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January 22, 2007

Earnings Season Concerns...
by Mark McMillan

Index Advisor 006
1/22/2007 7:57:10 AM

Recommended Trades:

Thursday's trading gave a clear signal to short the SPYders (AMEX:SPY).

Open Positions:

We have the QQQQs short from a legacy Fundamental Trader recommendation. Once this trade is closed, we will report all index positions here.

We are short the SPYders at $142.54 entered at the open on Friday.

Overview:

Traders and investors have become more concerned with earnings as several bellwether tech companies have been punished. IBM, Intel, and Apple being among them. Semiconductors have been particularly hard hit in the 2.1% sell off in the last week.

This is earnings season and companies that just meet expectations or miss them are being punished. It is the taking down of earnings guidance and reporting of significantly lower revenues in Q4 that have investors concerned. The earnings slow down has been talked about but if it comes about that companies, on average, only report single digit growth in earnings, this will likely result in more profit taking. With some thirteen quarters of double digit profit growth, anything less may tip the balance in favor of the bears.

Economic reports were mixed with the Empire State index falling to 9.1 indicating continued softening in manufacturing activity. PPI and CPI both increased, with the former reporting 0.9% for December (0.5% expected) and 0.2% core PPI versus and expected 0.1%. CPI was reported at 0.5% versus and expected 0.4% for December. Core CPI was reported at 0.2% resulting in an 2.6% annual CPI increase in 2006. Industrial Production rose by 0.4% in December following three months of negative numbers. Capacity utilization came in nearly exactly as expected at 81.8%.

Positive news came from housing starts, reported at 1.642M versus an expected 1.57M. Building permits issued were also bullish, reported at 1.596M versus 1.505M. New jobless claims were reported at 290K while crude inventories increased by an unexpected nearly 6.8M barrels. Finally, the Philly Fed showed an increase in manufacturing from near zero to 8.3. Anything over 0.0 shows growth. Finally, the Michigan Consumer Sentiment report showed increased enthusiasm that the economy is sound with a 98 versus a prior 91.7 and an expected 92.4.

Oil has risen about one dollar in the last week to close just below $52.00 by Friday.

Natural gas has increased more quickly rising to less than twelve cents below seven dollars, closing at $6.886.

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

Market Climate

The market finished slightly higher last week after rallying early in the week then moving decidedly more negative later in the week. The markets have moved in split fashion with tech selling off hurting the NASDAQ with the largest single day loss in a couple of months reported on Thursday.

We will remind readers that while the ETFs continue to hang in there, investors are continuing to react more strongly to negative news than positive news. Friday's rally notwithstanding, the QQQQs have started to show signs of distribution, while the other indexes appear to see continued accumulation. We believe it is a time to be cautious and to protect profits.

The U.S. stock market composite chart:

The third failure to break through resistance in a month sets the stage for a likely move to test downward again or to break up through that resistance on a fourth attempt. It is interesting that the rally was to the underside of the mid-term uptrend line that provided support for the QQQQs since they rallied in summer 06. The failure to break through resistance was at this trend line as well as horizontal resistance noted from mid-Decembers high. RSI continues to hold at a middle level. The MACD, while continuing its downtrend is showing signs of a reverals to the upside. Trading action in the coming week should be pivotal.

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

A look at the weekly 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.

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

In examining the weekly charts, it appears that the DIAmonds could be topping. The Hirami is a weak reversal pattern that must be confirmed. Examining the daily chart shows a possible trend getting started to the upside. The Fractal indicator began moving down from a high level in conjunction with the upward move of the DIAmonds. With a tweezer top formation on Wednesday and Thursday, the $126.10 level becomes the resistance level to be overcome. A failure to break through that in the coming week would indicate trouble for the bears and a tradable short set-up could be taken advantage of. We will suggest a short trade in this instance, but we aren't there yet.

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

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

The weekly chart for the SPYders shows a Hirami, indicating a braking of the uptrend. A Hirami is a weak reversal signal that must be confirmed, but it takes on greater importance later in a trend, so is important at this time.

The daily chart shows evidence of trouble for the bulls with a failure to break through horizontal resistance coupled with being rebuffed as SPYders approached the underside of a medium term uptrend line is of concern for investors who are long the SPYders. Tuesday and Wednesday's high created a tweezer top with price closing below horizontal resistance dating to mid-December. The Fractal indicator shows the start of a new trend which is in conflict with the indicators. With the start of the move lower by the Choppiness Indicator, price was moving higher. Other indicators, however began moving lower almost immediately signaling confusion.

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

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

The weekly chart for the QQQQs shows a bearish reversal sign that may dominate trading. The Fractal indicator on this chart shows it is readying for a new trend to get started, but it isn't there yet.

Examining the daily chart, the 20-day moving average is coincident with the 50-day moving average. A further decline in the QQQQs would see a bearish cross of the 20-day MA cross below the 50-day MA. This would lead to acceleration to the downside. A continued bounce off of the 20-day moving average could sustain the medium term uptrend.

The Fractal Indicator shows the uptrend is exhausted and the market is growing choppier. Traders should have been short the QQQQs by the open on Wednesday and should watch for signs that the rally off of the 20-day moving average continues to show support or whether we indeed see the bearish cross of the 20-day below the 50-day moving average. The first would signal a sign to close the short trade while the second would suggest downside action to the $42.50 level or so, where the 100-day moving average is moving to now.

Conclusion:

Earnings season moves the market. If we continue to see companies taking down forward guidance, we believe a negative mood will persist and the market is vulnerable to a sell-off. On the other hand, if companies begin to over achieve on earnings expectations and maintain or raise forward guidance, we believe the market still has the potential to rally.

At this time, we believe that the market is overdue for a correction of some sort, and is more vulnerable to downside action, than it is poised for significant gains. We believe investors should take precautions to protect profits from long positions and should consider shorting the market as conditions warrant.

Regards and Good Trading,

Mark McMillan
Fundamental Trader Alert

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

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Copyright © 2006-2007 Mark McMillan

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