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IN THIS WEEK'S ISSUE:

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

We urge all readers to print out this newsletter each week for maximum benefit...

1. MARKET SUMMARY

The stock market turned mixed last week. After rallying sharply for more than a week, equities took a breather, falling for two consecutive days on Thursday and Friday (the market's first two-day losing streak since April 8th and 9th). In similar fashion, all 23 of the ETFs we follow finished mixed for the week. Debt-based funds all rose, while technology-oriented ETFs, after charging higher early in the week, tumbled as the week came to a close. Most other domestic-based equity funds managed to post decent gains, with the two Biotech funds surging higher. The two foreign-based ETFs slipped, led by Japanese equities, which made yet another fresh 20-year low.

THE WEEK IN REVIEW
I would not get terribly frightened by the end-of-week losses. Although I remain a confirmed bear, I do not believe we've seen the top of this rally. My only concern is that volume was fairly high on Thursday and Friday. However, the market's losses were fairly small and even the short-term trendline in the S&P 500 has yet to be challenged. Earnings reports were mostly in line with expectations, though I suspect they were better than general fears. The bottom line, however, is that the losses accrued at the end of last week were very minor. In addition, they came after a strong rally that had left most stock market sectors at least moderately overbought.

ECONOMIC ANALYSIS
I nailed last week's two main data items, as durable goods orders came in stronger than expected while first-quarter Gross Domestic Product (GDP) came in below consensus. More specifically, consensus expectations for GDP were for an improvement of 2.4%, yet my forecast was for a gain in the 1.5-2.0% range. The actual GDP figure rose 1.6%. I warned also that the price deflators would be a large part of the supposed weakness. Economists forecast a 2.0% deflator, but the actual figure came in well above that level. In fact, if you dig into the data, the result was not all that bad. Defense spending fell according to the report (the government apparently made most of its purchases in the run-up to the war), so government was not that big a factor. Next quarter should see some stock rebuilding in that category, plus we should also get a boost from the price deflator falling again. In fact, after all is said and done I would not be surprised to see Q2 GDP jump 4-6%!

Next week sees a few important figures. The quarterly employment cost index (ECI) is forecast to rise 0.7% (due Tuesday). Any jump beyond 0.9% would get the inflationists yapping. Not to worry -- it won't happen. The Chicago PMI, due out on Wednesday, is forecast to weaken to 48.0 from 48.4, but I suspect we could see an improvement there. The ISM manufacturing index, which is due on Thursday, shows consensus for a minor improvement to 47.0 from 46.2. Look for 48.0 or higher.

Next week's main events will be the monthly non-farm payrolls report and the unemployment report. Economists currently expect the unemployment rate to edge up 0.1% to 5.9%, while payrolls are expected to fall 60,000 after last month's 108,000 job contraction. With jobless claims sitting at their worst levels in recent history, I'm concerned that the unemployment rate could even creep up to 6.0%. The market wouldn't like that one bit.

WHERE DO WE GO FROM HERE?
While I would not be surprised to see a minor further test lower to start the week, yet another rally should ensue beyond that. It might very well look like a blow-off top (except it will represent the end of this bear market rally). Stocks could surge as much as 5-8% from the lows we put in early last week, but I expect to see a reversal lower by Friday. This would roughly coincide with a turn date forecast by a historically accurate neural net that I follow.

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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.  ETF RELATIVE STRENGTH MONITOR

(Note:  If you're a first-time reader or you are otherwise unfamiliar with our proprietary ETF Relative Strength Monitor, then please click here for a brief description.)

As a reminder, our relative strength rankings are based on returns in several time frames. As you can see, despite the fact that they all turned in positive performances last week, the debt-based ETFs all slipped (except for the iShares Goldman Sachs Corporate Bond Fund (LQD, $111.60)). This is because these funds remained among the worst performers (excluding dividends, which does put them at a disadvantage) over the past month and the past three months. Even last week, when they finished in positive territory, several of our equity-linked funds still managed to easily outgun them.

