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6/08/02 Technical Traders Report
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Technical Traders Report Subscribers:

MARKET ALERTS:
Targets hit Monday: AEP put (+$2.78 per option); CCMP (+$4.10 per option)
Buy alerts issued: AXP; MDC; FTEK; CVH
Trailing stops issued: None issued
Stop alerts issued: None issued

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SUMMARY:
- Market rallies back but did not make the turn.
- Market turns require all indicators to line up.
- Unemployment falls but more of a blip than a trend change. Still economic news is solid.
- April wholesale inventories drop as sales jump.
- Economy is acting as it should be in a recovery, but market lagging because of lingering effects of collapse, corporate stories, and war threats.
- Subscriber Questions

Market shakes off Intel, BGEN, RFMD, and TYC to recover, but fails to set a strong bottom.

Friday had the underpinnings for a real downside blowout with rising anxiety, earnings shortfalls, rising sentiment indicators, all the things you look for in a bottom. After an impressive gap lower, however, the market spent the rest of the day in a dogged climb back up. An attempt to turn positive late failed and that put a damper on the bulls' enthusiasm, but many were declaring the session a success.

Problem is, as we have seen, one session does not turn a trend. Friday's move is similar to many we have seen in this continued downtrend just in the last 5 months. A sell off followed by a reversal session on higher volume that gives rise to a modest move up and then the selling resumes. There has to be sustained institutional buying, i.e., it has to keep up for more than a reversal and following session. The overall downtrend is still in tact. Many of the stocks that recovered Friday are still below resistance. Defensive issues such as health services that led in the throes of the bear market continue to improve, several hitting new highs Friday and leading even as the indexes 'recovered.'

Sentiment indicators did not get to extremes.

There were some differences from prior reversal attempts Friday as volatility rose a bit higher and the CBOE put/call ratio closed above 1.0 in two sessions over the past month. Anxiety has no doubt risen as the VIX and VXN, put/call ratio, and bulls versus bears sentiment indicators show. They have not, however, lined up as we were looking for in the Thursday report over the Friday and Monday sessions. What would it take? A VIX spike to 50 or above and a lot more bearish analysts versus bullish analysts.

All of this occurred in October 2001 after the 9-11 attack. In February 2002, after the run up from that September low the put/call ratio closed above 1.0 twice and the VIX spiked to near 30 late in the month and again early in February. Bears were on the rise but did not outstrip bulls. It was closer, but the indicators that historically show a major bottom were not lined up. The stocks on the big indexes did not have great patterns. That led to a nice trading rally on the major indexes, but the move ran out of gas and was undercut as the selling intensified. A rally attempt in early May that sported a follow through session also failed after two weeks.

The indexes sold down to the next potential support levels and reversed on strong volume. The sentiment indicators rallied higher VIX hit 29.94 on the high) but reversed before critical levels could be reached. A rally on these readings is possible here just as in March, but as noted, the signals for a major bottom were not set with Friday's action. A couple more days of selling could have done it. Indeed, Monday is not out of the question for more selling. The rally Friday tried to turn positive but failed with selling in the last half hour. There was still concern about holding stocks after the rally, and its reversal from the highs late in the session is technically bearish and leaves open the door for selling Monday as many stocks are still below resistance even after Friday's reversal.

In sum the indications of strong negative sentiment that historically point to major bottoms were not hit Friday despite the negative sentiment we reported Thursday after the close. In all likelihood this means that the action Friday bouncing up off of some potential support levels is nothing more than a trigger point for another bounce higher in the continuing downtrend.

Small and mid-caps lead the way Friday, but are still below resistance as well.

The smaller issue indexes managed not only to reverse off of their lows, but also were able to close positive. For the S&P 400 (mid-caps) and 600 (small caps) that meant a bounce up off of their 200 day MVA. The Russell 2000 finished with a gain as well, though its move left it still below its 200 day MVA. Perhaps the smaller issues can re-establish their leadership roll from here; indeed those stocks performed the best Friday. The market desperately needs leadership again after the leaders fell into bases after reaching their peaks. That was a missing ingredient for the big indexes in the March rally, and it has plagued the big indexes all the way down. Many of the large caps are still in distributive patterns; they are not ready to return to glory from these points. Rally they can always do; steady return to leadership? Not as likely. That will have to come from either the recent leaders (homebuilders, retail, defense) or new sectors.

