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November 20, 2006

Will Housing Sink the Economy?
by Mark McMillan

Weekly Trader Alert #79
11/20/2006 8:07:04 AM

Overview

While politics still looms large as a discussion in the United States with the elections less than two weeks in the past, the talk has already shifted from gridlock between Democrat controlled Congress and the Republican President. Nancy Pelosi, the Speaker of the House supported a candidate for majority leader in the House and that candidate was defeated. The candidate is largely seen as a corrupt politician, due to being caught in a sting operation twenty-six years ago involving bribery. Another candidate was supported by members of the house, so the lack of consensus among Democrats is the new focus of political (and financial) talk shows.

The market likes this even better than the initial scenario for Gridlock, because there is even less chance of significant effect by efforts in Congress if the controlling party can't speak with one voice. This has weakened Pelosi politically while she does damage control.

Once again, the housing market appears to show new problems. Housing starts were down to their lowest level seen since the beginning of the decade and building permits fell to their lowest level since December 1997. Soft landing proponents suggest the housing slow down is what will allow the economy to slow and keep inflation under control, while still allowing the economy to continue to grow. The real question is does the consumer keep spending, which will allow this to occur.

In examining the labor market, it appears that unemployment continues to decline and there are signs of wage pressure due to a somewhat tight labor market. As long as the Fed doesn't raise rates, the economy will likely continue to expand.

The real question is, with a three years supply of new homes to work through, and with a record inventory of existing homes on the market, what will happen to the jobs created by the home building industry, and what will happen to home prices? Clearly, overbought markets are seeing a steady and rapid fall in home prices. California is seeing severe price declines, but that is attributed to the rapid rise in home prices seen through this decade. If other areas also begin to see significantly declines in home prices, then it is more likely the country will enter a recession than just see a slowing in the expansion.

Looking at the energy markets, oil lost $2.50 on Thursday, which also market the market top. Oil closed even lower on Friday after losing nearly four dollars from last week to close at $55.81. Natural Gas gained twenty-nine cents during the week to close at $8.18.

To understand more about our view on the markets, we will have to look at the charts.

Market Climate

We had suggested that at the beginning of the week, the markets could either move up to break through resistance or down to break through the 20-day moving average. The market continued to move higher week over week, with the 20-day moving average obediently moving up to support price as it climbed.

A chart of the composite of over 8,000 stocks traded on the U.S. Stock markets continues to be included.

The U.S. stock market composite chart:

Price walked the upper Bollinger Band until price reached the level of the 2006 highs (on May 9th). They retreated from those highs on Thursday and closed even lower on Friday. Since this is the second time level has been approached this year, we believe it to be a significant point of resistance, which, if broken through, will provide support in the future. It is likely that the market will have a bit of trouble moving up through this level.

Now that the market has managed to make a strong rally up to this point, RSI indicates possible weakness here. If this is joined with a high of MACD and a sharp reversal, then this could mark the local high. We will have to monitor this for a possible reversal this week.

Now, let's take a look at the charts for the major indexes.

A look at the chart for the Dow Industrials is represented by the Diamonds ETF (Amex:DIA).

Abbreviations and color key appears below:

Note the following order is Red, Yellow, Green, just like a stop light, so it might be a helpful mnemonic:
Thick Red line represents the 200-day simple Moving Average (200DMA),
The yellow line represents the 50-day simple Moving Average, (50DMA)
The green line represents the 20-day simple Moving Average, (20DMA)
The light blue line represents the 3-day Moving Average, moved forward three days in time, (3x3MA)
The thick blue line indicates the exponential 13-day Moving Average (13DMA)
Bollinger Bands are abbreviated as BB. There is an upper and a lower Bollinger Band that varies in distance from a central moving average (shown as light red/pink) based on the volatility of stock price movements.
RSI stands for Relative Strength Index. It is an oscillator, which can be used to determine how overbought or oversold a stock may be.

There is little to be gleaned from the chart of the DIAmonds. At this time, the DIAmonds have been walking the upper Bollinger Band. A definitive move starting above the and collapsing within it could signal the start of a new downtrend, however, that hasn't yet occurred. There is still more room to move up toward the upper boundary of the uptrend channel.

The DIAmonds are still clearly in their four month uptrend, and they succeeded in breaking up through the resistance that contained them for nearly three weeks. The choppiness indicator indicates this was part of a trend move, and that indicator hasn't yet reached the point of exhaustion yet.

The S&P 500 ETF, known as the Spyders (AMEX:SPY) is shown in the chart below:

The SPYders broke through the resistance that contained them, in a similar fashion to the DIAmonds. They too have been walking the upper Bollinger Band. They appear somewhat different to the DIAmonds in that they have already reached their upper channel boundary and also have a short term uptrend line that suggests this uptrend may stall at around the $141 level.

Similar to the DIAmonds, the choppiness indicator signaled this latest move was a trending move and it hasn't yet reached the point of exhaustion.