There have been two constants in relative strength terms recently: superb performance by Biotechs and atrocious trading in Japan. The Biotech HOLDR (BBH, $101.40) jumped 5.11% last week and is ahead a gaudy 13.25% over the past 13 weeks. The Nasdaq Biotech iShares (IBB, $55.65) soared 7.02% last week and are up 10.64% over that same period. Meanwhile, Japan WEBS (EWJ, $6.24) fell 2.04% last week and are off 12.85% over the 13-week reference period. The only other ETF to show losses during that time are the Software HOLDRs (SWH, $27.89), which fell a mere -0.07%.

Given my expectation that the stock market will likely make just one last run higher, I will start looking for technology issues to underperform. The Software HOLDRS (SWH), which are already trading poorly, will be a prime suspect, as will the still somewhat overbought Semiconductor HOLDRS (SMH). The Energy SPDR (XLE), which is approaching oversold levels, may prove to be a good defensive play as stocks approach their highs. The same can be said for the Biotech sector, although I'd first wait for Biotechs to alleviate their overbought status.

Here is this week's ETF Relative Strength Monitor...

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4.  THIS WEEK'S TRADES

RELATIVE STRENGTH ETF TRADING IDEA:
There is no relative-strength-based trading idea this week. However, if the market rallies sharply early in the week, then I may send out a flash based on some of the ideas noted in our Relative Strength Monitor section above.

SHORT-TERM ETF TRADING IDEA:

SELL TWO DOW DIAMOND (DIA, $83.16) MAY 2003 $87 CALLS AND USE THE PROCEEDS TO PURCHASE MAY 2003 $84 PUTS
I expect the stock market to turn higher again this week after a brief fall early in the week. There is room for a rally towards the $87 area as shown by the target in the chart below. However, do not sell the calls until prices are close to the target area. More specifically, do not sell the calls unless you can get at least $1.25 for them (since each options contract is for 100 underlying shares, this would equal $250). At worst, DIA should about match its 2003 high at $88.88. Given that the option is fast approaching expiration, your potential loss should be relatively small on the calls.

If my expectation for a sharp drop proves correct, then the puts should finish "in the money." Buy as many puts as you can with the money you bring in from the call sale (as long as you do not spend more than that amount). I would not be surprised to see DIA drop to the low-$80s before May is out!

This trade looks attractive for the following reasons:

• DIA is near its target and is due to turn lower.
• Significant momentum divergences are warning that the uptrend is weakening.
• Implied volatilities are very low, so as prices tumble, the puts will increase even more quickly in value.

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RECOMMENDATION:

SELL (WRITE) TWO MAY 87 DIA CALLS (DAVEI, $0.35) at $1.25 or higher
... and at the same time...
BUY AS MANY MAY 84 DIA PUTS (DAVQF, $2.10) as you can with the proceeds from the call sale

TARGET:  Sell half of your puts when they double and close calls at that point. Hold remaining puts at least until DIA reaches $82.00
STOP:  Close your call positions if DIA trades above $89.00 (keep the put since it will be essentially worthless anyway, yet could post gains if the market collapses beyond that point)

The profit potential here is difficult to compute because it is not clear how many puts you will be able to purchase. However, your risk will be less than $400, barring an opening gap higher. The potential gains are enormous. If both options expire worthless (this would happen if DIA finished between $84 and $87 on the third Friday in May), then your loss will be limited to your commission less whatever cash was left over from the call sale.

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LONG-TERM ETF TRADING IDEA:

BUY iSHARES LEHMAN 20+ YEAR TREASURY BOND FUND (TLT, $88.92) ON A DIP
As I've noted recently, I expect the stock market to turn sharply lower in the near future. Given that investors are likely to rotate their cash into bond funds at that time, purchasing TLT makes eminent sense. Although this is a lower-volatility play, our potential losses on the trade will be fairly small.

