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November 24, 2003

Closing Bell
by Adam Oliensis

Weekly Economic News Diffusion Index (WENDI)

The flow of economic news continues to improve. With a just-above-average 14 reports this past week 4 were neutral and the rest were of the bullish variety. Bullish data came out of the NY Empire State Manufacturing Survey and the Philly Fed, from the Consumer Price Index and from Residential Construction. Also from a continued decline in Initial Jobless Claims, the Conference Board's Leading Economic Indicators, and from Internet Sales. The Semiconductor Equipment Book-to-Bill also contributed. This is the first week since WENDI was born during which there were no Negatives.

The Weekly WENDI rose to 61% (100% is the theoretical high). The Cumulative Weighted WENDI rose to 32 and the 4-Week Weighted Moving Average hit a new high as well at 33%. With both the Conference Board's and the ECRI's leading indices showing continued strength as well, it appears that the good news will continue to flow for some considerable period.

The details of what's summarized above are as follows:

1. Business Inventories: Rose 0.3% in September, ahead of expectations while the Inventory to Sales Ratio remained at historic lows. Business confidence is rising enough to begin rebuilding what's in the supply chain. Inventory rebuild will add a bit to economic growth during the quarter, if modestly. Qualified Bullish (0.5).
2. NY Empire State Manufacturing Survey: Reached a record high of 41 in November with strength in New Orders, Shipments, and Employment among the broad array of positives. The only negative was the squeeze between higher prices paid and lower prices received. Bullish (1).
3. BT-M Chain Store Sales Snapshot: Fell 0.8% W/W for November 15 but was up 6.2% Y/Y, the strongest Y/Y growth in 18 months. Sales have fallen off as tax rebate checks have been spent. However prospects remain extremely positive for the holiday season. With the negative W/W number and the positive Y/Y, we'll go with Neutral (0).
4. Consumer Price Index (CPI): The headline number was unchanged for October (0.0%) while the core number rose 0.2%. Y/Y Core inflation is running at 1.3%, just 0.1% above its 40-year low. We are not seeing deflation but inflation is tame. That's a good thing. Bullish (1).
5. NAHB Housing Market Index: Pulled back in November, but to the 3rd highest reading in almost 2 years. The index remains strong. We'll qualify our view of data because of the decline, but in truth it's "just barely"qualified. Qualified Bullish (0.5).
6. MBA Mortgage Applications Survey: Rose by 5.9% last week with Purchases rising by 13.5% and REFI's falling 1.9%. Applications have consolidated at a high level since August. Neutral (0).
7. ABC News/Money Mag Consumer Comfort Index: Rose a point for November 16 to -17, near the top of the recent consolidation. A rise above about -15 and we'd start leaning to a bullish interpretation. Neutral (0).
8. New Residential Construction: Surprised to the upside for October at a 1.96M rate, up 2.9% with single-family starts hitting a new all-time high. New Permits were also strong, so the activity will continue apace. Housing starts have strong multiplier effects. New houses need new appliances, new furnishings, new accoutrements, and so on. Bullish (1).
9. Semiconductor Equipment Book-to-Bill: Hit "unity" (1.0) for the first time in more than a year owing to particular strength in Bookings (orders). The improvement in global chip sales is accelerating and the industry is starting to build out capacity again. We need the BtB to exceed 1.0, though, before we'll see this as unqualifiedly bullish. Qualified Bullish (.5).
10. Jobless Claims: Initial Claims fell to 355K for November 15, down 15K from the prior week's upwardly revised number, and well into the territory associated with jobs expansion. The 4-week moving average fell to 367K, the lowest level since early '01. Continuing Claims rose by 21K. However the 4-week moving average of Continuing Claims is on the decline. Bullish (1)
11. Chicago Fed National Activity Index: Came in at 0.1 for October, so close to ZERO as to be neutral. Neutral (0).
12. Conference Board Leading Indicators: Rose 0.4% in October on top of an upward revision to September from -0.2% to 0.0%. This index has not fallen below 0% since the spring.Bullish (1).
13. Philly Fed Survey: Backed off for November to 25.9 from 28, but remains extremely robust with Shipments, New Orders, Unfilled Orders, and Number of Employees showing strength along with the 6-Month Outlook. Inventories fell markedly, so weakness in the Average Workweek may be forced to improve as inventory is restored to historic ranges. As with the New York survey, there is some profit squeeze on between rising Prices Paid and the slower improvement in Prices Received...but that's part of what keeps the CPI so low...Net, net this report is Bullish (1).
14. Internet Sales: Grew by 27% Y/Y in 3Q03, a slight deceleration but still extremely strong. Bullish (1).

