Benjamin F. Edwards & Co.

By Pete Biebel, Vice President

The market had another strong week. The broad averages all gained nearly 2%. The S&P 500 has pushed beyond the upper end of the range I had been expecting. While it’s nice to see the averages continue higher, it’s a little unnerving seeing how frothy the market is getting.

Seeing the market perform so well in the face of concerns like a plodding recovery, fiscal irresponsibility, looming international financial crises and continuing high unemployment is like seeing an overweight, pack-a-day smoker with bad knees leading in a 10-K. Where I had expected to see a wheezing, coughing market stumble into a correction, it instead kicked up its heels and sprinted higher. Each time it appeared to be reaching the point of exhaustion, it ran beyond what seemed plausible.

There’s little doubt that much of the impetus for this behavior has been from external, stamina-enhancing sources. We’ve known for a while that the Fed’s quantitative easing has been helping to juice the performance of the stock market. Although the Fed’s mandate was never to run the market averages to new highs, their monthly liquidity injections have served to turn our Ralph Kramden economy into a Steve Austin market.

Another part of the explanation is that factors like unemployment, higher payroll taxes and higher gasoline prices have very little impact on the people who are investing in stocks. For investors, the stock market is the only game in town. The Fed’s purchases have pushed fixed-income prices to very expensive levels. Bonds provide very little hope for a decent return. As long as the equity averages keep trending higher, those investors have little choice but to throw more money at the stock market.

A third source of buying power is the covering of short sale positions. Many traders have doubted the ability of the market to continue higher. The more aggressive of those traders have repeatedly attempted to bet on a market top by short-selling stocks. Those shorts have repeatedly been crushed by the market’s run and have repeatedly been forced to pay up to close out the losing positions. The percentage price increases in the most shorted stocks has been two to three times greater than the rest of the market.

As I mentioned last week, we’ve recently seen the buying shift to the more cyclical, speculative sectors away from the conservative, defensive sorts of stocks which had been the leaders in the early stages of the rally. Volume is still questionably low. The short squeeze, the sector rotation and the low volume are signs that the market’s legs are beginning to wobble. If we could see its heart-rate monitor, it would probably be glowing red. While there are no signs that the market has gone into shock, it does seem to be hyperventilating. If our hero stumbles now, he’s in danger of being trampled by a herd suddenly running in the opposite direction.

On the positive side, the market’s upward momentum, which had leveled-off through March and early-April, has ramped back up to its highest level in two years. That suggests that, even if a short-term pullback is right around the corner, a higher high is still likely over the intermediate-term. Four sectors in particular, Consumer Staples, Consumer Discretionary, Financials and Healthcare, have also achieved levels of upward momentum that are probably too high to suggest that a long-term top is at hand.

I had expected that the 1650 area on the S&P 500 (SPX) would be the average’s upper boundary over the past few weeks. The index nosed through 1650 last Wednesday and Friday’s new record closing high at 1667 is about one percent above that level. I’ll guess that the averages will not be able to climb much beyond current levels. The frothiness suggests we need a time-out. A blow-off rally that quickly reverses is still a possibility, but less likely now after last week’s action. The odds are against our runner continuing much further, but that doesn’t mean he won’t. I just wouldn’t bet on it.

Three or four weeks of dull, sideways action, similar to the average’s behavior through March, would help to restore the strength in market’s weary legs. The risk is that we won’t get off that easily. Even a short-term pullback could bring much greater volatility. The 1600 level is about the mid-point of SPX’s April/May advance. Dropping back to that level would only be about a 4% pullback.

One topic you might want to discuss with your financial advisor is how much the sector weightings in your portfolio have changed over the past six months. A little rebalancing now could be just what the doctor ordered.

The big event on this week’s calendar of economic news is a pair of items from the Federal Open Market Committee on Wednesday. At 10:00 EDT, Chairman Bernanke will testify before the Congressional Joint Economic Committee. Even more significant will be the release of the minutes of the FOMC’s May meeting at 2:00 that afternoon. Of particular interest will be any comments regarding the potential tapering of the Fed’s quantitative easing program and to what degree they address evidence of excessive risk-taking.

