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IN THIS WEEK'S ISSUE:

1. MARKET SUMMARY  
2. WEEKLY ETF PERFORMANCE  
3. THIS WEEK'S TRADES  
4. CONTINUED GUIDANCE ON PREVIOUS TRADES  

1. MARKET SUMMARY

THE WEEK IN REVIEW
For the first time in a while the U.S. stock market actually ignored good news, as it recorded its second consecutive weekly loss. While the drop was anything but powerful in the broad indices, the Nasdaq-100 Trust (QQQ, $25.04) tumbled 4.4% and the Semiconductor HOLDRS (SMH, $24.28) lost 6.9%. Only the fixed-income-based ETFs, Oil Service HOLDRS (OIH, $59.45) and Canada WEBS (EWC, $9.69) managed to eke out marginal gains.

In accounting for last week's losses, market pundits will likely tell a story about concern over a weak U.S. dollar, war with Iraq or a sudden concern over the U.S. economy. The lack of logic behind such thinking only becomes clear when you consider the fact that just a week ago, on December 6th, the government released a much weaker-than-expected unemployment report, yet the stock market rallied strongly. This is one of the main reasons why it is important to look behind the headlines and combine a thorough understanding of how the markets process the fundamental data, and then apply technical analysis to complete the picture.

Several brokerage firms decided that now would be a good time to downgrade the chip sector. This helped take semiconductor shares sharply lower on Friday. Although at least one analyst suggested that there has been little or no growth in years from that sector, others suddenly found the religion of market timing and lowered their ratings simply because stocks in this sector had rallied so much. As a technical analyst, it is good to see fundamental analysts offering timing advice -- especially since it will make technical analysts look even better. After all, because we specialize in market timing, technicians' market timing calls should, in general, be superior.

ECONOMIC ANALYSIS
I can barely contain my excitement when we get good news and the market falls anyway, and nobody can seem to understand why. Last week's data were certainly bullish, in general, on the economy. The University of Michigan's consumer confidence index rose substantially, and was well above expectations. Retail sales jumped 0.4% in November, which was about double consensus estimates. And to top it all off, producer prices (as measured by the PPI) fell 0.4% last month, aided partially by falling energy prices.

There was a bit of talk regarding deflationary risks after the PPI data were released. I have long been an advocate that the risk of deflation is far greater than inflation right now. However, a month ago, when the PPI jumped 1.1%, there was talk that the Fed was keeping interest rates too low and that there was risk of inflation. While I still see much greater risk to deflation, it is not my base forecast. Yes, ultimately I do expect that there will be much lower levels for stocks in the coming five years, but I do not see a total collapse of the global economy, which would probably be a prerequisite for deflation to take hold.

One reason why the strong retail sales report did not give us much of a boost was because chain store sales numbers were so atrocious. In fact, I was rather surprised that we got as much of a boost from that data as we did.

I guess I would be remiss if I didn't at least make mention of the fact that, as expected, the Federal Reserve held rates steady. I do think the Fed hinted that they were a bit nervous about the recovery, but I am definitely in the minority regarding that opinion.

WHERE DO WE GO FROM HERE?
This week begets a veritable potpourri of economic data, though Monday does give us a brief respite. Of course, things could get interesting if the New York City transit system goes on strike. That should just do wonders for weekly unemployment claims and chain store sales, as the NY economy gets rocked (as if it needed anymore bad news).

Tuesday will be the busiest day of the week. With deflation fears suddenly returning, the Consumer Price Index (CPI) will be closely watched. Expectations seem to be around 0.1-0.2% for total and core around 0.2%. Market watchers will scrutinize housing starts as well. Interest rates had picked up recently, though they've dropped a bit the past week or two. Market participants are not expecting the earlier increase in rates to have caused any problems at all, as housing starts are expected to rise in November as compared to October's reading. If we fall short, then you can be sure the economists will blame the snowstorms in the Northeast around Thanksgiving.

Fifteen minutes before the market opens on Tuesday, we will also see industrial production and capacity utilization data. Tiny increases are expected, though very cold weather in the northeast, in my opinion, might permit a stronger-than-forecast number. You will have to wait for the economists to back utility numbers out to get the real story. That usually takes at least a few minutes before it is reported.

With the dollar on the rocks, we might see a bit more interest in the trade report, which is due out on Wednesday. Though I do not agree with standard analysis of these data, many believe that the U.S.' large trade deficit is a negative for the dollar. Of course, if we see a jump in imports, that could help the dollar, as it could be seen as a sign of an increase in demand.

Weekly jobless claims are due out on Thursday. Last week's result, as I had warned, saw a jump. This week should move back to trend, as the seasonals will now no longer have to deal with the late holiday week. The Philadelphia Fed manufacturing report and leading indicators are also due for release on Thursday. The latter garners little interest, while the former usually only provides a brief move in the markets. Finally, Friday sees the final revision to third-quarter GDP and is not likely to be a market mover since the data are so old.

So, how will it all play out? A lot does seem to depend on how bellicose the U.S. is on the international stage as the inspections in Iraq play out. Short-term, the bond market appears to have completed a rally, which in theory could signal the start of a major drop (though with the dicey stock market situation, the pattern will only lead to minor losses). Equities are also near a very short-term bottom. If we find a floor on Monday morning, and if the dollar can also halt its hemorrhaging, then I suspect that a rally of 2-3 percent is likely in stocks. However, what is extremely exciting is that we may be due for a very powerful move lower and it could start early this week! I will present a couple of ideas that will take advantage of this below.

