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InvestmentHouse Weekend Update:

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

- Stocks overcome some negative news, rebound from Thursday.
- Economic undercurrents continue as current account deficit widens, Fed holding fewer instruments for foreign countries.
- Stocks set up for the coming week if investors are ready.
- Subscriber Questions.

Stocks end volatile week holding the range.

The news was not all that good for stocks Friday with a weaker semiconductor book to bill report issued Thursday evening, an expanding current account deficit, and more despicable terror acts in the Middle East. The news was sprinkled throughout the session, the last item shaking the market late, and stocks never quite got back on track afterwards.

Even with the last hour shakes stocks managed a positive close. SP500 moved over the down trendline intraday and was making a successful test when the afternoon news hit. That kept it from breaking that resistance on some stronger volume, though the volume was attributable to expiration position shuffling as opposed to any significant accumulation by institutional investors. Thus the move over that resistance would have been nice, but it would still take Monday to show that it was something more than expiration volume and volatility.

Not to say the action was negative. Stocks overcame some bad news and a softer open to close positive. SOX closed negative again, but it managed to hold some support at 450 and show a nice doji on the candlestick chart as it rebounded off its lows. Overall the indexes maintained their lateral move, bounced back some from the Thursday up and down action, and showed no real inclination to sell off. They are still set up in decent shape to try for another breakout this week.

If they do make the break higher, the issue still remains how high they will rally before this early summer move runs out of gas. It has not been a barnburner move by any stretch with volume remaining low and the moves either way mostly modest. Some are saying that a breakout will usher in a summer rally past the April highs, etc. We are not so optimistic, setting the April highs as our target, but will gladly let stocks run if they will. Certainly the action would have to change, i.e., there needs to be more sustained buying, for the indexes to clear those levels.

THE ECONOMY

Trade gap hits a record. Will foreign investors start leaving the pool?

At $144.9B the current account deficit hit 5.1% of GDP. The current account is the broadest measure of overall trade. The 5% level is considered key. Back in 2002 we discussed the 5% level as key at least in the sense others consider a key level. When there is a deficit in the number, the US needs other countries to invest more in the US to cover the gap. We buy more of their stuff, they are buying less of our stuff, so we need more foreign investment in other US assets (e.g., equities, debt) to make up the difference so we can keep running the deficit. At some point that deficit gets to an uncomfortable level for foreign investors. That can be caused by insecurity about the future of the economy, interest rates, inflation, etc. Indeed, the size of the gap itself can cause the insecurity because of the fear of what a large current account gap might cause. In other words, the gap�s own shadow can scare foreign investors away.

If foreign investors don�t want to finance the gap they sell their dollar denominated investments and move the money elsewhere. When you sell anything and there is not another buyer standing in line willing to pay a higher price for it, price falls. Selling can beget more selling, and then you have falling prices in US assets. That is another way of saying potential deflation, something Japan just spent a dozen years mired in.

Are there any signs this is happening? Thus far they are few and modest, but there are some. We have reported that there was an outflow of foreign capital from the US equity markets. There has been some of this continually ongoing since 9-11. The threat of terror reduced the value of US assets in the eyes of some foreigners. The weakening dollar after that event also showed the same effect: uneasy foreign investors putting some of their assets in non-dollar havens just in case.

The flow out of equity markets picked up some the past three months. The Federal Reserve�s holdings of securities for foreign investors fell over 5% the past quarter. There is a definite flow of funds out of the US. The key is whether the flow becomes a flood. There are a lot of issues that are a long way from finding resolution. Iraq, the war on terror, Fed rate hikes, what direction the US is going to take economically, socially and globally after the election, higher oil prices. Foreign money may just be taking a sabbatical until some of these issues are resolved. For now it is not critical, but it is very interesting that it started as the current account gap neared 5%. Again, that may be something of a self-fulfilling prophecy as the 5% of GDP in and of itself caused some to flee. After this initial flow the key is whether it remains light or picks up speed.

How does the Fed react?

The outflows are in the same league as rising energy prices: the Fed does not like them because they cut against economic growth and the Fed cannot do a whole heck of a lot about it without crushing the economy. Monetary policy cannot impact energy prices but in a very indirect way. It can make the US somewhat more attractive to foreign investors if it jacks interest rates up well above market rates; that makes the dollar more valuable as foreign investors want to put their money into the US and take advantage of above market rates without risk. Of course that torpedoes the economy as US investors do the same as opposed to investing in the US economy. In the long run that means you get low growth and interest rates the eventually have to fall due to lack of economic growth.

