; it cannot be denied. You may want resources directed to foster growth in other areas, but you cannot deny there is overall growth and strong growth at that.

Strong manufacturing sector helps reduce inflationary pressures.

As one manufacturer from the Chicago region stated, manufacturing is on fire. That is good news for inflation. Everyone worries about a strong manufacturing sector indicating more inflation; treasuries sold off on the news of strong Chicago gains. Yet, manufacturing is the supply side, the part of the economy needing to catch up to demand. If it is really cranking up, that is very good news vis- -vis inflation. More supply means supply finally starts to catch up with demand. In other words there are goods to meet demand and prices don't have to be bid higher as dollars fight for a limited number of goods. In a free market, supply will meet demand. It was meeting demand back in the late 1990's and 2000, but the Fed blocked it, choked off demand when it dried up the money supply, and left producers with mountains of inventory. With supply free to meet demand, there was no problem with inflation. Indeed, the numbers showed that. The Fed, however, killed off demand and the effects of that lasted well into the demand recovery in 2002. The Fed impacted supply even after its rate hikes because it left the supply side in such a sorry shape when it killed off demand. Just now supply is starting to come to life, and we can only hope that the surge in manufacturing is a sign that it is catching up to demand.

When will the Fed raise rates?

It is getting closer to the June FOMC meeting, and the FFF contract shows 25 basis points still priced in. We have said all along that 3 strong jobs reports in close proximity would mean the Fed is ready to raise rates. Yes it is using a lagging indicator to trigger its rate hiking campaign, but that is what it has told us. The strong regional manufacturing reports and their employment sub-indexes are indicating a third consecutive strong monthly report. New non-farm payrolls in excess of 200K is what we are expecting the jobs report to show next Friday. That will be enough for the Fed to act at the late June meeting.

Unfortunately, the Fed is going to play its usual cloak and dagger games regarding how much it is going to raise rates and when. It likes to keep the market guessing despite all of the rhetoric regarding transparency and the new statements. It is going to say it will 'go slow', but that is no guarantee as we have discussed. That only means the Fed will act too long and end up doing too much, all the while keeping the market guessing as to when it will finish. That won't give the Fed the cushion it needs soon enough, and it won't give the market the certainty it needs. The market has already moved through 5 months of correction, and that could easily be enough to set the stage for the next move. The Fed, however, has only just recently made clear it will raise sooner than later. That puts additional uncertainty in the market and extends the correction. The Fed says it does not want a repeat of 1994, but it is acting as if that is what it wants. As we noted Thursday night, history lessons are never learned or at least are never applied to real life. The Fed may say it doesn't want another 1994, but it is going by the same playbook that gave us 1994. Five months into a correction and the Fed is just hinting around about rate hikes. The market hates that uncertainty, and it finds it hard to make significant gains with the Fed cloud overhead, not to mention the other near term problems. Five months can stretch into most of 2004 if the Fed is not clearer. Again, a one step move to the target level with a pre-released statement saying what it was going to do and why would be a huge shot of certainty to the market as well as give the Fed some disaster maneuvering room. Will it happen? Ha.

THE MARKET

Overall a positive week, and not just in the fact the indexes posted gains, the first time in four weeks. The week saw a follow through to the rally that started modestly two Tuesdays back. That follow through is a necessary step to set up a further move though it does not guarantee the move. Stocks continued higher after the follow through, though there was no major rush higher. As noted, there were some solid breakouts from leadership stocks as the indexes worked to form the second leg of their double bottom bases. The action may have been modest overall as stocks took a breather ahead of the Memorial Day weekend, but it held its gains and is set up well for a further move.

Despite what many say, this looks like the summer rally to us. It started early, but so does Christmas shopping season each year as well. It is not waiting for the Iraq handover, and it anticipated the break in the oil price climb higher, starting to rally just before prices per barrel peaked on the adamant Saudi statements regarding production. Even after the close Friday, more OPEC and non-OPEC producers were saying they were already ramping up production to help ease prices. They know all too well that if prices remain too high for too long western economies suffer. If that happens prices will decline anyway because demand goes down and who knows when it will resume. Far better to push prices lower now, avoid a recession, and keep demand solid. Again, that has helped kick off an early summer rally a week before it is officially summer.

While we don't think this summer move will be sustainable through year end as was the 2003 recovery tour move, we don't necessarily buy off on what Merrill Lynch and others were telling their clients Friday. Basically they were saying it was going to be a tough summer, and with stocks already at resistance they did not expect the market to make further headway but would bottom in September after a tough summer. There were several brokerages and pundits stating this point Friday. It is getting to the point of being accepted conventional wisdom. That is typically a problem for that view. We think this rally could surprise more to the upside than they are anticipating before it peaks out and makes a late summer dip into September.

