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money investment, investment help
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2/19/05 Technical Traders Report
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Technical Traders Report Subscribers:
MARKET ALERTS
Targets hit alerts: None issued
Buy alerts issued: JNPR; BAX (bonus)
Trailing stops issued: ATCO
Stop alerts issued: MER
The market alert service is a premium level service where we issue intraday alerts relating to the general market conditions, when stocks hit action points (buy, stop, target, etc.), and when we see other information impacting the market or our stocks. To subscribe to the Daily alert service you can sign up at the following link:
http://www.investmenthouse.com/alertttr.htm
SUMMARY:
- Market closes the week quietly, holding the line for next week.
- Core PPI rattles stocks, sends bonds lower.
- How powerful are interest rate hikes?
- National sales tax or a flat income tax versus current system
- Price patterns set to rebound but volume, breadth and new highs have lagged.
- CPI will tell more about Fed as market deals with important level.
Stocks wade through tough week, giving up some ground but hold hanging in the pattern.
Some finished the week in better position than others as SP500 and SP600 held near support while NASDAQ undercut its 50 day EMA. The action was mirrored Friday as the large closed modestly higher while the rest of the market sported modest losses. All indices finished the week lower, however, as they try to consolidate the February gains and set up for another upside move to take on the late 2004 highs. That consolidation received a jolt Thursday as stocks sold on rising volume. Friday there was no big rebound, but the selling pressure abated, allowing stocks to hold the line and indeed some leaders were making breakouts.
It was not an easy session. Option expiration was on tap, but that seemed to have no impact; stocks were volatile, but in a very narrow range. Moreover, volume was pipsqueak level until news about MRK, PFE and friends as the FDA Cox 2 hearings sparked buying in those issues. Without that trade it was one of the quietest expirations we have seen. Even with the light trade, however, stocks were up and down. The core PPI was much stronger than anticipated, and that sent treasuries tanking as the long end played some catch-up. Michigan sentiment was a bit lower, but that did not make much of a dent in the action. Stocks simply found the going tough after a week of heavy news, a Thursday attempt to sell the market, and a long holiday weekend ahead.
That weekend gives investors time to mull a week filled with news. The primary event was Greenspan's two day testimony to Congress. Unfortunately, the majority of the time was spent on social security; important, but there are also many other important economic issues that could have used some more attention than they received. About all Greenspan had to answer about interest rates was that he was going to keep raising rates and that he would know when he had reached neutral when he had reached neutral. It was mildly encouraging he still just wants to get back to neutral, though the Fed never knows it is at neutral until it gets past that point. Thus lies the fallacy of the 'go slow until you know' strategy. It usually ends up as go slow, get frustrated when nothing happens, then really sock it to rates just as the economy finally reacts. At least Greenspan did not say that the current levels were accommodative; perhaps that leaves him some room to stop hiking earlier if need be. Wishful thinking.
The Friday close left the indices still below the late 2004 highs, trying to hold up and try another run at those highs. NASDAQ is not providing much help as it fell back below the 50 day EMA, but as noted all along, it has lagged the move higher. Though the indices held up fairly well to close the week, they have the same problems facing them, and not just the prior highs. The February volume has lagged the January selling volume while breadth and new highs were mediocre. It has to prove something this week given the less than inspiring internals of the move thus far.
THE ECONOMY
Core January PPI surges past expectations, fanning inflation fears.
What do tobacco, alcohol and autos have in common? A costlier Friday night for college students. Well, not really unless the higher costs producers faced in January are passed through to the CPI. Those items were the leading price gainers in the core PPI in January, however, pushing producer costs close to a six year high. Prices rose 0.2% overall, but jumped 0.8% less food and energy. Tobacco, liquor and autos were higher, but they did not explain the entire run-up in costs. Prices were simply higher across the board and more than offset the 1.8% drop in natural gas, the 4.2% drop in gasoline, and the 0.2% food price drop.
