us stock market, trend trading stock

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6/30/01 Technical Traders Report
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Technical Traders Subscribers:

TONIGHT:
- A wild ride on Friday.
- What the various markets, economic reports, and yes, stocks, are telling us.
- Continued improving economic news, at least on the home front.
- How do we react to this environment?
- Subscriber Questions
- Team Trades

THE SUMMARY

As if the usual market activity is not enough, the systems break down for the second straight session.

A WCOM employee started a diagnostics test in the afternoon, and that effectively shut down major portions of the Nasdaq Friday. WCOM runs key parts of the Nasdaq's electronic system, and the diagnostic program shut down trading. On top of that, Friday was Russell rebalancing day and the quarter end. That alone is enough without the technical glitch. Anyway, the Nasdaq decided it best to reopen things for an additional hour of trading, but all that did really was add to the confusion about what the heck really happened on the markets Friday. Fortunately, there are other things that happened Thursday and over the past few weeks that tell us what is going on in the bigger picture.

At the end of the session the Nasdaq was higher on higher volume while the Dow and S&P 500 were down a shade on heavier NYSE volume as well. So much for that. Determining volume from Friday is next to impossible. About all we can safely say is that it was most likely higher based on the quarter end and Russell shuffling. Those usually lead to higher volume sessions, but this one was an aberration: when this happened in March volume was higher but nowhere near this high. As we said, there are other things we are looking at right now that help us understand what is going on.

What are the markets and other indicators telling us?

Thursday night we made it pretty clear we see things in the economy and the market that are not exactly in the mainstream of thought these days. However, we were not in the mainstream of thought in early 2000 when we saw weakening economic numbers as a result of the Fed interest rate tightening. It took 9 months for the Fed to realize it needed to cut rates, and we were already in a growth recession (from 6% growth to 2% growth at that time) if not a textbook definition of one. The market was the first to tell us that the slowing economic numbers were in fact a portent of what was to come.

Now we feel the markets are again telling us what to expect in the future. Contrary to many, we feel they are telling us that the economy is already recovering and will continue to do so, and that means earnings will start to recover and stock prices will start to improve. There are factors that may make this recovery less than a rocket shot straight up, but overall the wheels are in motion for that recovery and we are seeing it happen now. Let's look at what we are talking about.

The stock market is recovering.

So many don't think the market is in good shape, partly because they have never seen a market that did not just run up 25% or more each year. That is the market overall. That means a lot of stocks ran up 50%, 100%, and more during that same period. No, it is not doing that thus far this year, but we have to look at what has been happening to the market and strip away all of the garbage heard about it every day.

Sure the market is down for the year, but we do not judge it on the year but on where it is from the low. Back in March and April the indexes hit their lows for the year thus far (we say thus far, but we believe they have indeed hit their lows). At that time they started back up, the Dow and S&P 500 off of small double bottom patterns and the Nasdaq off of the bottom of its third downleg of the bear market. From there it rose 43.7% before it recently corrected 15% of that move. It is now trying to head higher on a surge of volume, and that means institutional buying. It has yet to take out its high since bouncing off the low, and there is always the chance it could drop again to test the April low. We don't think it is going to do that. The Dow and the S&P 500 have experienced similar rises and then corrections since launching off of the bottom.

As noted earlier last week, this action is very, very similar to the action that was experienced in the 1973 to 1974 bear market. Three legs down, rally off of the lows, correction to test the rally, then onward and upward. The Dow came all the way back down to test the low while the S&P 500 did not. We have seen similar pullbacks as what the S&P did in 1974; again, maybe we get an actual test of the lows, but we doubt it at this point.

What else? Stocks have been breaking out of sound bases aplenty. Not many techs of course, but look at retail, financial, building, education, leisure, restaurants, software. These are not the big, household brand names, but the smaller players that have been ignored for so long but have excellent business and profit growth. Many were tested in the recent correction and some caved in; that happens on any correction as the market again weeds out the fittest. But these stocks have started asserting themselves again even as the major indexes waffle around: the A/D line is rising again just as it did when the rally got its legs back in April.

Indeed, the Nasdaq just reconfirmed its initial rally by confirming the move it made up off of the bottom on my birthday, June 20. Seven days into the rally it rose 2.4% on rising, above average volume. That confirms the start of the latest rally in this run and it never violated the prior confirmation. It is starting to build on itself. This, however, is being overlooked by those who only look at the indexes and plot whether they are up or down for the year, etc. They do not understand or won't take the time to understand that there are a LOT of stocks that are setting up and breaking out of great patterns.

