equityletter.com 1/14/08

I. General Market Overview
The second trading week of 2008 brought more of the same action, continued selling pressure. Evidence continues to mount that the U.S. consumer is exhausted. With declining home equity and unemployment on the rise, the U.S. consumer’s tap has run dry. Lowered earnings guidance from several retailers and the increasing of loan loss reserves from credit card companies Capital One Financial and American Express were not well received by equity markets. The higher default rates from the credit card issuers signify that the housing induced credit crisis is spreading like wildfire to other areas of the economy.

In a speech last week Federal Reserve Chairman Ben Bernanke emphatically declared that the Fed stood ready to take “substantive” action to remedy the economy from the troubles induced by the current credit contraction. We remain of the view that the cure is just not that simple. Other than a resulting short term equity market bounce, aggressively lowering interest rates will not reverse the de-leveraging trend that currently faces U.S. financial institutions. The easy money era created by the Greenspan led Federal Reserve fomented far too many financial excesses that must take time and financial pain to cure.

The merger announced last week between Bank America and CountryWide Credit is one of necessity rather than synergy. CountryWide Credit is simply too big to fail. The ripple effects of such a failure could quite possibly have caused a complete seizure in the U.S. financial system. The rumored deal between Washington Mutual and J.P. Morgan is very similar in nature. One can only imagine the behind the scenes discussions between our Federal Reserve, Treasury Secretary Paulson, and these struggling financial institutions.

We continue to expect aggressive interest rate cuts in the near future. These rate cuts will cause a near term short covering equity market rally which should be used to reduce long exposure. The next four to six months will continue to be rough sledding for U.S. equity markets.

II. Sector Analysis
The IEF-88.57 (I-share 7-10 year Treasury bond) continued to trend higher last week as the yield on the 10 year Treasury declined from 3.85% to 3.82% 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 Financial Select Sector Index (XLF-27.50) continues to remain under heavy selling pressure. With the proposed bail out, I mean merger, between Bank America and CountryWide Credit and a rumored deal between J.P. Morgan and Washington Mutual we would expect some type of over sold bounce in this battered sector. We view the 30.00 price level as significant over head price resistance. State Street Bank (STT-82.80), of which quarterly earnings are due this week, continues to remain the most attractive technical chart of the group. Although currently in deeply over sold technical conditions, Bank America (BAC-38.50), CitiBank (C-28.56), Wells Fargo (WFC-28.20), and J.P. Morgan (JPM-40.86) continue to remain in negative weekly formations.

The Brokerage sector (XBD-191.48) broke our weekly support price level of 190.00 intra-week but managed to hold above it on a closing basis. We remain of the opinion that the XBD will face formidable price resistance at the 210.00 price level. Lehman (LEH-58.15) appears the most technically attractive at this time. Any weekly closing price below the 57.50 price level would cause a change of favored status for LEH. The rest of the sector, including Goldman Sachs (GS-198.74), Merrill Lynch (MER-54.69), Morgan Stanley (MS-48.39) and Bear Stearns (BSC-79.90), all appear poised for a near term bounce in share prices. We would view this potential bounce as short term in nature and an opportunity to reduce long exposure.

B. Builders
At this time we shall remain negative on the home building sector (XHB-16.65). It is not time to play hero and try to pick a bottom in this group. The highly anticipated coming interest rate cuts will not be a cure all for this bloodied sector. We would continue to avoid long exposure and look to short any significant rallies here. The 20.00 price level is now major over head price resistance.

C. Semiconductors
This group (SMH-28.20) has been punished mercilessly in the first two weeks of 2008. With quarterly earnings due this week from heavyweight Intel Corp (INTC-21.99), the sector is poised for a possible short covering upside rally. Once again, we would view any rally as short term in nature (possibly 2-3 weeks) and an opportunity to reduce long exposure. The weekly charts remain in “sell” mode for ADI, NVLS, SNDK, MU, AMAT, and TXN.

D. Retailers
The weekly technicals of this sector (RTH-86.50) are a direct reflection of the unfortunate state of the U.S. consumer. Despite a 4.00% rally in the shares of WalMart (WMT-47.72) this past week, the overall state of the sector remains to the downside. Whichever retailer we might choose to discuss, Target (TGT-49.95), Home Depot (HD-24.71), Walgreens (WAG-33.70), Sears Holdings (SHLD-96.17) or BestBuy (BBY-44.20), the weekly price trends continue to reflect distribution. Readers should use any significant price rallies in this sector to reduce long exposure.