So you might conclude that the Fed has to ignore it. Or does it? Over the past quarter the broadest measure of money supply has risen 22% on an annualized basis. That is huge. Huge. That has led to several conspiracy theories as to the reason such as the Fed is anticipating some massive negative to hit the US. Maybe a terror attack, maybe a big meltdown in a major Wall Street firm or bank. With the Fed funds rate at 1%, there is not any real ammunition to stimulate the economy in the event of a major disaster, so the theory is the Fed is monetizing the economy even more in an effort to get it really running ahead of this event.

There are some major problems with those theories, one of the most apparent of which is the Fed�s impact in such situations is not in the quiet background ahead of disaster, but in bold moves following the event where the world looks to the Fed and says �TGIF, thank God it�s the Fed� as the central bank makes a dramatic move such as, well, injecting tremendous liquidity into the system.

There is another possibility. The Fed sees the possibility that more foreign funds may be leaving, and it is pumping more liquidity into the market to help speed the US economy and perhaps offset some of the negatives associated with the current account gap to the extent foreign capital will have to think twice about leaving. It can do this even as it talks of rate hikes. Remember, the Fed was lowering rates during the bear market but the money supply was not rising. It was not providing real incentive to borrow. Not until late in the game did it really let money supply go. Well, the opposite can happen here. It can raise rates but still pump up money supply. Even with rate hikes, at these low overall rates there is still a lot of stimulus. This is just a possibility for the dramatic jump in money supply. Frankly, the conspiracy theories about some big yet secret event to the entire world is a bit much. Usually the actual explanations are not nearly as entertaining as the speculation.

Did you hear the one about the minimum wage?

It is once again being proposed that the minimum wage be raised in order to �get America out of poverty.� Laudable goal, dubious methodology. The way to get America out of poverty is to remove incentives to stay in a poverty-inducing payment system. Take that money and use it to educate and train in areas the economy needs skilled workers. Provide incentives for employers to provide day care so single moms and dads can take the training and take those jobs. Put the rest of the money back in the economy to further drive technology and job creation.

History is replete with minimum wage rate hike examples. You know what happens when you hike the minimum wage? You get fewer workers doing the same work all of the workers did before. Small businesses won�t hire that extra helper; they will simply make the others do that work. The problem is that simply raising the required wage does not generate more money, it simply causes a reallocation as to where it goes. If a small business only has a set pool of money it can pay its workers given its level of sales and expenses, it is going to cut back on something. Typically it is the number of workers, but it could also be that the business cuts its hours, civic donations, charitable donations, etc. None of those are good for the economy or those that live in this country. Again, a higher minimum wage does not create anything in the economy; it actually is destructive to those it is supposed to help and is another tax on small businesses that now have to make do with fewer employees or other investments in their business that could have made them more productive and profitable.

THE MARKET

To this point the upside move has been back and forth enough to make Job lose patience. Light early summer volume has kept SP500 and NASDAQ below the 2004 downtrend while DJ30, NASDAQ 100, and small to mid-cap indexes continue to hold over their 2004 downtrends. Leaders are holding up overall, but there continues to be erosion as the bottom drops out on apparently strong stocks. Big name semiconductors (INTC, AMAT, TXN, KLAC) continue to show very weak action while a few (e.g., BRCM) look very good. At the same time stocks such as MSFT and GE are showing a rebirth, rallying higher on strong volume as the come off their lows and form the right side of their bases. At the same time, big name industrials such as MMM continue to power ahead on volume.

Sounds like a market in transition, and while MSFT may be performing well, techs overall are having a rough go of it as NASDAQ has lagged the other indexes. It suffered two distribution sessions last week to add to the one the prior week. Breakdowns have not been confined just to technology, however. Even some of the defensive health and medical stocks are seeing the bottom open up and swallow them.

That has left energy stocks as one of the market leading groups. Historically that is not usually a positive for the market. Consumer, materials, and medical stocks are also leading, sectors that are a bit better for the market overall as they contain some growth stocks. Growth stocks are the market leaders in bull runs. If the more defensive, slower growth stocks take over, it is a sign the market is not anticipating strong continued economic growth.

Even with all of these undercurrents the indexes are still poised to continue the move off the May lows. Near term NASDAQ and SP500 have to take out their down trendlines. SP500 is at the doorstep, NASDAQ has some work but can make the move in a session as well. Again, the upside after that move is questionable above the April highs unless a real volume surge is maintained. As we noted last week, the market anticipates resolutions to issues well in advance, and it has yet to show action that suggests overwhelmingly favorable results regarding Iraq, the Fed, etc. At the same time it is setting up for the break higher. The strength of any upside breakout past the downtrend will be the best indication of the potential for the remainder of the rally. Indeed, a breakout itself could be the indication that the market has resolved its near term issues with Iraq, etc. As with all meaningful moves, volume will play the big role as the majority of investors will either want to move into stocks more aggressively or simply continue the same low volume meandering.