Note that several ETFs will go ex-dividend this week, and some may make capital gains distributions. If I make any trades in these securities, then I will post that information in the trading section. You should check with your tax advisor regarding your own tax situation and how to report such distributions.

One final note: there will be 15 companies dropped and another 15 added to the Nasdaq-100 Index on December 23rd -- a week from today. You might see some early activity in those issues affected throughout the week as portfolio managers attempt to earn extra returns on the index changes.

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2.  WEEKLY ETF PERFORMANCE

Below you'll find a table of weekly performance data for all ETFs that I track for this newsletter...

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3.  THIS WEEK'S TRADES

TRADE #1: SELL THE S&P 500 SPDRS (SPY) SHORT AT $90.57
As I mentioned in the "Where do we go from here?" section above, I am very excited about our trading prospects at the moment. Although bear markets are unpleasant and nothing makes me unhappier than to see the U.S. economy struggle, opportunities such as this do not come along very often. The S&P 500 could easily tumble 20% in the next two months and the Nasdaq Composite could sink even 30% from current levels.

Don't jump just yet. There is room for a rally after a potentially weak open today. The S&P 500 SPDRs (SPY, $89.34) should rally at least back to the $91.00 area, and it even has an outside shot at pushing up towards $92.77, which would be halfway back to its recent high.

I am not just pulling this out of the hat. I warned on CNNfn on November 22nd that I was expecting a top in a matter of days, and at that time I forecast a new low beneath the October futility level by early 2003. And, in the November 25th issue of The ETF Authority, I initiated a put trade on QQQ with this idea in mind. I did not stick with that trade for long, though my readers did still manage to make 50% on the trade.

I am going to recommend two trades to take advantage of this idea. The first is to short the S&P 500 SPDRs. Since I expect at least a small bounce, I recommend sales at $90.57.

Usually, I recommend stops at a distance of 2-3%. However, because I see a chance for a 20% profit here, you really need to keep your stop a bit wider than that. Therefore, place your stop at $93.57. The first target is $82.08, but in the end, I expect that this ETF will bottom out below $74.00 in the first two months of 2003.

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RECOMMENDATION:

Sell SPY at $90.57
Target: $82.08
Stop: $93.57

SPY goes ex-dividend on Friday. As such, if you are short, then you will have to pay the dividend out on that date. The price of the stock should fall by a like amount though. At that time you will have to adjust your stops and targets lower by that amount. I will advise you of the exact amount when that data becomes available.

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TRADE #2: BUY MARCH 2003 23 PUTS ON THE NASDAQ 100 TRUST (QQQ) AT $1.20
For those of you who don't want to short SPY and have to worry about paying out a dividend, you can also short the market by purchasing puts. Unfortunately, there aren't any options available for SPY, so I will use the next best thing instead -- the Nasdaq-100 Trust (QQQ, $25.04).

You may recall that I previously suggested purchasing the March 2003 24 puts on November 25th. With the market lower now than it was then, I'd rather buy the March 2003 23 puts instead (symbol QAVOW or QAVOW.X on Yahoo, $1.35). This is because if the market rallies a bit further than forecast, then the lower sensitivity to price movements afforded by a more out-of-the-money put (this is called the put's delta) will allow you to stick with the trade more easily.

Since a rally is likely on Monday, you should be able to purchase the puts below their closing level noted above. Buy the March 2003 23 puts on QQQ at $1.20. Place your stops at $0.60 (QQQ would probably have to rally about two points for that to happen). Ultimate targets will be well past $4.00 for this option.

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RECOMMENDATION:

Buy QAVOW at $1.20
Stop: $0.60
Target: $4.00
Sell half of your position at $2.50 to lock in gains

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TRADE #3: BUY THE RETAIL HOLDRS (RTH) AT $70.85
You may recall that I did say that the stock market has a good chance to rally 2-3 percent to start the week. You also may have noticed that retail stocks have just about been annihilated after setting a high on December 2nd, as it became abundantly clear that consumers were just not interested in buying unless items were a bargain (eBay-aholics excluded). The Retail HOLDRS (RTH, $71.60) are now down nearly 10% since the second of the month.

Friday was particularly unpleasant, as RTH tumbled $1.70, or more than 2% on the session. Although I remain exceedingly bearish this sector, I suspect much of the bad news is already in for the short-term. Barring a terrorist strike, at least a minor bounce is likely. I do see room for a moderately lower open, but buying on a dip here might make some sense. Just keep your stops good and tight! The exact parameters for the trade are shown below.

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RECOMMENDATION:

Buy RTH $70.85, but do not enter trade if RTH gaps below $70.85 at the open on Monday.
CANCEL TRADE IF NOT ENTERED BY CLOSE ON TUESDAY, DECEMBER 17th.
Target: $73.10
Stop: $70.35

RTH pays a dividend of approximately $0.03 on December 18th. Lower your stop and target by that amount prior to the open on that day.

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4. CONTINUED GUIDANCE ON PREVIOUS TRADES

I closed all three of my outstanding positions for a profit on Thursday. Additionally, neither of the two trades I recommended last week were executed. For more information, please see the News Flash I sent out to subscribers alerting them of these adjustments:
http://www.StreetAuthority.com/etf/flashes/12-12-02.htm

Good trading in the week ahead!

Steven W. Poser
Steven Poser
Editor
The ETF Authority
New York, NY

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