This week's NASDAQ 100 ETF (QQQQ) Chart is below:

This chart shows the QQQQs have broken upward to new highs for the year. The QQQQs have been walking the upper Bollinger Band and moved sideways on Friday. This move and other indicators suggests the momentum of the up move may be failing and the QQQQs will either rest or decline from here. The $43 level will likely provide support here though, so a short trade would have to be made as a swing trade to enter the trade above $44 and exit near the $43 level.

The choppiness indicator has reached the level where trending moves are exhausted so consolidation is likely at this time.

Fundamental Trends

The big surprise this week is that two retailers are back in the top five after having made a hasty retreat the previous week. All five are repeats within the previous two weeks.

There are five retail industries in the top screen. In addition, foreign banks continue there, and are joined by the brokers, which have become red hot after some much M&A activity and the recent IPO of the Nymex. There are two apparel industries supplying retailers with product. Periodicals are also in the top screen as recent offers to buy large newspapers have caused prices of companies in the industry to vault upward.

The auto and truck industry is now in the top screen. Auto and Truck parts retail is also in there as are the steel and steel alloy industries (lots of steel in automobiles). There are still two petroleum industries in the top screen (U.S. Integrated and Field Services). Finally, the most interesting is the staffing industry. Staffing implies a need to fill jobs. This implies expansion of the labor market or at least more competition to attract labor.

We continue to look for a bargain in the oil space. With a recent low put in for the price of oil, perhaps we will get a sell-off in oil stocks and can achieve a good entry.

The Industry leaders (ranked 1st-5th out of 190) are:

The laggards look almost the same as they did last week. The only addition is home textile makers which appear to be a victim of the overall slow down in the housing market. While many of these companies have material business in other textile and related industries, such as supplying the apparel industry with fabric, the huge inventory of new homes and existing homes on the market clearly has investors concerned over the prospects of such a significant decline in demand for products from these companies.

Drug stores are in sixth to last place, with concerns over competition from Walmart in the generic drug space. We suspect this is also related to margin impacts that are likely with Democrat initiatives to put a prescription drug program into place, cutting margins to everyone related to the pharmaceuticals industries.

The Industry laggards (ranked 186th-190th out of 190) are:

Trade Recommendations

We will be making another trade recommendation intraweek, as well as sending out a short topic email on the VXN option volatility index and its correlation to the NASDAQ market. These may come out on the same day and likely earlier in the week than later.

Current Portfolio

We entered the trade is Skyworks Solutions (NASDAQ:SWKS) at $6.99. We encouraged those that hadn't already entered the trade to be patient and try for an entry between $6.75 and $6.80. The low for trading on Friday was $6.81 and was probably about as good an entry as you will be afforded if you haven't already entered this trade. We have a stop in at $6.70.

FDG has rebounded as a bottom appears to have been put in for the Canadian Royalty trusts due to the Canadian government's decision to tax existing trust beginning in four years. Coal continues to be unloved.

Generally, our model uses set stop prices to control risk. Index ETFs, including DIA, SPY, QQQQ, and IWM are managed somewhat differently, in that trades will be reversed to time the market, as opposed to using a set stop limit.

Unlike the majority of position trades in the fundamental trader, our ETF trades may see us exit positions prior to specific profit goals being achieved, as we are more concerned with positioning for the correct direction of the market more than with achieving a specific profit level. The reason for this is the profits come over time with a fair number of exchanges for long and short trades.

* Initial stop prices are set to cause us to exit our positions if they close below these levels. You will note they are generally kept pretty tightly the opposite side of the trades we initiate. Historic volatility would imply that intraday price action may trade outside of these values, so that condition is insufficient to cause an exit from an existing position. On significant movement beyond our stop prices, we may issue an intraday message to exit the position or to maintain the position. You may chose to implement an absolute stop below these suggested stop values, but that stop should be wide enough to take care of the daily volatility for the stock in question. You can examine the candlesticks for an idea of intraday price fluctuations.

Entry prices are adjusted to account for dividends paid. The stock price was adjusted by your broker, to reflect the dividend taken out. The non-adjusted entry price reflects the actual entry price, without the adjustment for dividend values.

LVPB Concept: The concept is a Light Volume Pull Back, where a stock's price will pull back to a support level on light volume. Obviously, heavy selling is a sign of weakness, and we would not want to buy on a heavy volume pullback. However, we will occasionally place stocks on the LVPB (Light Volume Pullback List) to indicate a "re-entry" buying opportunity, when we have already entered a position. This should be used to add to existing positions, or to enter a position if you missed the initial entry.

LVPB Portfolio Stocks:

Conclusions

We have noted the markets propensity to keep this uptrend going. We continue to believe that market participants see a somewhat rosy scenario unfolding where the economy will continue to expand and the housing market will provide the necessary drag to slow that expansion and curb inflation enough to achieve a soft landing. Whether market participants are correct or not is yet to be seen. The main thing is that we can't fight the tape and the long bias should be maintained until this uptrend is broken.

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Regards and Good Trading,

Mark McMillan
Fundamental Trader Alert

Please use fundamentaltrader@stockbarometer.com for questions/coments.

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