THE ECONOMY

Unemployment falls to 5.8% but job creation is weak.
Expectations were for a rise to 6.1% from 6%, but the number fell. End of the employment draught? Not likely. Weekly jobless numbers and continuing unemployment claims are not showing this. Continuing claims have been pesky, rising each week. Part of this is masking the true employment figure as some are staying on unemployment because they can do so; extended benefits do that. That explains a small part of the continuing claims, but not a large percentage, however.

The big thing we have to look at is jobs. Jobs ultimately show the economic recovery though they lag its origins. Jobs rose 41K, less than the 50K expected. More troubling: April jobs were written down to 6K from 43K originally reported. Just as in March when the 50K gain was revised negative, April's were revised heavily downward. Still, April and May (if the May figure holds) represent the first consecutive gains in non-farm payrolls since March 2001. Manufacturing continues to improve with 19K net jobs lost (lowest in 19 months, i.e., since the manufacturing recession started) versus its 110k average in 2001.

The workweek in May was disappointing. It was flat at 40.9 hours. Usually the workweek has to be expanding before rehiring starts. In other words companies need to have their current workers pushed to the max before they hire. Thus, the falling unemployment number was more likely a blip; the economy is not at the point where it is going to trigger a lot of new hiring or rehiring. When it does, the economy will need to generate 100K jobs per month in order to rehire all those laid off (about 8.4 million were out of work in May) as well as the new workers added to the pool with population growth, i.e. college and high school grads entering the job market.

April wholesale inventories fall sharply.
Inventories fell 0.7% in April the sixteenth straight month it has fallen. Wholesales sales rose 1.6%, the highest rate in three years. Inventory to sales ratio (the amount of time it would take to burn through inventories given the current sales rate) fell to 1.23, the lowest in 10 years. With this kind of improvement it will not be long before companies have to undertake inventory rebuilding again as we saw in January, and that means more orders to manufacturers. A very good sign for the economic recovery.

ECRI jumps higher to 124.2.
After settling back for three weeks and then holding flat last week, this fast-moving leading indicator of economic activity vaulted to 124.2 from 121.9. A major jump that shows economic activity on an upswing again even as Greenspan announced last week that the economy was in a 'soft spot.' We commented at the time that the cycle appeared to be starting up again after a lull just as the market does even as it continues in an up or down trend. It is normal for dynamic processes to take breathers in their trend, and that is what the economy did; now it appears to be on the rally once again. Indeed, the annual rate for the ECRI was 5.1%, the fasted in 17 months. Excellent indication for 6 months down the road: continued expansion that is accelerating, not slackening.

THE MARKET

Once again short covering and some buying came in to rescue a big selloff. What was the most likely culprit? Short covering once the Nasdaq and Dow bounced up off of potential support levels (1500 and 9500, respectively). As we have seen in the past, when these levels are hit after selling, a round of short covering is triggered. These short covering rallies have fizzled in just a few sessions in most cases. This selling had a higher volatility reading and two higher put/call ratio closes. That can lead to a bigger bounce in the overall downtrend as seen in March. It can also just roll over on Monday with more selling given the failed attempt to turn positive Friday. Mondays following poor weeks have a history of bad results.

In any event, the recovery precluded the spike in sentiment we wanted to see, and it also turned some of our put plays that were knifing lower around. Most of those, however, are still below resistance and we are not getting happy feet and bailing out. What we saw Friday was a short covering move after the indexes hit the next level of support; it potentially had the underpinnings for a short term move up, but not for a major bottom.

Economy rallying but market lagging.

As reported the past week, the economy is recovering, performing exactly as one would expect from an economy moving out of a recession. Some sectors are leading the charge while others lag. Leading indicators are up, manufacturing and services have expanded for four straight months, inventories are being sold down sharply, factory orders are up, confidence is rising. Jobs are not there yet, but that is actually normal for the relatively early stages of this recovery. From the look of it, the economy is starting to expand more rapidly, even faster than our Federal Reserve chairman may think.