Scheduled economic reports on Thursday include the weekly Initial Jobless Claims and New Home Sales. Initial Claims have continued to trend lower despite last week’s unexpectedly high 360,000 reading. This week’s report is likely to come in around 345,000 for the week ended 5/18, a level that is just above the four-week moving average. The rate of New Home Sales, after trending higher for the past two years, has been hovering near its four-year high. The annual rate of new home sales in April is expected to come in around 425,000 units, above March’s 417,000, but not quite back to January’s 437,000.

An update on Durable Goods Orders will be released on Friday. While the consensus expectation is for an increase of a little over one percent, many expect a weaker number. The volatile Transportation component is expected to help the overall number. The consensus on the “ex-Transportation” reading is for just a 0.4% increase.

By Pete Biebel, Vice President

The party is in full swing. The stock market had a pretty good week. The major averages gained 1 to 2%. The ratio of advancing issues to decliners was about 5 to 2. And the number of stocks setting new 52-week highs was the highest weekly total in months. Overall, it was good follow-through action after the breakout rally on Friday, May 3rd.

Even the best parties have some undesirables. Two areas of concern at this current soiree are volume and sector-rotation. The volume last week was fairly low, and that’s generally not a good sign in an uptrend. Perhaps the reason is just that willing sellers are harder to find. Anyone who has taken a profit over the past couple months has probably realized that they got out too early. Even short-term traders are now likely more inclined to sit on positions. They’ll hang on into the wee hours rather than leave the party early.

Looking at sector performance, we see that Consumer Staples and Utilities were down for the week. They didn’t just underperform, they went backwards. The Healthcare sector managed a small gain for the week, but it lagged well behind all the other sectors that were up for the week. Those three sectors had been this bash’s rock-stars. Now they seem to be losing some of that festive spirit. The sideline money that had been pouring into defensive stocks has apparently concluded that those sectors have gotten too rich. The NASDAQ Composite has outperformed the Dow and the S&P 500 over the past several weeks. Meanwhile, international markets and the more cyclical sectors have been showing improving strength. Apparently, these more speculative groups have become the target for new purchases.

Volume is too low and speculation is increasing, but it’s not time to go home yet. Enjoy the party, but be alert for signs of trouble. Keep mingling, but be ready to duck. I still think that the 1650 area on the S&P 500 (SPX) is likely the upper end of the market’s range over the next few weeks. 1600 should provide pretty solid support. Violating the 1580 level, which is about 3% below SPX’s closing price of last week, would set off the alarms.

One fairly reliable sign of a short-term top in the price of an index (or a stock or a commodity) is a Key Reversal. While a key reversal can occur on any timeframe (hourly, daily, weekly, etc.), I suspect that conditions are in place allowing for a key reversal on the major indices in one of the next few weeks. These reversals normally occur at the end of a long trend and signal exhaustion of the move. For a key reversal on a weekly basis, the index makes a new high, usually early in the week, but then reverses and ends the week below the previous weekly close or, even worse, below the previous week’s low. The probability of such a formation in the next few weeks is pretty low, about the same as the probability of that person next to you at a party choking on a bacon-wrapped water chestnut, but if it happens, you’ll be glad you knew the Heimlich maneuver.

The calendar of economic reports this week should provide a little more excitement than last week. The report on Retail Sales for the month of April will be released this morning. On a year-over-year basis, sales have been growing at a decreasing rate. After a surprising 0.4% decline in March, the consensus for the April Retail Sales reading is a 0.3% decrease.

PPI and CPI updates are due on Wednesday and Thursday. Economists expect PPI for April to decline 0.7% following a 0.6% drop in March. The core rate, excluding food and energy, is expected to tick up 0.2% matching the increase in the prior month. It’s a similar story for CPI: the overall rate is expected to decline again (-0.3% in April vs. -0.2% in March), while the core rate is expected to show another small increase (+0.2% vs. +0.1% in March). Wednesday will also bring an update on Industrial Production; a small downtick of 0.2% is expected following a 0.4% increase for the prior month.

Thursday’s weekly Jobless Claims number will probably come in around 352k after a surprisingly low 323k last week. Thursday will also see updates on Housing Starts and the Philly Fed Survey. A large increase in the number of multi-family units contributed to big jump in the March Housing Starts reading, which showed 1.036 million annual new starts. However, a decline in the number of new building permits in March suggests that the April Housing Starts reading will likely decline to about 970,000 annual new starts. The Philly Fed Survey is expected to show another small increase in manufacturing, +2.2% compared to +1.3% in March.