'Dead' sectors showing life. Moreover, they report on them, but they do not notice what is happening all over the market: stocks are moving in most sectors, even those packaged shipped out as 'dead on arrival.' We looked at many, many sectors this past week and this weekend. We see movement in sectors that looked really bad. Not everything is a buy of course, but there are leaders that are already in good patterns or are setting them up. There are the sectors we mentioned above, but they are leaders. What about scientific and technical instruments, software, restaurants, semiconductors, media, and yes, even the internet? There are life signs in all of them.

The economic news is improving.

What has changed this time for the market? For one, we started to get some indications from companies that suggested the slowdown may be coming to an end and that the second quarter just might be the bottom. As usual, that started the process of accumulation that goes with looking ahead for the recovery that is coming. Along the way came the second quarter earnings warning season, and though common knowledge to everyone that it was going to be bad (as we said before, bottom means bottom, not something better than bottom), when warnings came from the obvious sectors (telecom with NT, LU, NOK; networkers with JNPR, CSCO, RBAK, etc.) and some other more traditional sectors (e.g., IP), fear of the short term overcame logic and reason for the longer term. What logic and reason? Let's take a look.

Second, 250 basis points in interest rate cuts (now 275 basis points) and a tax cut (though a very watered down one) are not to be shortchanged. The power of such moves has been demonstrated throughout history. While some are bound and determined to argue that such actions will not help in an investment slowdown because of overcapacity, they ignore some fundamental principles. Among them, our economy is not in as bad of shape as it was in the 1930's, nor is it as bad as it was in the early 1970's. It simply is not. Look at the numbers; they are not even close.

Third, the economic news is, despite the incredible gloom we hear each day on the news, getting better already. Housing and construction never really slowed down, nor did consumer spending. There was a lot of worry about construction (we really were concerned) and spending, but permits jumped back up and spending did not flag much. The latter could be a problem as there is no pent up demand to be released as the consumer kept borrowing and buying during the slowdown, but that speaks to the degree of the rate of climb back up, not whether we are going to have one or not. Beyond that, however, we are seeing the down economic sectors start to turn. Now we hear everyday that they are still in the tank, but this is the same thinking that says the stock market has to recapture its old highs before we make any money. That is simply not true! If the economy starts back up, businesses can grow right now. They don't have to wait until there is 6% growth again to say "whew, glad that is over." Look at consumer confidence; it was falling, but now is firming and we see future expectations way out in front in the last two readings. Consumers see better times ahead and that helps spending. Moreover, energy costs are plunging, jobless claims are falling (a full discussion in last Thursday's summary), the Philly and Chicago PMI's are rising (they were in the dumpster), durable goods orders are jumping sharply, and companies (e.g., ORCL) are saying that they are getting 'big deals' back in the door or that they are going to turn a profit where a loss was expected (e.g., PALM).

One other thing to consider: the economy will pick up in certain sectors and in certain geographic locations. We have talked about certain sectors lagging, but we are also most likely going to see some areas lag. For example, where in Texas the economy has been pretty robust, in California there have been energy problems and the technology problems. So, when we see stories come in about slow areas of growth in the U.S., we have to remember that other geographic areas are still humming right along.

A lot of this evidence is being given the 'yes, but what about . . ." treatment. That is ALWAYS the case. There are always those who just cannot accept numbers because they cannot divorce themselves from their emotions. Yes you can argue that we are delivering a positive message and that thus it could be clouded by hope and not reason. Well, we did not want to admit in 2000 that things were going downhill, but we had to look at the numbers. Looking at the numbers today we can say that yes they are not great, but they appear to have bottomed and are in the process of turning. It won't be that all economic reports from here on are glowing just as stocks don't just turn up one day and rise each and every day that follows. The point is that the economic numbers are turning, and that means down the road we feel we are in good shape. Stocks are starting to reflect that now.

Bond market has made up its mind.

Outside the stock market and our view of the world, take a look at the bond market. It has pretty much priced in the model of an economic recovery and the end of the rate cutting cycle. Bond investors are looking at all of the economic news that has come out and cited above as well as rising stock prices, and have collectively decided there are better places to be other than bonds. The yield curve has reverted to where it should be, i.e., the short term yields lower than the long term yields as longer term factors in more risk and inflation that is always factored in. It is hard to bet against what the bond market is telling you in the grand scheme.

Summary.

We have the stock market, economic indicators, and the bond market all showing us the same thing. These are powerful historical and current trends and evidence that to us indicate that this is a buying time while others are timid. Again, that is the way it always is. Retail investors usually do not get in on the early moves, but come into the picture as things are playing out. Witness: the massive selloff in 2000 was preceded by unprecedented individual investor activity. Of course the advent of the personal computer and internet helped that to happen, but it is still a common historical occurrence. What retail investors need to understand is that they need to learn the signs of a turn around and get into the leading stocks when it is starting, not when it is ending. This is what we are teaching in our seminars and preaching in the newsletters. We have been putting a lot of long term money on the line of late based on this analysis. Not every play is going to work out as, for example, we saw LEN get thrown back at us on Friday. So, we move on to the next winner when it shows us the buy signal, and we are off and running again. The key at this point is to dump the losers early and let the winners work for you, putting your money into the winners as they prove themselves. Again, get rid of the losers before they can hurt you and put more money into the winners that will work for you.

