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

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Granted there are some who got a head start on the holiday shopping binge, in particular those who have engaged in the recent feeding frenzy in technology and Internet related stocks, but for the majority of shoppers the day after Thanksgiving marks the traditional kick off of the holiday spend-o-rama bowl.

This year's holiday shopping season promises to be the strongest this decade, a fact which has not gone unnoticed by investors who have bid up the prices of e-commerce stocks.

The strongest labor market in decades, soaring stock prices, strong economic growth and low inflation have combined to lift consumer confidence to near record levels this year, sending the consumer on a year long buying binge which has created a self perpetuating circle of  consumer demand fed economic growth .

This week's latest batch of economic data indicates that neither the economy nor the consumer's appetite to spend is likely to slow anytime soon.

Preliminary third quarter GDP figures indicate the economy grew even faster than first estimated, at a 5.5% clip.  Consumer demand showed no signs of slowing down despite this year's jump in long-term interest rates from 5.05% to 6.23%.  Real personal consumption expenditures rose 4.6% in the quarter.

Signs of a pickup in economic activity, rather than the hoped for slowdown, were in evidence throughout the third quarter GDP numbers.  Real Final Sales of Domestic Product, which excludes the effects of inventory changes, grew at a 4.6% pace compared to the second quarter's 3.2% rise.  Real Gross Domestic Purchases rose 6.1% in the quarter versus the second quarter's 3.2% increase.

Any way you stack it the economy remained strong in the third quarter, growing at a pace far above the 3.5% annual rate that N.Y. Fed President McDonough earlier this week indicated was the upper limit for sustainable growth. 

Perhaps the only things that didn't show strong growth during the quarter were corporate profit margins.  Unit profits, or the profits per unit or real product, declined in the quarter as labor costs and other corporate costs ate into margins.  Also declining during the quarter were the domestic profits of non-financial companies, which fell 2.1% in the quarter.  Although total after tax corporate profits rose 3%, and 11.7% year-to-year, the decline in unit profits is a potential source of trouble for a stock market that is priced to perfection.

Friday's release of October Personal Income and Spending figures was sweet music to the ears of retailers as this holiday season begins.  Personal incomes grew 1.3% during October, their biggest jump since 1994.  Subtracting the effects of farm subsidy payments, the rebound from Hurricane Floyd, and union contract signing bonuses, personal income still grew at a robust 0.5%--a healthy enough figure to ensure that the confident consumer remains smiling and willing to pull out the wallet.

The consumer remained in spending overdrive mode during October, with personal spending rising 0.6% and real personal consumption expenditures rising 0.4%.  The consumer stepped up the pace of spending in all categories during the fourth quarter's first month, with durable goods purchases rising 0.8% versus September's 0.1%, nondurables rising 0.3% versus September's unchanged reading, and services purchases increasing 0.4% compared to 0.3%.

With demand showing no signs of slowing down from the third quarter's torrid pace, fourth quarter GDP is likely to once again come in strong at 4.5%-5%, a level that will once again put the Fed's finger on the rate hike trigger.

Consumer demand is unlikely to ease until consumer confidence eases from current levels, a scenario which is unlikely as long as the stock market remains near record levels and the unemployment rate remains near a 30 year low.

Perhaps the most worrisome of this week's economic data was the Initial Jobless Claims numbers, a number that was largely ignored by many investors during Wednesday's pre-Thanksgiving tech sector and Internet stock surge.  Initial claims declined 13,000 to 274,000 in the latest week, and the 4-week moving average fell 1,250 to 286,250.  The insured unemployment rate dipped to 1.7% from 1.8%.  The numbers indicate a continued tightening of labor markets.

While the stock market's short term outlook remains favorable, the market's longer term outlook is looking increasingly negative.

NASDAQ and the Internet stocks continued their rally to new highs this week as we expected, and momentum is strong enough to carry the stocks higher in next week's early going, but beyond that all bets are off.

As we have said previously, the market is nearing the end of a blowoff top, with the recent parabolic moves by tech sector and Internet stocks the final phase.  Euphoric sentiment leaves the market defenseless against the unexpected, and a sharp change in the prevailing opinion.

While the bond market has already shifted its views on the outlook for the Fed's interest rate policy, the stock market's current euphoria has left it largely unprepared for a sudden shift by the consensus to a more hawkish outlook on interest rates.

