The Goldilocks Economy...

By: Mark McMillan | Tue, Sep 5, 2006
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Weekly Trader Alert #68


We were quite bearish last week, on the ability of the market to continue to move higher. It appeared that we were correct for the first four days of the week, and then markets moved higher to achieve multi-month highs. With that said, we are entering the historically most difficult month for stocks to advance. In fact, September is generally a losing month for the stock market, with the average monthly loss averaging 1 to 1.5%.

Goldilocks is a fairy tale about a girl who tastes bowls of porridge. The first bowl is too hot, the second bowl is too cold, and the third one she tastes is just right. The so called Goldilocks Economy, is one where growth is not too hot (so inflation is in check) but not too cold (where growth slows and a recession occurs) but rather, just right. This Goldilocks economy is now being talked about once again on Wall Street.

The August employment report, which was inline with expectations in terms of moderating job growth (a slowing economy) and more importantly, wages, only went up 0.1%, which was below expectations and may allow for a "soft landing" for the economy. In addition, the ISM index slipped to 54.5 from 54.7, which shows sustained moderate growth (anything over 50 shows growth, but the closer to 50, the more moderate the growth).

Oil fell through the week to close at $69.19 for a barrel of light crude. Natural gas fell below $6.00 on Friday ($5.82), which is near its low of the year ($5.47). We currently see ideal conditions to argue for a continued bullish advance.

The Index Put/Call ratio was 1.58 on Friday, with the 5-day Moving Average up to 1.59, while Equity Put/Call ratio was 0.67 with its 5-day Moving Average at 1.69.

The Index ratio isn't yet at rarified levels, but is high enough that a push higher could see the number climb significantly and then a top would be likely. Advance/Decline ratios have been deteriorating for the NASDAQ but recently strengthened on the broader indexes.

We have now entered seasonally weak September so a strong uptrend is against historical odds at this time.

Market Climate

The US Composite has done another about face. Two weeks ago, the market retreated from the 200-day moving average and it looked as if it could go lower. Last week the market used the support of the 20-day and 50-day moving averages to avoid a sell-off and has moved higher.

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:

Two week's ago, we suggested that a breakout above the 200-day moving average was imperative or a retest to the 50-day moving average was likely. That came about but again we are at the 200-day moving average, essentially closing on or just above it. There is more room to run up toward the top of this channel, however, and we could see further upside. If so, that will be "walking the band" as price is on top of the upper Bollinger Band now. The strongest markets "walk the band" upward, and the weakest markets walk the band in the opposite direction. Most markets turn around when price hits the band. What will happen in this case has to be watched, and a short trade can be put on based on a rejection of walking the band.

Perhaps the most important indicator that something is amiss is the divergence between a climbing price and a weakening RSI line. RSI did start moving up in the last two days of the week but a continued divergence as price moved up would make a nice short trade set-up. Last week, we noted the opposite condition and noted this was bullish but cautioned that MACD was set up for a bearish cross. That bearish cross never occurred, and so the uptrend continued. With the opposite condition holding, i.e. a bearish RSI Price divergence, we are now inclined to look for a new downtrend to get started.

The spring, that has been coiling tighter and tighter through the week finally uncoiled on Friday. All index ETFs had a markedly higher open. Let's take a look at the details on each chart of the major index ETFs now.

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 pneumonic:
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.

Last week we were bearish for the prospects of the DIAmonds to stay within the uptrend channel. As it turns out, the DIAmonds were up to the challenge. They were not only able to maintain the uptrend, but actually climbed up and out above the upper Bollinger Band. While price doesn't usually stay above the upper Bollinger Band for a long period of time, as long as it does so, it would be foolish to bet against the progress of the DIAmonds.

We did believe the most likely scenario was for the DIAmonds to move up toward the recent top, and they did this, but then continued beyond that point. While we see the DIAmonds are now in oversold territory, the strongest markets are able to maintain an uptrend while in oversold territory for awhile. In this case, we believe it could continue for up to a week.

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

The SPYders look very strong right now. The move up and over the upper Bollinger Band and then closing outside of the Band is impressive. While moves outside of the Bands tend to be limited in duration, while they occur, rallies or sell-offs can be quite impressive.

We are still looking for seasonal weakness to kick in at some point. Until the SPYders retreat from the move outside the Bollinger Band, we will have to stay with a long trade. A likely point of resistance would be a challenge of the May high, which is only about $1.20 above Friday's trading range. That is less than one percent higher. Of course, a move above that could see further follow-through as well.

