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IN THIS WEEK'S ISSUE:

1. MARKET SUMMARY
2. THIS WEEK'S TRADES
3. CONTINUED GUIDANCE ON PREVIOUS TRADES

1. MARKET SUMMARY

THE WEEK IN REVIEW
The Dow Jones Industrial Average broke a string of eight consecutive weekly gains last week. The venerable index rose nearly 26% from its lows, on an intraday basis, before falling 2.8% last week. Even with these losses, the Dow has still gained 20.1% since hitting a multi-year low on October 10, 2002. The Nasdaq Composite and S&P 500 also turned in losses for the week, with each dropping for only the second time in the past nine weeks.

Disappointing holiday sales, a poor ISM purchasing managers report and continued weakening in auto sales all hit the equity markets hard last week. Factory orders also came in on the low side of consensus, while durable goods orders were revised lower as well.

Adding to the market’s malaise was the apparent nail in United Airline’s (UAL, $0.92) coffin, as the government failed to provide the nearly bankrupt airline with loan guarantees. UAL shares tumbled below $1.00 on Friday as the company is now expected to file for bankruptcy.

Adding to the pall has been renewed concerns regarding U.S. and British saber rattling towards Iraq. Condaleeza Rice’s "suggestion" to U.N. lead inspector Blix that the inspections be more aggressive clearly shows that as far as America is concerned, the only acceptable result from the inspections will be proof of weapons of mass destruction, and then likely military action against Iraq.

Then came Friday: after initially getting hammered by a much weaker-than-expected non-farm payrolls and unemployment report, the stock market reversed course, bouncing off trendline supports. Ostensibly, share prices were helped by the resignations of Treasury Secretary O’Neill and economic adviser Lawrence Lindsey.

The twin resignations apparently gave a lift to stocks as investors interpreted the moves as a sign that the Bush administration will actually start to focus more on the economy. O’Neill, in particular, was not loved by the financial markets, unlike former President Clinton’s choice, Rubin. Interestingly, there is talk that another former Goldman Sachs chairman, Stephen Friedman, is now under consideration for a senior administration position.

A renewed dedication to domestic economic policy -- and possibly a greater show of concern towards empowering the SEC to regulate corporations -- could go a long way towards healing what ails the equity market.

ECONOMIC ANALYSIS
On the economic front, there were but two important releases last week. The ISM’s monthly purchasing managers index held just below 50 for the third consecutive month. Although many bullish analysts opined that the ISM says that only levels below 42 are indicative of recession, the data show a continuing malaise in the U.S. economy, rather than the much hoped for recovery.

The overall report was more mixed. Though new orders slipped below 50, production jumped to 54.6 from a sub-50 level last month. Inventories remain low as well. This could become an engine for future growth if demand picks up.

Last week’s payroll and unemployment report was not as bad as the market’s initial reaction implied. Although the unemployment rate jumped to 6.0%, with a 0.5% surge in the rate for adult males (5.7%), seasonal adjustments for the November to January period are highly suspect. The delayed start to the holiday selling season due to this year’s late Thanksgiving likely means that some of the hiring for the holidays was delayed. While weak sales as reported by Wal-Mart (WMT, $53.04) and others (Wal-Mart did report a record single day following Thanksgiving, but November overall was below plan) was a negative, the late start probably means that at least part of the November negative number will be reversed in December, as many hires will not show up until that payroll and unemployment report.

WHERE DO WE GO FROM HERE?
Although nobody is talking about it, the FOMC meets next week. The reason that the meeting is not even on anybody’s radar screen is that nobody expects the FOMC to change either the Fed funds rate, or its bias. Barring an unforeseen event between now and Tuesday, I cannot find any reason for the Fed to revise rates, or its bias. However, the markets will carefully pore over the statement, and if there is any additional caution noted in the text, the markets might start removing the reversal higher in official rates that is currently built into the yield curve for the middle of next year.

We're going to see some important data releases this week. November retail sales is due out. Consensus is for +0.4% total and +0.3% ex-autos according to CBS Marketwatch. I suspect the real consensus is somewhat lower than that, given the rotten reports emanating from retailers these days. Even so, that information has already been largely priced in. It would probably take a number below zero to really hurt the market.

The producer price index (PPI), 3Q current account, inventories and weekly unemployment claims are also due out over the course of the week. The quarterly current account data are not likely to move the markets, though the recent rally in the US Dollar versus the Japanese Yen could falter if the numbers are much worse than expected. PPI is forecast at flat and is unlikely to cause a problem (though last month’s surprising gains will be in the back of everybody’s minds). I doubt that there will be any problems from those data.

The inventory data due out are old -- October -- and so are not particularly relevant, though weak current levels remain consistent with a manufacturing environment that is unwilling to make any bets on recovery. Finally, the claims data are likely to worsen as seasonal adjustments move back to more normal levels for the first week of December.

Friday’s short-term reversal day in stocks was welcome. Unfortunately, the week’s damage was substantial despite the day’s gains. While I would not signal the all-clear here, there is definitely room for the stock market to test higher to start the week. If the S&P 500 moves much above 932, or the Nasdaq Composite rallies past 1466, then I would have to reconsider my current bigger picture bearish stance. I expect that gains will be limited, but well-placed purchases on a pullback early in the week, with fairly tight stops, may make for profitable trades this week.

