Market Update

The markets have rebounded from yesterday's loss. As of this writing, the QQQQs are up .8%, the IWNs are up 1.1% and the SPYs are up 1.3%. All of the markets are establishing some strong intra-day support levels.

We may be seeing two technical patterns right now.

1.) An inside day -- think of this like a triangle pattern.

2.) A dead-cat bounce. Prices drop hard, then rebound slightly. It's akin to dropping a, well, dead cat from a high height (sorry for the visual).

As with all technical analysis -- it's about probabilities not certainties.

New Home Sales Plunge

From Bloomberg:

New-home sales in the U.S. fell last month by the most in 13 years, pointing to more weakness in the real-estate market that limited economic growth last year.

The 16.6 percent decrease to an annual rate of 937,000 in January, less than any economist had forecast in a Bloomberg News survey, Commerce Department figures showed today. The pace of sales was the slowest since February 2003. A measure of housing inventory rose to the highest in three months.

The figures show home construction will remain a drag on the economy even with lower borrowing costs and more incentives from builders. More cuts in home prices may be needed to stir buyer interest as builders keep reporting increased rates of canceled orders.

OK -- the housing market has not bottomed in any significant way.

Here are some other thoughts.

1.) Mortgage rates are low right now. In addition, the 10-year Treasury has rallied, further lowering rates. Interest rates aren't the issue.

2.) Are sub-prime mortgage problems and increasing credit standards starting to filter through the market? We saw the first wave of sub-prime mortgage problems later last year, and a second wave recently. If these two events are related (but remember we have a correlated not causation related events) we could have further drops in the next few months.

3.) Are household debt levels starting to hamper further debt acquisition? Household debt is now over 90% of GDP and 120% of overall national disposable income. Debt payments as a percentage of disposable income are are record highs. Are these factors starting to restrain the housing market?

Chicago PMI Drops Slightly

Here is a link to the full report.

The overall index dropped from 48.8 to 47.9.

Production decreased slightly, but new orders increased slightly.

Inventories increased in a big way from 38.5 to 56.5 -- the largest gain in 30 years.

Here's a big phrase from the report: overall demand down 28% - 30% and sales incentives are high. When you have to pay people to buy your products you have problems.

While this report isn't completely recessionary, it is leaning in that direction. In addition, we have two downward trends in the overall business barometer number. The first started at the beginning of 2005, and the second started in mid-2006. Things still appear to be moving down, although I wouldn't call this a recessionary stage yet. But we're pretty close.

GDP Increases 2.2%

From the BEA:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.2 percent in the fourth quarter of 2006, according to preliminary estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 2.0 percent.

The GDP estimates released today are based on more complete source data than were available for the advance estimates issued last month. In the advance estimates, the increase in real GDP was 3.5 percent (see "Revisions" on page 3).

The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, state and local government spending, and federal government spending that were partly offset by negative contributions from private inventory investment and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, decreased.

Let's look a little deeper into the numbers:

Personal Consumption Expenditures increased 4.4% -- a strong number. However, domestic investment decreased 11%. Residential investment decreased 19% -- by far the biggest reason for the overall drop. Nonresidential investment decreased .4%. While nonresidential fixed investment (buildings etc...) increased 2.8%, equipment and software investment decreased 1.8%.

Personal consumption expenditures added 3.05% to the 2.2% number. Purchases for non-durable goods added 1.38% to the 2.2% number with food purchases responsible for .69. Services added 1.2% to the 2.2% growth. Durable goods purchases added .47. This is the third quarter in a row when durable goods purchases have been weak.

Gross private domestic investment subtracted 1.92% from growth. That means if housing had been neutral (0% growth), overall growth would have been 4.1% - 4.2%. That should give you some idea of how important the housing slump is to the current economy.

Short version -- this number is weak but not cataclysmic. In addition, a downward revision has been expected.

