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5/25/01 Technical Traders Report
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Technical Traders Subscribers:

TONIGHT:
- Week closed out with the major indexes lower on light volume.
- Critical week ahead for the market as indexes and individual stocks flirt with support levels.
- Economy is the key to the future of this rally and stock prices.
- Fed hinting at winding down rate cuts.
- Subscriber Questions

THE SUMMARY

Nasdaq up, Dow down for the week as holiday leads to lackluster end to the week.

The indexes did not give us the move higher at the end of the week, but instead flirted with support levels at the close. Volume was light the latter part of the week, and extraordinarily light Friday. when those conditions exist movements up and down can be exaggerated. As the point of least resistance appeared to be up, we were looking for a late run into the close. That did not happen as the indexes sold down to close just off of their lows for the session. Even with the lower closes Wednesday and Friday, the Nasdaq managed a 2% gain for the week. The Dow was down 2.6% on the week.

The Memorial Day weekend finds all three major indexes right above levels that should act as support. These are levels that were just broken through over the past two weeks that had acted as resistance. A test of a break through resistance is expected. The key will be whether this test is successful. The selling was on low volume; if you have to have a test and some selling, it is best to be on low volume as it shows there is no dumping of shares.

Even with the selling, the overall price and volume action remains good on the Nasdaq and not so bad on the Dow and S&P 500. This even as the bulls fall back in number. That remains a good sign as there are still doubters of any rally. The action is similar to what we saw up to the Fed rate cut on 5-15 with low volume selling and rising pessimism that the rally would last. Again, the negative sentiment is good from a contrarian standpoint. It helped launch the last big move up.

Critical week ahead.

Contrary indications aside, this is a critical period for the indexes. As noted, they are coming down to test what should be support. Breakout stocks are doing the same. Most of the action has been on low volume which is want we want. Still, there are some stocks that are diving, and that is always something to take note: breakouts are the icing on a rally. We have been seeing waves of breakouts week after week. That is what we like to see. Now we are seeing some stocks such as HOTT, CPN, and RESP diving down on higher volume, the latter two undercutting their 50 day MVA's. The building companies (RYL, LEN) have been diving as they anticipated the weaker housing numbers. Failed breakouts are always something to pay close attention to. They were the hallmark of last summer's rally when it failed.

We are not saying that this one is failing. Again, price and volume action remains solid on the Nasdaq and not bad on the Dow and S&P 500. The indexes are at critical levels, some stocks are under pressure, and there was economic news out Friday that was not the best. What we need to be watching for at this juncture are signs that leading stocks are starting to price in worse economic times than better.

It is the economy, and the indexes and the stocks should tell us.

We have stated again and again that the economy is the key to the market. Stocks have been taking the cue from statements by INTC, MU, AMD, SEBL, PSFT, NVDA and others that they see a bottom in the economy and are affirming their earnings guidance for the year. Investors have also taken heed of the 250 basis points in rate cuts from the Federal Reserve as providing sufficient stimulus for the economy in the latter part of the year. The tax cut plan is nice, but not many are expecting that to provide a lot of near-term stimulus. The key would have been investment tax credits to get business to start buying equipment and major reductions in the capital gains tax to get investment capital up and running.

That is what has been driving this move: expectations of a better economy giving rise to higher future earnings. Higher future earnings means stocks are worth more now in anticipation of those higher future earnings. If the economy does not respond or is not responding satisfactorily and that confidence in the recovery is shaken, that can be trouble. If companies have to retract those positive outlooks in the coming weeks with warnings in June or do so at earnings season in July, that is trouble for the market short term.

Will we have to wait for that first statement that there is trouble on the earnings front? Most likely not. Remember, in early 2000 the market started broadcasting its signal that the economy was in trouble as a result of Fed rate cuts that would not end until May of that year (even though the Fed kept rattling its saber all the way into December). The market started distributing (institutions dumping shares), leading stocks started breaking down, a correction ensued followed by the bear market. Long before it became a bear, the market was telling us that things were heading lower.

