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IN THIS WEEK'S ISSUE:

1.  MARKET SUMMARY  
2.  WEEKLY ETF PERFORMANCE  
3.  ETF RELATIVE STRENGTH MONITOR  
4.  MODEL ETF PORTFOLIO   
5.  TRADE OF THE WEEK   
6.  CONTINUED GUIDANCE ON PREVIOUS TRADES  

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

(1.)  MARKET SUMMARY

As we enter the unofficial start of summer, equities continue to trade near the top of the trading range that they've been in for the better part of a year. Internals remain positive, with more stocks rising than falling, and with volume and new highs versus new lows also sporting bullish ratios. However, we have had a hard time moving higher recently, and I suspect the post-war honeymoon is approaching the end of its run. With this in mind, it may make sense to take some defensive action at this point.

THE WEEK IN REVIEW
After falling sharply on Monday and continuing their losses on Tuesday, equities spent the remainder of the week grinding higher, though they finished slightly lower versus last week's close. All eyes seemed focused on the U.S. government's raising of the terror threat level. SARS remains barely on the radar screen (and is thus a major risk). Meanwhile, the market continues to price in a strong likelihood of a rate cut in June. The bond market continued higher as well, as Fed Chairman Alan Greenspan warned that there was still little proof that the economy was gaining traction. However, he was quick to point out that economic conditions did not appear to be getting any worse either. Bottom line: It was a relatively quiet week in front of the long holiday weekend (the markets will be closed on Monday, May 26th for Memorial Day).

ECONOMIC ANALYSIS
Last week barely showed up on the economic data radar screen. Of minor note was the fact that weekly unemployment claims came in at about 400,000 for the 14th consecutive week. Labor is a lagging indicator, but so far it is showing no signs of improvement.

Alan Greenspan's testimony to Congress on Thursday didn't bring any surprises. He addressed the very real risk of SARS harming the American and global economies and stated that a pickup in economic activity was reasonable to expect, but we do not have enough post-war information as yet to make reliable forecasts. He opined, as I often have in these pages, that the risk of deflation is still greater than the risk of inflation. However, despite this, short-end futures slipped on Thursday, but remained well above key support levels.

My opinion remains that the U.S. economy is in very poor shape and that Europe is even worse off (another reason why the back of the Euro's rally versus the dollar is due to be broken soon). The European Central Bank (ECB) is finally starting to realize the risk going forward and has made it seem as if they will cut rates at least one more time. Unfortunately, the ECB is unlikely to ease enough, and in the meantime, Canada continues to be on the rate hike path. Given that Canada is America's largest trading partner, a slowdown there would be damaging to the American economy.

After Monday's holiday, we have a pretty busy week of economic data. Consumer confidence is due out on Tuesday and forecasts are calling for yet another spike higher here. Existing home sales are also released on Tuesday and are seen gaining ground. Low and falling interest rates continue to prop up a market that is due to implode as the economy weakens, especially since interest rates will not be able to fall much more as the economy's engine starts to sputter.

Durable goods are forecast to slump sharply this month after a surprisingly good showing in the March data. Consensus is for about a -1.2% decline. I expect the actual figure to come in slightly better than that. Thursday begets the second take on Q1 GDP. Better balance of payments data may lead to a marginal improvement from the first estimate of 1.6%.

Friday sees Chicago PMI (forecast to edge higher, though I am not so sure that we can exceed April's 47 reading in any meaningful manner). Also due out are University of Michigan consumer confidence plus personal income and spending. Once again, individuals probably spent more than they made. Sooner or later they will have to pay the piper on that one!

WHERE DO WE GO FROM HERE?
Sentiment remains nervously bullish. However, what was interesting is that the tech sector was weaker than the broader market last week. This may be a sign that things are changing. However, I still see risk to a brief new high, though that possibility is not strong enough to actually get outright long for. In fact, as you will see below, I wish to sell options to take advantage of any rally to sell into, and my thinking is that we will fail to make a new peak. On the downside, even if we do not make a run to new lows just yet, an S&P 500 (SPX, 933.22) slide towards 880 to 840 or 850 is likely and has probably already begun.

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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.)

The bond market had a stellar week, as Alan Greenspan signaled that the Fed would buy long-maturity Treasury notes and bonds in an attempt to flatten the yield curve. The Fed feels the yield curve is too steep and it wants to bring borrowing costs down even more because it fears deflation far more than inflation. This will also allow the Fed to possibly hold off on firing its few precious remaining rate cut bullets.

The announcement led the 20+ Year Lehman U.S. Government Bond iShares (TLT, $95.85) to jump 2.3% last week. Only the two biotech funds I track -- the Biotech HOLDR (BBH, $115.20) and the Nasdaq Biotech iShares (IBB, $63.69), which I hold in my model portfolio (see below) -- rose more last week. BBH soared an astounding 10.6% last week and is now up 29.0% over the past 13-week period (IBB is ahead 32.3% in the same time and gained an impressive 3.1% last week).

I am quite pleased that although the Dow Diamonds (DIA, $86.23 fell, they still managed to outperform both the S&P 500 and the Nasdaq. That was why I chose that index fund for our model portfolio rather than QQQ or SPY.

Tumbling in the rankings was the Pharmaceutical HOLDR (PPH, $75.65), which lost -4.7% last week and is ahead just 7.2% in the past 13 weeks. Only three equity-related funds have performed worse. Its 0.2% return during the most recent four-week period ranks it dead last (remember – the strongest fund receives a ranking of "23", while the weakest gets a ranking of "1") across all 23 funds that I track (including the debt market funds). The rest of the rear guard comes largely the from technology sector, although the Retail HOLDR (RTH, $75.85) has also been weakening.