Market Sentiment

VIX: 14.99; -0.16
VXN: 20.02; -1.31
VXO: 14.75; -0.29

Put/Call Ratio (CBOE): 0.8; +0.01

NASDAQ

Rallied to tap resistance at 2000 once again, but gave back most of the move. Holding up, but needs to make a move to take out that level soon.

Stats: +3.06 points (+0.15%) to close at 1986.73
Volume: 1.729B (+16.33%). Big volume jump, but that was in all likelihood attributable to expiration though stocks such as MSFT, CSCO and DELL posted gains on big volume increases. Regardless of the Friday action, volume has to show some non-expiration strength on the next breakout move.

Up Volume: 930M (+513M)
Down Volume: 699M (-350M)

A/D and Hi/Lo: Decliners led 1.13 to 1. Mushy breadth as techs are still sluggish with NASDAQ underperforming much of the market thanks to SOX.
Previous Session: Decliners led 1.5 to 1

New Highs: 65 (+5)
New Lows: 73 (+30)

The Chart: (Click to view the chart)

A 26 point range, closing in the middle of the range. NASDAQ tapped the 50 day SMA (1974) and the 200 day SMA (1971) on the low (1973.91) and managed a rebound. Toward the close, however, it was falling as opposed to rising. Volume was above average for the first time since early May, but again, expiration drove that increase. NASDAQ held its ground above near support and below the 2004 down trendline at 2002. It is getting pinched between the two. There is a lot of pressure from the topside, and SOX as we noted Thursday, is a big drag on techs. That is one reason we believe that NASDAQ can bounce near term and move toward the April highs: SOX has sold hard and is due a relief bounce. That bounce can allow NASDAQ to break the trendline and test those highs. Unless SOX can pull a similar move and clear its 200 day SMA at 488, the move will be limited when SOX runs out of steam on its relief bounce.

QQQ gave a big intraday move up to 36.84 but it could not hold, fading similar to NASDAQ. Volume was extremely light as QQQ continued to hover over the down trendline (36.29).

S&P 500/NYSE

Decent action but gave up a brief breakout over the down trendline. Still ready to complete that move.

Stats: +2.97 points (+0.26%) to close at 1135.02
NYSE Volume: 1.494B (+15.27%). Above average volume as well, the first in just about a month. It too was expiration volume, so we are not putting much stock in it. NYSE volume, however, has showing positive attributes recently. Tuesday it was up on a solid up session. Thursday the index was down on rising trade, but the index made a strong comeback to close basically flat. This volume is indicating it is ready to make the break higher.

Up Volume: 901M (+199M)
Down Volume: 574M (+22M)

A/D and Hi/Lo: Advancers led 1.27 to 1
Previous Session: Advancers led 1.38 to 1

New Highs: 144 (+14)
New Lows: 22 (-18)

The Chart: (Click to view the chart)

This past week SP500 may have made the higher low that often comes right before a breakout. Monday it was under pressure, but held key support at 1125. That was the low point as the close held above the 10 day EMA (1130) the rest of the week with the Friday close right at the 2004 down trendline. Still in a good overall pattern since March, and as noted above, the price/volume action of late has been markedly improved. While it gave up the break over the 1135 trendline (high at 1139.08), it is still poised to make a move that sticks as it works for the April high at 1150.

DJ30

With MSFT and GE showing very strong trade and most other components rising on solid volume gains, DJ30 tapped the top of the recent range on the high (10,438) on strong volume. Seems the technology components were finally in sync with the more �industrial� components. Not all was upside volume, however, as WMT and HD were lower on some hefty trade. All in all, however, DJ30 continues to hold easily over its down trendline (10,330), tapping the 10 day EMA (10,351) on the low once more. Price/volume action has improved nicely, and DJ30 looks set to continue higher this week toward the April high (10,570).

Stats: +38.89 points (+0.37%) to close at 10416.41
Volume: 300 million shares Friday versus 170 million shares Thursday.

The Chart: (Click to view the chart)

THIS WEEK

Despite the struggles on NASDAQ, precipitated in large part by a languishing SOX, stocks are set up for a break higher. They were set up for a break higher at the start of the prior week as well, but the time was not right at that time either. The indexes are cheating higher as the June 30 Iraq handover and the FOMC meeting approach, and we still do not believe they will wait until the actual events to start their moves. The market anticipates events with respect to its more significant moves. Thus we still anticipate an upside move ahead of that period. Indeed, if stocks run to the April highs by the time of the meeting we could see the turnover and FOMC decision lead to a pullback.