That almost presupposes that the major indexes will be unable to breakout from the double bottom patterns that are forming, thus sending them back into their bases to form up once more into October for a possible break higher right ahead of the election. For now we see a decent follow through as well as some strong stocks making breakouts and bucking for leadership. If those continue to improve we could see significantly more upside to come during the current move.

It was very interesting to see SP400, the mid-cap index, in the lead Friday. While small stocks have been getting the tough love treatment on the financial stations (i.e., like them but have to leave them in favor of large caps), mid-caps may present an alternative that investors can move into and feel they are getting a better value. Not that the mid-caps did not run as did the small caps during 2003; they did. They are often overlooked in the comparisons of small and large caps. They may prove to be a happy medium for those looking to get out of small caps but who do not want to own lumbering large caps.

Market Sentiment

Despite the gains for the week, sentiment remained dampened. Bulls declined while bears rose, but not enough to turn the tide. The put/call ratio remained at high levels all week, indicating investors were still not comfortable with the move higher, using the bounce to hedge their long plays and speculate on some downside action.

VIX: 15.5; +0.22
VXN: 21.33; -0.17
VXO: 15.82; +0.29

Put/Call Ratio (CBOE): 1.05; +0.11. Another close over 1.0, the tenth in three weeks. Definitely moving to more extreme levels, and indeed it appears the market has started a meaningful bounce after those repeated closed over 1.0.

NASDAQ

Modest gain, moving laterally as it takes a breather on low volume after breaking over its 200 and 50 day EMA last week.

Stats: +2.24 points (+0.11%) to close at 1986.74
Volume: 1.246B (-24.26%). Amazingly weak volume to close out a decent week that saw some accumulation action. Nothing major, but up on rising volume and lower on declining volume. That is what you want to see.

Up Volume: 709M (-339M)
Down Volume: 512M (+16M)

A/D and Hi/Lo: Advancers led 1.09 to 1
Previous Session: Advancers led 1.2 to 1

New Highs: 56 (-22)
New Lows: 22 (-1)

The Chart: (Click to view the chart)

After clearing the 200 and 50 day EMA (1956, 1966), NASDAQ was content to move laterally Friday, holding onto its gains on low trade. Not a bad cap to a week that saw a higher volume advance on the follow through session that sets the stage for a further rally. After a gap lower that undercut the March lows and then a gap right back up (clearer on the QQQ), this advance has commenced. That gap lower then immediate gap higher is a bullish technical indication, and thus far that appears to be the case. It is also a classic double bottom with the right leg undercutting the left, shaking out (scaring out?) the last sellers before starting the rebound. Still a lot of work to do on the 4.5 month base. A trip up to 2075 near the middle of the pattern, would be a very solid move in itself and warrant at least a rest to form a handle. From there whether it breaks out or not remains to be seen given the strength of the market at that time.

QQQ continued its advance toward the hump in its double bottom (37.50). It never violated its March low and thus is considered technically in better condition for sustained upside movement.

S&P 500/NYSE

Nowhere session on very low volume, but after retaking the 50 day EMA that is not a bad day. Rest is good.

Stats: -0.60 points (-0.1%) to close at 1120.68
NYSE Volume: 1.17B (-19.21%). Major volume drop off as the large caps took a breather after a solid move off the 200 day SMA and up to the 50 day EMA. Good volume action given the index was taking a breather.

Up Volume: 629M (-408M)
Down Volume: 519M (+134M)

A/D and Hi/Lo: Advancers led 1.37 to 1
Previous Session: Advancers led 2.26 to 1

New Highs: 65 (-15)
New Lows: 15 (-3)

The Chart: (Click to view the chart)

Held the Thursday break over the 50 day SMA (1117) as volume remained low and it still needed a breather after the strong Tuesday and Thursday moves. Showing much better price/volume action (up on rising sessions, down on falling sessions) as it provided a follow through move this past week. It is sitting just below near resistance at 1125, tapping at that level on the highs the past two sessions. It may walk laterally for another session or two before it resumes, but we expect volume to start improving this week. It needs to for it to break and hold a move over 1125.

DJ30

Could not break over the 50 day EMA (10,214) or the higher simple 50 day MA (10,246) as the blue chips never got on track Friday after some big point gains last week. It has set up similarly to the other indexes, but it has yet to successfully take out the 50 day MA after it was able to recapture the 200 day SMA (10, 064) Tuesday. Still think it is following as opposed to leading.

