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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
Last week we saw the European and Japanese stock markets fall, yet the U.S. markets managed to rise. The Dow and the S&P 500 gained a bit more than 2%, while the Nasdaq-100, as measured by the Nasdaq-100 Trust ETF (QQQ, $27.10), jumped more than 5%. Friday was easily the most impressive session, as the Nasdaq rose and the broad market finished flat despite a much weaker-than-expected payroll report.

Market sentiment may provide some hints going forward. Some investment polls suggest that there remains only a slight plurality of bullishness, meaning that there is room for shorts to still get hammered. However, as I will discuss later, other measures suggest complacency, implying limited potential for further gains.

Get your earnings calendars out -- earnings season has begun! Intel starts the parade on Tuesday after the market close. Other important earnings releases during the week include Apple Computer (AAPL), IBM (IBM), Sun Microsystems (SUNW), Microsoft (MSFT), Fannie Mae (FNM) and General Electric GE).

THE WEEK IN REVIEW
The U.S. stock market continued its strong gains last Monday morning, but then proceeded to slip from Monday afternoon until Wednesday's close. A widely misunderstood set of unemployment claims and chain store sales data helped stocks surge on Thursday. Most impressive, however, was the ability for equities to shrug off a much weaker-than-expected non-farm payroll report on Friday morning.

The bond market lost substantial ground for the week and treaded water on Friday -- a disappointing performance given the weak economic data released in the morning. Interest rates remain beholden to the stock market.

Market commentators opined that the gains in stocks and better news on the Iraq front (I'm not sure what these people are reading) helped take some of the flight to quality bid out of the Treasury market. Comments by Fed Governor Gramlich on Friday helped lower interest rates most closely tied to Federal Reserve Board policy, as he suggested that if the labor markets did not improve, the Fed would take notice. This increased speculation that the Fed's next move was still more likely to be a cut than a rate hike. He also noted that the Fed was more concerned about deflation risks than inflation risks.

ECONOMIC ANALYSIS
The main event last week was Friday's surprisingly weak non-farm payrolls report. Payroll employment slumped by 101,000 in December, and November was revised to a loss of 88,000 jobs from the originally reported loss of 40,000 jobs. The more politically sensitive, but less economically robust, unemployment rate remained unchanged at 6.0%.

The data, though unquestionably weak, were not as bad as you might think. Retail trade lost 104,000 jobs in December, after a loss of 40,000 in November. Hours worked increased in the manufacturing center, as did overtime hours. This confirms the better-looking ISM data reported a week ago. Watch for a rebound in non-farm payrolls in January, as the lower-than-normal hiring during the holiday season should result in the seasonals adding a substantial number of jobs in next month's report. We got the first hint of this from last week's low weekly unemployment claims release.

All other data last week were overshadowed by the payroll report. The ISM's less widely followed services survey came out on Monday and was weaker than expected, yet it provided nary a hiccup in the markets. Factory orders slumped 0.8%, which was slightly weaker than expected, but included the already reported (and weak) durable goods data.

Next week's reports will be important. We start with Retail Sales on Tuesday, which are forecast to increase 0.4% (though only 0.2% ex-autos). To be honest, that sounds too high to me ex-autos, though I suspect that car and truck data could actually surprise on the positive side.

Producer Prices, due on Wednesday, should be little changed and are not likely to move the market substantially unless prices surprise on the upside. There is some risk to the total number though, as I suspect energy prices increased more than economists have in their forecasts.

The CPI data -- due for release on Thursday morning at the same time as the weekly claims figures -- should be its normal benign self. Claims data may remain on the low side as seasonals slowly unwind. Consensus estimates for the Philadelphia Fed's manufacturing report are for a substantial gain (released at noon on Thursday). The Philly Fed number does often cause a quick reaction, although its overall impact is usually limited.

Friday also sees a load of data, with the trade balance, industrial production and capacity utilization all due for release. The trade data have been fairly uniform of late and are again forecast to come in near a gap of $35-36 billion dollars. An increase in the trade deficit (America imports more goods and services than it exports), though allegedly bad for the dollar, could actually help the stock market since the implication would be that the economy is picking up some, thus the increased demand on the import side. Capacity utilization and industrial production are expected to edge up, although I see little evidence of real gains.

WHERE DO WE GO FROM HERE?
Once again, we are entering the week with stocks looking a bit extended on the upside. I see potential for a retest to the lows probed following the payroll report on Friday. I am also concerned because expectations are for pretty decent tech earnings, as evidenced by the fact that the Nasdaq Composite Index is at its highest level in more than a month and is up 9.1% since its December 31, 2002 low.

Earnings data have the potential to galvanize the market this week. With key technology firms such as Intel (INTC), Microsoft (MSFT) and Q-Logic (QLGC) due to report, and with the stock market a bit extended and near recent highs, any disappointments could be a problem. The Nasdaq Composite Index closed above its 200-day moving average for the first time in recent memory. Prior moves past that level have not been sustainable.