Have fun. Be safe.

By Pete Biebel, Vice President

Last week I guessed that if the S&P 500 was going to climb above 1600, then it would need to happen very, very soon. On both Monday and Tuesday, the S&P probed that barrier. When the market pulled back on Wednesday, it raised doubt about its ability to move beyond 1600. Then Thursday’s rally ran the index right back up to the edge and provided momentum for Friday’s vault up and over.

The S&P 500 Index had lapped up against the levee at 1600 each of the first four days of last week. The attempts at that level served to clearly define the obstacle. The pressure was building and everybody was watching to see if the barrier would hold. Friday morning’s employment report proved to be dam-busting news, and the market surged through 1600 and rushed onward. When it was exceeded, a flood of buyers rushed in and any potential sellers quickly backed away.

But now what? Was Friday’s action the resumption of the uptrend, or was it a buying climax? I have no reason, yet, to doubt the trend. Over the past couple months, each time that the market seemed to be deteriorating and that an intermediate-term high was potentially forming, the averages were able to hold above the “danger zone” levels and eventually move higher. Even last week, when the market was in a position where it had to move higher and soon to avoid rolling over, it moved higher. With the upward momentum generated by the Thursday/Friday surge, 1625 becomes my next short-term target, and 1650 is the top of any range I would expect to see in the next couple months.

The Thursday/Friday surge could also have been the last-gasp effort of an aging bull. That may be a low probability scenario currently, but I’ll be watching for indications that the probability is increasing. I would be very concerned if the S&P 500 dropped back below 1565, especially if that level was broken in just the next few weeks. And, although it’s unlikely, if S&P 500 ends this week below 1580, I would treat it as a very negative development. That type of quick, sharp reversal following last week’s surge would be a sign to take defensive action.

Last week’s stampede was a good one for the long-shots, from a sector perspective. The dark horse Technology sector came out of nowhere to lead the pack, and by a healthy margin. Energy and Industrials also turned in surprisingly strong runs. That’s a trifecta that would have paid very well based on the early-week odds. Consumer Staples, Healthcare and Utilities had been the odds-on, pre-race favorites based on their recent performances, but they struggled to finish at the rear of the field. The Utilities sector was down for the week. The international indices have been performing better lately; the Emerging Markets sector and European markets had a very good week. The EAFE Index now has the best five-week performance of all the sectors I track.

One conversation-inspiring aspect of the recent volatility in precious metals prices is the size of the premium being paid for some physical metal products. One-ounce silver coins, for example, are selling at prices about 20% above the spot price of silver. I mention this because recent discussions in the media have suggested that “paper” metal (positions in gold and silver futures contracts or ETFs) are likely to underperform physical metal prices if that market was to spike higher for whatever reason. (“Try buying food with an ETF!” is a common argument.) Is this premium price for silver coins symptomatic of the de-coupling of prices? Can we not trust “paper” gold and silver?

The rush to buy easily portable, easily “transactable” metal in smaller size/denomination silver bars and coins has been especially evident since the precious metal melt-down two weeks ago. Demand is high and supply is low at a time when anxiety is high. Ergo, ipso facto, abracadabra, a premium price results. Why, then, is this demand not also reflected in the price of the metals’ futures and ETFs? The reason is that the supply of futures contracts and ETFs is not limited; the supply of coins is. In fact, the following three current market realities are strong arguments that the “paper” and physical prices are not de-coupling and that, at least for the time being, the “paper” prices are still representative of the market prices for the metals…

1. The bid price for the one-ounce silver coins is more than 10% below the offer price. Knowing that, we can conclude that the premium asking price is actually more indicative of an illiquid market than of any detachment from the “paper” market.
2. The market quote for 1,000 ounce silver bullion bars¹ is right on the spot price of silver. The asking price for such bars is a mere 1% premium over spot.
3. A similar phenomenon is evident in the physical gold market. One-tenth ounce coins are offered at a 10 to 12% premium over spot. Larger coin and bullion sizes are trading with much smaller, if any, premium.

