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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

U.S. equities turned in a powerful rally on Thursday. The weekly chart for the S&P 500 shows an outside reversal higher; the weekly Candlestick, however, failed to signal a bullish engulfing line as equities initially opened stronger last Monday. Gains were not as impressive in the Nasdaq Composite, as that index did not manage to exceed the prior week's high. The rally impressed in size (the German stock market rose nearly 10% last week), but volume remained low. Of greatest concern to the bears is that some of the fixed-income charts are warning of a top, though stock market charts still maintain substantial downside risks.

The strong gains in the stock market led us to close our short S&P 500 SPDR (SPY, $91.35) trade at our predetermined stop level of $89.39 on Thursday morning. The trade earned readers a total return of 0.8%.

THE WEEK IN REVIEW
U.S. equities turned in their best performance since mid-October after the S&P 500 failed to follow through on losses beneath their lows of November 13th, 2002. This level was $87.45 for the S&P 500 SPDRs. The pattern in the Nasdaq-100 Tracking Stock (QQQ, $25.68) is a bit different. The QQQ did not fall below its medium-term low set on November 11th, 2002 of $24.15.

The catalyst for last week's surge was a much stronger-than-expected Institute for Supply Management (ISM) monthly purchasing managers report. The surprising news of broad-based strength in the manufacturing sector sent stocks across the globe sharply higher. I will cover that release in greater detail in the following section.

Other economic data from last week were more mixed. The markets really did little prior to the New Year, but activity will most likely start to approach normal levels this week.

Although the stock markets had not really been oversold, intermarket analysis provides a bit more insight into the late-week surge. The U.S. Dollar (USD) was oversold against both the Yen and the Euro, while the bond market was extended on the upside. These markets have tended to trade opposite stocks, so reversals there often portend reversals in stocks.

Japanese bonds might have finally reached the end of their years-long bull market, and U.S. debt futures also look toppish. Bund futures (German government bonds) might have also seen the end of their bull market. If debt futures have topped, then there is some risk that my call for new lows in equities will not end up taking place. More on this in our "Where Do We Go From Here?" section below.

ECONOMIC ANALYSIS
Last week's data were mixed. The Conference Board's Consumer Confidence Index fell in December to 80.3 from 84.9. Consumer confidence has never had a very high correlation to GDP growth -- or to much of anything, for that matter -- though its importance is raised because it is a known fact that the Federal Reserve considers it to be a factor in its rate decisions. The main surprise in the confidence data was that the data were so weak when the already-released University of Michigan consumer confidence survey was more benign. The Conference Board survey did cover later information from December, and the constant reports of very weak Christmas spending, coupled with the lack of a Santa Claus rally in stocks, may have weighed on the results.

Most other data released last week were of secondary importance. Existing home sales were a bit weaker than expected, but new home sales released the prior week were strong. Construction spending rose in line with expectations and the weekly jobless claims data saw an increase. Remember though, seasonal adjustments tend to go awry in that series from mid-November through early January. The Chicago Purchasing Managers Index (PMI) fell more than expected, but showed pockets of strength, including a surprising jump in employment data.

The big event last week came from the monthly ISM Report on Manufacturing. Market consensus had been for a small increase, from 49.2% to 50.0% (a figure above 50% represents expansion, while a figure below 50% signals contracting activity). The index instead jumped to 54.7% and was strong across the board. New orders jumped to 63.3%, up from a sub-50.0% reading in November. Employment was still contracting, at 47.4%, but that represents a substantial improvement from November's 43.8%. Although poor seasonal adjustments may have had some part in the jump last month, the gains are worth taking note of. If employment can keep improving and if orders hold up, then we could be in for a surprise in Q1 2003. In addition, note that inventory levels, according to the ISM survey, remain low, which could also fuel a pick-up in the economy. Remember, if demand improves and inventories are low, manufacturers will need to quickly ramp up production, leading to increased employment as well as a pop in output.

