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5/22/04 Investment House Daily
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MARKET ALERTS:
Target hit alerts issued Friday: None issued
Buy alerts issued: CYBS; ULGX
Trailing stop alerts: None issued
Stop alerts: None issued

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SUMMARY:
- Expiration a sleeper as market continues lateral, low volume move.
- Oil falls as Saudi promises more production.
- Expiration is over, but same problems still present.

Market leaves town quietly after Wednesday reversal.

Wednesday foretold something potentially worse for expiration Friday, but it never materialized. The market started positive on some soothing words about oil production from Saudi Arabia, and an attempt to sell it off midday was met with some modest buying that kept the market positive on the close. Modest gains, modest breadth, modest volume, but given expiration Friday and that Wednesday reversal, it was a decent way to close the week as the hedge funds and traders closed the market flat given the OPEC weekend meeting and the large at the money options positions.

The indexes went nowhere during the session, failing again at near resistance but also holding over near support. The indexes have more or less moved laterally the past two weeks despite high volume upside and downside reversals that typically indicate a swing in the action coming in the direction of the reversal. They ended up canceling each other out in the near term, however, as investors continue to factor in near term issues. As we have discussed, there are few overriding problems confronting the market such as the Iraq handover and associated anticipated increase in violence, oil prices, Fed rate hikes and inflation (maybe some politics as well) that are keeping a lid on the upside. The positive outlook for the economy is keeping stocks from falling as well. Thus the lateral move the past two weeks.

THE ECONOMY

Fed says it stands ready to fight inflation.

Thursday's report discussed how the Fed was walking a tightrope yet again (that always seems to happen when you try to regulate markets) now that oil prices are spiking just as the Fed must raise rates from an extremely low level. It also has the supply deficit to deal with and inflation that can result because supply has yet to match demand. As we have noted before, and though Greenspan denies it, monetary policy alone cannot solve economic problems. You can flood an economy with money, but if no business has reason to borrow or spend (such as after a nasty business slump as in 2000 and beyond) all it does is put more money in the system with the same amount of goods. That is the classic, textbook scenario for inflation. Greenspan kept telling Congress that no tax cuts were needed, that tax cuts would be too late to do any good, and that the Fed had it all under control. Rate cut after rate cut, however, failed to produce any economic spark. Then the tax cuts were passed and, gee whiz, they actually jumpstarted supply. The Fed came back and admitted they actual were timely and had the desire effect, something the major media, unlike the Fed, never had the sand to admit after blasting the tax cuts as an untimely waste (as if the 50% of government spending is not an absolute squandering of our tax dollars; they seem to believe that a huge, bureaucratic, centralized government is better at allocating resources than the people making the buying and selling decisions on the frontline of the economy).

After many comments that jobs were the most important element in the economy, the Fed realized it was losing even more credibility with the financial markets. As discussed Thursday, employment is the most lagging indicator, and the Fed's focus on that to the exclusion of strong price growth is driving using the rearview mirror. We do not advocate Fed rate hiking campaigns simply because they often cause the very recession or bust the Fed was trying to avoid (i.e., the Fed fears the economy heats up too much and supposedly then crashes of its own weight) and because they come after the Fed intervened in the first place. Let markets alone and they will function the most efficiently. Regulate them and you create the imbalances that then require a very imperfect Fed to try and rebalance. The result is often swings that would not have occurred, and those that would have occurred are exacerbated, not mitigated as the Fed likes to tell us. Hell, the Fed takes credit for somehow saving the world economy from something worse in 2000. Frankly, we never bought into the argument that too much prosperity is a bad thing.

Indeed, the market has tried to balance things on its own once the Fed said it was going to start raising rates. Indeed, the market has done exactly what the Fed should do but typically refuses to acknowledge would work: take rates up immediately to the level it thinks they need to be in order to accomplish the goal. The market pushed rates right up to where it thinks neutral is. Just two weeks back one Fed governor responded to a question why didn't the Fed do that, and the answer was the usual, go slow, be prudent, respond to events. Sounds good, but the history of rate hiking shows that does not work. The Fed goes slow and ultimately gets frustrated because nothing happens. It never does; it always happens all at once when the cumulative hikes suddenly slam the economy. It talks a good game, but it cannot live up to the task.

Set the target, take it there all at once or in smaller steps, and give the market some certainty. Bernacke came close Friday when he responded with actual calculations that set the target rate at 3.7% to 4.7%. The Fed won't raise rates to that level anytime soon, yet the fact those figures were thrown out there tells the market, finally, that the Fed has some targets and it is not playing the "I'm thinking of a number between 0 and 20" game that requires the market to guess. It is also interesting in that it shows us that the Fed is also looking beyond Greenspan; more and more Fed governors are somewhat breaking ranks and not spouting the company line or typical Fed dogma under Greenspan. Again, Greenspan takes the nomination but then retires sometime after the election.