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

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(4.)  MODEL ETF PORTFOLIO

Performance Summary:
                                                        S&P 500   Model Portfolio
Last Week              -1.17%       +1.19%
Since Inception        -1.17%       +1.19%

Our first week proved to be a good one for our Model Portfolio, as we easily outperformed the market. The Semiconductor HOLDR (SMH, $27.12), which we shorted, was the second worst performing fund last week. Meanwhile, the Energy SPDR (XLE, $24.12) and the Nasdaq Biotech iShares (IBB, $63.69) were the 2nd and 3rd best equity-linked performers.

Going forward, I have only decided to make one adjustment to our portfolio right now: I will sell a June DIA 88 call (DAVFJ, $0.80) as a partial hedge against our long DIA position at Monday's open. I won't mind if we get called on this trade, since I believe the market is set to slip substantially in the short-term. Furthermore, with such a limited amount of time until expiry, the option is going to see some substantial time decay in the coming weeks. There are no margin requirements for the sale since the position is covered by our long DIA position. If you get called, you will wind up selling the current DIA position for a profit of $1.01 and will still receive the option premium.

I do see substantial risk that stocks could move lower in the near term. However, I do not yet have a sell signal. I will revise the portfolio with a flash if a deeper correction appears likely to start (or begins).

To give you an idea of things I am looking at for the portfolio going forward, here are some possible actions.

If the stock market weakens, as I expect it will, then with IBB so overbought, I think it would be risky to hold it much longer. I have targets about 5% higher than here, but with RSI well above 70, if stocks fall sharply, then IBB will probably not have as much of a defensive impact as it has during other recent market declines. However, the Pharmaceutical HOLDR (PPH), which is oversold, would become favored. Therefore, I will likely switch out of IBB once it reaches its upside potential, or if stocks start falling more quickly. Additionally, a reversal in equities will have me move to short QQQ or SPY as well and close out our long DIA position. I will not do that until I have a clear sell signal. Once the bond market corrects a bit, I would also like to initiate a long position in the 20+ Year Lehman U.S. Government Bond iShares (TLT).

If I am wrong, and equities continue their gains, then I will shift our SMH position to a LONG position and will exit DIA and purchase QQQ instead. I will also look at a long position in the Financial SPDR (XLF, $23.61), which tends to act well in an up market.

MODEL ETF PORTFOLIO

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(5.)  TRADE OF THE WEEK

SELL SHORT 1,000 SHARES TECHNOLOGY SECTOR SPDR (XLK, $16.14) ABOVE THE MARKET
Despite strong gains in the stock market over the past three months, XLK has acted relatively poorly. Its 2.2% loss last week ranked it as one of the poorest-performing ETFs on our radar screen. And given that tech stocks have acted well lately, the fund's 9.4% 13-week gain has been a bit of a disappointment. The five-wave drop from the recent high gives us an opportunity to sell with a well-defined risk.

I am not going to risk a huge amount of money here, as there is still a chance that equities will manage one more rally (though that is not my preferred stance). And, the poor trading recently in this fund makes it a safer bet. It never managed to reach overbought levels, but did exhibit momentum divergences as it made its new highs. XLK also achieved a price target and then fell from near there.

Other reasons for concern are that XLK now is in a sell signal from daily MACD and has not been able to hold above the median Andrews Pitchfork line. A break beneath the lower blue line shown (at $15.66 on Monday and rising about $0.05 per day) would confirm a reversal of the uptrend would signal that a deep correction (or worse) may be underway.

I like this trade because:

• Price targets were achieved.
• We have already had a five-wave drop, with another due.
• We have a well-defined selling range.
• Momentum divergences.
• MACD sell signal.
• Unable to breach Andrews Pitchfork median line and risks break of next support line.

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RECOMMENDATION:

SELL SHORT 1,000 SHARES TECHNOLOGY SPDR (XLK, $16.14) AT $16.26 OR BETTER (DO NOT SELL IF IT GAPS OPEN ABOVE $16.39)

TARGET:  $15.26
STOP:  $16.54

Assuming a sale at $16.26, your profit would be $1,000, or +6.15%. If stopped, assuming a sale at $16.26, your loss would be just $280, or -1.72%.

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(6.)  CONTINUED GUIDANCE ON PREVIOUS TRADES

LONG SIX (6) NASDAQ 100 TRUST (QQQ, $28.10) SEPTEMBER 2003 27 PUTS (QAVUA, $1.30)
DATE RECOMMENDED:  May 19, 2003
DATE ENTERED:  May 19, 2003
BOUGHT SIX QAVUA AT $1.40
TARGET:  Close when QQQ falls to $26.14
STOP:  QQQ reaches $29.20

QQQ remains in a weak position. Many of its technicals are similar to the XLK trade described above. We have momentum divergences, targets achieved and one five-wave leg lower completed. Another leg down is due. Resistance is heavy from $28.39 to $28.62.

This position is currently down $0.10, or $60.00.

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SELL SHORT ISHARES RUSSELL-2000 GROWTH FUND (IWO, $44.25) AT $46.75
DATE RECOMMENDED:  05/12/2003
TARGET:  $40.50

IWO never moved up to our entry price, so we have not yet taken this trade.  I have now decided to cancel this recommendation.

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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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