There was one other impressive item: Car and truck sales were well ahead of expectations. Trucks had been forecast to hit a 7.3-million-unit sales pace, but instead came in 20% ahead of that figure at 8.8 million. Car sales also exceeded consensus, reaching 6.1 million versus expectations for 5.8 million. Weak retail sales will be ameliorated by these results when the government figures are released later this month. Continued strong rebates and 0% financing, after a slow November, are keeping auto dealer showrooms busy.

Next week's main event will be the December payroll and unemployment report on Friday, January 10th, 2003. Remember that seasonal adjustments caused December to be far weaker than expected. Some of the payback for that might come in the December time period, but I suspect most of the bounce back will show up in January's report. Traditionally, the norm is for layoffs in January as seasonal workers leave retailer payrolls. Those losses will be smaller than usual this year, giving the January report a boost. However, this effect will be relatively minor for December. Market consensus is for the unemployment rate to remain steady at 6.0% with non-farm payrolls improving from -40,000 to +28,000. I suspect that we might see a 0.1% improvement in the unemployment rate.

You should also watch the "hours worked" figure. Private hours worked were unchanged in November at 34.2, with manufacturing hours and overtime hours also unchanged at 40.7 hours and 4.1 hours, respectively. Even if payrolls do not improve substantially next month, increases in these numbers would be consistent with the gains shown in the ISM report and would be bullish for stocks and the dollar, while bearish for the bond market.

Other data due out next week are mostly second-tier reports. Monday sees the ISM services index. ISM is new to this (services) game, and the survey is less widely followed and is unlikely to move the markets much. Last month already was strong at 57.4%. Market consensus is for the services index to ease back towards 56.0%. Factory orders are scheduled for release on Tuesday morning and are forecast to have fallen 0.6% in November. This data is fairly old and includes the already announced -- and weaker-than-expected -- durable goods report. Watch for a surprise on the upside if the durable goods part of the data are revised higher, which sometimes happens.

Finally, the preliminary University of Michigan January consumer sentiment report is due out on Friday, but it will likely be overshadowed by the payroll report earlier in the day. Expectations are for a drop below 85.0 after hitting 86.7 last month. Consumer credit on Wednesday and weekly claims on Thursday are unlikely to be any more than fleeting market movers.

WHERE DO WE GO FROM HERE?
Last week's rally was more than impressive and I would not be surprised to see equity prices push higher for another week or two. This should get the masses bullish, as the whole world "knows" that the first week of trading tells you what the market will do for the rest of the year. I do expect equities to have a good 2003, but I am not yet convinced that prices will not -- at least in the broad market -- take one more dive, with new lows not at all out of the question.

That said, the mark of a good trader or analyst is to know when he or she is wrong and to admit it. As of now, gains are still consistent with a turn lower. Prices are well below their highs set in early December. If turnover surges in the New Year and prices accelerate further, then I would start to show concern that this market could continue higher and not seek out new lows. The short-term focus of this letter will allow you to take advantage of this rally anyway, as two of today's trade recommendations below are to enter long stock trades if prices ease a bit first.

In the much shorter term, however, Friday's late gains have left many intraday momentum measures stretched and with minor divergences. Although prices might marginally extend gains in pre-opening trading on Sunday night and Monday morning, I do not foresee a substantial continuation higher on Monday. The early boost will likely come out of the Japanese market, which has been closed the past three days. Much of Europe is closed on Monday, so liquidity will be relatively low today.

Expected losses should be fairly small. Though I still fear an eventual substantial drop, the short-term direction leaves potential for gains in the time frame that I use for my recommendations.

Keep your eyes open for updates during the week. Last week, I had mentioned that I thought the Pharmaceutical HOLDRs (PPH, $77.60) looked attractive. My expectation was for a small continuation lower, which did not happen. I chose not to follow-up with a flash to chase the trade only because it was a holiday week. That was unfortunate, as PPH rose almost 7% last week and was the best performer among the ETFs that I track! Admittedly, I was not quite that bullish.

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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:  BUY SOFTWARE HOLDRs (SWH, $28.64) ON A PULLBACK EARLY IN THE WEEK

The Software HOLDRs (SWH, $28.64) remain within a trading range that has been in place since early December. Prices have likely nearly completed a five-wave advance begun after bottoming on December 31st at $26.89. This was only slightly below their mid-December $27.12 nadir. Resistance sits in the $28.77-$28.95 range. I would not be surprised to see a brief move above that level early on Monday, but I am not convinced that prices can hold above there.