Asian Market Recap

From the WSJ:

nvestors in Shanghai-listed stocks Wednesday bucked the very trend they'd begun a day earlier, bidding shares well into positive territory, even as other Asian benchmark indexes plunged for a second straight session.

Shanghai's Composite Index gained 3.94% to close at 2881.07, reversing a negative performance in the early part of the morning session. The Shanghai index, which tracks shares listed on the bigger of China's two stock markets, fell 8.8% Tuesday, triggering a global selloff that led to the biggest one-day losses in the U.S. since the wake of the Sept. 11, 2001, terrorist attacks.

The decline in Shanghai Tuesday followed concerns that the government may introduce additional macro-economic tightening measures to cool speculative activity. On Monday, the Shanghai benchmark ended at an all-time high.

In Tokyo, stocks plunged in the wake of the overnight dive on Wall Street, where the Dow Jones industrials fell more than 400 points. (See related article.)

The Nikkei 225 stock index fell 515.80 points, or 2.85%, to finish at 17604.12 on the Tokyo Stock Exchange. Around Asia, Hong Kong's Hang Seng Index ended down 2.46% at 19651.51. Australia's S&P/ASX 200 closed 2.69% lower at 5832.50. Shares of BHP Billiton fell 5.1%.

South Korea's Kospi Index ended down 2.56% to 1417.34. Singapore's Straits Times Index finished down 3.72% to 3111.94 and New Zealand's NZSX-50 ended 1.5% lower to 4037.12. Markets in Taiwan were closed for a public holiday.

Australia * -2.70%
Hong Kong * -2.46%
India * -4.01%
Indonesia * -1.31%
Japan * -2.85%
Malaysia * -3.91%
Pakistan * -1.74%
Philippines * -7.92%
Singapore * -3.72%
S.Korea * -2.56%
Sri Lanka * -0.45%
Taiwan * 0.02%
Thailand * -1.0

Nikkei Opens 700 Points Lower

From the WSJ:

Japan's Nikkei 225 index tumbled more than 700 points at Wednesday's open in Tokyo, falling below 18000 for the first time in nearly a week, as investors sold stocks across the board in the wake of steep losses on Wall Street.

Not good.

What Will Happen Tomorrow

Let's look ahead.

1.) Today has a huge down day on record volume. None of the daily charts found a meaningful technical bottom.

2.) The markets have rallied for the better part of 6 months without a major correction.

So before we get to tomorrow's economic news we already have a strong bearish bias.

Tomorrow we have GDP, new home sales and the Chicago PMI.

There's been a lot of talk about a large downward revision to this number -- a revision in the range of about 1% in GDP growth. If this happens the US economy will have three straight quarters of sub-par growth.

The PMI has been hovering around 50 for the last few months. While there was a big upward move in the NY Fed index this month, the Philly index was mediocre.

New homes sales are also important, especially with the problems in the sub-prime mortgage market right now.

Each of these numbers is important, although I think the GDP revision -- if it's large -- will be the big number of the day.

What the Hell Happened Today

OK. The markets are closed. Let's take a breath and look at what happened.

A big drop in China started it off:

The Shanghai Composite Index, which surged an astonishing 127% in 2006 and is up 13% over the last six sessions, plunged 8.8% -- the biggest one-day decline in 10 years. Worries the Chinese government may step up its efforts to curb speculative buying interest have been attributed to the consolidation that has aggravated ongoing concerns about overbought conditions and talks of a correction.

Here's more from Bloomberg:

China's stocks tumbled the most in 10 years on concern that a government crackdown on investments with borrowed money will end a rally that drove benchmarks to records.

...

The Shanghai and Shenzhen 300 Index slid 250.18, or 9.2 percent, to 2457.49. The measure, which jumped 13 percent in the past six sessions, closed at a record yesterday.

Today's rout wiped out $107.8 billion from a stock market that doubled in the past year as 249 of the key index's 300 shares plunged by the 10 percent limit. The 300 index is valued at 38 times earnings, compared with 16 times for the Morgan Stanley Capital International Emerging Markets Index.