Once more the key is how much of the cost rise passes to consumers. Typically there is not a one-to-one pass through to the consumer side. The Fed focuses on the CPI and its components, so the PPI is basically a potential indication of price hikes building in the pipeline. They may never make it through to the consumer. This will be a moot point by Tuesday as the CPI will be released next week, but it was another problem investors had to deal with Friday, and judging from the volume and the lack of movement on the indices, they all dealt with it by going home early.
The funny thing is, we all see prices rising but the overall measure of price gains is being offset by drops in some areas such as electronics, computers, etc. We have noted before that some of the durable appliance makers are raising prices because material costs are high. Deere & Co. (John Deere) reported a 30% profit increase last week but also said it had raised prices twice in just three months. Fortunately for Deere, enough people want its green and yellow machines to keep its results solid. That shows pricing power that has been lacking for many years. That good demand in the face of rising prices indicates continuing economic strength, but it also suggests more inflation ahead as demand continues to outrun supply in this recovery.
How much power is left in Fed rate hikes or cuts?
No one doubts Greenspan's ability to influence markets and even Congress when he wants to. He was known for jawboning the market in the late 1990's, getting it to do what he wanted without having to do anything to interest rates. Tax cuts were problematical during Bush's first term, and indeed as Greenspan was opposed to them at first, they did not pass. He dropped some hints that he would not be opposed to the right kind of tax cuts, and shortly thereafter the cuts started to come through. Much of this is specific to Greenspan given his tenure on the Fed. Many view his interventions in the political process wrong, including a couple of former Fed chairmen. He has definitely expanded the Fed's reach into the process well beyond price stability.
Even Greenspan's jawboning, however, does not hold sway over the market. That was clear in the 1990's when he all but called investors foolish with the infamous 'irrational exuberance' utterance. That had a short term impact, but stocks marched ever higher, stoked by a lot of money the Fed was gladly making available.
It took actual rate hikes, and a lot of them, to finally get the market to stall and the economy as well. It was not until Greenspan hiked rates to over 6% before the advance sputtered. He threw in a 50 basis point zinger in May 2000 after the market had made its first dive lower, just for good measure. It was not really the rate hikes that did the job, however. It was the draining of the money supply pool that brought the market and the economy down. Massive liquidity fueled the run higher, and it was a massive Fed money recall in early 2000 that took away the ability to rally.
Think about it. The economy was roaring and investment dollars were looking for places to go. With the kind of returns people were making, the Fed's rate hikes were not going to slow that activity. What is 7% when you can make 50% or 100% relatively quickly? No, it was the lack of money at any price that sent the market into vapor lock and then the economy. It did not matter how high or low rates were; the Fed dried up money by putting banks on restrictive status (thus limiting the quantity and quality of loans) and basically turning off the money spigot. You couldn't get money if you wanted it. The venture capital dried up as well once the smart money started to see what the Fed was doing. It was not the cost of money that stalled the market and the economy but the lack of money.
Fast forward to 2001 and 2002. The Fed had crashed the market and then the economy. It started to cut rates but nothing was happening. Then 9-11 hit and it cut rates further. It continued to cut and cut but the market and economy continued to decline. Some said the Fed was 'pushing on a string' in that rate cuts were unable to bring about any upside in the market or economy. Eleven rate cuts and no impact. Of course the Fed was not really playing the whole game. It still had many banks on restrictive loan status and money supply was not growing nearly enough to even begin fueling an incentive to spend. Further, its rate cuts were behind the real rate of inflation, again providing no incentive to get aggressive in borrowing.
It was not until fiscal incentives were enacted that the economy started to pull out of the recession. The Fed finally started to significantly increase money supply after these incentives were signed into law. That made money available along with a reason to access that money (if you wanted the tax break you had to spend some money). That is when the market bottomed and the economy followed about 6 months later.