The week ahead will be very light on economic reportage. The big number of the week will be the Jobless Claims report on Thursday morning. The most important aspect of this week’s only potentially market-moving number is that it will serve as your subliminal reminder to order some flowers and get your Mother’s Day card(s) in the mail. If you have not yet purchase your card(s), let alone mailed it/them, then, when you hear the commentator announce the update on Initial Claims for Unemployment on Thursday, that will trigger a reminder to drop everything and take care of your responsibilities for the approaching holiday.

Expect Initial Claims to come in around 330,000, slightly above the prior week’s number. Last Wednesday’s disappointing ADP report weighed noticeably on the market. Last Thursday’s Initial Claims number was much better than had been expected and, in combination with Friday’s new and improved Unemployment number, helped launch the averages higher. A big surprise in the unemployment claims report could be a strong catalyst for the market, one way or the other.

¹ This is a product size with available supply, but limited demand. From a portability and “transactability” standpoint, this may still be a reasonably transportable size, but don’t expect to be able to get change for one at your local gas station or fast-food drive-thru. It would be about as useful as a $24,000 bill that weighs 60 pounds.

By Pete Biebel, Vice President

Picture a trio of characters rolling a huge log up a hill. In the beginning, the going was easy. Their legs were fresh and the hill was not too steep. It was kind of like our stock market climbing higher in early-January.

When the hill got steeper and their strength began to ebb, a couple friends came along to help roll the log higher. That effort contributed to the February gains. When their endeavor needed more muscle in March, another helper arrived. The higher they got, the tougher it became to make additional progress. It’s the same with the stock market.

The week before last (S&P, Dow and NASDAQ all down more than 2%), it looked as though the group had progressed as far as they could, and were in danger of losing control of the log and having it roll back. Then last week, out of the blue, another character showed up to help. The question now centers on the capability of the new helper to add propulsion: Will this late help be able to make a significant contribution to the progress, or has our new helper already spent what little energy he/she brought?

The week before last, the damage to the market averages warned that the market’s five month rally may have seen an intermediate-term top. If we had seen much follow-through selling last week, that would have sealed the deal. Instead, the market reversed and quickly climbed back above what I had called the “all clear” level, 1570 on the S&P 500. Unfortunately, that’s all it did. The major averages did not break out and race higher. In fact, most did not even get back to their recent highs. So, while the rally came in the nick of time, it failed to provide enough progress to eliminate the worry. Our heroes stopped the log from rolling further downhill, but they don’t seem to be able to move it higher.

Sector performance last week raised another concern. The three sectors that had been the undisputed leaders of the rally performed poorly last week. All three reached new highs intra-week, but ended the week well off of those highs. Consumer Staples and Healthcare were down for the week, and Utilities finished with a minute gain. The sectors with the best performance last week were the dogs: Basic Materials and Energy. I doubt that either of those sectors will be able to continue that outperformance.

Now the market is in a position where, I believe, it must break out to new highs very, very soon, or risk dropping into a more prolonged correction. If the S&P 500 can punch through 1600, we’ll need to see immediate follow-through and the ability of the index to hold those gains if we have any hope of seeing sustained higher prices in the near future. The 1540 level on the S&P is now the key area; violating that support would greatly increase the probability that the major averages have seen an intermediate-term top.

My bias continues to be to wait for more evidence before deploying new capital into stocks. Talk to your financial advisor about what actions, if any, you might want to take if the averages roll over in the next week or two.

The week ahead brings another bountiful week in “Earnings Season.” This will be the last of the big weeks; we should see reports from 132 of the S&P 500 companies. Subsequent weeks will have no more than 35 quarterly earnings reports from those 500 companies.

The key economic data this week will bring updates on Employment, Housing and Manufacturing. The Employment data begins with the ADP report early Wednesday. Economists expect the ADP report to show an increase in private payrolls of 155,000 jobs, slightly below the March reading. The Jobless Claims report will be released early Thursday; expectations are for an increase to 345,000 new claims compared to 339,000 in the previous week. Friday morning features an update on the Unemployment Rate, which is expected to remain at 7.6%.

The housing data, including updates on Pending Home Sales today (consensus +0.9% versus -0.4% previously) and the S&P/Case-Shiller Home Price Index tomorrow (consensus home prices up 1% in February and up 8.9% year-over-year versus 8.08% previously), are expected to show continuing improvement, but are unlikely to move the market.