The State Council, China's highest ruling body, has approved a special task force to clamp down on illegal share offerings and other banned activities in the market, the government said. The group will provide advice on regulations and policy explanations of the securities market, according to a statement published Feb. 25 on the central government's Web site.

I can't speak to the practices these proposed regulations are supposed to curb. However, I would assume they are a problem for the Chinese market.

Other developing countries sold-off in sympathy with China. The ETF for Malaysia was down 9%, Brazil was down 8.59%, Mexico was down 8%, and Singapore was down 7.8%.

So at the open, there was a rolling worldwide sell-off going on starting in Asia.

In the US, the big drop in durable goods that came out before the open added fuel to the bears fire.

Orders for durable goods decreased by 7.8% last month to a seasonally adjusted $203.90 billion, the Commerce Department said Tuesday. Durables rose 2.8% in December, revised from a previously estimated 2.9% increase.

A key barometer of business-equipment spending -- orders for nondefense capital goods excluding aircraft -- fell by 6.0%, after increasing 3.6% in December. Shipments for nondefense capital goods excluding aircraft decreased by 2.7%, after dropping by 0.8% in December; the shipments are used in calculating gross domestic product.

The 7.8% decrease in overall durable goods orders surprised Wall Street. The median estimate of 21 economists surveyed by Dow Jones Newswires had durables just 3.2% lower in the first month of 2007.

The manufacturing sector weakened in 2006. The economy had cooled and receding demand caused inventories at companies to pile up. Firms had to adjust inventory levels and depleting supplies meant fewer orders and cuts in production of goods. The auto business was hit particularly hard. The Federal Reserve recently reported industrial production made a surprising drop in January, falling by 0.5%.

So, before the US markets opened, the Asian markets tanked and there was bad economic news.

Here is daily chart of the SPY.



Notice this chart closed near the low point of the day and the last bar had big volume. There was one bounce about 3 PM. This chart says essentially one thing: the bears were in complete control of the day.

Here's a daily chart of the SPY's



In one day the average broke through the uptrend and went through the 20 SMA and 50 SMA on enormous volume.

Here's a 5-minute chart of the QQQQs



Like the SPYs, the QQQQs saw one bounce. They closed on the low point, although volume was weak on the last sell-off.

Here's the daily chart for the QQQQs



There was less technical damage on this chart -- although the damage is still pretty big. The QQQQs have been trading in a range since the end of November. Today we started near the top of the range and closed near the bottom on enormous volume.

Here's the daily chart of the IWNs



Like the other two averages we've looked at, there was one bounce. The index closed at the low point of the day, although the volume was weak.

Here's the daily chart of the IWN.



This index was rallying well until today. However, we broke through the uptrend, 20 and 50 SMA on enormous volume.

So, here's the summation.

All of the indexes dropped hard on big volume. They have all broken uptrends and moved through their respective 20 and 50 day SMAs.

All of the various sectors were down big as well. This sell-off spared no one. Basic materials (XLB)- down 3.17%, Financials (XLF) down 4.67, Energy (XLE) down 1.95%, Consumer Staples (XLP) down 3.06%, Health Care (XLV) down 3.04%, Consumer Discretionary (XLY) down 3.39% and Utilities (XLU) down 1.32%.

These are the kind of days that turn trends around. The bottom line is the volume indicates everybody was looking for the door today. The breaking of trend lines indicates a reversal occurred, further confirmed by the huge volume totals. The SPYs are clearly moving lower. The QQQQs need to move through 43.5 or so and the IWNs need to move through 78.60 for there to be a real break. But given today's action, we could have further drops tomorrow.

Market Update After Close

It's a bloodbath in the market right now. After the close I'll have a market update.

Existing Homes Sales Increase 3%.

From Bloomberg:

Sales of previously owned homes in the U.S. rose more than forecast in January to a seven-month high as lower prices and warm weather brought out more buyers.

