Market Jumps with Chips Leading the Way

MARKET OVERVIEW

Friday provides plenty of follow through to the new SP500 resistance break.

The stock market had a sluggish start. It was sluggish well into the night primarily because China raised its bank reserve lending requirements by 50BP. That is the fourth time in the last two months. Every time China takes a step to slow down its economy, it has deleterious effects on the rest of the markets in the world because of China’s voracious growth appetite. It wants commodities, industrial equipment, and everything it can get its hands on.

Governments are typically not that successful in their ability to manage a slowdown. When they try, it worries investors and prices come out of the market. Even with the sluggishness, US futures were improving in the wee hours toward the open. This even though there were some not-too-great numbers with respect to retail sales and the CPI. That did not slow the market down; it continued its improvement into the open.

It tested down initially but then continued the rally unabated, although there was a hitch in the get-along half an hour into the session. The Michigan Sentiment preliminary for January came in at 72.7, well off the 75.5 anticipated. Note how the market sold back just as it hit the closing price from Thursday, at a technical resistance point. There was reason to stall with the news, but it overcame it. It rallied higher throughout the session. Nice action, indeed. Looking at the SP500 shows the sprint up to the close a bit clearer. Not bad action at all. No inclination to sell, and investors bought the entire day. NASDAQ, +0.75%; SP500, +0.75%; Dow, +0.5%; SP600, +1%; SOX, +2.7%; NASDAQ 100, +0.78%.

This was a fairly important move for the indices. The SP500 bumped up against the 127% Fibonacci extension and moved laterally for a week, but it did not stall out or roll back over. A lot of pundits thought it might do that. We kept an open mind about it. It was a perfect opportunity for a correction, but it didn’t do it. It broke higher Wednesday, stalled a little on Thursday, and then continued to the upside on Friday. That has all the feel of a breakout, particularly when you look at the percentage gains as well as the increasing volume.

There were a lot of positive attributes to this move, and there is still room to the upside before SP500 hits the resistance from 2006, 2007, and 2008. There are peaks and valleys waiting for SP500 to hit them   but they are still waiting. That gives SP500 extra room to move higher into earnings just as it is doing now. It may not last. It may not make the move stick, but it is having a great run. It is enjoying the first rounds of earnings and even overcoming some selling on Friday.

There was news contributing to the early depression in the market other than the Chinese data. The CPI for December came out hotter than expected. It rose 0.5% versus the 0.4% expected. The core was right in line at 0.1%. Food and energy is where most of the price increases are coming from, but we are told not to worry about that because they are stripped out and not part of the core. The problem is that the core consists of things that are not food and energy, such as flat-panel TVs and personal computers. These types of things declining in price, but we do not need to purchase them every day to survive. We do have to eat, and we do need gasoline and heating oil. We have to make it to work and heat our homes   particularly given the weather of late.

We need to buy those things every day, but we are told by the economists in the government not to worry about it. They say we need to worry about PCs and flat panel TVs and whether those prices are going down. They don’t put it exactly that way, but that is the sum total of it. Do you trust the economists and the government, or do you trust the numbers? I am not going to make any judgment calls, but I think you know what hits and really hurts in this struggling economy. Right now, it is food and energy, but it will bleed into other items. It takes energy to create steel and other items that go into the products we consume. Cotton is hitting all-time highs. Corn is surging. The clothes we wear, food we eat, and the petroleum we burn are all going up in price. There is no inflation, mind you.

The market was not buying into that, which is why there was some sluggishness on the day. Michigan Sentiment was also a problem. Industrial production was much better than expected at 0.8%, doubling the 0.4% anticipated. Capacity rose to 76%, up from 75.5%. That put it at its highest level since August of 2008. Remember, August of 2008 was right before it hit the fan. The SP500 was trading around 1260 on the first of August, before everything hit. Now we are closing at 1293. There are at least some parallels with the same SP500 price. It is the highest level on the capacity utilization since the market finally fell off in that big tumble right before all of the “stuff” hit the fan with the financial crisis. It was an ugly downdraft. It is nice to see things are coming back, but they are not coming back that fast. Hardly an inspiring recovery.

Business inventories turned out to be quite interesting at 0.2% when 0.8% were expected. Very similar to wholesale inventories. Companies are not excited to build up inventory, but sales are good. Sales are depleting inventory, and in theory that means there will ultimately be production to refill the coffers. We still have to go through an ugly 2011, most likely. The housing crisis slide that began in the summer of 2005 will probably crescendo in 2011 with foreclosures at the worst they have been. As is often the case, when the negatives hit their peaks (or what appear to be horrible numbers that will not get better), that is when the bottoms are put in. There is anticipation of a bottom in houses in 2011. That may just be a forecast where it cannot get any worse, so it is about time a bottom is hit. Sometimes those can be your most accurate forecasts.