Saudi Promises more production.

Though it says supply is not the issued, Saudi Arabia Friday was pushing for a 2 million barrel per day increase in production ahead of the weekend OPEC meeting. Not only is Saudi Arabia pushing for the increase, it is already openly stated it would overproduce its 7.3 million bbl/day quota, saying it has allocated orders for 9 million barrels from its customers for June, and if more was needed, it was going to provide it. So much for production limits. Indeed, OPEC is already producing 2.8 million bbl/day over its production limit as prices have still risen.

Prices continue to rise, so there are obviously other issues other than just supply. The biggest is the perception of supply problems. Saudi has a capacity to produce 10.3 mbd, so there is still excess capacity. The problems include one we discussed last week, i.e., the potential for supply disruption given the geopolitical turmoil that could result in attacks on production facilities in the Middle East. If the terrorists cannot get to the US from within, do it without at the lifeblood of commerce. Even if Saudi et al have good intentions, if the terrorists are successful, intentions don't matter. Bin Laden has said he would topple Saudi if it did not bow to his version of Islam, and disrupting supply is a way to do it.

There is also pressure on the refined product side. Gasoline is in low supply so prices are up. The Bush administration gets the blame for this because somehow that 'oilman from Texas' is letting his friends gouge the consumer. Oil and gas is very cyclical. Visions of $50/bbl to $100/bbl oil in the late 1970's turned into $9/bbl in short order. It has always been boom or bust based on economic and cartel actions, and right now it is again a combination of both pushing prices higher. Oil companies made less because demand was less until very recently when the economy and world economy started to recover. You don't build extra capacity when there is recession just as Cisco didn't go out and build new production factories when it had piles of product in warehouses.

Of course, energy companies are more than willing to let prices rise to make the easy money. There are things that could be done to increase supply, but they are short term as refining capacity is a problem now with several old plants unable to maintain their rates of production. Energy companies may try to get some legislation to make it less expensive for them to build new capacity. Given that the market has price product at high rates, that should not be used as a solution. The incentive is there. Other than new plants, the regulations regarding the special gasoline blends could be eliminated short term. There are multiple formulations required in over a dozen regions in the US. One of the problems is that the old refineries cannot just switch out day to day to produce runs of these different fuels. Thus there is an imposed bottleneck on the system. We have to decide if we want some lower prices in the short term in trade for some more ozone short term. The EPA said no, but the administration could sign an executive order otherwise.

The problems are exaggerated by tons of money speculating prices will run higher. As the US buys for the SPR every day and OPEC claiming (until now) it was unable to impact price in the current market, speculators could bet against these market factors and continue to drive prices higher. Some decisive action on the gasoline (i.e., US regulation issues) side and OPEC saying it will produce whatever is necessary would help break this sequence that is ratcheting oil higher. Friday oil fell below $40/bbl on the Saudi comments. Indeed, Saudi says it wants and indeed sees oil at $23/bbl. If the US would take some action to help break this easy speculation game in the short term that would start breaking down the spiral and help prices adjust to where actual demand places them as opposed to speculative fear and greed.

Again, we said last week we thought oil prices were ready to peak even before Saudi came out with its thoughts. The oil charts were showing the peak even as speculation on the financial stations ratcheted higher. It is not a done deal yet, but it is starting to show the cracks that stall out a rally.

THE MARKET

Expiration came and went quietly other than that violent reshuffling late Wednesday. Monday brings a new expiration and that reshuffling to close May is over. Historically the Monday following expiration goes the opposite direction, but that has not been the case recently. With the big Wednesday reversal that was in preparation for expiration, however, it keeps us alert for potential selling on Monday.

As for the technical position, the indexes closed out the week in decent position given the high volume up and down reversals that have punctuated otherwise low volume drift. Friday saw NASDAQ close over the 10 day EMA and the March lows as it managed a recovery from the Monday gap lower and then held up very well after the Wednesday reversal. As usual SP500 held over the 200 day SMA and QQQ has yet to break below its March lows. Despite the violent swings the indexes held their ground, albeit at the lowest possible levels without necessarily giving way to a breakdown.

That still leaves them in precarious position heading into this week with the same near term downtrends and fighting with the short term moving averages as well as the same problems that have provided sufficient uncertainty to prevent the indexes from making a positive bounce from their potential double bottom patterns. The lateral move is a sign of strength the market did not look like it had. The issue now, and as it has been for the past two weeks, is whether the lateral move is the best the market can muster before another move lower or if it finally is comfortable with the near term uncertainties and can build off of this 13% NASDAQ, 7.5% SP500, and 9% SP600 correction. If the majority of the indexes can move one way or the other with respect to their 200 day SMA, the trend will be clear. Of course, that is just a restatement of the overall issue.