Purchases increased 3 percent last month to an annual rate of 6.46 million, up from a 6.27 million December rate that was higher than previously reported, the National Association of Realtors said today in Washington. Sales fell 4.3 percent compared with a year earlier.

The report suggests that housing, recovering from its worst slump in 15 years, may be less of a burden on growth this year, economists said. Cheaper homes and low borrowing costs are spurring sales, while a plunge in January housing starts reported this month shows builders are trying to reduce a glut of unsold properties.

First -- color me impressed (and a bit surprised).

I think a fair amount of this has to do with interest rates.

Here's a chart of the 10-year Treasury, expressed by the interest rate.



A while back I observed the 4.85% was near a restrictive interest rate on housing. Notice that rates have been dropping since the beginning of the year, and now stand at 4.55%. That is good for housing.

Durables Goods Orders Drop

From Bloomberg:

Durable-goods orders fell 7.8 percent in January, reflecting the biggest slide in business equipment demand in three years, the Commerce Department said in Washington. At the same time, the Conference Board's consumer-optimism index unexpectedly increased to the highest level in more than five years, and the National Association of Realtors said existing- home sales rose more than forecast.

Durable-goods orders excluding transportation equipment dropped 3.1 percent, the most since July 2005. Excluding military equipment, orders fell a record 7.8 percent last month, while inventories of all durables rose 0.3 percent.

Reluctance to Invest

The figures suggest reluctance among companies to invest carried into 2007 after spending on equipment such as computers, machines and communications gear fell by the most in four years in the fourth quarter. Bloated stockpiles at auto dealers and construction-equipment makers may restrain production early this year, Bernanke told Congress this month.

These numbers are great cause for concern. Industrial production decreased .5% last month. Now we have a drop in durable goods orders, further indicating a manufacturing slowdown. The ISM number -- which comes out later this week -- has hovered around 50, which indicates contraction. The Fed surveys have been mixed this month.

China's Markets Drop Almost 9%

From the WSJ:

Shanghai's benchmark stock index plunged nearly 9% on Tuesday, its biggest drop in more than 10 years, as investors unloaded shares to lock in profits after recent gains. Asian-Pacific markets ended mostly lower.

The Shanghai Composite Index tumbled 8.8% to close at 2771.79, its biggest single-day decline since it fell 9.4% on Feb. 18, 1997, just after the death of Communist Party elder Deng Xiaoping. The Shanghai index had gained 1.4% on Monday to 3040.60, extending a spate of record high closes.

Shares in airlines, steelmakers and financial issues led declines, and Chinese traders said profit-taking was sparked by concerns additional macro-tightening policies could be introduced following the annual session of the China's National People's Congress that gets underway March 5.

Foreclosures Increasing

From Marketwatch:

And RealtyTrac reported last week that the number of homes entering the foreclosure process increased by 19% in January, compared with December's numbers. Compared with January 2006, the number of homes in the process is up 25%. In 2006, a total of 1.2 million homes entered the foreclosure process, 42% more than 2005.

On Technical Analysis

A poster has asked the very legitimate question of why do I use technical analysis.

I struggled for a long time with this question myself. However, it wasn't until I read some of the older classic trader's books that I really started to understand how it works. The works of Gann, Schabacker and Gartley-- especially Gartley-- were incredibly enlightening. First, none of these traders used TA exclusively; they used it as part of an overall strategy. For example, in one book written in the 1930s, Gann spends a great deal of time talking about what industries will start to boom in the 1940s. He would combine these observations with TA to determine when to buy. All of these traders clearly stated many times that TA was not the hold grail and that the markets would do everything they could to make a fool of you. In other words, always be prepared to be wrong.

What I found confusing was the inclusion of a large number of indicators -- RSI, Stochastics, MACD etc.... These more modern ideas were really more statistical noise to me then helpful indicators. That's one of the reasons I almost never use them. I like to know where prices are now, where they have been. how many people are buying and selling (volume) and what the general trends are (simple moving averages). These basic data points are often all any trader really needs to know.