TUESDAY

The market is closed on Monday for the Martin Luther King holiday. Tuesday will open with the Empire Manufacturing Index out of New York. We will have some housing market sentiment. On Wednesday we will see the usual stories about mortgage purchases, but then it will kick into building permits and housing starts. While they are important, they really do not mean anything at this stage.

We do not want to see them higher right now. They have been volatile, and volatility is a sign of change. We will have to see. We do not want the builders building a lot of new homes. If they get that confidence, that is always worrisome. If they are confident enough to build right now, however, more power to them. I guess I have to say that simply because someone has to be doing something in this economy.

People I know are trying to get loans for their small businesses, and it is incredible. You can get the loans if you can put up collateral such as money, but if you had the money maybe you would not be seeking a loan. I will not get caught up in that, but small businesses are still having a hell of a time out there getting the funding to move forward. Credits will help, but still you still need the money to buy something.

On Thursday we go back to the usual initial claims, but there are also existing home sales, leading indicators, and the Philly Fed. Remember, that was just revised to 20.8 from 24.3. The expectations have dropped considerably.

That is the news that will hit, but there could be other stories out of China. Remember, it always comes in threes. There is definitely more economic data ahead, some possible news out of China and other growth areas, and we have more earnings. The flood gates will open, as they say on the financial stations. Thus far, the reception has been favorable overall. It has helped break SP500 out of this consolidation below the 127% Fibonacci extension. It is picking up steam. The indices and the market are gathering momentum overall as they make the break. Volume is up, pricing is strong, and leadership is breaking to the upside.

Many believe that a correction is imminent. This even as the SP600 hits a new rally high and as the SOX blasts off, leading the market upside. We may get a sudden reversal that takes the gains out of the system, but it typically does not happen that way. It can if there are bad things out there   and there could be. Europe could be a problem, and it was this week. There could be implosions that the market does not see coming. That is always detrimental. It can take a quick 5% out of the market if something unexpected hits. Right now, nothing nefarious seems to be in the weeds.

The market is running higher and we have been taking positions on the upside. We have also been taking gain as stocks rally higher. At some point there is a turn in earnings. The good news (if it is a good-news season) saturates the market and individual stocks. They get all the gains they can handle and just cannot go any higher. What goes up starts to slide back down even on good news. We are very impressed with this move without a doubt. We are in the group anticipating a top. The thing is, while we anticipate it, we cannot call exactly where it is. There are areas where it looks like it may occur. With SP500 it could have been at the 127% extension, but it was not.

What you can do is prepare. The market has the final say, but we have to prepare for what may happen. We have some downside plays and some upside plays. We take gains   partial or whole   were necessary. We do not go in blind. We do not try to pick the tops and bottoms, but we have to be ready. You have to prepare for whatever comes your way.

The market remains strong. It is continuing its rally on volume, defying a lot of the pundits. As I said in the market close alert, I am more than fine with that. Our positions continue to increase in value, making us very good money. It is a very good start to 2011, adding onto an outstanding 2010. Again, we are in that area where we see another strong run to the upside and the indices are approaching resistance. 1313 is SP500, and that gives another 20 points to the upside. The next is 1325 to 1327. That gives even more possibility to the upside, and we will be more than happy to let our positions run toward those resistance levels.

Do not get too excited, however. Do not think it can only go up. The indices look strong. There is no reason to believe they will roll over anytime soon based on the technical action: Higher volume, strong price moves, breakouts, and leadership. Although General Patton said that there was no reason to assume the Germans would launch a major winter offensive, and therefore he expected that is exactly what Germany would do. We cannot let down our guard and believe everything is going to continue to rally.

Expect the unexpected. More than that, be ready for the unexpected. Stay skeptical. Be critical with respect to the market and your plays. As soon as you think you have it licked, that is when you get licked. For now, the market and stocks are acting right and looking good. All is right in the world, but do not forget that this is earnings season. There has been a rally into earnings season. They are just getting cranked up, and the initial response has been favorable. A lot of euphoria on the early earnings announcements often leads to the back half of the season getting profits taken. The saturation point is hit, as noted earlier, and the good news simply cannot drive stocks further. That does not mean a crash, but it means a pullback.

We will do what we have been doing. As stocks rally and they hit initial targets in logical places (127% extension, 161% extension), you take gain. Not all of it. You take partial profits because you will let some run, and they do keep running. As we get closer and you have good gains built up into stock positions, take some money off the table. NKE was running well into earnings. We took some money off the table, and then it gapped and was never was able to recover. We had to take the rest of them off. We did not lose much because we had a huge gain built into it.

We will be taking some more gain. A lot of our positions do not have earnings reported until late January or early February. I know we can get more out of this run. We do not want to get greedy and try to squeeze the last nickel out of it, though, because we might get the squeeze put on us. If you have good gains in a position going into earnings, take some profit. We have already taken profits on AAPL, but it has had a great run this week. We can look at taking some more.

Jon Johnson