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

The QQQQs have the most interesting chart this week, as it just crossed over into an inverse head and shoulders pattern. That suggests that a challenge to the resistance of the 200-day moving average might be in the wings. On the other hand, Friday's shooting star candlestick, which was also a long-legged doji suggests indecision on the part of traders. Monday's trading may reveal the QQQQs mimicking the other two major indexes we regularly monitor with a move and close above the upper Bollinger Band. If so, that signals a strong market that is likely to continue a bit higher.

Note the 200-day moving average is above the $40.00 level, so a swing trade might be put on with an exit at the 200-day moving average. That would yield a two to three percent profit, depending on exact entry/exit prices. The trade would likely be completed by mid-September, so would last less than two weeks.

Fundamental Trends

The top 31 industries include five retail industries, three utilities, four food industries, and two bank industries. Number six is generic drug makers and number seven is nursing homes. Ship transportation remains, as do Equity REITs and auto and truck manufacturers.

It seems apparent that big money continues to play defence, with a continued belief in the consumer. The vaunted HealthCare sector remains largely absent from the top (allowing for nursing homes in seventh place).

For a couple of weeks, we have observed that none of the riskiest industries were represented at the top and that continues this week, with the noted exception that gold/silver mining stocks have moved up into 30th place.

The tone is decidedly defensive still.

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

The laggards seem to have reshuffled a bit but remain largely unchanged. The one difference is perpetual laggard Personal Soap and Cleaning products replaced Steel Alloys. It should be noted that Steel Alloys have been declining for many months, and specific stocks such as TIE have been in a descending triangle pattern with a break out imminent. A move down would be shortable and TIE is on the candidate list.

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

Trade Recommendations

The Ishares Lehman 20-year bond (AMEX:TLT) hit a new high on Thursday, and backed off a bit on Friday. It may go as high as $88.40 before reaching a top, or last Thursday may have been a top. We will likely recommend shorting the TLT if it hits $88.40, or if it shows signs the top was put in on Thursday.

BPT dropped to our entry price recommended level but it was a "stale" recommendation. A stale recommendation is one that is five trading days old or older. When a trade recommendation is this old, initial conditions for recommending the stock may have changed so the recommendation must be re-asserted. In this case, entering at the recommended level would have been profitable, but that is hindsight. The new entry we will attempt for this trade is $75.00.

Buy shares of BPT with a limit of $75.00 or better.

Our market outlook is that a new downtrend is likely to get started soon, we are going to look for good short trading candidates as soon as the market commits. We don't want to step in too early, as short covering is a primary reason that markets become more overbought, and we need to make sure that we enter the short trades near the top.

We are looking at one ETF long trade, which is the QQQQs if they extend the inverted head and shoulders pattern, we would look to enter the long trade and exit it at around the 200-day moving average. Stay tuned for intraweek advisories as to entry, stop, and exit levels.

We will look to enter swing trades on the ETFs we follow when it appears the market has topped.

Current Portfolio

Both FRO and HP left the portfolio last week, FRO on Tuesday at the open of $42.34 and HO on Wednesday as it descended past our stop at $24.70. FRO was entered at $41.80 but was ex-dividend on Tuesday when we exited. Your will be credited with the $1.50 dividend, bringing our net entry price to $40.30, and our profit on that trade to a bit more than 5%. The loss on the HP trade was just under 3%.

As an FYI, I believe that both of these stocks will head higher but may delay until the oil complex again pushes higher. The same holds true for BPT, which we may try to enter again, if the price is right.

We are continuing to hold FDG and look forward to receiving another quarterly dividend to unit holders at the end of September. This will again bring our cost basis down by an amount likely between $0.75 to $0.90 cents per share.

Finally, our ETF trades all hit their limit prices and three full positions were sold on Monday for nice profits between 2.3 to 4.3%, and a half position was sold at a nominal 0.6% loss. While we could have remained in the positions, we eliminated the risk of an anticipated downturn be exiting at our limit prices.

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:

Closed Positions

These are being updated now and may be in place before you receive this email.


Last Friday, we correctly predicted the struggle for the Index ETFs to move higher, until the explosive move on Friday. We are now in the position where the NASDAQ and the Russell 2000 have been unable to move solidly higher at the end of the week, while the S&P500 and DJIA have made new highs on a strong move on Friday.

The market could enter a new uptrend next week, but is unlikely to be able to make much headway, as it would begin this uptrend in an oversold state. We must be patient and watch the market as it develops to best position to enter trades at a market turning point.

Big money managers and other Wall Street heavy hitters will be returning from their vacations as of Tuesday, the day after the Labor Day holiday, which marks the end of summer (and the end of wearing white pants if you were brought up in a proper East Coast household in the United States). With their return, we should see more volume committed to trading and the market will likely have a different character to it.

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Regards and Good Trading,



Mark McMillan

Author: Mark McMillan

Mark McMillan
Fundamental Trader Alert

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