I noted earlier that there seems to be a decent amount of skepticism as to how much further the market can rally. However, implied volatilities on index options, which tend to move in the opposite direction of the trend, are now at their lowest level since late April of last year. There is very little fear in options land, as these levels represent essentially the mid-point of where volatilities traded throughout 1999, when the Nasdaq Composite nearly doubled!

The outlook, however, is mixed at best. Prices are near the top of a trading range. Usually there is undue optimism when such levels are attained. Right now, that evidence is mixed. Elliott Wave counts do allow for another 5% higher or so in the S&P 500, at least after a small correction, and as much as 10% in the Nasdaq Composite. But first we will need to test lower to start the week. And, if we do that on strong volume on Monday, then all bets to the upside are off. I still favor one more leg down to new lows. The only question is whether it will happen now or in about a month.

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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 S&P MIDCAP 400 SPDR (MDY, $81.43) ON A PULLBACK TO $80.55 (okay to buy on gap below there)
Midcap SPDRs look set to slip about one percent, or maybe slightly more, to start the week. But, because the rally from their late December low was clearly impulsive (in Elliott Wave terminology), I expect one more leg higher.

I do not wish to chase the market right here, and I expect a pullback to start the week towards $80.55, or even a bit lower than that. From there I expect to see a rally of more than four points, or about 5%. 

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RECOMMENDATION:

Buy MDY at $80.55 or lower

STOP: $79.35

TARGET: $84.00

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TRADE #2:  TRADE BREAKOUT OF RECENT TRADING RANGE FOR TECHNOLOGY SECTOR SPDR (XLK, $16.54)
As you might have been able to tell from my commentary above, I expect equities to rally a bit more, although I am more than a bit nervous that people are getting a bit too enthusiastic about the market's potential here. However, it is rarely ever healthy to your P&L to overanalyze the markets. In doing so, you could easily spend all your time awaiting the perfect set-up and miss opportunities, such as the one currently presenting itself in XLK.

XLK likely needs to test its recent lows before breaking higher. Any move below last Tuesday's $15.98 nadir would be a negative. If the market is not going to fall, then prices should never move that low, so sales on a break below there make sense. On the other hand, if XLK rallies past last week's highs, especially following a pullback first towards Friday's lows, then I'd expect a rally to at least $17.24.

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RECOMMENDATION:

Buy XLK on a move above $16.70

STOP: $16.25

TARGET: $17.24

Or…

Sell XLK on a move below $15.98

STOP: $16.71

TARGET: $14.72

DO NOT EXECUTE BOTH TRADES. ONLY EXECUTE THE ONE WHOSE PARAMETERS ARE MET FIRST.

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TRADE #3:  SHORT JAPAN WEBS (EWJ, $6.92) AT $7.08
The chart pattern for EWJ remains consolidative. I still see room for one more leg lower to a new low in the Japanese stock market. The dollar, though it might slip a bit in the next couple of sessions, is gearing up for, if not a reversal, at least a rally. Gains in the dollar translate into lower prices in Japanese shares on a foreign exchange translation basis. (Note, however, that Japan has a large export sector, and when the dollar strengthens, those stocks usually rally. Also, beware that a strong dollar is often tied to a strong stock market in the U.S., which could theoretically help Japanese stocks. My take is that those positives do not outweigh the current negatives for Japanese equities.)

For this swing, I do not think I want to wait for a new low, though if losses do accelerate, then I will take them and adjust my targets lower. Keep stops just above the high touched since the early/mid-October low. My target for the short is about one percent north of trendline support, which currently stands at $6.64 and rises less than a penny per day.

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RECOMMENDATION:

Short EWJ at $7.08

STOP: $7.26

TARGET: $6.72

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4. CONTINUED GUIDANCE ON PREVIOUS TRADES

I closed one trade this week and I have one outstanding trade at the moment...

TRADE #1:  LONG MARCH 2003 23 PUTS ON THE NASDAQ 100 TRUST (QQQ) AT $1.20

This trade was stopped for a loss of $0.60 last week.

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TRADE #2:  SHORT RUSSELL-2000 GROWTH FUND (IWO, $41.94)

RECOMMENDATION:
Sold IWO at $41.63
STOP: $42.25 (adjusted from $42.35)
TARGET: $40.02 (adjusted from $39.75)
CURRENT PRICE: $41.94

IWO closed near the upper end of its month-long trading range. However, volume was much higher as prices fell last week than it was on Thursday and Friday when it advanced. Still, I have lowered my stops to just above Friday's highs, as IWO did reach its best level in almost a month and I see no reason to let losses accrue beyond there.

Watch this stock closely on Monday morning. If equities cannot turn lower on increasing volume, then I might send out a flash to close this trade early. IWO's low price on Friday was $41.25, and any inability to trade below there would be a warning that the stock could continue its rally.

I have also raised my price target to exit from $39.75 to $40.02 -- or just above the January 2, 2003 low -- to avoid risking missing a great gain by being greedy for an extra 25 cents. If IWO's losses accelerate and it appears as if stocks are breaking down, then I will adjust targets to lower levels accordingly.

Good trading in the week ahead!

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

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