equityletter.com 1/07/08

Note: Event Calendar is located at bottom of page
I. General Market Overview
The equity markets have welcomed in the New Year with investors fleeing for the exit door. After spending 2007 ignoring a plethora of negative issues (credit defaults, skyrocketing oil, declining U.S. dollar declining housing prices, stagflation, etc.), 2008 has begun with a broad based sell-off of a magnitude not witnessed since the year 1932. The jump in the December unemployment rate to 5.0% this past Friday ignited a sharp market decline as investor fear of an imminent “recession” has increased considerably. Market bulls will point most assuredly to the inevitable further lowering of interest rates by the Federal Reserve as reason to remain calm and ride out the storm. The difference this time is that lower rates will not serve as the appropriate cure in an atmosphere where struggling financial institutions are forced to institute much stricter lending standards. De-leveraging will remain the major theme for 2008. Unfortunately we view time and price as the only medicine that will cure the illness that currently torments the equity markets. Time, could be six months to maybe a year. In regards to price, we could be looking at possibly 10%-15% below current market levels. We would view any market rallies resultant from interest rate cuts as an opportunity to reduce long exposure or to initiate short positions. Investors should buckle up as 2008 appears headed for a turbulent ride.

II. Sector Analysis
The IEF-88.04 (I-share 7-10 year Treasury bond) gained sharply for the week as the yield on the 10 year Treasury declined from 4.10% to 3.85% on the week. The IEF has regained weekly upside momentum as broad equity market weakness has sent investors fleeing for the safety of U.S. Treasuries. We see 86.70 as a strong price support level for the IEF. Readers should look to buy weakness here as the Federal Reserve must abandon inflation fighting concerns in favor of re-igniting growth.

A. Financials
The ugliness continues for this battered sector. While possibly over-sold over the near term, the XLF (27.38) remains in a gnarly downtrend. The 30.00 price level is now very formidable price resistance. We would continue to underweight the likes of Bank America (BAC-39.85), CitiBank (C-28.24), Well Fargo (WFC-27.49), J.P. Morgan (JPM-40.93), and Washington Mutual (WM-13.07), and resist the temptation to “pick a bottom”. The only bank that appears attractive at this time is State Street Bank (STT-81.82). Any weekly closing price under 78.00 for STT would cause us to abort our bullish stance here.

The Brokerage sector (XBD-192.54) is sitting in a very precarious position. The 190.00 price level is a two-year low and if violated, does not bode well for the group. We could very well see the XBD drop to the 150.00 area. The 210.00 price resistance level seems to be an ideal short entry spot. With the derivative game essentially over for now, private equity on the sidelines, which eliminates heightened merger activity, only astute risky trading bets of the major brokerage firms can save this sector from further decline.

B. Builders
A couple of weeks ago we mentioned the Builders as a possible long trade. We stated emphatically that any weekly closing price for the XHB (16.99) under the 19.00 level would abort this short term bullishness. The last trading week of 2007 the XHB closed at 18.87 therefore our short term bullish view had changed. The XHB appears headed for further weakness. Once again readers must resist the temptation to pick a bottom in this sector. The 19.00-20.00 is now major price resistance with a near term downside price objective of 14.00.

C. Semiconductors
The precipitous three-day 20% decline in the shares of heavy weight Intel (INTC-22.67) speaks volumes for this sector. Previously strong names such as Texas Instruments (TXN-30.53) and Novellus (NVLS-24.69) also suffered similar fates. The Semiconductor Index (SMH-29.25) now rests perilously near a three year low. Any failure for the SMH to hold above the 28.00 price level will have dire consequences for the group. WATCH THIS LEVEL INTENTLY!!!

C. Retailers
This sector is screaming of an end to a healthy consumer. WalMart (WMT-45.72) and BestBuy (47.61), the two stronger price charts in the group are flashing pending signs of weakness. The weak get weaker as Home Depot (HD-24.96), Sears Holdings (SHLD-101.42), Target (TGT-48.08), Walgreens (WAG-34.29), and Kohl’s (KSS-40.90) all remain under heavy selling pressure.

D. Steels
Across the board weakness in the components of the SLX (81.00) has caused significant technical damage for this group. The story here has been strong demand from foreign growth. The recent price action in this sector is sending an important message. If the U.S. economy catches a cold, YES, the world economy as a whole will also come down with the sniffles. U.S. Steel (106.05), Nucor (NUE-54.82), Mittal (MT-73.14), and Steel Dynamics (STLD-55.53) are all flashing impending signs of coming price weakness.

E. Pharmaceuticals
At times this sector, defensive in nature, can be a nice place to hide when the economy weakens. The recent price action for the PPH (78.28) is proving this thought to be a myth. It is becoming apparent that this sector is beginning to price in a Democratic Presidential victory in the upcoming election. We see near term price support for the PPH around the 75.00 level. We shall look for any price rally to the 81.00 area as an opportunity to initiate a short position.

Take note that the VIX-23.94(CBOE Volatility Index) increased from a reading of 20.74 the previous week. Volatility held price support around the 18.00 area and is once again on the upswing. We see a test of the 30.00 level as quite apparent with even higher levels quite achievable in the current market environment.

III. Gold
GLD (streetTracks gold index) – The GLD-(85.13) advanced $2.13 or 2.57% for the week. After enjoying a sparkling net return in 2007 of 30.45%, the GLD has continued the strong upside momentum in to 2008 by gaining a quick 3.24%. The precious metal is now at a 28 year high with many a pundit now prophesizing $1000.00 per ounce in 2008 for the price of the yellow metal. With an economy suffering from “stagflation” and equity markets in turmoil, this may very well be the case.