Market Sentiment

Last week saw bulls contract while bears expanded, though at 43.6% and 26.7%, neither are on the verge of providing a powerful crossover signal. Sentiment continues to erode and downside hedging and speculating continues to build, both good contrary indications for the market, i.e., indications the market is getting to a point it could make a rebound. As noted before, however, sentiment indicators are not accurate timing indicators. A dog can be pretty unhappy for a long time before it decides to run off, and market sentiment indicators are no more accurate as to time.

VIX: 18.49; -0.18
VXN: 24.9; -0.64
VXO: 19.16; -0.2

Put/Call Ratio (CBOE): 1.12; -0.09. Another close over 1.12, making that the ninth in the past three weeks. The overall put/call level, however, while showing an incredible rise in the moving average, has not closed below 1.0 yet. When it makes a close over 1.0, a bottom or at least a near term rally starts to come together.

NASDAQ

Managed to move back over the 10 day EMA on the close, continuing the low volume attempt to hold near the March lows and form a double bottom.

Stats: +15.5 points (+0.82%) to close at 1912.09
Volume: 1.379B (-10.67%). Another session of low, below average volume in the three week range below the 200 day SMA. Unlike SP500, volume even on the reversal sessions (up and down) has been low. There is a definite lack of current interest for technology as money piles up on the sidelines. Low volume consolidations, however, are not necessarily bad.

Up Volume: 994M (+358M)
Down Volume: 329M (-556M)

A/D and Hi/Lo: Advancers led 1.77 to 1
Previous Session: Decliners led 1.33 to 1

New Highs: 36 (+7)
New Lows: 78 (-23)

The Chart: http://www.investmenthouse.com/cd/^ixq.html

Tapped some support at 1900 on the low and managed to close over the 10 day EMA (1911) for the first time this month. Hardly a market turning event, but something it has been unable to do as it looked to be readying for more of a downtrend below the 10 and 18 day EMA. As it is it closed over the March low (1896.91) as it still is in the game for a double bottom base. Right now the pattern is negative but not overwhelmingly; if it was it would have rolled over after that Wednesday reversal.

The large cap techs as measured by the NDX and QQQ have yet to give up the March lows. There is a theory that investors will turn to large caps during this stage of the market for any further uptrend, and there is some historical support for this notion. We have noted that the market has failed to move without the small and middle caps since early 2003, but there is always the case that a transition is in progress right now. As the NASDAQ 100 is the largest cap NASDAQ stocks and it has been holding up similarly to the large cap SP500, there could be more credence to this idea. We will let the market show us which stocks to move into, small cap, large cap, or both. What is important right now is that the large caps are helping to hold back the tide right now, but the market has not said yet it is ready to make that move back up.

S&P 500/NYSE

Another session close below the 10 day EMA after trying a break higher, but managed a gain on some rising volume. Not great, but definitely not bad.

Stats: +4.37 points (+0.4%) to close at 1093.56
NYSE Volume: 1.256B (+4.02%). Volume edged higher Friday. Higher volume is not unusual for expiration Friday, but volume has been extremely low overall and the volume was still well below average Friday. Unlike NASDAQ, volume has spiked above average on the reversal sessions, up and down, showing much more participation in the large caps.

Up Volume: 840M (+311M)
Down Volume: 402M (-267M)

A/D and Hi/Lo: Advancers led 2.01 to 1. Very solid trade, but NYSE A/D is never up without participation from the smaller caps as well.
Previous Session: Advancers led 1.4 to 1

New Highs: 24 (+13)
New Lows: 29 (-22)

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

Continued to walk sideways. SP500 has enjoyed a very narrow closing range the past two weeks despite the wild intraday swings. That shows us a lot of hedge funds and speculators are helping market makers and specialists keep the prices in a range, but it also shows a pretty decent, low volume fight between buyers and sellers over the key 200 day SMA (1082). The lateral move is much more pronounced in SP500 than in the other indexes as it compresses over the 200 day and below the 18 day EMA (1101). The action in this index remains positive on the whole with a normal correction and consolidation of a strong run, holding above key support. Despite all of the problems with the Wednesday reversal that looked quite ominous, SP500 still looks to be putting together a rebound from this key level.

DJ30

Has stemmed the slide and is now moving laterally below 10,000 and the 200 day SMA (10,042). It too showed that reversal action Wednesday, but shrugged it off by the Friday close. Volume was up Friday as DJ30 closed higher but gave back 70 points from the high that tapped at the 200 day. It remains below the March lows at 10,007 and key resistance at the 200 day. This maintains its near term downtrend below the 10 and 18 day EMA (10,008, 10,086), but as noted, it is trying to convert into a lateral move. The downside still has the upper hand at this stage, however; it has to prove that it is ready to resume the move higher as it struggles below a lot of key resistance.

Stats: +29.1 points (+0.29%) to close at 9966.74
Volume: 180 million Friday versus 155 million Thursday.

The chart: http://www.investmenthouse.com/cd/^dji.html

End part 1 of 3

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