A recovering economy ultimately leads to rising earnings and rising earnings lead to rising stock prices once future earnings are perceived to have surpassed current stock values. In the current market acceptable P/E ratios are lower. Thus earnings have a ways to go, but an accelerating economic recovery will trigger that perception of value sooner than later.

The big indexes, however, is still moving down. In our view it is doing so because expectations of future earnings have not surpassed current value perceptions due to a few lingering events. First is the lingering effects of the technology collapse. Tech is still trying to pick up the pieces left over, and it is not there. Technology must go through more consolidation; there are too many tech companies still left even today. There is still a massive overhang of technology equipment that that was not bought, and business are starting but as of yet have not really begun in earnest a resumption of technology investment. Current systems are good enough for the current economic conditions, so there is no need to invest until business is substantially better. That combined with the historical sluggishness of asset classes involved in large run-ups and then collapses is holding technology back and will most likely hold it back until late 2002 or 2003. It can always have interim bounces as we have seen the past year, but it still appears to have more basing to do.

Second there is the continuing corporate stories of extreme largess from CEO's and officers taking advantage of the boom. As we noted last week this is nothing new and is usually associated with boom times when CEO's are elevated to supernormal status and they start to think they can do no wrong. It is not as widespread as the perception, but when you see the shenanigans at Enron, Global Crossing and now Tyco where the actions were simply outrageous by some of the officers, there lingers that question about whether even the lowered earnings expectations can be trusted. Third there is the war on terrorism, the continued Middle East unrest, and the tensions on the Indian subcontinent. Those are combining to keep investors burned by the series of events that sent the stock market lower from moving back in. Those investors include some mutual funds that don't have to remain fully invested and the hedge funds that are free to invest as they see fit, i.e., the really big money.

These events are preventing the market from starting to recover ahead of improving economic numbers and ultimately future earnings improvement as would be the normal situation. As history has shown, however, these events keeping a lid on the market for a time are actually the norm. The events are not the norm, but when they occur (e.g., 1930's), a lagging recovery is the norm. It will not prevent recovery, however; it just pushes it out further. We are going to come up to a stronger Q2 than expected and an even stronger Q3 from our reading of the economic indicators. That will help get those leading sectors moving again; most likely not technology yet, but that will come in time after the rest of the market is moving up.

Thus longer term there is recovery in the not too distant future; it is during the near term that we still have to deal with the current downtrend and work down to the September 2001 lows to get the sentiment indicators to the right levels. Friday was a test of the next support level down. Given the sentiment readings it was not the bottom; any bounce at this point will give way to another down leg closer to the September lows. Last week was a big step in the process of getting to levels of fear and price that will weed out most of the remaining long term investors in the large caps. The process is not over according to the historic indicators. If Friday's recovery turns sour early this week, it could come soon. We will still, however, have to deal with a historically slow time in the market during the summer at the same time.

VIX: 26.65; -0.81. On the high the VIX reached 29.94, just below the late-January intraday high at 30. Well, well off the September intraday spike to 57.31 that signaled that major bottom. At best this move indicates a March-like rally that led to a 100 point rise on the S&P 500.
VXN: 52.24; +2.48. Highest close of the year, but as with the VIX it is well off of the levels that indicate major bottoms, e.g., 80 and above (91.79 in September 2001).

Put/Call Ratio (CBOE): 0.79; -0.24. Was very high intraday, well over 1.0, but intraday reading on the put/call ratio historically are inconsequential. It is the close. There have been two over 1.0 on the CBOE the last month, but another such close along with a spiking VIX would have been good.

Summary of sentiment indicators: Again, they are lining up and looked good Thursday until the Friday recovery diminished their gains. The put/call ratio has given a positive reading with two closes over 1.0 on the CBOE, but that is a minimum, and without the other indicators lining up with it, the likelihood of Friday being an important bottom is not likely.

End Part 1 of 3

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