In both instances the actual rate hiking or lowering had little to do with the economic slowing or acceleration. The key was the money supply and an incentive to take advantage of that increased pool of money. The Fed definitely played a role by manipulating money supply, but the rate hikes were mostly symbolic. Interest rates are always slow to have an impact on the market and economy. When rate hikes finally take effect, they typically do so all at once with a big slowdown. That does not come, however, until money supply contracts significantly and stays lower. Interest rate hikes may have more impact in a slow or slowing recovery (what we have now?), but the underlying key is the money supply. If there is no money available, it does not matter what the money costs. Thus the real power behind any economic period is the amount of money available and the incentives to put that money to work.
What kind of tax overhaul is best?
National sales tax.
There is a lot of talk about a national sales tax right now. It is not an income tax but a consumption tax; you use it you pay it. Proponents argue it will raise national savings because when a person makes the decision to hold off on a purchase and keep it in the bank that is money that does not go to the federal government to be spent. As Greenspan said Thursday, keeping the money out of the government's coffers in the first place is how you increase saving. As he noted, government spending is the biggest contributor to lack of savings in the US.
A sales tax would further eliminate the need for the IRS, one of the most hated and feared agencies in the US with powers that, and you better believe it, supersede the Constitution. The cost of the IRS in compliance and enforcement alone would save hundreds of millions of dollars. Then there is the cost of paperwork and compliance with tax laws. Companies have entire sections devoted to tax. Billions of dollars annually are spent on compliance costs. It is not just figuring out the laws but in actually keeping log books, etc. as required under the code.
Eliminating all of this would free up billions to be spent elsewhere. That is why it is said GDP would jump over 10% in the year the change was made and that effect would linger at lesser growth rates for a time thereafter as well.
The cons.
Offsetting that GDP growth burst due to extra available funds would be a natural slowing of economic activity as a result of a new tax. The rate floated around DC is 23%. Buy a car, figure in another 23%. That $500 suit just went up $115 in addition to state and local taxes. That pizza looks good, but maybe tonight we eat at home so our tax bill is lower. If you want to slow or harm something, tax it. Too high an income tax prior the Reagan tax cuts harmed economic growth. Money was locked up in tax shelters because the incremental cost of each dollar made was higher and higher. People who could would stop working after earning a certain amount of money for a year. With incremental dollars taxed at 70% to 90%, what was the use in working harder? When the taxes were slashed, the money came pouring out of those tax shelters and went into the economy buying capital goods. That is what sparks growth. Thus, the money freed up from compliance would not all just enter the economy because there would be a significant cost of it doing so.
A 23% rate is simply too high to work. It actually puts many in a worse off condition. If you are in the 28% or better bracket, you are most likely structuring how you receive your income to knock your effective tax rate lower. As we saw with John Kerry's wife, she made a lot of scratch in 2003 but paid 12% on what she made because of how she made it. Basically a tax in excess of 13% is not going to fly. It won't get the support it needs to pass because too many would have to pay more in taxes. Again, there is that offset to the economic boost cutting out the IRS and compliance costs would give.
Finally, what happens if there is an economic slowdown and some stimulus is needed? The Fed can tinker with rates, but as discussed, that has minimal impact. It would pump up money supply and that would help. But the real boost to growth, that incentive to spend money when no incentive otherwise exists, is not there. If there is no tax on income then incentives designed to lower that tax won't be available. About the only thing that would be possible is incessant tinkering with the sales tax rate or raising or lower the level of exemptions from the tax (or what the tax applies to). It starts getting complicated.
Worse, it is demand side driven. A tax on consumption impacts demand directly. As we have seen to a certain extent in this recovery and in recoveries much further back in history, if demand drives the recovery without adequate incentives for supply to build up in anticipation of that demand, then there is inflation. Higher demand means more dollars chasing fewer goods because demand is there but supply has not ramped up to meet it. If you cut the rate demand increases; supply would as well, but at best no faster than demand. If you raise the rate demand decreases, but so does the incentive to invest in capital goods because it costs more.