The Dallas Fed Survey leads off the manufacturing sector data today. This index of manufacturing activity in Texas is expected to come in around 5.0; solid, but down slightly from March’s 7.4, the highest reading in a year. Wednesday morning should see updates on both the PMI Manufacturing Index (expected to remain flat at 52.4) and The ISM Manufacturing Index. Expectations for the ISM survey are for a slight down-tick to 51.0 from 51.3. Recent reports from New York (Empire State) and Pennsylvania (Philly Fed) have shown disappointing manufacturing growth in those states. Economists will be watching to see if that disappointment is spreading to other regions.

Personal Income and Outlays will be announced this morning. Small upticks are expected for both. Personal Income likely increased 0.4% compared to a 1.1% increase in the prior month. The consensus for Personal Spending is an increase of 0.1% following an increase of 0.7% in the prior month.

International Trade numbers will be reported on Thursday. Economists believe the balance of trade deficit probably decreased slightly to $42.3 billion from a $43.0 billion deficit in March. The FOMC will publish the minutes of their most recent meeting on Wednesday afternoon.

By Pete Biebel, Vice President

The timing and the extent of the market’s weakness last Monday was Wall Street’s version of the tornado sirens blaring. Like the thermometer on an unusually warm spring day, the S&P 500 had just recently climbed to record levels. My concern was that, if those gains were given back quickly, then the previous week’s quick rally would likely turn out to be the failing last-gasp of a long uptrend. In that case, we could be in for some stormy weather. That concern became a reality last Monday. If the barometer had dropped as quickly as the market averages that day, then we’d all be seeking shelter in the basement.

The S&P, which closed near 1589 on the previous Friday, quickly dropped below 1570 on Monday. That breach greatly increased the odds that the recent high would not be exceeded any time soon. The index dropped into the 1540 area later in the week before rebounding on Expiration Friday. Overall, it was a pretty damaging week.

The good news is that it’s not universally bad news. While there are many sectors where it’s already raining heavily, we can still see areas where conditions are favorable. Consumer Staples, Utilities and Healthcare indices are all at or very near recent highs. Conversely, Basic Materials and Energy have already sustained heavy damage. And, over in Precious Metals Land, the unfortunate residents of Gold-Burgh and Silver-Town got pounded.

Small-cap stocks, as evidenced by the Russell 2000 Index, have already broken down ahead of their large-cap brethren. Another threatening sign is the recent performance of the DAX, a key German stock market index, which has been more or less paralleling our market for nearly a year. Germany’s role in the efforts to resolve the European financial crisis makes this gauge of their market an indicator for the likelihood of a successful resolution to the crisis. The DAX had a pretty rough time last week. It dropped to a new short-term low and is now down for the year.

I think it’s time to prepare for some stormy weather. I’ve written recently about keeping the rain parka handy; now is probably a good time to turn on the weather radio. Remain clam, don’t panic, just be prepared to take action. Talk to your financial advisor about a defensive plan for your portfolio.

Here are a few things to watch for as the radar images are updated:

• Seeing the S&P 500 close above 1570 would be a good sign, or the “All Clear” signal.
• I believe a more likely course is for S&P 500 to drop through the 1540 level that marked the area of last week’s lows. Seeing that would increase the probability of further declines.
• Once below 1540, a decline to and test of the 1520 area would be likely. Closing below 1520 would be a sign of weakness, or a “signal to take shelter.”

This will be the third week of the new Earnings Season, and where last week was the largest in terms of capitalization of the companies reporting, this week will be the biggest week in terms of the number of companies reporting. Over the next five days, 178 (or 35.6%) of the S&P 500 companies are due to report.

The key economic reports this week begin with Existing Home Sales today followed by New Home Sales tomorrow. Annual sales of existing homes have been trending higher for the past couple years. February’s reading of 4.98 million was the highest level in over three years. The consensus for March’s number is 5.01 million. The rate of new home sales declined in February following a big increase in January. The expectation for the March number is 420,000 homes, just below the January peak.

The report on Durable Goods Orders is due on Wednesday morning. The volatile Transportation component has caused some erratic readings over the past few months. February saw a larger-than-expected increase of 5.7% after a surprising decrease of 3.8% in January. The number for March is expected to show a decline of 2.9%, but the “ex-transportation” reading should show an increase of 0.6%.