Stats: -16.75 points (-0.16%) to close at 10188.45
Volume: 159 million Friday versus 187 million Thursday.

The Chart: (Click to view the chart)

THIS WEEK

Last week the market set up a further upside move with its follow through to the rally that started the prior Tuesday (5-18-04). Volume was decent, but notably lower given the pre-holiday week. What most are looking for this week is whether volume picks up, and if so, does it work in the same direction as last week, i.e., does accumulation take place.

There are some major economic reports to be released such as the ISM (national manufacturing), ISM services, productivity, factory orders, and the May employment report. The latter will be the focus as investors try to get a handle on when the Fed will raise rates. 215K are expected as of now, but we think it could easily top that given what the regional manufacturing reports are showing. If the ISM employment sub-index is strong, you can expect that expectations will be ratcheted higher.

The return from Memorial Day officially marks the start of summer for the market, and in normal summers that typically means slower trade. After a rally all of 2003, we expect this to be more normal: early summer rally that peaks out sometime before July earnings, then a waffling remainder of the summer where stocks struggle and slide into September and October. Typically stocks find a bottom in September and start a meaningful move in October. With the election in November and the Fed starting to raise rates, that is even more likely this year.

Again, we think the summer rally has already started, anticipating the softening in oil prices this past week when it bounced off the lows two weeks back. We think the market will be hard pressed to breakout over the April highs, but that depends upon the strength. If things improve in Iraq, if there is no major insurgency or terrorist attack there, we could see the handover factor get priced in as well. All of this would help the follow through continue to build, and we would expect to see more breakouts flowing as it does.

That is where we will be looking with respect to plays: the stocks that set up good patterns and then are part of the waves of breakouts. We will see how big the waves are or if they are ripples. Again, we are not expecting a watershed rally, so we will set our targets but be realistic and take what the market gives on the moves. If they run out of gas early, we will protect what we have made.

Reports are coming in regarding an attack in Saudi Arabia relating to oil facilities. 10 people are reported killed including one American. One British citizen was dragged behind a car. Hostages have been taken and there is now a standoff as Saudi troops have surrounded what are said to be Al Qaeda terrorists. We have written about our concern of attacks on Middle Eastern oil facilities, and it is not too hard to draw a connection between Saudi's statements about increasing oil output. It is a tenuous situation. The attack does not appear to have hampered any production, but we expect to see some nervous response in oil prices this week, and in the recent past that has put pressure on the equity market.

Support and Resistance

NASDAQ: Closed at 1986.74
- Resistance: 1990 to 2000, the top of the late 2003 base. 2050 represents some prior price points and has stopped NASDAQ the last time it tried that level. Breakout from the pattern is 2080. 2089 is the February closing high. 2112 is the early January high.
- Support: The simple 50 day MA (1972) and 50 day EMA (1966). The 200 day SMA (1956). 1900 to 1890. The April lows (1880, 1878). 1850 below that. Some price tops at 1777, 1750.

S&P 500: Closed at 1120.68
- Resistance: 1125 stalled the last bounce attempt. The April and January highs (1150 to 1155). Next is 1159 (February highs) and 1160 to 1175 the highs in that double top that spanned late 2001, early 2002.
- Support: The exponential 50 day MA (1114), and the simple 50 day MA (1117). The 18 day EMA (1107). 1106 is a May 2002 top and represents some early 2001 lows. 1096 to 1100. The 200 day SMA (1085). April lows (1079, 1076). 1075 to 1070 from the December consolidation. 1058 - 1060 from November tops.

Dow: Closed at 10,188.45
- Resistance: The 50 day EMA (10,214). The simple 50 day MA (10,247) and price resistance at 10,250. 10,570 is the April high. Price consolidation at 10,600 level. 10,747 is the February high.
- Support: The 18 day EMA (10,104). The 200 day SMA (10,064). March low (10,007). 9900-9850.

Economic Calendar

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

6-01-04
- Construction spending, April (10:00): 0.4% expected, 1.5% March.
- ISM Index, May (10:00): 61.5 expected, 62.4 April.

6-03-04
- Productivity, rev. Q1 (8:30): 3.7% expected, 3.5% prior.
- Initial jobless claims (8:30): 337K expected, 344K prior.
- Factory orders, April (10:00): -1.0% expected, 4.3% March.
- ISM Services, May (10:00): 66.0 expected, 68.4 April.

6-04-04
- Non-farm payrolls, May (8:30): 215K expected, 288K April.
- Unemployment rate, May (8:30): 5.6% expected, 5.6% April.
- Hourly earnings (8:30): 0.2% expected, 0.3% April.
- Average workweek (8:30): 33.8 expected, 33.7 April.