11/12/2010 9:15:53 AM

The markets had a gap down open but were able to recover some of the lost ground before the close. Cisco started it off with weaker than expected guidance which shows that expectations about business growth needs to be tempered...

Recommendation:
Buy DIA to cover the short position at a limit of $112.37.
Buy QQQQ to cover the short position at a limit of $52.90.
Buy SPY to cover the short position at a limit of $120.02.

Daily Trend Indications:

- Positions indicated as Green are Long positions and those indicated as Red are short positions.

- The State of the Market is used to determine how you should trade. A trending market can ignore support and resistance levels and maintain its direction longer than most traders think it will.

- The BIAS is used to determine how aggressive or defensive you should be with a position. If the BIAS is Bullish but the market is in a Trading state, you might enter a short trade to take advantage of a reversal off of resistance. The BIAS tells you to exit that trade on "weaker" signals than you might otherwise trade on as the market is predisposed to move in the direction of BIAS.

- At Risk is generally neutral represented by "-". When it is "Bullish" or "Bearish" it warns of a potential change in the BIAS.

- The Moving Averages are noted as they are important signposts used by the Chartists community in determining the relative health of the markets.

Current ETF positions are:
Short DIA at $108.57
Short QQQQ at $49.66
Short SPY at $114.82

Daily Trading Action

The major index ETFs opened significantly lower and then accelerated to the downside. The NASDAQ-100 reached its intraday low within three minutes of the open with the index down two percent. The Dow and S&P-500 to most of twenty minutes to reached their intraday apex. The rest of the session was spent in a sawtooth pattern upwards. The final hour and a half saw continuous selling pressure until a high volume spike in the final fifteen minutes allowed the major indexes to finish with only fractional losses. The Semiconductor Index (SOX 382.49 -4.85) lost one and one quarter of one percent while the Russell-2000 (IWM 73.25 -0.29) posted a fractional loss. The bank indexes closed lower retreating from their 200-Day Moving Averages (DMAs) with the Bank Index (KBE 23.88 -0.14) 24.02 +0.39) and the Regional Bank Index (KRE 23.88 -0.12) fell about one half of one percent on the day. The 20+ Yr Bonds (TLT 96.33 -0.05) was again almost unchanged. NYSE volume was somewhat light with 951M shares traded. NASDAQ volume was heavy with 2.560B shares traded.

There were no economic reports of interest released. Instead, it was all about Cisco (CSCO) guiding below estimates. The major reason cited was the decline in spending by governments, whether state and local governments within the United States or foreign governments. The budget cutbacks are affection government spending and Cisco, which gets 22% of its revenues from government contracts, was adversely affected. The market seemed to shrug much of that off to only affecting Cisco and thereby ignored the affect of government cutbacks on the overall economy. The cutbacks are expected to last over some five years before spending will reach recent levels, which will obviously slow GPD growth, corporate earnings, etc. However, the market shrugged off this wakeup call and closed down only fractionally.

The U.S. dollar posted a 0.6% gain on Thursday as it continues to press on overhead resistance. It hasn't yet broken through but is up 3.0% over the past five session.

Energy (+1.0%), Materials (+0.9%), and Healthcare (+0.2%) moved higher while Utilities and Consumer Staples were unchanged. That left five of ten sectors in the S&P-500 moving lower on the day led by Tech (-1.8%).

Implied volatility for the S&P-500 (VIX 18.64 +0.17) rose fractionally while the implied volatility for the NASDAQ-100 (VXN 19.37 -0.09) actually fell about one half of one percent. The incredible complacency in this market suggests we are now set-up for a greater fall.

The yield for the 10-year note rose three basis points to close at 2.60. The price of the near term futures contract for a barrel of crude oil was unchanged at $87.81.

Market internals were negative with decliners leading advancers nearly 2:1 on both the NYSE and by 2:1 on the NASDAQ. Down volume led up volume by nearly 2:1 on the NYSE and by more than 2:1 on the NASDAQ. The index put/call ratio rose 0.07 to close at 1.16. The equity put/call ratio rose 0.09 to close at 0.58. For such a large scare in the market, put/call ratios changed very little. We have rarely seen this level of complacency which sets the markets up to move lower as market participants have little downside protection in place.

Commentary:

Thursday's bounce back from a large gap down opening was an example of bulls run amok. You have huge piles of money that can be thrown at the market to bolster stock prices and that is what happened on Thursday. With the costs of funds to the big money houses next to zero, the large dealers simply stepped in the way of the bears and the markets rose. Ignoring that news, as well as the news that China reported a +4.4% year-over-year (yoy) rise in prices was an example of the bullish mania that has hit U.S. equities markets. This trend higher has been accepted as fact by most participants such that U.S. equity funds have seen inflows, instead of outflows, which was the pattern for previous months. This means that retail investors are back in the market due to the sustained nature of the bull run. Retail investors are notorious for port timing of the market, so we shall see how long this run lasts.

A day later and the Shanghai Composite tumbled 5.2% with European bourses following suit. This is a reaction to expected rate hikes by Beijing due to the runaway inflation they are beginning to experience. Beijing, in an attempt to cool rising prices, will also put in capital controls to prevent foreign investment in its markets, including equities and real estate.

We are still looking for a move lower to the levels we have been listing since last week and perhaps lower. In fact, all the major indexes and the Russell-2000 moved out of uptrend states and into trading states which suggests this rally could be in trouble. We removed our instructions to close the short trades in order to see if the bears could get something more significant started to the downside. The bulls, however, just bought the market and stocks finished with only fractional losses. Market internals and implied volatility are showing incredible levels of complacency but that doesn't mean that the markets will sell-off just yet. We are reinstating orders to close the short trades.

We hope you have enjoyed this edition of the McMillan portfolio. You may send comments to mark@stockbarometer.com.