Barring a news event that would take the market powerfully lower, I expect that any losses should maintain the mid-day dip on January 2nd at $27.85. Although there is still no overt sign that SWH has actually bottomed, potential gains at least towards the $29.25 level make this a trade well worth taking.

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RECOMMENDATION:

Buy SWH at $27.90 (do not buy if prices gap open below $27.72)

STOP:  $27.48

TARGET:  $29.26

Reminder: You cannot trade HOLDRs in odd lots. SWH goes ex-dividend on Tuesday, January 7th. The dividend should be minimal, but I will provide updated guidance on Monday.

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TRADE #2:  BUY FINANCIAL SPDR (XLF, $22.78) ON PULLBACK EARLY IN THE WEEK
The pattern here is not very different, on an intraday basis, from SWH noted above. However, the daily pattern for XLF ($22.78) shows two clear and corrective three-wave drops off the high set on December 2nd at $23.87. Gap resistance at $22.90 halted gains on Friday, and failure to follow through higher on Monday should permit a moderate pullback early in the week. I am looking to enter a long trade on a drop towards the 38.2% retracement back to the December 31st low of $21.76, which comes in at $22.46. Trendline support, from the old downtrend line now broken to the upside, comes in at $22.43 on Monday and slips about $0.03 per day.

Care is needed here. I would not buy if prices fall very sharply at the open on Monday. There is some risk that the markets are forming a head and shoulders reversal lower. Failure to exceed Friday's peak by Wednesday or Thursday would argue for us taking profits early. There's lots of risk at the end of the week when payrolls come out, and impulsive-looking drops early in the week, followed by only a grind higher later, would leave risk/reward suggesting you to close your longs prior to Friday's key economic data.

My main preference is for a retest back towards the December high at $23.87, with the minimum target at the December 17th high of $23.18.

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RECOMMENDATION:

Buy XLF at $22.50 (do not buy on gap open to this level or lower)

STOP:  $22.10

TARGET:  $23.18  (I will likely raise the target to $23.87, so be on the lookout for a News Flash)

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TRADE #3:  BUY iSHARES LEHMAN 20+ YEAR TREASURY ETF (TLT, $86.48) ON MONDAY

This is probably going to be a quick trade and the targeted gain is less than I typically look for. Essentially, the long end of the bond market has fallen a bit too far a bit too fast over the past few sessions. To wit, TLT tumbled more than 3.5% at one point from its intraday high on December 31st before closing Friday at $86.48. A 62% retracement of the losses would target $87.99, which would represent a gain of 1.7% from Friday's close. Since stocks may open a bit stronger on Monday, you should be able to enter a long trade at a slightly lower level than $86.48. Stops should be beneath Friday's $85.83 low. In fact, with the December 17th low so nearby at $85.68, I'd place stops just beneath there.

One must be careful when shorting fixed-income ETFs, as dividends are substantial. However, the next ex-date is not until the start of February. In the meantime, accrued interest will add to the value of the fund every day.

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RECOMMENDATION:

Buy TLT on an open between $86.54 and $86.27 on Monday only

STOP:  $85.67

TARGET:  $87.99

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4. CONTINUED GUIDANCE ON PREVIOUS TRADES

I have one outstanding trade at the moment...

TRADE #1:  LONG MARCH 2003 23 PUTS ON THE NASDAQ 100 TRUST (QQQ) AT $1.20
If losses in the next few days look corrective, I may close this trade early. While ultimately I still see new lows, there is risk of another leg higher in the stock market, which would take the options too close to my stops at $0.60. A 50% retracement of the recent gains may allow us to exit at breakeven. But if losses accelerate, then I will stick with the trade.

RECOMMENDATION:
Bought QAVOW at $1.20
STOP:  $0.60
TARGET:  $4.00
Sell half of your position at $2.40 to lock in gains
CURRENT PRICE: $0.95


Good trading in the week ahead!

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

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