That being said, TA is not a holy grail of analysis. It can increase the probability of success. It is not a guarantor of success. In fact, no form of analysis is perfect. I've seen companies that were fundamentally undervalued languish at low prices for years despite the fact they were undervalued.

So here's the point.

1.) TA can help you figure out where prices have a higher probabilty of going.

2.) TA can tell you when it's a better time to buy.

3.) The markets can hand you your ass at a moments notice.

Will Commodities Rally Soon?

The charts from the metals got me thinking about the overall commodities situation. Here is the daily chart from Stockcharts:



Notice the chart has broken through the downtrend started in early December. In addition, we have a nice strong uptrend that has broken through the moving averages. Finally, the 20 Day SMA has crossed the 50 day SMA -- another bullish sign.

Here's the weekly chart:



On the weekly chart we've also broken through the downward sloping trend line, crossed a moving average and are in a strong uptrend. While we are far off our highs of last year, the trend appears to be heading up.

Oil Moving Up

From Reuters:

Some analysts see a growing upward momentum for oil and note the latest data from the New York Mercantile Exchange points to an increase in investment by large funds.

"It is the first time this year that the large speculative funds are showing a net long position in crude oil," said Olivier Jakob, an analyst at Swiss-based Petromatrix.

Oil prices have swung between a high of $78.40 last July, when fighting flared in Lebanon, and a 20-month low of $49.90 in January when an expected influx of fund money failed to materialise, disappointing oil investors.

A steady recovery in prices since late January has been supported by gradually tightening supplies -- OPEC has twice cut output since November -- and by concerns over a possible disruption of Iran's oil supplies.

Strong net-long positions entering the market + decreased supply because of production cuts + summer driving season + Iranian tensions = higher prices.

Metals May Be Looking At a Summer Rally

Here are three charts that may indicate metals are thinking about a summer rally:

Here's a chart for copper:



This is the weakest of the three charts, largely because of large sell-off and gapping down formation. The gap down could be a selling-exhaustion gap, indicating the last of the sellers finally got out of the metal at the beginning of the year. Using Gann style accumulation analysis, this means the only buyers will be longer term investors who are looking at making a long-term play. If that is the case, than copper has formed a base here and is looking to rally.

Here's a chart for Palladium:



We saw consolidation in the latter part of last year in a classic triangle trading pattern. This period essentially shook-out the positions from the previous rally and allowed other longer-term players to accumulate longer-term positions. Either way, the 6-month consolidation helped to establish a base for a summer rally.

Here's the chart for Silver:



This chart's analysis mirrors that for Palladium, although the triangle consolidation is a bit wider.

All of these charts are possibly signaling an upward move. Remember we still have China and India on-line for very strong growth rates, increasing demand for base metals.

Sub-Prime Funds Drying Up

From the WSJ:

Fears about defaults are slowing the gusher of investor funds going to riskier segments of the mortgage market. That means less money available for "subprime" loans to riskier borrowers, forcing lenders to focus more on borrowers who can afford down payments and have well documented finances. With fewer lower-income Americans able to buy homes, downward pressure on prices will probably increase.

These pressures have intensified in recent days. The cost of insuring mortgage-bond holders against default risk, as measured by the so-called ABX index, has soared, deepening the concerns of investors in collateralized debt obligations, among the biggest holders of riskier mortgage bonds. Managers of some CDOs are delaying new offerings to "wait for the dust to settle," a process that could take weeks or months, says Chris Flanagan, head of CDO research at J.P. Morgan Chase & Co.

"CDO managers and hedge funds still want to do CDOs, but the conditions are much, much tougher," David Liu, a mortgage analyst with UBS AG, adds.

So, lenders still want to do deals, but are actually asking for documentation and savings and being more selective.

"It's tightening up a lot," said Eddie Carmona, branch manager at Homewood Mortgage in Carrollton, Texas, a mortgage broker that handles subprime borrowers.