You would have to start exempting businesses and certain kinds of expenditures, etc. to get the targeted incentives you want to have. In the end you get the same kind of accounting nightmares you get now. At least it would be less convoluted at first because we would start with a clean slate (at least theoretically; once the special interests got their way there would be plenty of exemptions and special rates already built in at the start). That alone might be worth it.
Flat tax.
Steve Forbes advocates a flat income tax of roughly 15%. You strip away deductions and just pay the tax. That reflects reality and thus has a chance of passage: the 15% reflects what a lot of 'rich' people pay after getting their assets and income structured to take advantage of the deductions and varying tax rates between types of entities. Since it is an income tax you can target incentives by credits and deductions when needed.
No one is talking about the need for stimulus, but as in our discussion of the Fed, it is not the strong economic generator it is made out to be. Indeed, when it starts trying to fine tune the economy we usually end up with big problems. You can turn on and turn off an incentive at any time. You cannot do that with rate hikes because their effects are felt as much as a year later. Think of it as trying to shoot a target 200 yards away with a .243 caliber rifle or lobbing a stone at the target with a medieval catapult.
Is there really a simpler way?
In the end each method has its shortcomings. The income tax started out as something simple, but look where it is today. Social security was simply a feel good program at the start because you had to outlive the averages by three years just to get a check. Now it pays a multitude of additional benefits and for 20 years or more.
As noted, starting over with a clean slate has definite benefits even if ultimately it turns into another 40 tentacle octopus. Starting with a flat income tax at a sufficiently low rate has a slight advantage in our view as it would allow necessary supply side incentives when the inevitable economic slowdowns occur. Some might view this as entering the reform with a defeatist mentality, but it is actually reality. If we can harness the power of freeing up billions and billions in compliance and IRS costs and not offset them by limiting demand with more consumption taxes (state and local taxes are already killers) and still have the ability to stimulate supply as needed, then we have a system that will work. At least until the special interests get it all carved up in 20 years.
We have left the discussion of a VAT (value added tax) for another day. Of the choices, it is most probably the worst given the unintended results that will follow it.
THE MARKET
Stocks finished basically flat for the session and down for the week. The indices are testing the rebound, but the action has been backwards from what you want to see: lower overall volume on the move higher compared to the January selling that started the base, relatively weak internals as it approached the prior highs, the start of some distribution late in the week. You want to see volume swell as it rebounds and breadth and new highs ramp up as it approaches the old high. And, of course, volume fading as it makes the test.
There has been no breakdown and indeed SP500 and SP600 are holding near support on the test. If the volume can turn around and internals improve on a rebound, hope springs eternal. The January selling looked pretty wicked but it managed to turn the page and rebound. Not the best rebound with NASDAQ lagging, but that provided the opportunity for a follow through by the techs after the large caps and small caps broke to new post-crash highs.
They will have to prove that move, however, given action leading up to this point. It was an inauspicious end to the week with techs sliding back through the 50 day EMA Thursday and some distribution in the NYSE indices. There is still leadership breaking out, but it will need the backing of the rest of the market if it is going to hold up. Friday the large caps were the gainers as what gains were posted were on very narrow breadth.
Market Sentiment
Bulls versus Bears: Bullish advisors rose to 56.6% this past week, above the 55% level that is considered bearish. Bears fell to 21.2%, hanging on above the 20% level that is considered bearish. Still right at extreme levels indicating there is not a lot of ammunition on the sidelines available to push stocks higher.
VIX: 11.18; -0.59
VXN: 17.87; +0.34
VXO: 11.05; -0.63
Put/Call Ratio (CBOE): 0.86; -0.04
NASDAQ
NASDAQ was the early leader along with the small caps, but by the close they had swapped with SP500 and SP600. Very low volume so no distribution as on Thursday.
Stats: -2.72 points (-0.13%) to close at 2058.62
Volume: 1.625B (-17.69%). Lost some ground but hardly worth mentioning and on volume that was also hardly worth mentioning.
