 The ETF Authority for Monday, January 27th, 2003 Volume 2, Issue #4 Published weekly on Sunday evening, The ETF Authority is a short-term swing trading newsletter that can help you profit from some of the most heavily-traded securities on the market -- exchange-traded funds (ETFs). *Please
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MARKET SUMMARY There is always the constant worry that foreigners will pull the plug on U.S. assets, and Treasuries in particular. Europe's current laissez-faire attitude towards the terrorist threat and ambivalence towards U.S. Middle East goals may raise the probability that investors will repatriate their dollar-based holdings. Never forget: investors generally vote with their wallets and they are well aware that a mass exodus would result in a collapse in asset values, which would help absolutely nobody. While exposures may be lightened -- and that may already have occurred -- a wholesale reallocation out of U.S. stocks and bonds seems unlikely, at best. ECONOMIC ANALYSIS There was no economic data of consequence last week. Housing starts surprised on the upside. Builders continue to throw away money as the bubble readies to burst there. I'm hearing the same "it is different this time" that I heard in 2000 with regard to Internet stocks. As long as interest rates remain low, housing prices may not collapse. Yet if inflation moves to negative territory, then the real cost of borrowing will be huge until deflation ends. The next housing bust is likely right around the corner. After last week's dearth of economic data, we have a cornucopia of numbers due out over the next five days. Several of them are important. Monday's existing home sales (10:00 AM) are forecast to have fallen in December. Any December data are always suspect due to the holidays (not many people buy homes as Christmas presents). The market expects fairly steady sales near a 5.5 million annual rate. Tuesday sees December durable goods data announced at 8:30 AM. Last month saw a fall of 1.5%. Consensus is for a small rebound to +0.5%. Talk from some of the corporate earnings reports does suggest that sales were not so bad (ex-retail anyway) in Q4. There is not really a direct relationship, but I suspect that after two months of negative numbers, we can beat consensus for this volatile series. New home sales will also be released on Tuesday morning at 10:00 AM. The figure rarely moves the market and is expected to ease to a shade above a 1.0 million annual rate. The semiannual two-day FOMC meeting also begins on Tuesday. The rate decision will come out on Wednesday. Even a confirmed bear like me does not see any chance of a rate move unless we see a major geopolitical event between now and then that would make it necessary. Thursday will be the main event, as the initial fourth-quarter GDP estimate comes out. A worsening trade balance and weak capital expenditures has market consensus near a 1.0% annualized rate of growth. This is a substantial slowdown from the 4.0% Q3 growth rate. Although the GDP data do not technically show us as being in a recession, these anemic growth rates, coupled with huge consumer debt loads (exacerbated by people refinancing their homes and taking money out of their houses at inflated valuations), leaves the U.S. in danger of a significant weakening later this year. However, the relevant numbers are for Q4, and to be honest, given corporate earnings data and the fact that auto sales were much stronger than previously thought in December, I suspect that we could surprise on the upside. Look for a number in the 1.3% to 1.5% range. Also out on Friday, at 8:30 AM, is the Employment Cost Index (ECI). This number used to be a favorite of the inflation hawks because they were concerned that strong increases here could prevent the Fed from cutting rates. Although the forecast increase of 0.9% is above the inflation rate, at this juncture that acts as a tax on employers and probably lessens the chances for pay increases. Benefits (especially health insurance) have been on the rise again, and companies have little or no pricing power. This means that a high ECI could actually prove to be a positive for the bond market and could hurt equities. Only a strong increase in the salary section of the survey, suggesting that firms actually have the wherewithal to increase pay levels, could possibly be seen as a positive by the stock market. Overall, I doubt the ECI will prove to be much of a market mover. Friday's data include personal income and spending at 8:30 AM. Once again, spending is forecast to be well above income (0.6% versus 0.2%). More important will be consumer sentiment data due at 9:45 AM and the Chicago Purchasing Managers report. The former is expected to be little changed from the prior 83.7 level (risk to the downside amidst increased war rhetoric and sinking stocks), while Chicago's purchasing managers data is forecast to improve to about 53.0 from December's 51.3. Last month, strong employment numbers in the various purchasing managers reports did not see any follow-through into the monthly governmental non-farm payrolls data. Observers will look closely to see if the employment sub-index remains strong here (and next week in the national ISM survey). WHERE DO WE GO FROM HERE?