Similarly, this market will tell us if things are going to fall apart before the real words are uttered (if in fact they are uttered at all). We will see the indexes undercut levels that they have just worked on breaking through, and they will do it on higher volume. Stocks that have been breaking out and running higher (LOW and the rest of the retailers, the builders) will start to tank. The builders anticipated the slowing housing market and have already faltered. Stocks start to anticipate bad news ahead of time through the collective that is the market. That is why we keep an eye on the indexes and the action of the leading stocks.

THE ECONOMY

What is the economic news telling us?

We have been concerned about the housing market. It has been very strong, but we have noted the falling number of permits the past two months. We have also noted how we had heard that the migration of workers out of California and other tech areas had pretty much come to an end. Also, lumber prices had been skyrocketing and housing costs were rising even though interest rates were low. That combination has started to impact this level. Existing home sales were down 4.2% in April (-3.4% expected). That came on the heels of new home sales dropping 9.2% during the same period. Those are down from already excellent levels, but we hate to see this stalwart of the economy softening. Especially since the rest of the economy is not looking too steady.

GDP lower than expected.

GDP was revised lower to 1.3% (2% originally reported). Still above zero, but well off the 3.5% 6-month average. Inventories were down $19 billion for the quarter versus up $55 billion in Q4 2000. That reduced the GDP and is good as it may allow factories to start churning out more goods sooner when stocks get low. Consumer spending remained decent at +2.9%, though slightly down from the +3.1% of the previous quarter. Business investment in tech equipment, however, was way down, falling 2.6%. Does not look like a quick tech recovery still.

Durable goods, those goods expected to last 3 years are more, fell 5% (-2% expected) after a gain of 2.9% the previous month. With not as many houses sold there is not as much need for washers, driers, dishwashers, air conditioners, furnaces, water heaters, etc. This is a volatile number of course, but the much larger than expected drop gives little hope for a quicker recovery through the summer.

Michigan sentiment rises. Sentiment was higher at 92 than April's 88.4 reading, but it did not meet expectations of 92.5. Still not bad, and current and future expectations both notched strong gains. The government's report comes out on Tuesday, and similar rises are expected. There is no question that the consumer has held up remarkably well given the jobless claims and layoffs. The relative recession we are suffering through is definitely on the business side of the ledger.

Economic Cycle Research Institute still sees a recession. The weaker data of late has turned what was slightly promising economic news over the past couple of weeks into what the ECRI is calling a recession ahead. Without homes leading the way, there is not much else holding the economy up. It is thus predicting a recession in fact on top of the relative recession we have already suffered as the economy slowed from 6% growth to 1% growth in Q4 2000. Hard to be happy about that.

Where is the Fed on this issue and other miscellaneous news.

Some talk about the end being near emerged this week. Governor Meyer said the Fed had to be careful it did not go too far the other way and potentially ignite inflation. Greenspan said the economy was still at great risk, but also said the 250 basis points in the bag should help out a lot at the end of the year. Some read that as conditioning by the Fed to get ready for the end of the cuts. Probably is just that, conditioning; the Fed is not sure when it will stop, but it wants to be ready. At this point there is no sign that its cuts have done much other than finally get some investors to believe that the economy will be better off. We would have to agree as five rate cuts always ignites the economy as long as we are not in a major depression. We are not there yet by a long shot.

The FFF contract is pricing in a 25 basis point cut at the end of June. That is a long, long way away, and all kinds of economic news is out before then. This far out it is too unreliable a measure. We will say that if the economy does not show any improvement by the, 25 basis points is a lock, and 50 is not out of the question.

$9 billion flowed into equity stock funds last week after the big move up the day after the rate cut and then Monday's big gain. Money is coming in off the sidelines; the interesting thing to see will be how it fares this Wednesday when the next counting period ends; will investors view the sideways and downward movement favorably? Probably not, but again, there is already money there ready to be put to work.