Up Volume: 697M (+336M)
Down Volume: 907M (-693M)
A/D and Hi/Lo: Decliners led 1.27 to 1. Modest downside breadth but down on basically a flat market.
Previous Session: Decliners led 2.11 to 1
New Highs: 71 (-29)
New Lows: 44 (+12)
The Chart: http://www.investmenthouse.com/cd/^ixq.html
NASDAQ slipped further below the 50 day EMA (2075) Friday but held above some support at 2054 on the low. Volume was extremely low, continuing the overall lower trade this month. Unlike SP500 and DJ30, NASDAQ has not made the run up the right side of its base where you want to see the volume surge. That means this lower volume is not necessarily a bad thing for NASDAQ just yet. Of course the higher volume selling Thursday was not a good thing either. Holding at 2050 to 2040 (the most recent low) would be the better action to avoid a lower low.
NASDAQ 100 could not hold a move over the 50 day EMA either and it is still in its three week range between 1500 and 1550. As with NASDAQ, it is working on its 7 week base and the lower volume is not that big a deal at this point of the base.
After the big break higher off the 200 day SMA (419), NASDAQ is making a pretty nice looking test of that move, holding the 10 day EMA (427) on the Friday close. A good place for it to hold and rebound as it also represents the early February interim high on this move. Best break off the 200 day SMA since giving up the 200 day back in early 2004, and it needs to make a stand if it is going to continue that move.
SP500/NYSE
The large caps were lagging Friday before they took over the lead as the large cap drug stocks rallied late on the FDA hearing re Celebrex, Vioxx, and friends. Volume jumped with the drugs moving higher late; before that volume was quite weak.
Stats: +0.84 points (+0.07%) to close at 1201.59
NYSE Volume: 1.546B (-1.86%). Volume jumped as the session wound down. Lackluster volume moved above average as the big drug stocks rallied. It did not offset the Thursday distribution that occurred on some of the strongest volume of the month. Overall volume has been sub-par on the move higher. That will have to change if it attempts a breakout.
Up Volume: 739M (+283M)
Down Volume: 784M (-310M)
A/D and Hi/Lo: Decliners led 1.76 to 1. SP500 posted a modest gain as breadth was almost as poor as Thursday when there was a bit more serious selling ongoing. That means the move was the large caps moving higher.
Previous Session: Decliners led 2.01 to 1
New Highs: 178 (-119)
New Lows: 17 (+1)
The Chart: http://www.investmenthouse.com/cd/^spx.html
After the Thursday distribution (higher volume selling), the large cap index tapped support at the 50 day SMA (1194) and rebounded to hold 1200. The move back up was due to the late surge by the large cap drug stocks. That takes some luster off the recovery, but you take it the way you can get it. SP500 remains in its pattern, a 7 week cup that is forming a handle. Volume on the right side of the base as it moved up was lacking, indicating that the big money was not totally buying into the move. Breadth was so-so and new highs were not there either. The pattern looks nice but the internals don't back it up thus far.
SP600 continues working laterally the past two weeks in the handle to its 7 week base. Same action as SP500, selling back Thursday on rising volume, but it has held the 10 day EMA (327) the past two sessions, showing a tight doji at that level Friday. It remains in good shape to try a breakout move, but as with SP500, it suffers the same internal weakness, i.e. lack of new highs and poor breadth.
DJ30
The blue chips posted the best gain of the session on the strength of the drug stocks. That is why it recovered late and that is why volume was up on the session. It undercut the 10 day EMA (10,751) on the low and rebounded to easily hold that level. It received help from the drug stocks but regardless it held its 8 week base, working on the handle to the pattern. It is still in a very nice looking base. Unlike the SP500, its volume has been low all during the pattern. Not saying that is any better as it did not show any swelling volume as it moved up the right side of the pattern.
Stats: +30.96 points (+0.29%) to close at 10785.22
Volume: 335 million shares Friday versus 257 million shares Thursday.
