equityletter.com 1/21/08

Note: Event Calendar is located at bottom of page
I. General Market Overview
Bad news begets more bad news. A combination of unsettling corporate news and poor economic numbers continued to pressure U.S. equity markets. Tempered guidance from semiconductor giant Intel Corp., the poorest quarter of retail sales in seventeen years, worries of bond insurer defaults, efficacy questions concerning drug behemoth Merck and their cholesterol drug Vytorin, a “shadow” banking system riddled by the uncertainty of future loan loss provisions, should we continue the list? The major U.S. stock markets indices are down roughly ten percent in the first three weeks of 2008. When will the madness subside? Time and price is the only answer to this important question. At some point in time the markets will appropriately price in the negative issues that face the U.S. economy. We see potentially another ten percent haircut for the major U.S. indices.

A note to Federal Reserve chairman Ben Bernanke. If you are going to talk the talk, walk the walk. Ben, you obviously have not learned the lesson of trying to jawbone the markets. Eight months ago when discussing the potential de-stabling effects of increasing sub-prime loan defaults, you assured markets that the issues were well contained and would not spread to other areas of the economy. This poor attempt at jawboning damaged your credibility. My, my, your tune has certainly changed. You now speak of “substantive” fiscal and monetary stimulus. Mr. Bernanke, if your going to talk the talk, walk the walk.

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-89.61 (I-share 7-10 year Treasury bond) continued to trend higher last week as the yield on the 10 year Treasury declined from 3.82% to 3.65% 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. The bond market continues to anticipate “substantive” action from the Federal Reserve. Readers should look to buy weakness here as the Federal Reserve must abandon inflation fighting concerns in favor of re-igniting growth. Any weekly closing price below the 88.40 price level would signal a pause to the uptrend in the IEF.

A. Financials
The Financial Select Sector Index (XLF-25.50) fell by another 7.27% last week, remaining under intense selling pressure. The fear associated with the potential collapse of major bond insurers is rippling throughout the sector. State Street Bank (STT-74.08), which we have had a previously bullish outlook, has now given up the ghost. We would now use strength in STT to reduce exposure. Although currently in deeply over sold technical condition, Bank America (BAC-35.97), CitiBank (C-24.45), Wells Fargo (WFC-25.48), and J.P. Morgan (JPM-39.59) continue to maintain in negative weekly status.

The Brokerage sector (XBD-177.87) broke our weekly support price level of 190.00 last week and now appears destined to work lower toward the 150.00 area. We remain of the opinion that the XBD will face formidable price resistance at the 200.00 price level. Lehman (LEH-53.25) has closed below our weekly support price and now readers should look to sell any measurable price rallies. The rest of the sector, including Goldman Sachs (GS-187.21), Merrill Lynch (MER-51.87), Morgan Stanley (MS-45.11) and Bear Stearns (BSC-72.39), all remain mired in gnarly downtrends. Use any significant strength in the Brokerage arena to reduce long exposure or initiate short positions.

B. Builders
At present we shall remain negative on the home building sector (XHB-17.20). 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. On a bright note, near term bullish action in the shares of Pulte Homes (PHM-10.00) and Ryland Group (RYL-25.85) shall be noted. We would only look to initiate long positions in these names upon a re-test of recent lows. We would also emphasize using very tight sells stops on said long positions.

C. Semiconductors
As goes Intel (INTC-19.00) so goes the SMH (27.91)? Intel has lost 30% of its market capitalization in three weeks. By tempering forward guidance due to economic uncertainty in their recent earnings conference call, Intel has cast a cloud over the Semiconductor sector. This week we shall hear from Texas Instruments (TXN-29.46), will the negative news trends continue? We shall remain negative on sector components Micron (MU-6.44), SanDisk (SNDK-27.74), Novellus (NVLS-25.02), and Analog Devices (ADI-27.54). On a positive note, the shares of Applied Materials (AMAT-18.02) could be a possible outlier in the sector. We would look to purchase AMAT upon a re-test of last week’s lows (16.44). This positive signal would be aborted if AMAT closes the coming week below 16.44.

D. Retailers
This sector (RTH-87.80) managed to buck the general market malaise and squeak out a 1.54% gain for the week. It seems that the scenario of future fiscal and monetary stimuli has provided the impetus for some short covering. Home Depot (HD-26.28) is flashing a near term signal of strength. At best, we would consider purchasing HD shares upon a re-test of the 24.50 level. A weekly closing price above 48.08 would cause us to take a look at the shares of WalMart (WMT-47.58) from the long side. Walgreens (WAG-33.71), Sears Holdings (SHLD-89.43), and BestBuy (BBY-44.25), continue to reflect distribution and should be avoided from the long side at present.

E. Steels
The current weakness in the steel sector (SLX-72.26) is reflective of the wobbly state of foreign equity markets that at present act as stable as a three-legged stool. At this time we would continue to use any price strength in U.S. Steel (X-104.72), Nucor (NUE-51.22), Mittal (MT-62.70) and Steel Dynamics (STLD-48.57) as yes, an opportunity to reduce long exposure.