Big calendar this week. Lots of news from sentiment to the employment report. That will have everyone abuzz this week and could be market moving. The economy is the key as we said. Funny thing; we should not expect any real relief yet. AT A MINIMUM, it takes 6 months for a cut or hike to be felt. These numbers WILL NOT reflect that now; that is what Greenspan was saying Thursday night, though no one seemed to be getting that. If companies continue to look down the road and see things looking better, we are in good shape. If they start looking only past their noses (e.g., CSCO), it could be a problem as they start backtracking on earlier statements.

THE MARKET

Very important week for stocks ahead. Investors start looking ahead to earnings warnings and announcements, and they will either factor in the good or the bad. If things remain as they have been, the markets are set up nicely for a run higher.

Overall market stats:

VIX: 23.15; +0.21. Volatility barely moved as the S&P suffered a pretty significant drop. Volatility is at the low 20 range, and that can start signaling complacency. We would like to see it hopping back up on any selling day, but it is mired at this level. Again, that can signal apathy, and that is not good for the market.

VXN: 52.46; -0.76. The Nasdaq 100 falls and volatility falls as well. It was a lazy day, but as with the VIX, this does not show there is a lot of concern out there. May have just been the quiet, quiet action at the end of the week, but worth keeping an eye on.

Put/Call ratio (CBOE): 0.64; +0.05. Put activity rose on the selling Friday, but it was nothing spectacular or similar to what we saw on Wednesday's selling. Still, it is well above the 0.4 level that can be an indication of a complacent market.

NASDAQ: Up for the week, but finished the week flirting with the 2232 to 2250 level that we want to act as support for the next move higher.

Stats: Down 30.99 points (-1.4%) to close at 2251.03.
Volume: 1.385 billion shares (-25.5%). The second lowest volume of the year in a really slow session. 832 million downside versus 532 million to the upside. Not a blowout either way, and a continuation of the decent price/volume action that shows no dumping of tech shares.
A/D and Hi/Lo: Declining issues took a narrow lead again at 1.05 to 1. It was really a stalemate until the end of the session. A concern: the A/D line has flattened out; not the worst sign, but we should note that the broader market was moving even as the big names techs were moving sideways before the last moves up. We would like to see that continue. New highs rose to 153 (+22) even during the selling as new lows rose to 28 (+4).

The Chart: http://www.investmenthouse.com/cd/$compq.html

It gets depressing and frustrating at times watching this market. It makes some great moves on great volume, then bleeds back before making another great move. We are still waiting to see if this last pullback on low volume leads to yet another jump higher. Price/volume action remains good, but the moves are not just up, up and away in most stocks and definitely not in the indexes. We are making good moves on breakouts, but then again other stocks run up $10 and give back $8 before moving higher again. It is not yet a market that is racing ahead; it is still putting in the time needed to build that base in coming out of the bear market. It is good that it is building a solid foundation; it just gets a bit frustrating.

Again this is a critical week for techs. The index is at support from 2232 to 2250. It has tested it once, risen a bit, and now has pulled back to that level on low, low volume. That is a recipe for another move up if the market is still believing in the future. Along with the market, many key breakouts have pulled back to test the move higher, and they too are at critical stages. Will we see them fall back into their bases as did RESP or will they catch support and power back up on rising volume as they should do in a healthier market. Overall things still look positive, but we do see some warning signs. These could easily be swept away by some high volume moves to the upside.

Dow/NYSE: After knocking close to 11,400, the Dow has done nothing but sell off back to what should be support at 11,000. It has done it on light volume, a good sign if it had to happen, but it did trade below 11,000 late Friday before edging back above that level to close. Another critical juncture here.