The latest Jobless Claims report will be released early Thursday. The consensus is for 351,000 new claims, roughly in line with the prior week’s number. The consensus for First Quarter GDP growth, due out on Friday, is an increase of 3.1% driven largely by an estimated 2.8% increase in personal consumption. A poor GDP report could be a negative catalyst for the market.

Please don’t blame the weatherman weatherperson.

By Pete Biebel, Vice President

Following on the heels of its worst week so far this year, the market, last week, had its best week since early-January. The major averages all posted gains of between 2% and 3%. For the past few weeks, I guessed that if the S&P 500 rallied through 1570, then it would reach the 1585 – 1590 area quickly. I also guessed that such a surge would be temporary and likely a good short-term selling opportunity. Now that the market has climbed to these lofty levels (the S&P 500 ended the week at 1589), I think my guessing could use a little fine-tuning.

The market has outperformed and outlasted its doubters. Like some hyperactive kid at a fancy wedding reception, it refuses to slow down. The carousing hasn’t been without a trip or two, but no damage, no serious injuries. Last week was the equivalent of another cupcake and a couple of Mountain Dews. This thing is really wound up, but now even the casual onlooker realizes that the end could be coming soon and it could get messy.

While I believed this sort of rally was a low-probability event, the way in which it unfolded is about what I expected. It was quick (about 90 minutes Wednesday morning), the leading groups continued to lead, and it was fueled, in part, by short-covering (some of the biggest gains were in some of the most heavily shorted stocks). The week saw no evidence of any budding improvement for stocks in emerging markets or China. Both Gold and Silver sparkled with modest gains early in the week. Both melted under heavy selling pressure late in the week.

However, the rally also had a couple of unexpected features. It was broad, and it was persistent. For the week, advancing issues outnumbered decliners by about an 8 to 3 ratio – that’s pretty good breadth. The week also produced 604 new (52 week) highs among NYSE stocks. That’s not quite as many as the early-March weeks generated, but it’s still a solid result. The rally saw a respectable follow-through attempt on Thursday, and, in the face of some lousy news and a weak opening on Friday, the averages gave back relatively meager fragments of their early-week gains.

The broad averages are performing better than I expected. I’m not seeing any signs to the contrary in the other indicators/sectors that I’ve been watching for clues. I had expected that any quick burst higher, like we had last week, would be a good short-term selling opportunity. Now that we’ve seen the burst, I wouldn’t be in a rush to sell just yet. Take advantage of this opportunity to raise stop-loss levels on tactical positions. That quick burst higher also increased the risk/reward ratio over the near-term. I’m not inclined to be a buyer at current levels.

The round-number level, 1600, will probably now be a magnet for the S&P 500. Although I won’t be surprised to see that level reached soon, I doubt that the S&P 500 will be able to climb much above 1610 over the next several weeks. If it drops back into the 1570 area or lower this week, then the “last gasp spike higher” scenario may still be in play. The 1525 level is where the alarms would go off (“Hey, that kid just knocked over the wedding cake!”), but that’s now a long way away.

Although last week marked the official beginning of another long Earnings Season, the vast majority of the earnings reports will be made over the next three weeks. This week, 74 (or 14.8%) of the S&P 500 companies are due to report. Those companies represent about 26% of the Index’s capitalization, so this week brings more than its fair share of large-cap company reports. Remember as well that this week ends with an option expiration Friday.

The key economic reports this week come on Tuesday and Thursday. Tomorrow morning we’ll get a triple-header with reports on CPI, Housing Starts, and Industrial Production. Economists believe the CPI report for March will show little if any change in the index following a .7% increase in February. A 0% reading for March would reduce the year-over-year inflation rate to 1.6%. The core price index is expected to show a 0.2% increase for a year-over-year rate of +2.0%. Housing Starts should show continuing improvement. Starts in March likely increased to about 930,000 (annual rate), from 917,000 in the prior month. After climbing 0.7% in February, Industrial Production is expected to show just a 0.2% gain for March.

On Thursday, the ever-popular Jobless Claims report will be accompanied by the results of the latest survey of manufacturing conditions by the Philadelphia Federal Reserve. The consensus for Jobless Claims is for 347,000 new claims, roughly the same level as the 346,000 initial claims reported for the prior week. Last month’s results on the Philly Fed Survey showed a small uptick (+2.0) following two months of contraction (-5.8 in January and -12.5 in February). The consensus for this month’s reading is +0.0.