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2.  THIS WEEK'S TRADES

TRADE #1: BUY XLK ON A BREAK ABOVE $16.24
Although I remain bearish for the medium-term, I see a good opportunity developing for a 3-5% rally in the Technology SPDR (XLK, $16.09).

As you can see from the chart below, a possible inverted head and shoulders pattern is forming, which is a bullish reversal pattern. (Please note: This is an intraday version of the inverted head and shoulders. It does not imply the start of a major bullish run for XLK!) Add to that the momentum divergence at the lows and retracement potential to nearly $17.00, and I cannot help but recommend purchases this week -- IF MY REQUIREMENTS FOR ENTRY ARE MET.

There is little doubt that the Nasdaq has been the star performer since the low on October 10, 2002. XLK has soared more than 50% since that time, touching $11.40 per share at its low, and reaching as high as $17.80 last week. The fund then tumbled more than 10% intraweek before rallying just about 4% from low to high on Friday.

My initial reaction would be to say that now is the time to buy, but the drop between 2:30 PM and 3:30 PM on Friday afternoon was a concern. For that reason, I only want to enter a LONG trade here on a move above neckline resistance, which currently comes in a $16.23. Since the high on Friday was $16.24, I would rather buy on a break above that level instead of above $16.23. Classic head and shoulders measures would then project a gain of $0.66 to $16.89. However, with the wave-a high at $16.54 and the 50% retrace of wave-iv peak at $16.79, the rally may fall a bit short.

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RECOMMENDATION:

BUY XLK on break above $16.24
Cancel trade if XLK falls below $15.98 before a break above $16.24

TARGET: $16.79
STOP: $15.97

Raise stop to $16.24 if prices reach $16.54

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TRADE #2: SELL SPY SHORT AT $93.74
As I noted above, I am bearish in the bigger picture. Most of the sector ETFs that I track show potential to rally this week, but their volatility, coupled with their strong intraday reversals on Friday, leave the risk/reward unfavorable for entry on the long side (outside of the above-noted XLK trade). However, if prices do rally as I expect them to, then there will be an excellent chance to profit on the short side (expected gains from current levels for the S&P 500 SPDRs -- symbol SPY -- are only around 2%, which is not enough for me to recommend a purchase).

SPY completed one Elliott Wave pattern from 96.05 to 91.43. The price action since then is incomplete and requires further gains. The gains are not expected to be large enough to enter on the long side, but will provide an excellent shorting opportunity.

Unfortunately for the bulls, volume was very low on Friday, leaving me more than a bit disbelieving in the continued ability for the broad market to rally. The lack of a clear pattern higher here means that the best way to take advantage of a continuation of this rally is to find a low-risk place to sell!

Look to short SPY at $93.74, the 50% retracement of the bearish wave pattern noted above. Place stops a bit above the 76% retracement to that high. Initial downside potential will be to last week’s $89.98 low, but I am looking for a break below the 19-November nadir to catch some weak bears before another minor recovery is possible. I will re-evaluate as we approach that area since my main target is new lows beneath what was seen on October 10th.

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RECOMMENDATION:

SELL SPY SHORT at $93.74

STOP: $95.03

TARGET: $89.75

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3. CONTINUED GUIDANCE ON PREVIOUS TRADES

I have three outstanding trades at the moment (all of which I recommended in my sample issue, which can be found on our web site at this link):

LONG QQQ MARCH 24 PUTS AT $1.00
This trade is currently up 55% from the purchase price (last trade was at $1.55).  My original strategy was to buy the puts on November 25th, which I had been looking for as a possible turn date. Stops were at $0.50 and I recommended selling half of your position if the options doubled.

A rally in the underlying QQQ ETF past $27.80 would likely suggest at least one more new high was possible. As long as QQQ remains at or below that level, the overall picture remains negative.

CONTINUE TO HOLD YOUR MARCH 2003 PUTS UNLESS THE UNDERLYING QQQ TRADES ABOVE $27.80.

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LONG IEF AT $83.90, TARGET $86.50, STOP $83.00
Since you received a $0.52 dividend, the proper parameters should have been adjusted to:

TARGET: $85.98
STOP: $82.48

The rally from the $82.99 low set last week, plus the inability to hold on to much of its gains following a weaker-than-expected payroll/unemployment report, leaves me nervous over the short-term potential here. I AM THEREFORE RAISING MY STOP LEVEL ON THE TRADE TO $84.13, JUST BELOW FRIDAY’S LOW. If you get stopped at this price, then you will still show a gain of nearly 1% in just over a week.

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SHORT THE JAPAN WEBS (SYMBOL EWJ) AT $7.01
The dollar appears to have begun a move lower, which may offset some of the expected losses in the Japanese stock market. Add to that risk for a small rally in Japanese share prices in reaction to the bounce in U.S. equities on Friday, and I find the risk/reward less favorable. TRAIL YOUR STOP DOWN TO $7.00.

Good investing in the week ahead!

Steven W. Poser
Steven Poser
Editor
The ETF Authority
New York, NY
Steven@StreetAuthority.com 
swp@poserglobal.com

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