THE ECONOMY

Numbers continue to improve.

We won't get too deep in it given the coverage above, but there were some important numbers. First, the Chicago PMI rose to 44.4 for June, well above the 39 reading expected and May's 38.7 report. That is as we expected: a surprise to the upside on this number. It was still below the 50 reading that would indicate expansion, but this was a huge jump for the indicator and yet another sign that the worst is most likely over.

Michigan sentiment was revised higher from its mid-month reading, coming in at 92.6 in June versus 92 in May. This is a continuation of the trend higher since the abysmal 90.6 reading in February (the lowest in 5 years). Again, consumer sentiment continues to improve, and that will help keep things moving forward.

Oh yes, Q1 GDP was revised down to a 1.2% increase versus the 1.3% increase previously reported by the government. No surprise there. The surprise will be if Q2 GDP was not negative, but with the late surge in the economic numbers, we may get away without having a negative GDP quarter. That would be almost amazing given the way things looked in November and December. Of course, when you fall from over 6% growth to almost flat in three quarters, that is pretty amazing as well.

THE MARKET

Overall market stats:

VIX: 21.63; -0.81. Volatility is going nowhere soon so it seems. Of course the S&P went nowhere as well and that explains Friday's flat line. Volatility is at levels considered to show apathy, and that is not good for the market. As we noted before, however, while this may act as a drag on any rally, we cannot elevate a secondary indicator to primary status. The S&P still has its work cut out for it, however.

VXN: 45.49; -3.22. Nasdaq volatility has now plunged to levels not seen before, at least not seen since the index was officially created back in January. Backdating the data, however, volatility has not hit the August 2000 low nor the lows hit when the Nasdaq was on its 80% run in 1999 to early 2000. At that point volatility spiked as the index sold off. That is the reverse of how a contrarian indicator should act. Again, we are watching it, but there is not a lot to worry about at this point as far as we are concerned simply because of its history.

Put/Call ratio (CBOE): 0.58; +0.08. Not much to take from Friday's action as trading was all over the map with all of the glitches. For now it looks as if we can say that the ratio is in the middle.

Sentiment: Over the week we saw bullish newsletter writers decline, worn down by the recent correction hitting the rally off of the lows. We felt this correction was a shorter term, Q2 earnings type of thing, and we will know more this week. We like seeing the bulls get ruffled by some selling off of a strong rally. Good for the market longer term.

NASDAQ: Crazy day with halted and late trading. The only reason it was reopened was because it was the end of the quarter. Otherwise they would have called it and gone home early. Should have.

Stats: Up 35.08 points (+1.7%) to close at 2160.54.
Volume: 2.072 billion (+6.2). At best we can say volume was a bit screwed up, but higher as we thought it would be given the rebalancing. Other than that, hard to say. 1.318 billion to the upside and 370 million to the downside as best we could tell. That left 382 million unchanged, a very large number indeed. So, let's just say volume was up on a gain in the index.
A/D and Hi/Lo: Advancing issues continued to lead, rising to 1.75 to 1 (1.65 to 1 Thursday). New highs came in at 277 (+127) as new lows fell to 40 (-11).

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

The moves were pretty much across the board as large and small techs enjoyed another nice session as they did on Thursday. A nice day, and the Nasdaq did manage to break and hold above the simple 50 day MVA (2137.12), but bouncing down off of its high at 2180.11. Who really knows what would have happened if trading had been 'normal.' Would it have bounced down and close just under what we consider resistance from 2160 to 2200? Who knows? The fact is, it is there right now, and after 5 straight gains, will it be able to forge ahead or will it need to take a breather? It does not have much room to catch its breath if it is going higher; maybe down to 2100 and even 2077, the bottom of its trading range. The index has moved form 1990 to 2160 in just under 2 weeks. We have July 4 on Wednesday. We may see some profit taking ahead of that, but again, we are not anticipating any knifing lows. The index has once again confirmed the previous rally that started in April as it has now confirmed the reversal on June 20 after the correction of that first rally. It has a lot of resistance ahead of it as there will be earnings that disappoint, etc. in the next two weeks. But, we believe that we will see more and more companies come out and say 'yes things were crappy last quarter but we knew that would be the case; we like what we see moving forward.' With the improving economic climate, that is hard to beat.

End Part 1 of 3

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