Earnings Season Concerns... 2

By: Mark McMillan | Tue, Jan 23, 2007
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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 reversal to the upside. Trading action in the coming week should be pivotal.

Fundamental Trends

Four of five leaders remain in the top five, with Metal/Glass Containers leaving in favor of Real Estate Management.

The meat industry continues to hold just below the leaders board. Steel Alloys also maintains a position off screen as does the Meat Products industry.

Three retail industries (discount stores, department stores, and jewelry stores) are in the top screen (top 31 industries). There are three building industries (Cement, Wood Products, and Residential/Commercial) in the top screen, with the first two listed in the sixth and seventh positions.

Healthcare now has two industries in the top screen (Nursing Homes and Outpatient care). This is worth watching for more industries to enter, and in particular, individual stocks that may be moving up.

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

The laggards are persistent, with a repeat of last week's cellar dwellers, although they have moved around slightly.

We are focused on the plastics industry and are looking for a rebound. At this time, several companies are highly undervalued. This valuation doesn't yet reflect the significantly lower raw material costs due to the lower price of oil.

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

Trade Recommendations

We didn't get filled on our trade recommendation for Diamond Offshore Drilling, missing our limit price by seven cents. This was due to a delay in getting the alert sent out as the stock actually traded some thirty-seven cents below our recommended entry price. We are continually watching for good entries to energy related stocks but it is a volatile sector.

We are currently monitoring the Cement Industry for a long trade entry. We have five candidates, but the most likely would be Texas Industries (NYSE:TXI). We are waiting for a pull back to around $67. The stock has been in a strong uptrend but entered a consolidation stage in the last few days as the market has sold off. We are hoping for a pull back to support for our entry.

We are also looking at long trades in the forest products industry, but there are only three candidates to choose from.

Current Portfolio

We are still in a short trade on the QQQQs. As we anticipated, a downtrend has begun with a sharp move lower last week. Our entry to this trade was far from optimal so we are currently behind but a move down to an expected level of $42.50 would make this a profitable trade.

FDG seems to have found a bottom and continues to pay out a large quarterly dividend amounting to annual gains of 15-20% of its price. It just hit a local top, and we would expect some softness, but we expect the bottom to hold.

* 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:


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.

We will look for short candidates, but we are balancing that with a continued search for stocks that will but the trend and so look for long entries in the strongest industries that are defying the latest downturn.

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Regards and Good Trading,



Mark McMillan

Author: Mark McMillan

Mark McMillan
Fundamental Trader Alert

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