From a technical standpoint the weekly trend for the GLD is to the upside, with the 81.98 price level being key weekly closing price support. We view the weekly chart as in a short term overbought stage and would only look to initiate long positions upon price declines to around our weekly price support level. Any weekly closing price below the 81.98 will signal a near term price correction to the 77.00-78.00 price area.

We currently have no position in the GLD.
IV. Energy- (Oil, Oil Service, Nat’l Gas, Coal)
The Large Cap Integrated Oils, despite crude oil reaching the $100.00 milestone, appear to have succumbed to overall market selling pressure. The XOI (1525.45) now appears vulnerable to a price correction to the 1425 price support area. Individual issues that are flashing weekly sell signals include the likes of Exxon Mobil (XOM-92.08), Chevron Texaco (CVX-93.35), and Conoco Phillips (COP-85.56). We would reduce long exposure upon rallies with the idea of repurchasing at levels 7%-10% lower.

The Oil Service (OIH-187.30) held up relatively well despite the broad market weakness. The 186.61 price level must be maintained on a weekly closing basis to keep the uptrend intact. Individual names in the space that have managed to maintain favored weekly technical status include Transocean (RIG-142.46), Schlumberger (SLB-98.00), Halliburton (HAL-38.01) and Ensco (ESV-59.03). At this time we would avoid Baker Hughes (BHI-79.61) and B.J. Services (BJS-23.06).

Natural Gas (XNG-571.82), after reaching new all time highs, closed the week on a sour note and has put in what is called a “key reversal” on the weekly chart. We shall look for a price correction to the 540.00 price area for the XNG.

The Coal sector, a stellar performer in the second half of 2007, is now signaling time for a price retreat. A Merrill Lynch analyst downgrade of the sector and overall market weakness has made the group vulnerable to a near term price correction. The meteoric rise in the shares of CONSOL Energy (CNX-65.48), Arch Coal (ACI-41.31) and Peabody Energy (BTU-57.78), has stalled. We advise reducing long exposure upon rallies in the Coal’s at this time.

V. Dow 30 Analysis
Our Weekly Trend Indicator (WTI) measures in at -28, a sharp decline from the previous week reading of +2. The Dow Jones Industrial average declined 4.29% for the week to 12792.70. After posting a roughly 6.50% gain for all of 2007, the DJIA has begun 2008 with the biggest first week decline since the year 1932. The S&P 500, as measured by the SPY (141.31), in three short trading days declined 3.35%, completely wiping out the 3.24% gain from all of 2007. Small caps issues, as measured by the IWM (IShares Russell 2000 Index Fund- 72.09), after posting a negative return of 2.70% in 2007, rang in the New Year with a decline of 5.04%.

The weekly chart of the DIA now firmly resides in the “sell the rally” mode. With 29 of the 30 Dow Industrial components currently in what we categorize as weekly “sell” formations, the DIA now faces very formidable headwinds. We now view the 132.00-134.00 price levels as major resistance and would view any rally to these levels as an opportunity to initiate a short position. We feel that the DIA is destined to test an important price support level around the 120.00 area.

Readers should take note that Dow Jones Industrial component AA is scheduled to report quarterly earnings this week.
Dow 30 stocks with positive weekly signals:
AIG
Dow 30 stocks with negative weekly signals:
AA, AXP, BA, C, CAT, DD, DIS, GE, GM, HD, HON, HPQ, IBM, INTC, JNJ, JPM, KO, MCD, MMM, MRK, MSFT, MO, PFE, PG, T, UTX, VZ, WMT, XOM

· Underline names have changed from previous week*
VI. OPEN POSITIONS
NONE
VII. CLOSED TRADES
2008 NET RESULTS ON CLOSED TRADES ASSUMING EQUAL DOLLAR AMOUNT INVESTED IN EACH TRADE:
VIII. KEY EVENTS IN THE WEEK AHEAD:
Monday, January 7
Economics
Earnings
Before: SCHN
After: BLUD, LWSN, QMED
Events
(())
Tuesday, January 8
Economic
10:00 Pending Home Sales: -0.5% cons.
3:00 Consumer Credit: $8.5 bln cons.
Earnings
Before: AYI, CYCL, STZ, CMOS, FDO, GAP, GBX, KBH, NUHC, RPM, SVU

After: APOL, EXFO, INTV, OXM, XRTX
Wednesday January 9
Economic
8:30 MBA Mortgage Applications:-11.6% prior
Earnings
Before: EMMS, HELE, MERX, MOS, TONS

After: AA, ETP, RBN, RT, WDFC
Thursday, January 10

Economic
8:30 Initial Jobless Claims: 336 k prior
10:00 Wholesale Inventories: 0.4% cons.
10:30 Crude Inventories

Earnings
Before: CRAI, MTB, MTRX, MTG, MSM
After: CAMP, HIS, SHFL, SNX, PAY
Friday, January 11


Economic
8:30 Export Prices ex-ag: 0.8% prior
8:30 Import Prices ex-oil: 0.7% prior.
8:30 Trade Balance: -$59.4 bln cons.
2:00 Treasury Budget: $52.0 bln cons.
Earnings
Before: INFY

After: HALO    

* The following information has been provided for informational purposes only and should not be used or construed as an offer to sell, a solicitation, or an offer to buy, or a recommendation for any security. EquityLetter does not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regard to the results obtained from its use.