There is no doubt that the stock market is short-term oversold. I am not convinced that Friday's lows represent a short-term bottom. But, barring a further escalation in military rumblings, I doubt that we'll see a huge immediate move lower without at least a small bounce. That said, trying to catch a falling knife will rarely improve your overall health. Purchases, though tempting, should really be done only after an impulsive-looking rally (five waves in Elliott terms) completes. Then, stops can be set at the just-set lows, or even at a reasonable retracement towards those lows. Prices currently sit at their lowest levels in three months. The drop below the December 31st, 2002 nadir puts us firmly back in the grips of the bear. The S&P 500 currently sits at levels only briefly touched, as prices soared after ricocheting off their October 10th, 2002 bottom. There is little support here. That said, the first sign of a bounce might permit healthy gains. Prices have fallen more than 9% from their 2003 peak in the S&P 500. A 38-62% retracement of that fall represents a tradable rally. However, if we see no sign of a rally, or if war breaks out, then stocks could just slide into oblivion. In that scenario, sales at almost any price should become profitable. I honestly expect a major bottom in stocks to take place in the February/March timeframe. I've been writing about this idea since I began writing THE ETF AUTHORITY back in November. The broad market, as measured by the S&P 500, should reach down towards 760, at a minimum, with 700-720 more likely. I even see about a 20% chance of a fall to as low as the 620s and at least a small risk (less than 5%) of losses mounting into the low/mid-500s. The Nasdaq Composite should also reach a new low, and sub-1,000 levels are not out of the question. If you recall, last summer the media and every analyst was looking for a capitulation to signal the end of this bear market. It never really happened. I suspect we will need to see a three-billion-share day with losses approaching 10% in one session before it is all over. The Nasdaq's losses could even exceed 10% when that finally happens! To review, my preference is for a 3-6% rally from levels within 1% of Friday's lows. From there, losses should accelerate by the end of the week. If prices do not quickly mount a rally, then equity values could evaporate more quickly than previously anticipated. Below you'll find a table of weekly performance data for all ETFs that I track for this newsletter...
Special Note: I researched and developed these trading ideas on January 25th, 2003. If we see a major change in the geopolitical landscape by Monday morning, then I will provide you with a News Flash and may cancel or revise some or all of these trades. TRADE #1: BUY
ISHARES 20+ YEAR TREASURY BOND FUND (TLT, $87.97) ON A PULLBACK It might be tempting to just jump on the bandwagon and buy here. That would not be a good idea. The completion of a five-wave rally already suggests a drop is due. The possible shooting star also warns of lower prices first. However, there is not enough downside potential to enter into shorts here, so I will look for a place to buy later this week.
At a minimum, I would expect a 38.2% retracement, although
50.0%-61.8% is also possible. To be honest, I would start getting mighty
nervous over the bullish potential if we started encroaching on the 61.8%
retracement neighborhood, especially since the 50.0% retracement nearly
perfectly coincides with support from a gap higher.
I am not going to try to catch this on the way down, but rather will wait for a set-up to buy. There is a pretty decent-looking channel developing in this ETF. Note that the high and low touches on the channel did not alternate, so it is less impressive than it actually appears at first blush. The channel comes in at $76.12 on Monday and falls $0.08 per day. There is also a Fibonacci extension target at $76.30. The next major support area comes in at the mid-November low of $75.80. There is a large amount of support within 1% of current price levels! Since I do not want to buy without positive price action
first, the trading strategy below will be fairly complex. Upside potential
is not that great from current levels, as there is risk that the ensuing
bounce will only be a fourth wave. Therefore, I would not chase a strong
open.
A five-wave drop is at or near completion here. The corrective rally forecast should extend into the upper-$22s and possibly to as high as the mid-$23 range, though that high is unlikely. There is substantial resistance at $22.72, but I expect that to fall on the ensuing corrective bounce. Our stops will be wider than normal, as the pattern calls for a third-wave drop well below $20.00! I might revise this trade and follow this ETF lower if prices start collapsing.
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recommended trades... 4. CONTINUED GUIDANCE ON PREVIOUS TRADES
This trade was not executed last week. I've decided to cancel the order, as it is unlikely we will see $91.80 again until after the stock market bottoms.
RECOMMENDATION: SMH did not fall as low as our $22.00 buy level. Please
cancel this trade.
We were stopped for a small loss on this trade as the U.S. dollar failed to reverse higher.
RECOMMENDATION:
Steven W. Poser
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