E. Steels
Proving that there is currently no place to hide in this market correction, the steel sector (SLX-78.27) tested the low end of a sixteen week price range (75.00-90.00) last week. The bulls on this group like to cite the story of strong international demand for steel. We remain of the opinion that a U.S. economic slow down will adversely demand across the globe. A weekly closing price below 75.00 for the SLX will indicate further downside for this once Teflon sector. We would use any price strength in U.S. Steel (X-106.58), Nucor (NUE-53.91), Mittal (MT-67.07) and Steel Dynamics (STLD-53.19) as yes, an opportunity to reduce long exposure.

F. Pharmaceuticals and Healthcare
Last week we mentioned our dislike for the price action in the Pharmaceutical sector (PPH-82.66). We stated that we thought that this sector was not acting well despite the defensive nature of the group. It was stated by this writer that the group appeared to be pricing in a Democratic Presidential victory. Well, to our dismay, the PPH promptly rallied 5.65% on the week. Comments at a heatlthcare conference from various companies within the sector helped propel the group higher. Weekly buy signals have been generated by Pfizer (PFE-24.02), Merck (MRK-60.55), Wyeth (WYE-47.84), Johnson & Johnson (JNJ-67.88), Abbott Lab’s (ABT-60.50), and Eli Lilly (LLY-56.81). We would cover all short position and now begin to buy this sector upon price retreats.

We now believe it is time to buy Amgen (AMGN-47.62). Last week the company reaffirmed earnings estimates. We shall look to initiate a long position this week in AMGN. Our protective sell stop will be placed at 44.49.

G. Internet
The Internet sector (HHH-54.65) continues to remain in corrective mode. Google (638.25) must hold above the 600.00 price level or is destined to test the major 550.00 support level. Ebay (EBAY-29.68), Yahoo (YHOO-23.36), and Amazon (AMZN-81.08) all display technical traits of stock under distribution.

Take note that the VIX-23.68(CBOE Volatility Index) surprisingly enough, declined from a reading of 23.94 the previous week. Volatility held price support around the 18.00 area three weeks ago 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-(88.58) advanced $3.45 or 4.05% for the week. The GLD has maintained the strong upside impetus in to 2008 by gaining 7.29% in the first two weeks of trading. The precious metal seems to be benefiting from portfolio rebalancing as money managers attempt to participate in the strong upside momentum.

From a technical standpoint the weekly trend for the GLD is to the upside, with the 84.57 price level being key weekly closing price support. We continue to 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. The current extended nature of the weekly chart of the GLD has skewed the risk/reward ratio in favor of risk. Any weekly closing price below the 84.57 will signal a near term price correction to the 78.00-80.00 price area.

We currently have no position in the GLD.
IV. Energy- (Oil, Oil Service, Nat’l Gas, Coal)
Last week we stated that despite crude oil reaching the $100.00 milestone, the Large Cap Integrated Oil companies appeared vulnerable to profit taking. The XOI (1463.80) fell 4.04% for the week and now appears ready to test an important price support level, 1400.00. Individual issues that are flashing weekly sell signals include the likes of Exxon Mobil (XOM-90.30), Chevron Texaco (CVX-90.67), and Conoco Phillips (COP-83.04). We would reduce long exposure upon rallies with the idea of repurchasing at levels 7%-10% lower.

The Oil Service (OIH-179.75) has now succumbed to the broader market weakness. The OIH is flashing a weekly sell signal. We would use any rally approaching the 190.00 level to reduce long exposure in the OIH. Schlumberger (SLB-94.01) is due to report quarterly earning this week and we do not like the technical set up approaching said earnings. Previously strong names Transocean (RIG-136.39) and Halliburton (35.92) are now indicating that it is time to take profits.

Natural Gas (XNG-575.08), after reaching new all time highs in the prior week, rallied 0.57% for the week. We shall look for a price correction to the 540.00 price area for the XNG to initiated possible long positions in the group.

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-65.27), Arch Coal (ACI-39.17) and Peabody Energy (BTU-55.44), 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 -18, an unusual improvement from the previous week reading of -28. This improvement can be explained by the across the board strength in the pharmaceutical related components of the Dow Jones average. Pfizer, Merck, and Johnson & Johnson all displayed relative strength in the past week. The Dow Jones Industrial average declined 1.51% for the week to 12606.30 and is currently showing a negative return for 2008 by 4.84%. The S&P 500, as measured by the SPY (140.15), declined 0.83% for the week and is 4.18% to the downside year to date. Small caps issues, as measured by the IWM (IShares Russell 2000 Index Fund- 70.22), continue to under perform large cap issues. The IWM fell 2.59% this past week and is in the red by 7.63% year to date.