We expect next Friday's employment report, along with November's oil-price-rise enhanced CPI and PPI numbers, to cause a seismic shift in the consensus view on future Fed rate hikes, a shift which will likely mark the end of the current blowoff top.

Looking further out, the real danger to the market is that the majority of investors still operate under the assumption that "one more quarter-point rate hike will do the trick".  In reality, as we have said before, there is no way to predict when the current rate hike cycle will end, or the number of rate hikes that will be needed.  The Fed will be forced to keep its hand on the rate hike trigger until the economy slows down to a sustainable pace and labor market conditions ease.

With consumer demand and economic growth remaining at unsustainable levels despite this year's sharp rise in interest rates, the current rate hike cycle will likely last far longer and carry interest rates much higher than anyone expects-- an event which could carry stock prices far lower than anyone expects.

The second blossoming of the Tulips should come as no surprise because the mood in our town recently has been eerily reminiscent of the carefree days of last Spring, that time when the days were spent frolicking in the sun without a care in the world, that time when Fed induced interest rate jitters had yet to cast a black cloud over the landscape.

When the summertime jitters finally departed earlier this month, it was no surprise that all soon reverted to how it had been before their appearance--no surprise because throughout the summer of discontent the word capitulation never entered the vernacular.

Without capitulation, without a widespread sense of fear, there was nowhere to go but up when the last shackle of uncertainty was lifted--nowhere to go but back to the crowd pleasing favorites of Spring.

Thus, it should have come as no surprise that the crowds soon returned to the land where the promises of analysts are great but the potential delivery of meaningful profits is barren:  the Internet stocks.  For those with a little knowledge of the market's past, and for those who have been through a major top or two, this return to the most speculative of the bunch also should have come as no surprise because this is where the crowd most often congregates during those times when it seems nothing can go wrong, those times when sentiment skyrockets and all clamber to get aboard a streaking train of seemingly limitless profits to be made, those times that go down in the history books as a blowoff top.

Despite today's selloff by the major averages, we don't think the end of the trajectory has been reached yet--there is still a long line of people rushing to throw their money at the crowd pleasing wonder stocks of the day.  Thus, we think there is most likely one last gasp left in this parabolic juggernaut before the building list of negatives bubbling beneath the surface force a retreat from la-la land--a retreat that could very well start with the release of the November employment numbers.

With the phrase "this time it's different"  once again returning to the tip of every pundit's tongue and with the boldest of learned camera hungry gurus now seeing NASDAQ 4300 just over the horizon, now is perhaps the time to stop and reflect, because "this time it's the same".

The scenes of frenzied crowds in an accelerating rush to participate, of commentators unanimously proclaiming the all clear sign, of novice traders growing careless as a runaway trend gives them false hope in their abilities as traders, the chants of "It's a New Era, this time it's different", the mass exodus of the bearish into hibernation, the air thick with complacency--we've seen them all before, collectively they're known as the end of a major trend.

This time around, market history is holding true to course.  Extreme levels of complacency have instilled a sense of permanence, a sense that nothing can go wrong, a blindness to all that conflicts, a complete unawareness of signs of trouble brewing--a state of market psychology we affectionately refer to around here as the Blinded Superman Syndrome.

The greatest enemy of those afflicted with the Blinded Superman Syndrome is, of course, the continued pressure of the crowd as mass opinion feeds on itself, creating a blindness to any potential potholes in the road ahead.

As Winter approaches, and sentiment retraces the path of the Spring, there is a growing list of potentially trend reversing factors building momentum just beneath the surface: from a still strong economy and ever tighter labor market to surging oil prices and rising intermediate goods products prices, from rising bond yields and a rebound in consumer confidence to increasingly narrow breadth and an advance/decline line that is rapidly sinking back towards its lows.

Perhaps the greatest threat to the market going forward is the tech stocks themselves, where extreme levels of bullishness have left the market with no room to maneuver in the event the wildest of expectations are not met.

With the valuation levels of many leading NASDAQ stocks now discounting all expected earnings growth into the early years of the next century, it should be remembered that the technology sector's ability to make it through this quarter without suffering the effects of a Y2K related slowdown is still very much up in the air.

The October Durable Goods report showed a 15.3% plunge in orders for electronic equipment, the largest decline in 2 1/2 years.  Shipments of electronic goods fell 1.1%, their third straight decline.  While one month's durable goods report does not make a trend, the NASDAQ's recent runup has left it in an extremely vulnerable position in the event that October's slowdown in orders continues into the quarter's last two months.