Securities Research Services

Monday, October 30, 2006

Economic Trend in Rapid Decline

The trend is your friend is pretty much the basic battle cry uttered under the breath in mantra-like repetition of any experienced trader. On Friday the market got a fair look at the economic trend that has been unfolding with the release of the GDP report. The government has done decent job of covering up the declining economy and has given the market the impression that a "soft landing" was in the cards. In fact, economic growth has been in rapid decline, indicating that the recession projected by the inverted yield curve may in fact be right around the corner and not later next year as had been originally projected. The stock market reacted to this information by selling off against the underlying uptrend in a fashion that we have not seen since this trend began last summer. That was probably the warning shot across the bow. Wall Street has been doing a good job keeping this rally going and it seems unlikely that they will let go of this agenda prior to the elections next week. Likewise, as we mentioned, mutual funds are scrambling to put their latent cash to work as they close out the books on their fiscal year. These two factors should keep the current trend alive. That is to say that last Friday's sharp decline should be met with a sharp contra rally back up to the latest highs. There are signs, however, that this rally has finally hit the wall that will turn it back. Money has been flowing out of the Dow, which is a very different technical development from what was occurring as this rally was underway last July. Likewise, the semiconductor sector, which is a leading indicator for the tech sector, is developing a head and shoulders pattern and has met with sharp distribution on each move up to the upper end of its trading range. The S&P still has good money flow, which may be due to the fact that mutual funds are busy putting their money to work. The trend in this sector could continue for a while, while tech starts to diverge through underperformance. We will be using today to look for stocks that are rallying weakly back up to broken support in order to start balancing out our open positions with some shorts in the weaker sectors.

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