MASTERING
THE TRADE
ORIGINAL, INTERACTIVE SEMINAR ON TRADING USING
TECHNICAL ANALYSIS 

 SEC FILINGS

Yesterday's rebound in bonds was impressive, but excluding the afternoon Buffet bounce effect (he was rumored to be buying bonds), the day's gains were not large enough to indicate that bond market sentiment has turned the corner.  Traders are still living economic report to economic report, with emotions shifting on each piece of data.  Bond traders will be faced with another barrage of data today, with the release of Business Inventories, CPI, and Industrial Production and Capacity Utilization figures.  The key figure to watch today will be the Core CPI, which we expect to come in at or below expectations following Tuesday's productivity numbers.

The stock market's reaction to yesterday's benign inflation numbers was less than encouraging.  The Utilities did surge on the news, gaining 4.53 on the day, but after an initial rally the encouraging data was largely forgotten by the rest of the stock market.  An afternoon selloff in Internet stocks quickly spread to the rest of the market, with NASDAQ ending down 24.54 on the day and the S&P 500 gaining just 3.56 on the day, held aloft by a 9% spike in shares of IBM.  

Yesterday's 106.82 point surge in the Dow was 0 parts inflation and 93 parts IBM.  Subtract IBM, Hewlett-Packard, and JP Morgan and the Dow's impressive rally quickly becomes a modest loss, hardly an impressive showing on the backs of the day's economic reports.

While yesterday's Retail Sales figures proved to be a blessing for the shares of financials and utilities, they could also prove to be a curse for the shares of the overextended auto maker and retail sectors.  New car sales fell 0.8%, their second straight decline, and sales of general merchandise department stores declined 0.4%. Excluding gasoline, retail sales have now declined 0.1% in each of the last two months.  The figures will have to pick up if the current lofty share prices of many retailers are to remain aloft.

The market itself is likely to remain aloft for a while longer.  Bullishness among retail investors is heating up to a fever pitch.   Figures released last night by AMG Data showed $7.1 billion flowing into equity funds during the past week (with 69% into growth funds), the largest since October 8, 1997 (shortly before the market took one of its patented October tumbles). The inflow in funds will have to find a home somewhere, and that place could be in one final blowoff top. That is, provided that the market can make it past resistance at 11226...

After an initial 200 point plunge following the announcement of Treasury Secretary Robert Rubin's resignation, the market quickly recovered, comforted by the belief that Lawrence Summers would maintain his predecessor's strong dollar policy.  The initial sense of loss quickly transformed into a warm feeling of hope for the future.  Many market participants viewed Rubin's resignation as a sign that the global economy was finally out of the danger zone, thus allowing Rubin to finally make his long rumored departure from public life.  The doctor stayed with his patient while it was in intensive care, and throughout a long recovery period, and was finally able to go on a much deserved vacation.

There are a few naysayers, ourselves among them, who will probably say that this view smacks of more than a hint of dangerously rising complacency among many market participants. There are signs of a nascent recovery in many Asian nations, but there are also many recoveries where hope alone is the only thing that has recovered.  South Korea continues to show documented signs of recovery, with the economy expected to grow 3.8% this year, but it is not South Korea upon which investors and traders are pinning their hopes and dollars, it is Japan, where an economic recovery exists only in the dreams of portfolio managers.

This placing of bets upon expectations, rather than upon actual results, continues to increase the risk of a serious setback in world markets if expectations are not met.  The divergence between investor's hopes for economic growth and the actual performance of the economies upon which investors have pinned their hopes for a global recovery continues to grow, and with its growth the risks increase.   Hope can travel only so far before it must justify its existence.

The levels of complacency exhibited by many pros, and the extreme levels of bullish sentiment exhibited by retail investors, have left the U.S. market in a position of extreme vulnerability to the unexpected.  The current strong divergence between bond market sentiment and stock market sentiment adds to the danger levels.

Baby Internet, a boisterous tot who craves the spotlight, gladly accepted his old role back after his friends the Valuation Clueless increased his recommended daily allowance of AOL and Yahoo.  The introduction of a new toy, TheStreet.com, to Baby Internet's playpen only added to his good cheer.

Mama Big Cap Tech, who also yearns for the starring role, let the youngster have his fun during the day, but shortly after the market's close she decided it was her turn to share in the limelight. With a quick drink from her bottle of magical Cisco potion she accomplished the task, setting the stage for her return to prominence in today's trading.

Now that Mama Big Cap Tech has reclaimed her rightful place, we should fill you in on the details of that magical Cisco potion.  It is a potion that is powerful, and yet tends to be underestimated. It often exceeds expectations, and yesterday was no exception.  We have more than a suspicion though that it wasn't the exceeding of expectations that caused the 4 point jump in its price in after hours trading, rather it was the accompanying announcement of a 2 for 1 stock split--and it is at this point that we start to worry.

The reaction of investors thus far to Cisco's better than expected results has been positive, but muted in comparison to the reaction that would have been obtained only a few months ago.  NASDAQ will likely rally today, but the magnitude of the rally will likely be disappointing.  NASDAQ futures are up only 2.75 points this morning. We said yesterday to start worrying if Cisco exceeded estimates and the tech stocks didn't stage a powerful rally.  The tech stocks return to the limelight will likely be a brief one because the levels of bullish sentiment needed to produce a sustainable rally just aren't there this time around.