The weekly chart of the DIA, albeit currently in an over sold condition, firmly resides in the “sell the rally” mode. With 24 of the 30 Dow Industrial components currently in what we categorize as weekly “sell” formations, the DIA continues to face formidable over head price resistance. We view the 130.00-132.50 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 components C, GE, IBM, INTC, and JPM are scheduled to report quarterly earnings this week.

Dow 30 stocks with positive weekly signals:
AIG, JNJ, KO, MO, MRK, PFE
Dow 30 stocks with negative weekly signals:
AA, AXP, BA, C, CAT, DD, DIS, GE, GM, HD, HON, HPQ, IBM, INTC, JPM, MCD, MMM, MSFT, 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 14
Economics
Earnings
Before: FCSX, MTB
After: DNA
Events
Marcus Evans Location Based Services Forum
TD NewCrest London Oil Sands Forum
Financial Research Associates Investment Managers' Summit Financial Research Associates Hedge Funds Conference Bear, Stearns & Co. Inc. Latin American and Caribbean Markets Conference Financial Research Associates Microfinance Conference MicroStrategy Incorporated Annual User Conference Dresdner Kleinwort German Investment Seminar Chemical Week Associates Transportation, Distribution and Security Conference CLSA Asia Investors' Forum IQPC Real Estate IQ China 2008: 2nd Tier and Beyond Conference

Tuesday, January 15
Economic
8:30 Retail Sales: 0.1% cons.
8:30 Retail Sales ex-auto: 0.1% cons.
8:30 PPI: 0.2% cons.
8:30 Core PPI: 0.1% cons.
8:30 NY Empire State Index: 11.5 cons.
10:00 Business Inventories: 0.4% cons.
Earnings
Before: SCHW, C, FRX, LEN, MI, MESA, EDU, STT, USB, CBSH

After: CAMP, FUL, INTC, LCB, LLTC
Events
Euromoney Institutional Investor PLC The Central & Eastern European Forum Euromoney Institutional Investor PLC Saudi Arabia Housing Finance Conference Credit Suisse Group Auto Analysts of New York Conference RBC Capital Markets Canadian Bank CEO Conference Forbes Inc. Optimizing IT for the Enterprise-Washington D.C. Conference Capital Link, Inc Analyst Panel Discussion Santander Central Hispano Latin America Conference AeA Sales Leadership Roundtable

Wednesday January 16
Economic
8:30 CPI: 0.2% cons.
8:30 Core CPI: 0.2% cons.
9:00 Net Foreign Purchases
9:15 Capacity Utilization: 81.3% cons.
2:00 Fed’s Beige Book
Earnings
Before: AMR, ASML, JPM, NITE, LCRY, NTRS, PGR, WFC, TONS

After: CLC, GKK, KMP, LOGI, RMBS
Events
American Legal Media (ALM) Private Equity Saved Forum
ICR Inc. XChange Conference
Stanford Group Company Healthcare Conference
IncreMental Advantage-Managing Intellectual Property for Maximum Returns Confere... NAA The Chinese Automakers and the American Market Conference-NAA Members Only Standard & Poors Global Best Practices in ERM for Insurers and Reinsurers Confer... IPAA - Private Capital Conference Opal Financial Group Public Funds Summit Semiconductor Equipment and Materials Int'l Strategic Materials Conference

Thursday, January 17

Economic
8:30 Housing Starts: 1150 k cons.
8:30 Building Permits: 1140 k cons.
8:30 Initial Claims: 322 k prior
10:30 Crude Inventories: -6736 k
12:00 Philadelphia Fed

Earnings
Before: APH, BK, BBT, BLK, BGG, CIT, CMA, CBH, CAL, DSL, FHN, HBAN, IIN, IGT, MMR, MER, NVS, PH, PNC, PPG, AMTD
After: CREL, FNB, IBM, NVEC, PNFP, STX, SWKS, TRMK, PAY, WM, WIT, XLNX
Events
Deutsche Bank Annual Taiwan Conference
WJB Capital Group, Inc. ADC Telecommunications Conference Call Bear, Stearns & Co. Inc. Mortgage and Structured Products Conference Deloitte Touche Tohmatsu Private Equity CFO Roundtable NYSSA American Gas Association: Outlook for the Natural Gas Industry Conference Deutsche Bank Securities Inc. Hedge Fund CTO Summit IPAA OGIS Master Limited Partnership Conference Forbes Inc. Optimizing IT for the Enterprise-Chicago Conference

Friday, January 18


Economic
10:00 Leading Indicators: -0.1% cons.
10:00 Michigan Sentiment-Prel: 74.5 cons.
.
Earnings
Before: ACO, GE, JCI, SLB, WL

After:
Events
Wharton School Private Equity & Venture Capital Conference Bear, Stearns & Co. Inc. Mortgage Servicer Conference       

* 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.