Stats: Down 117.05 points (-1.1%) to close at 11,005.37.
Volume: NYSE volume was indeed the lowest this year at 828 million shares (-25.3%). No institutions were left in the office to do any buying or selling on Friday. Down volume led 555 million to 258 million shares. Lower volume pullback to support. We will see if it holds.
A/D and Hi/Lo: Declining issues were back in front 1.17 to 1 (advancing issues led 1.08 to 1 Thursday). As with the Nasdaq, the breadth the NYSE has showed us started to fade a bit last week. New highs fell to 114 (-9) as new lows also fell to 14 (-10).

The Chart: http://www.investmenthouse.com/cd/$dja.html

The Dow tested ever lower, hitting 10,993.79 on its low right before the close. It managed to bounce and thus keep support at 11,000 'in tact,' and that is about all you can say good about the session. It was weak, and the light volume at the end of the session acted to exacerbate a move down as traders exited positions before the long weekend. The Dow has been in a steady pullback since breaking 11,000 and running up to 11,350. It has shown no enthusiasm since that move, and the pullback has been steeper than it was in early May when it made that lateral move before the last big rally higher. We will see how the index holds up. A breach of support is a sign of a weaker move to the upside than we had hoped, and it starts the cycle over again and increases the possibility of a test lower once again. Critical week.

S&P 500: The big cap index is showing action very similar to the Dow: strong break over resistance at 1270, a nice move higher from there, but volume fails it and it has fallen back down to that support as of Friday's close. It did not penetrate that support on Friday as did the Dow. That is a bit of consolation, but not a whole lot. Support from previous resistance at 1270 and the 18 day MVA is 1272.07. In a healthy market that should prove as a solid pad for the next move higher. If that fails, the next level is the 50 day MVA at 1247.77. That is a do or die in our view. If selling ramps up on the breach of support, the index is in for trouble.

Stats: Down 15.28 points (-1.2%) to close at 1277.89.
Volume: NYSE volume fell to the lowest of the year at 828 million shares (-25.3%).

The Chart: http://www.investmenthouse.com/cd/$spx.html

THIS WEEK

From the discussion of the markets, we do not want to come across as overly gloomy. We are just seeing some signs that the building that was going on as INTC, MU, AMD and others cited a bottom in the business cycle might not be taking hold as we had been looking for. The economy has not firmed up, but we should not expect the rate cuts to have taken effect at this point. They are for the fall and into the last quarter of the year. Up to this point, that is what the institutions and other investors have been building into stock prices. That is logical. Problem is, we don't set investor mentality, and now there is talk that there will be warnings and backtracking on statements made about the bottom in the economy.

Do we guess what is going to happen? Not really. We look at all the facts and can make judgments about where things are heading. As we said two weeks ago, it is hard to bet against 250 basis points in rate cuts and a tax cut not having the effect everyone wants. Indeed, there is most likely another 25 basis points at least coming on top of that. It would be the rarest of historical events if that did not see the market even higher down the road.

Short term we have to let the market do the talking, however. We do that by watching how it holds at what should be support at these levels. We won't panic on a close below these support levels, especially if it is on lower volume. But, once a close is made below them, the short sellers have new life and will try to drive it lower. That is the real test of the bulls; will they step back in and overtake the bears? If the selling is on higher volume, that means the bears have just jumped right in and we are going to watch from the sidelines or at least take some downside positions for the short term.

On the other hand, if we see the jump back up on some convincing volume to the upside (meaning preferably above average volume), we will feel a lot better about these levels holding for the next move up to bigger and better things. Low volume moves higher on Monday and Tuesday may just be a chance to get out of short term positions so we can wait and see if volume kicks back in. If it does not the move has a good chance of failing: a low volume rise back to the recent tops is a recipe for a double top.

Again we may have ready too much into the fade last week on lower volume. Everything is still in good shape from a price and volume perspective, there are still the rate cuts at work in the economy, and we now have a tax bill that the President will sign. That is powerful medicine that will cure in the long run; it is the short run we have to get through. Again the indexes have to find bottom around here and start higher on stronger, convincing volume.

End Part 1 of 2

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