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

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Short term market sentiment and the consensus opinion regarding the Fed's longer term plan of action have now done a 360 degree spin in the course of a week, without the help of new news or even Greenspan himself to aid in the reversal.  Last Thursday's benign summer has been transformed into this Thursday's cruel summer.

The market's interest rate outlook has now swung too far in the opposite direction.  The expected "single 1/4 point hike in rates" is now the "1/2 point jump followed by more hikes". The one hike Fed was never more than a trader's dream, but the present expectations of a 1/2 point hike are little more than a trader's nightmare.  The Fed will reverse last Fall's trio of desperate bail out rate cuts, but it will be done in 1/4 point nudges, not 1/2 point.

While we believe that an immediate 1/2 point hike would ultimately be in the market's best interests because after an initial flight to panic the market would regain its composure with the knowledge that uncertainty had been vanquished, it is not likely to happen.

Instead we are likely to see the stock and bond markets stage a powerful relief rally next week after the words "1/4 point hike" peal forth, and then quickly settle back into the same rate hike jitter, low volume trading patterns that have dominated recent trading.  The negative effects on sentiment of the prolonging of the stay of the market's most dreaded enemy, Uncertainty, will increase as the summer wears on, with a serious market setback the ultimate outcome as the sentiment boosting effects of second quarter earnings season begin to wear off.

NASDAQ rallied yesterday as investors in the Internet sector and large cap tech growth stocks continued to avoid the debilitating interest rate fears that have plagued the rest of the market.  Other investors who were long the stock market were not so fortunate as a tumbling bond market continued to wreck havoc on short term sentiment.

The rise in 30-year yields to a near 19 month high yesterday added to the market's concern that the winds of fortune have turned.  The short lived belief in a one-move Fed has now all but died, and with its death the stock market's ability to move to new highs is now in peril.  The jitters that have abounded since the release of April's CPI will not be calmed with the passing of next week's FOMC meeting.

While the stock market would greet a 1/4 point hike next week with a sign of relief and a move to the upside, any rally is likely to remain short lived as thoughts quickly turn to next Friday's Employment report, and then to the next Fed meeting.  While the bond market is now fearful of a 1/2 point hike next week, after an initial selloff following a Fed move of this magnitude, the bond market would likely quickly regain its composure and rally on the belief that a large move now had diminished the threat of a drawn out series of future moves to pre-empt inflation.

The negative stepped up the pressure around 2 p.m., with an assault so fierce in nature that even the online trader's sanguine cries of "Yahoo! Yahoo!" were soon buried beneath a new, more ominous cry of "one hike might not be enough, sell YHOO now".

The subsequent reversal in Yahoo! and other Internet stocks only added to the growing list of technical roadblocks the market has failed to overcome in its attempt to recover from the depths of May's despair.  Yahoo! climbed to an intraday high of 166 1/2, near the 38% retracement level of 170 we mentioned last week as the probable terminus for its rebound, and reversed sharply to the downside.   The failure of Yahoo! and the other Internets to move above resistance, coupled with the decrease in overall volume over the past month, paints a picture of a sector and of a market without the necessary firepower to trudge higher in the face of adversity.

Yesterday's sharp reversal by NASDAQ and failure of the Internets are not the only technical disappointments that have recently arrived in town.   We have also seen the S&P 500 stage a one day false breakout above resistance at 1343, and perhaps most importantly, we witnessed the bond market's post-Greenspan euphoric relief rally last Thursday as yields dipped to support at 5.95% and subsequently reversed after failing to break the impenetrable level.

Technical problems, however, are not the only problems in town. The market must still deal with the question of one hike or many, a question that last Thursday was seemingly answered but now is in doubt, a doubt that only grew after hawkish comments by N.Y. Fed Governor McDonough yesterday.

The rate hike blues are growing, but for now the long term trend for the Dow, NASDAQ, and S&P 500 remains up.  The short and intermediate term trends are still on the plus side , but significant cracks of weakness are sprouting forth, with 21 of 30 Dow stocks now in intermediate term downtrends. Perhaps its time to add a few protective puts to the menu...

When confronted with the question, Joe Dotcomly replied, "the market continues to show signs that it has bottomed and is ready to move to new highs following the recent volatility".  Seymour Cyclicalissi told us, "the market needs time to digest its recent gains, today's losses were due to profit taking and sector rotation". Our intern Biff Tulip told us, "today the market gave an educational lesson in Signs of a Top".

Our intern is a fast learner.

The market's "trend in the last hurrah stage" warning bells were working overtime yesterday.  Expectations continued to stretch skyward, volume disappeared, the smart money sold and the new speculative money bought, intermarket divergences abounded, complacency continued its rebound as the equity put/call ratio fell to 0.32 and VIX dropped to the danger zone of 21.29, and the list goes on...and on.

The market's "churning at a peak, looking for a leader" game of day by day sector rotation continued yesterday with a vengeance.   In the now familiar "yesterday's friend is today's enemy" sector allocation game, the cyclicals were on the losing end of the stick as fund managers fretted about a "lack of pricing power in a non inflationary environment".

While we tend to think that recent signs that the C.R.B. is breaking out of a multi-year decline indicate that the copper and paper producers of the world will have pricing power in the near future, we do not regard the cyclical stocks as good investments at this time.  The springtime runup in cyclical shares left the stocks at valuation levels that fully discount peak cycle earnings.

The urge to drive the market higher was there, but thoughts of a summer weekend at the beach and a mild case of the warning season earnings jitters conspired to limit the day's gains.  The market's resilience in the face of an earnings warning from Gillette and fears of an Intel earnings shortfall is not necessarily a sign of a healthy market because it was the inordinately high level of complacency that has built up in the hearts and minds of many market participants which allowed the major averages to cast aside the negative news.

At this point, it is complacency and not the Fed which poses the greatest danger to the market in the weeks ahead.  The extremes in bullish sentiment readings, which remained high throughout the market's month of worry despite the occasional "moment of doubt blurb" expressed by publicity seeking market gurus and fed to a soundbyte hungry financial press, are now escalating to a fever pitch which is increasingly putting the market at risk of a serious letdown.

While many will cite a double bottom at 10450 as proof that the market will continue chugging merrily along to new highs, the extremes in bullish sentiment that continued to occur as the market danced with the 10450 level do not confirm a bottom.  Rather than a major bottom, the sentiment levels seen at the 10450 level correspond to the classic patterns seen during a short term corrective move during a larger long term topping formation.

The large degree of rampant complacency is allowing expectations to build to extremes which cannot be satisfied.  The market could be disappointed on two fronts upon which it has placed its fortunes in the coming weeks: second quarter earnings and the one move Fed.  While we expect second quarter earnings to be strong, the current extremes in expectations surrounding their strength leave the market vulnerable to even the slightest disappointment.  Earnings will likely have to exceed already high estimates if stocks are to make it through earnings season unscathed.  The mere meeting of inflated expectations will not do the trick.

The widespread belief in a one-move Fed will allow the market to temporarily rally, but by rallying strongly the market will force the one-move Fed to quickly transform itself into the multi-move Fed if it hopes to be pre-emotive against the primary vehicle for future inflation: the wealth effect.