Earnings

Earnings estimates continue to rise.

The Forward 52-week Consensus Operating EPS estimate for the SPX now stands at $60.71, up at a 17% annualized rate over the past 3 months (according to Standard & Poors). The F52W PE is 17.1

Trailing 52-week Operating Earnings now total $53.08. (We include a time-weighted estimate for the current quarter's EPS from Oct. 1 to the present.) The T52W PE is 19.5.

Reported Earnings for the past quarter have risen to $12.37. That puts the current annualized run rate at $49.48.

While much is made by the bears of the PE on Reported Earnings being in excess of 30, over the next 4 months the large write-offs of '02 will fall off the look-back period on Trailing Earnings and this bearish argument will be tougher and tougher to hold to with any conviction. By spring T52W Reported EPS (magenta line) will have significantly closed the gap with T52W Operating EPS (yellow line). In other words, the quality of earnings will be perceived to be much improved.

Closing this gap should work toward narrowing the Risk Premium.

We have defined Risk Premium in this space as the amount by which the yield on the 10-yr Treasury would have to rise in order to bring it into line with the SPX's projected year-forward earnings yield. That is, how much would interest rates have to rise in order for the SPX to be at Fair Value on the Fed's model?

Over the past 2 weeks the rise in F52W EPS combined with the fall in interest rates has driven the Risk Premium up from 1.28% to 1.72%.

Relative to the past 23 years this 1.72% Risk Premium is 2.5 standard deviations above the mean. That's extremely high.

Relative to the past 43 years this risk premium is at about 0.8 standard deviations above the mean, which is high, but not extremely high.

Any way you slice it, though, the risk in the market is perceived to be much higher now than it was 2 weeks ago. Why? Well, everything we're looking at suggests that the problems are not coming from Earnings or from the Economy. We're seeing a shift in psychology from hope and greed to fear and risk aversion. And what's causing this? International Terrorism? The falling dollar? Loss of faith by foreign investors in dollar denominated assets? Rhetoric heating up on international trade wars? Some combination of all of the above, most likely, and perhaps a host of other factors as well, perhaps mostly that marketeers are now inured to all the short-term positive fundamental news. When that happens...when the market can't go up on good news, the longs get nervous, the shorts get bold, and the market drops.

Now that we're short-term oversold (as discussed below), let's see where we're headed...

Seasonality

This coming week is a little tricky in terms of measuring seasonality. It's the week before Thanksgiving, which is the 4th Thursday of November. On 6 out of 7 years that gives us the week of the 4th Friday (which, for our purposes, we call the 4th week). On 1 out of 7 years the 4th Thursday falls on the week of the 5th Friday (the 5th week) of November.

In order to avoid the vagaries of the calendar insofar as possible, we'll look at seasonality here in terms of 7-day periods starting the 1st day of the month.

Note: On this chart the period from the 29th of each month forward to month-end gets its own column. So each month has 5 periods. I deemed that fitting since "month-end" window dressing is worth considering on its own, especially in those months that end financial quarters.

The following chart covers the SPX from 1/3/62 to 11/21/03. (That's span of the data I have on my default download.) We're looking at the October-December quarter. So, in the chart below the left-most period labeled "Oct.7" shows us the performance of the SPX during the first 7 days of October. The magenta line shows the average gain for that 7-day period. The dark blue line shows us the percentage of years during which the SPX has had a net gain for the period.