The highlights for entering TLT are:

• Ability to rally last week despite weak equity market performance.
• Wedge pattern still shows higher prices short-term with dip due now. If stocks collapse, then this wedge could turn into a channel.
• Rebounding from oversold and unable to break down despite important sell signals, signifying possible failure of sell signals.
• ADX in futures market is very low and started to turn higher as prices rallied this week, signifying a possible new uptrend. This is not yet confirmed, however.

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RECOMMENDATION:

BUY 100 SHARES of TLT at $88.10

TARGET:  $91.36
STOP:  $87.25 (lower stop by size of dividend when TLT goes ex-dividend)

Assuming you buy at $88.10 and sell at $91.36, your gain would be $326, or +3.70%. In addition, this fund will pay a dividend either at the end of next week or the start of the following week, and this will add to your returns.

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5. CONTINUED GUIDANCE ON PREVIOUS TRADES

SOLD SHORT ENERGY SPDRs (XLE, $22.24)
DATE RECOMMENDED:  3/24/2003
DATE ENTERED:  03/24/2003
ENTRY PRICE:  $22.41
TARGET:  $21.00 (revised)
STOP:  $22.39 (revised)
GAIN/LOSS:  +0.8%

Maintain shorts here. However, we have been holding this position for a month now and XLE remains firmly range-bound. The sharp losses on Thursday and Friday might represent the start of a new trend lower. Failure to do so means another test higher. With XLE having tested resistance several times recently, and with the fund having missed our revised stop by only $0.03 last week, I do not want to tempt fate. ADX, a trending indicator, has started to turn higher from a very low level as prices have risen the past week or two. That could be a warning of a break, be it false or not.

I still expect this fund to move lower, but there may be better places to allocate your money. As such, if XLE does not start moving down as forecast relatively soon, then I will shift gears and will find a more attractive trade to place.

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BUY JAPAN WEBS (EWJ, $6.24) ON A PULLBACK
DATE RECOMMENDED:  Initial recommendation on 3/31/03
DATE ENTERED:  CANCELLED
ENTRY PRICE:  N/A
TARGET:  $6.80
STOP:  $5.95
GAIN/LOSS:  N/A

In last week's report I recommended canceling this trade on any move above $6.40, as this would have put into question the wave counts used as a basis for the recommendation. EWJ hit a high of $6.41 early last week, so we have therefore cancelled this trade.

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BUY DOW DIAMONDS (DIA, $83.16) ON A DIP
DATE RECOMMENDED:  4/21/03
DATE ENTERED:  CANCELLED
ENTRY PRICE:  N/A
TARGET:  $86.80
STOP:  $81.09
GAIN/LOSS:  N/A

The entry criteria for this trade was not met. DIA rallied to start Monday morning, invalidating the pattern I wanted to enter the trade on. This trade is now cancelled.

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BUY S&P 500 SPDRs (SPY, $90.23) WHILE SELLING SEMICONDUCTOR HOLDRs (SMH, $25.88)
DATE RECOMMENDED:  4/21/03
DATE ENTERED:  4/22/03
ENTRY PRICE:  Bought 60 shares SPY at $91.49, sold 200 sharse SMH at $27.50
TARGET:  SPY/SMH price ratio of 3.55
CURRENT PRICE RATIO:  3.49
STOP:  SPY/SMH price ratio of 3.46 -- trail by 0.01 for each 0.01 move above 3.51 this week.
GAIN/LOSS:  $248 -- the average of these two position is now +2.3%

This trade went spectacularly well almost from the moment we entered it. However, though we turned almost exactly at a Fibonacci target, we need to be very careful here. If stocks rally next week to new highs, then this trade could give back all of its gains (and then some). I think this will prove to be an excellent trade again, but if we show any further signs of strength in equities, then I want to exit this position quickly. I do foresee another leg lower here before the market really rallies, and we could reach our 3.55 target at that time. Trail your ratio-based stops higher by 0.01 for each 0.01 move over 3.51.

Thanks again for reading this week's issue, and good trading in the week ahead!

Steven Poser
Editor
The ETF Authority
New York, NY

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