That leaves us still looking at upside plays, and of course, if stocks continue a run past the April highs we will let them do so. If we see serious volatility and trouble at that level we will be ready to exit and also be ready with some downside positions. Again, for now that still leaves us looking at stocks that are in particularly good position to provide nice upside gains near term, e.g., breakout tests, 50 day EMA tests, solid patterns in high momentum stocks. There are still many solid stocks holding up quite well, ready to make a new or further upside move. We will take what the market gives on a further run from here, see how stocks react at the April highs, then move out and look to the downside if it gets rocky, take partial gains and ride the rest if it is still solid, and even look for more upside if it makes a really strong move at that point.

Support and Resistance

NASDAQ: Closed at 1986.73
- Resistance: 2000 is the top of the late 2003 base. 2002 is the January/April down trendline. 2024 is the June high. 2050 represents some prior price points and has stopped NASDAQ the last time it tried that level. April high is 2080. 2089 is the February closing high. 2112 is the early January high.
- Support: The 50 day SMA (1974). The 200 day SMA (1971). 1925 is some support. 1900 to 1890. The April lows (1880, 1878).

S&P 500: Closed at 1135.02
- Resistance: The March/April down trendline at 1135. 1142 is the June high. 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 10 day EMA (1130). 1125. The 50 day EMA (1121) and the 50 day SMA (1119). 1106 is a May 2002 top and represents some early 2001 lows. 1096 to 1100. The 200 day SMA (1093).

Dow: Closed at 10,416.41
- Resistance: Late April peaks (10,478 to 10,512). 10,570 is the early April high. Price consolidation at 10,600 level. 10,747 is the February high.
- Support: The January/April down trendline (10,330). The 10 day EMA (10,351) held on the lows all week. The 50 day SMA (10,257) and EMA (10,267). Price support at 10,250. The 200 day SMA (10,126). March low (10,007). 9900-9850.

Economic Calendar

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

June 24
- Durable Orders, May (08:30): 1.6% expected and -3.2% prior
- Initial Claims, 06/19 (08:30): 340K expected and 336K prior
- Help-Wanted Index, May (10:00): 40 expected and 38 prior
- New Home Sales, May (10:00): 1120K expected and 1093K prior

June 25
- GDP-Final, Q1 (08:30): 4.5% expected and 4.4% prior
- Chain Deflator-Final, Q1 (08:30): 2.6% expected and 2.6% prior
- Michigan Sentiment-Rev., June (09:45): 95.0 expected and 95.2 prior
- Existing Home Sales, May (10:00): 6.50M expected and 6.64M prior

SUBSCRIBER QUESTIONS

Q: In the Economy section you refer to the "ECRI" that comes out every Friday. What do the letters stand for and where is it reported? Thanks for the discussions on "supply side economics", it's making some sense to me now.

A: ECRI is the acronym for Economic Cycle Research Institute. It is a private entity that studies various aspects of the US and other world economies such as acceleration and deceleration and inflation prospects. The Conference Board puts out the LEI (Leading Economic Indicators) made up of a basket of 10 indicators. ECRI looks at several more indicators it has determined, after extensive study, give a faster and more accurate indication than other similar methods. By faster we mean it provides a more timely indication. The accuracy is historically proven with accurate calls of the 2001 recession, the end of the �Goldilocks� economy back in June 1999, and the Japanese recovery.

It has an impressive track record looking back, but it has a lot of the same problems of other indicators during the heat of battle. It gives indications, but you have to put them in context and figure out why they are showing what they are showing. Back in 2002 we were seeing an upturn in many points in the economy, but the ECRI was overstating some continuing slowdown. While it was picking up some of the same signs of improvement, they were overweighted by some continuing problems that were still worsening. Thus it blurred the potential recovery that was developing. ECRI was still pessimistic as we were turning optimistic. We received a subscriber question at the time regarding that discrepancy, and our answer was the same: ECRI offset the improved indicators with some that were still declining though they may have been a bit more lagging.

Nonetheless, it is a good indicator, particularly when looking at the trend. Right now it still shows a continuing decline in the annualized 4-week growth rate. It was down for the fifth straight week to 3.6% from 4.1%, a 13 month low. That is forecasting continued expansion, but at a slower pace in the second half. If the economy is not growing as fast, that puts pressure on stocks to advance their prices.