Enjoy the party, but keep the mop and bucket handy.

By Pete Biebel, Vice President

We were just riding along in the comfort and security of our bull-market limo, when there was a sudden sort of thump/bump/bang. “Goodness!! I nearly spilled my bubbly! Check with the driver, darling. See if he thinks something is amiss.” Last week the market hit some sort of bump in the road. Was it just a bad-economic-report pothole, or are the wheels beginning to fall off of the vehicle? Depending on which gauges you check, your reaction could be anything from, “No worries, James, just keep going,” to “Pull over! I wanna get out!”

The market has had many wild days recently. In a week with many triple-digit days, the Dow lost about 13 points, less than one-tenth of one percent. So, looking at the DJIA as our indicator, nothing happened. “Perhaps we just grazed a hitchhiker.” Why all the fuss? The DJIA is made up of two-and-a-half dozen of the bluest of the blue chip stocks; they are the biggest of the big-capitalization stocks, and, on balance, they had a yawner of a week. Unfortunately, the same cannot be said for mid-cap and small-cap stocks. On balance they had a pretty bad week. “Should we call road-side assistance?”

Looking for information in the more diverse, lower-capitalization averages, we see definite signs of trouble. The S&P 500 was down 1% for the week; the NASDAQ Composite was down 2%; and the Russell 2000 Small-Cap Index was down 3%. Also worth noting is that the Dow Transportation Index lost 3.5% for the week. Another ominous sign: Like a temperature gauge soaring into the red, the recent spike in Treasury note prices suggests that a lot of money is rushing into government bonds, in a “flight to safety.” The yield on the 10-Year Note, which had poked above 2% as the Dow was making its March highs, has plummeted to 1.7%.

The Consumer Staples, Healthcare and Utilities sectors continue to be the best performing groups. They’ve been at the top of the charts for the past several weeks. Now I’m seeing a distinct dichotomy among the sectors: We have the three clear leaders at the top with the other sectors lagging badly. Most of those other sectors have recently broken below their respective uptrend lines off the November lows.

The S&P was unable to punch through 1570. The index saw a quick 2% retracement, dropping to 1540 in early trading on Friday. With last week’s damage, the odds have increased for a test of the 1525 area for the S&P.

If I’ve been waiting and hoping for a correction in the rally, then why am I so concerned about one not-so-good week? The reason is that conditions are right for an intermediate-term top. The series of higher highs on the major indices has been accompanied by a divergence in the market’s upward momentum. When upward momentum was still strong, we could have confidence that any short-term pullback would be temporary and new highs would be reached soon. That is no longer the case. Where most market sectors were participating in the market’s gains through January and February, several of those sectors have recently seen significant deterioration in their ability to keep up.

I believe the keys over the next couple weeks will be…

• Will the S&P be able to hold at or above 1525? Dropping through that level would greatly increase the odds that an intermediate-term top has been seen.
• Will S&P be able to push through 1570 on a rebound rally? The market would need to see such a move soon to maintain any upward momentum.
• If so, will we see good breadth and wide participation in the rebound?
• Will Treasuries continue to rally?
• Will gold and silver reverse their current downtrends?

Even with last week’s pullback, I still need to allow for an attempt at a blow-off sort of rally to slightly higher highs. I still don’t think it’s a high probability, but if the index punches through 1570, then 1585-1590 will likely be reached quickly. In that scenario, I expect the three strong sectors noted above would be able to reach new highs, but none of the others. As noted last week, “Those gains, if and when they occur should be fleeting. That sort of blow-off move, if and when it occurs, could be a prime, short-term selling opportunity.”

The week ahead doesn’t have much in the way of economic data. On Wednesday afternoon, the minutes of the most recent FOMC meeting will be released. And Thursday morning, of course, the report on New Jobless Claims will be at the center of attention. The consensus is for 360k new claims vs. 385k in the prior week. On Friday morning, we’ll get updates on both the Producer Price Index (down 0.4%, core up 0.2% vs. +0.7% and +0.2% for Feb.) and Retail sales (down 0.2%, ex-autos down 0.2% vs. +1.1 and +1.0%). After the close today, we’ll get the first earnings report to kick off the new Earnings Season. And though this week is a light week in that regard, we should expect that corporate earnings news will increase in significance in the next couple weeks.

Happy Motoring!