F. Pharmaceuticals and Healthcare
The last two weeks of price action in the PPH (77.45) is the definition of a whip saw. A study questioning the efficacy of Merck’s (MRK-53.32) cholesterol drug Vytorin, sent the drug makers shares in to a 12% tailspin for the week. Weekly buy signals that were generated in the prior week have been aborted in Pfizer (PFE-22.50), Merck (MRK-53.32), and Wyeth (WYE-43.84). Johnson & Johnson (JNJ-66.29), Abbott Lab’s (ABT-59.43), and Eli Lilly (LLY-53.71) managed to maintain favored weekly technical status but currently sit precariously near critical price support levels. We advise readers to step aside for the time being in the PPH until the extreme volatility subsides and a more visible trend emerges.

Last week we stated that it was time to buy Amgen (AMGN-47.45). We went long AMGN on 1-17-09 at 47.40. This week the company will report quarterly earnings. Our protective sell stop shall be placed at 44.49. Our upside price objective for AMGN is the 52.00-55.00 area.

G. Internet
The Internet sector (HHH-51.65) continues to remain in corrective mode. Google (600.25) must hold above the 600.00 price level or is destined to test the major 550.00 support level. Ebay (EBAY-28.33), which reports quarterly earning in the coming week, needs to eclipse the 30.00 level on the upside in order to regain positive momentum. Yahoo (YHOO -20.78), and Amazon (AMZN-81.08) continue to display the negative technical traits of distribution.

Take note that the VIX-27.18(CBOE Volatility Index) increased from a reading of 23.68 the previous week. We see continue to see a test of the 30.00 level as quite inevitable with even higher levels quite achievable in the current market environment. We would view any spike higher in the VIX to the 40.00 area as an indication of an apex of fear in the marketplace.

III. Gold
GLD (streetTracks gold index) – The GLD-(87.42) declined $1.16 or 1.31% for the week. Year to date the GLD is up 5.98%. The strong upside weekly momentum for the GLD appears poised for a near term pause.

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)
Holders of all energy related equities ran for the exit door en masse last week and as is usually the case, the exit door is only so big. The XOI (1348.47) tumbled 7.88% for the week, slicing through the psychological 1400.00 support level like a knife through butter. A test of the 1300.00 level now appears quit probable. Individual issues in the Large-Cap Integrated Oil space that remain in weekly sell signals include the likes of Exxon Mobil (XOM-85.08), Chevron Texaco (CVX-83.46), and Conoco Phillips (COP-72.89). These issues all appear to be in an over sold condition. This being stated, one must be quite nimble and very well disciplined if trading these names from the long side.

The Oil Service (OIH-161.60), which we warned of impending weakness in our previous letter, dropped by a vicious 10.10% in the past week. The sharp decline of the OIH has left it vulnerable to further downside to the 140.00 price support level. We would now use any rally approaching the 175.00 level to reduce long exposure in the OIH. Schlumberger (SLB-79.52) reported quarterly earnings last week and responded with a 15.41% drubbing. We would continue to reduce long exposure in previously strong names Transocean (RIG-128.41) and Halliburton (32.40) upon any significant price appreciation.

Natural Gas (XNG-527.78), after reaching new all time highs just two weeks ago, was unable to avoid the carnage and dropped 8.22% for the week. If the 200 day moving average of 513.08 is violated on a weekly closing basis the XNG could quickly slide to the major price support area of 450.00-475.00.

The Coal sector, a stellar performer in the second half of 2007, experienced a similar fate as the other energy sub-sectors, heavy selling pressure. The meteoric rise in the shares of CONSOL Energy (CNX-59.80), Arch Coal (ACI-35.62) and Peabody Energy (BTU-49.35), 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 -20, a slight decrease from the previous week reading of -18. A putrid 13% of Dow thirty components are in what we categorize as weekly “buy” mode. The Dow Jones Industrial average declined 4.02% for the week to 12099.30 and is currently showing a negative return for 2008 by 9.29%. The S&P 500, as measured by the SPY (132.13), declined 5.72% for the week and is 9.92% 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 4.27% this past week and is in the red by 11.90% year to date.

The weekly chart of the DIA, albeit currently in a deeply over sold condition, firmly resides in the “sell the rally” mode. With 26 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 now view the 128.00 -130.00 price levels as major resistance and would view any subsequent rally to these levels as an opportunity to initiate a short position. The DIA is now testing a key price support level, that being the 120.00 area. Any failure to hold above 120.00 on a weekly closing basis will indicate further downside and an eventual test of the 110.00 price support level.

Readers should take note that Dow Jones Industrial components CAT, DD, HON, JNJ, MSFT, PFE, T, and UTX are scheduled to report quarterly earnings this week.

Dow 30 stocks with positive weekly signals:
HD, IBM, JNJ, MO,
Dow 30 stocks with negative weekly signals:
AA, AIG, AXP, BA, C, CAT, DD, DIS, GE, GM, HON, HPQ, INTC, JPM, KO, MCD, MMM, MRK, MSFT, PFE, PG, T, UTX, VZ, WMT, XOM
· Underline names have changed from previous week*
VI. OPEN POSITIONS
AMGN- 1-17-08 Long @ 47.40, sell stop 44.49
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 22
Economics
Earnings
Before: FCSX, MTB
After: DNA
Events
Tuesday, January 23
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
Wednesday January 24
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
Thursday, January 25

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
Friday, January 26


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 

* 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.