Carmona said down payment requirements are the biggest change he's seen.

"Before, you didn't have to bring a down payment," Carmona said.

Other changes:

Higher credit scores. Previously, borrowers with a FICO credit score as low as 570 (out of 850) could qualify for a single loan financing 100 percent of their home purchase, Carmona said.

"Now, across the board, it's jumped up to a 600 FICO score for an 80/20 loan," Carmona said, in which a second loan has to be taken out to finance the remaining 20 percent of the home value.

Rising interest rates. Rates on subprime mortgages have risen about a full percentage point since September, Carmona said, while regular mortgage rates have been relatively steady.

More stringent savings requirements. "They want to see borrowers have at least three months of reserves in their account in case of an emergency," Carmona said.

The 2006 vintage sub-prime loans are already defaulting at a high rate. That indicates lending standards were far too loose.

However, I think an economist can convincingly argue the increase in home ownership in 2006 and probably the latter part of 2005 was largely the result of very lax credit standards. Assuming that is true, that means the latter part of the housing boom was essentially a speculative excess rather than actual investment. That means we're going to have a prolonged shakeout period where poor credit risks have to be shaken out. This will lead to a prolonged period of correction in the housing market.

Home Supply Stores See Earnings Drop

From the Houston Chronicle:

Lowe's Cos., the nation's second biggest home improvement store chain, said Friday that its fourth-quarter profit fell 11.5 percent due to a slowing home improvement market amid a continued slump in the housing sector.

The Mooresville, N.C.-based retailer said it earned $613 million, or 40 cents a share, for the three months ended Feb. 2, down from $693 million, or 43 cents a share, a year earlier.

Revenue fell to $10.4 billion from $10.8 billion a year earlier. Same-store sales, or sales in stores open at least one year, a key measure of industry performance, fell 5.3 percent.

Analysts surveyed by Thomson Financial had been looking for net income of 37 cents a share on revenue of $10.36 billion. The estimate for earnings typically excludes one-time items.

On Tuesday, rival Home Depot Inc., the nation's largest home improvement store chain, said its fourth-quarter income dropped 28 percent. Its same-store sales dropped 6.6 percent.

"Sales continued to be pressured by a slowing housing market, tough comparisons to last year's hurricane recovery and rebuilding efforts and significant deflation in lumber and plywood prices," Robert A. Niblock, Lowe's chairman and chief executive said in a statement accompanying the results.

I don't see how this news can bolster any argument housing is bottoming. The short version is we still have a ways to go here.

Is Gold Telling Us Inflation Expectations Are Rising?

I'm not a big gold bug. However, gold can tell us what people may be thinking about inflation. If gold prices are increasing, it may signal that people think inflation will pick-up.

Here's a chart of the gold ETF:



Last week, the ETF broke through resistance on strong volume. In addition, an uptrend is strongly intact. Both of these moves indicate a bull run may have started.

Here's the weekly chart:



Notice the chart spent about 6 months consolidating gains in a classic triangle formation. Then last week, the chart broke-out on strong weekly volume. We also have a strong uptrend intact.

What set this off? Last week we had a bearish CPI report from the BLS. Here's a chart of the rolling change on CPI from The Capital Spectator



As the CS noted:

Core CPI is now running at a 2.7% annual pace through last month. That's up from 2.6% for 2006 and close to the peak of recent years (2.9%) set last September. The rising pace of core inflation is a problem because the Fed is widely reported to have a target of 1-2% for core. By that standard, the central bank is behind the monetary eight ball.

The Fed, in sum, has more work to do to bring core CPI down, or at least convince the market that core CPI is no longer rising. There's reason to wonder how this task will play out. As we reported on Monday, the pace of growth is rising for M2 money supply. Coincidence? For the moment, we prefer to err on the side of caution and answer "no."

So long as inflation is in that kind of uptrend, gold has a strong wind at its back.