Throughout the year the average "column" is up 54.6% of the time with an average gain of 0.13%. That tallies out to an average of 7.9% gains for the year.

October is an interesting month. The period ending Oct. 28 is the worst of the year, closing down an average of 0.79% and closing in the red 63% of the time. However the last 3 days of October change character significantly, averaging gains of 0.54% and closing up 60% of the time.

The coming period, ending November 28, has the highest win rate of the year at 71%, with an average gain of 0.61%, which is the 5th highest average return of the year. That said, however, 3 of the last 4 of these periods have been down as have been 5 of the last 9.

The final couple of days of November (which will not be trading days this year) tend to be flat. Then early December may show some strength before we see seasonal weakness heading into the 14th. (Perhaps consumers' and investors' attention during this period is focused on spending money on holiday shopping rather than on the market.)

Finally, holiday good cheer buoys sentiment generally, including in the stock market, as the last 2 ½ weeks into New Year's are very strong, each period rising about 2/3 of the time by averages of 0.45%, 0.72%, and 0.25%, respectively

Note: If we parse the periods by weekly (Friday) closes, we get some small variations in our results, but the larger pattern is essentially the same.

A Look Down the Market's Throat

Last week in this space we wrote about the preponderance of index charts showing ascending wedges. At that point 4 of the 13 charts showed breaks of those wedges and we commented, "Once a few of these wedges start to break, though, the odds favor that others will follow and we'll get a retracement of the wedge."

Let's check in on those wedges here (highlighted in yellow below):

All the yellow wedges are broken on the above 8 charts. We can expect the benchmark indices to test horizontal support areas (green) and the rising trendlines at the bottom of the blue zones.

However in the short-term all of our 5-day Stochastic Oscillators (red) are turning up from oversold.

As for our higher beta charts...

The COMP, the NDX, and the NDX Advance/Decline Line have broken their yellow wedges. However the SOX has not broken its wedge and the New York Beta Index (NHB) is in a constructive technical pattern as well. NHB has broken up and out of its yellow zone, tested down and slightly back into the yellow, and is now set up with a buy signal from near the new rising demand line (which used to be the rising supply line...broken resistance becomes new support).

To sum up...the lion's share of our charts look ripe to rally up toward broken support this coming week. We'll expect this rally to fail. If this rally is going to surprise to the upside then it will likely be led by the SOX and NHB, as they are in the most positive technical formations.

Bottom Line

SHORT-TERM: With all our short-term momentum oscillators turning up from oversold and with this week showing up very strong on a seasonal basis, we're looking for strength into the holiday.

MID-TERM: Expecting the rally to fail on tests up to broken support (new resistance) at the bottoms of the yellow zones. If the SOX and NHB can break to new highs that's a big positive for the market. Absent that happening, we'd look for lower lows into mid December.

LONGER-TERM: Looking for strength in the latter part of December and into January. Expecting a test of SPX 1070. On a break of SPX 1070 we'll look for SPX 1187.

This Tuesday we'll see GDP revisions for 3Q03 and the Conference Board's Consumer Confidence reading. Then Wednesday we'll get Jobless Claims and Durable Goods Orders among a host of reports. We're anticipating mostly good news, in line with the recent WENDI trends.

Despite what we anticipate to be good news, the market can't find any footing on which to rally from oversold early in the week, then we may be looking at a quick run to SPX 1021 and then to the 990-1010 band.

If you would like to join us for daily Pre-Market Updates, Afternoon Notes, and Intraday Trading Alerts please join us for a 30-day Free Trial at The Agile Trader.

Best regards and good trading!

Adam Oliensis,
Editor The Agile Trader

IMPORTANT DISCLOSURES

ALL PERFORMANCE RESULTS ARE HYPOTHETICAL.

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