The market could be faced with a leadership void in the not too distant future. The price of crude appears to have peaked and is falling fast this morning, with oil stocks in Europe sliding.  The other cyclicals are extremely overextended and in the best case scenario will enter a period of consolidation.  The cyclicals have been priced for perfection, and signs are starting to appear that perfection may be hard to obtain.  Asian markets are still suffering from overcapacity, and troubling signs of this have begun to make their presence felt: notably in the copper market where rising copper supplies will likely choke off producer's pricing power.

Looking beneath the relative surface calm of yesterday's market there were a few ominous looking fish from the doubtful investor genus, a family of fish which in the past has been known to cause a change in trend or two.  The doubtful investor fish's most prominent characteristic is his muted  reaction to events which in the past would have sparked a heated reaction.

Traders yesterday morning were given all of the ingredients needed to make one of the market's patented Merger Monday Euphoria Runs, but as the day wore on it became apparent that many of them had forgotten the recipe.   The overextended oil stocks were unable to make it out of  the starting gate, and the rally in the Internet stocks was more attributable to the presence of that habitual trickster, Mr. Dead Cat Bounce, than it was to a return of Mr. Bubble Maker.

Sentiment the past two days has exhibited all of the signs that commonly occur at a change in trend: what was once an event for careless merriment has now become an event for contemplation.  We would keep a close eye on Cisco's earnings after the close today: you can ignore the actual earnings numbers, but you should keep an eye on the Instinet numbers that follow. If Cisco meets expectations and the stock rallies, pulling other techs along for the ride, you'll know that New Era sentiment still has one last race to run.  However if the stock meets or exceeds estimates and fails to produce a powerful rally in the tech stocks tomorrow: watch out.

The Internet stocks, which rallied yesterday, can largely be ignored as an indicator of the market's next move, in today's trading.  Yesterday they had their dead cat bounce, today they'll have their TheStreet.com bounce.

Beyond the debut of the aforementioned 51,000 subscriber electronic financial newspaper, the market will be playing a second day of waiting for the big CPI and PPI. For the second straight day, we'll again caution you to proceed with caution ahead of this week's economic reports and next week's FOMC meeting.

Caution is warranted because yellow warning lights are flashing on several of our index charts, with the Nikkei, Dax, Toronto TSE300, and S&P 500 all teetering on the edge of giving short term sell signals. The FTSE has already given a short term sell signal, and a close below 6289 would trigger an intermediate term sell signal.

We must admit we were surprised at the stock market's reaction to Friday's better than expected employment report. After the release of average hourly earnings showed a lower than expected increase of 0.2 percent, we entered the trading day expecting the stock market's still rampantly bullish sentiment to power the market to a 140-150 point gain.  We didn't get it.  It took a last minute buy program to lift the Dow to a narrow gain of 84.77.

Friday's stock market action indicates that exuberance is ebbing, succumbing to a slow trickle down change of trend. In late March (see the 3/30 column), after Coca Cola's latest warning, we said that the deeply ingrained bullish sentiment which has built up over a period of years will not suddenly change course, rather the change in sentiment will be a gradual one.  We appear to be witnessing that now.  Lingering doubts are slowly entering the system, but the prevailing mood is still of a positive nature.  Hope still rings eternal among investors, but the decibel level is a little lower.

The bond market is a different story.  It is fear, not hope, that reigns here. Traders now see the  glass as half empty. We mentioned in that same March column that sentiment that builds over a short time frame changes trend rapidly.  We are seeing the beginning of this sentiment trend change in Internet stocks, and we are seeing the full effects of this rapid mood swing in the bond market where sentiment has turned fully bearish.

The implications of the rapid trend change in bond market sentiment are anything but a positive for the stock market.  When trader's enter a bearish mindset their perspective does a reversal and they see the negative while overlooking, or downplaying, the positive.  Such was the case on Friday.  A report that only months ago would have led to a sharp rally in bonds instead led to a decline as bond traders downplayed the average hourly earnings figures and instead focused on the negative: the possibility that the Fed will shift its bias towards one of tightening.

With stock market valuations at historical extremes, each further leap in levels of bond market bearishness and the corresponding rise in interest rates forces the eyes of stock market investors open just a bit wider.  This week's full slate of economic releases have the potential to force the eyes of stock investors fully open. 

Tomorrow's productivity figures will likely be benign, but it is Thursday's PPI and Friday's CPI where the danger lies.  Each release has the potential to push interest rates up to 6%, a level at which the New Era's "P/E ratio is a thing of the past" motto would swiftly be replaced with a full focus on valuation levels.  With bond market sentiment in bearish mode, the figures will have to come in below expectations in order to prevent a run at the 6% level.  A meeting of expectations would likely lead to continued selling in the bond market.

The potential for a surprise with the CPI and PPI figures lies to the upside, rather than the downside.  The sharp rise in oil prices has already led to higher than expected April inflation figures in Germany and the U.K.   The same risk exists in the U.S.