The chart: http://www.investmenthouse.com/cd/^dji.html
THIS WEEK
Consumer confidence and the Consumer Price Index (CPI) are the main economic events of the week to come, and after the jump in the core PPI it is going to garner the market's focus. Another Q4 GDP revision is out Friday, but that is old news.
Before that the market will most likely have tipped its hand as to what it is going to do. SP500 and SP600 have rallied to their post-crash highs and have to make some hay or retrench. The upside move has lacked real strength and started to sour Thursday with that higher volume selling. It looks again as if the market is going to roll over but it has turned failure into an advance already on this move. Thus while we are skeptical of the move to this point we are not going to assume it will fail. There are still many stocks in good patterns and making good moves; with the right catalyst they can lead the market higher from here.
We will continue to cautiously look at those plays to the upside and we will also have some downside action ready to go if this rally continues with the distribution and heads lower. There was a lot of talk about double tops Thursday after the hard selling; we were talking of the weakness ahead of that and hearing everyone else start the drumbeat Thursday made us take pause and look to see if there is some upside still here. The move is good enough to continue higher; it is just not a really strong move. With as much pessimism about the market's upside potential from here we cannot close out the option that it won't continue higher at least a bit further.
We are still running tighter stop losses on the plays. While the market has moved higher many of the new breakouts of late are surging but are not maintaining the move for as long. If that is what the market is giving that is what we will take from it.
Support and Resistance
NASDAQ: Closed at 2058.62
Resistance:
2066 to 2070, the bottom of the January lateral move.
The 50 day EMA at 2075
The 50 day SMA at 2098
2110 - 2112, the top of the November consolidation.
January high at 2154 (early 2004 high)
2250 - 2260 from January/February 2001 highs and lows.
2282 from 5-2001 high.
Support:
2050-54, prior resistance and the June high
2047, the June high.
2000
The 200 day SMA at 1981
S&P 500: Closed at 1201.59
Resistance:
Q1 1999 lows at 1215
December high at 1218.
October 1999 low at 1233
Q2 2001 peak at 1310.
Support:
1200 acted as resistance and now may hold as support.
1196, the mid-January high and the early December peak in the left shoulder.
The 50 day SMA at 1193.80
The 50 day EMA at 1188.60
1185, the top of the November consolidation range.
1175 second high in that double top that spanned late 2001.
1157 is solid support from January through March consolidation tops.
The 200 day SMA at 1139
Dow: Closed at 10, 785.22
Resistance:
10,868 from the December 2004 high.
10,975 - 11,000 from Q4 2000, Q1 2001
11,350 from the May 2001 highs
Support:
10,754 is the February high
The 10 day EMA at 10,751
The 50 day SMA at 10,649
The 50 day EMA at 10,613
Price consolidation at 10,600 level is a key level.
The late April, June peaks at 10,478 to 10,512
10,400, the bottom of the November/December range
10342 the early September peak.
The 200 day SMA at 10,305
Economic Calendar
These are consensus expectations. Our expectations will vary and are discussed in the 'Economy' section.
February 22
Consumer Confidence, February (10:00): 103.5 expected and 103.4 prior
February 23
CPI, January (08:30): 0.2% expected and -0.1% prior
Core CPI, January (08:30): 0.2% expected and 0.2% prior
FOMC Minutes, February 2 (14:00): These are taking on more importance as they are released closer to the fact.
February 24
Durable Goods Orders, January (08:30): 0.0% expected and 1.1% prior
February 24
Initial Jobless Claims, 02/19 (08:30): 306K expected and 302K prior
February 24
Help-Wanted Index, January (10:00): 38 expected and 38 prior
February 25
GDP-Prel., Q4 (08:30): 3.5% expected and 3.1% prior
Chain Deflator-Prel., Q4 (08:30): 2.0% expected and 2.0% prior
Existing Home Sales, January (10:00): 6.75M expected and 6.69M prior
End part 1 of 3
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