All indications were pointing to profit taking of some kind, with the big unknown being the severity of the decline.  With the action of last week and today, it seems we’re getting the answer.  Any correction won’t be severe.  Over the weekend I mentioned the following to registered members in the Weekly Market Review:

"Technical forecasts have been calling for some sort of correction (me included), but the big unkown is by how much and how severe.  If the action continues anything like last week, we won’t be down for long.  Despite a round of economic numbers last week that indicate an economy slowing a bit more than expected (who really knows what the heck is going on with the number of jobs?!), the major indices managed to hold their upward trends throughout the week.  I’d call it a big victory for the bulls.  The weekly pull back occurred on light volume.. just the kind of digestion you want to see.  The longer the bulls hold their ground and keep the market in the upward trend, the greater the chance we’ll be off to the races again.  However, with the elections on Tuesday and the deteriorating action in leading stocks last week, it pays to be very cautious at this point.  The action next week will be pivotal.  Stay tuned for the After Market reports during week!"

I certainly didn’t expect the bulls to come charging out of the gate Monday morning ahead of tomorrow’s election, but that’s what the market does best.  Move when you least expect it.   Today’s action was not out and out, frenzied buying by any stretch, but technically there was indication of accumulation in the Nasdaq as it reclaimed support of its upward trend line.  Both the S&P and Dow bounced off their respective trend lines.  Yes, today’s action was mighty positive and we should be preparing for the Nasdaq to take out its 52 week highs.  If not, the upward trend line on all indices are shaping up to be strong support levels.  Now bring on the elections!

In addition to the free Weekly Reviews, registered members of SelfInvestors.com receive After Market reports on days when the market makes a significant move.  In addition to commentary, I highlight any accumulation or distribution in the major indices, the action of leading stocks, industries/sectors leading and lagging the market and last, but not least a Stock of the Day.  If you’d like to receive these reports, all it takes is a name and an email address on the homepage at SelfInvestors.com.  Yes, you can use phony names as some people do.  I think one of these days I’ll post some of the names people put in that form.. somewhat entertaining.  Anyway, today’s Stock of the Day was Charles Schwab (SCHW), which broke out to a new multi year high with good volume.  Ever since Charles moved to slash commission prices a couple years ago, the company has been on a tear.

ABOUT:  Charles Schwab engages, through its subsidiaries, in securities brokerage, banking and related financial services. The Company provides financial services to individuals and institutional clients through three segments: Schwab Investor Services, Schwab Institutional and U.S. Trust. The Schwab Investor Services segment includes the Company’s retail brokerage and banking operations, as well as the division that serves company 401(k) plan sponsors and third-party administrators and supports company stock option plans. The Schwab Institutional segment provides custodial, trading and support services to independent investment advisors (IAs). The U.S. Trust segment provides investment, wealth management, custody, fiduciary, and private banking services to individual and institutional clients.

FUNDAMENTAL: A company that was a bit slow to offer discounted trading, but once it did the earnings and sales began to pick up again.  Earnings growth has surged to about 40 – 50% in the last couple years with strong sales growth around 20%.  Margins and ROE continue to rise just as they have for a couple years and are excellent.  Once again a premier company.

TECHNICAL: Broke out with good volume today to a new multi year high.  The construction of the base isn’t exceptional but it’s good enough for a great company in a strong industry and strong market.  The way I’d play this one is to let the breakout ride, then look for a light volume pull back to a buyable range.. just to make the stock prove itself.

SELFINVESTORS RATING: With a total score of 50/60 (27/30 for fundamentals, 23/30 for technical), SCHW is a top SelfInvestors breakout stock.

After any sustained move in the market up or down, I get a bit more hyper vigilant about looking for clues that the trend is about to change, at least in the short term.  That always begins with a read of the charts.. a trust in what the technicals are telling me.  This certainly goes along with my previous post about mastering emotions when trading – the more mechanical and technical you are, the less likely your emotions will influence your trading decisions.  I sent the following note to registered members of SelfInvestors.com over the weekend (you can sign up for these weekend and after market reports with your email address on the home page if you’d like) discussing this:

Focusing On the Charts, Not on Opinion

"Following a lengthy market run (or sell off) like the one we’ve had over the past couple months (which is rivaling the run off the market bottom back in ’03) I tend to get a little defensive and begin looking for any clues that the run is over, at least in the short term.  Those clues come in the form of technical analysis and only technical analysis.  In fact it’s during these times I try to read less about the various opinions on what the market will do and focus more on what the charts are indicating.  Granted, for those of us who are technical analysts or "chartists" it’s not always easy to trust the charts, but essential.

So what are the charts telling me and what am I "trusting"?  For the S&P and Dow, I’m fairly neutral.  The charts aren’t showing signs of significant weakness at this point and there are no significant resistance levels in sight.  What concerns me most is the Naz and the deteriorating action in the semiconductors which appear to have much more room to run.. to the downside.  In the Nasdaq, it faces formidable resistance at the April highs.  If you take a look at the weekly chart, what you’ll see is 3 straight weeks of weakening technical action.  By all indications, with the Nasdaq leading the way, the market begins to digest its gains now.

That being said, I don’t believe any correction from here will be severe and that any dips will provide anxious buyers who may have missed the bulk of the rally with an opportunity to get their feet wet.  I know I will be looking for an orderly pull back to begin leveraging gains with margin.  Remember that many investors are still stung by the 2000 crash and remain skeptical about the ability of the market to make them money with tolerable risk.  It wasn’t until recently that more friends of mine (who don’t follow the market) have begun to make comments about the market, but none of them are yet putting money to work.  We haven’t reached that frenzied stage"

A Round of Profit Taking Begins

If there has been any question about whether significant profit taking at these lofty levels would ensue, today’s action probably puts those questions to rest.  In the weekend review email I mentioned that I’m "trusting" the technicals which are telling me the Nasdaq was showing signs of a top (resistance, 3 straight weeks of weakening action) and that the correction begins now with the Nasdaq leading the way.  Today’s action confirms it. 

On Monday and Tuesday, the bulls held their ground just as they have over the past several days, preventing significant selling.  However, new fears are creeping into the market.  With the lower than expected GDP on Friday, the Chicago PMI at a 14 month low yesterday and a much larger drop in the Manufacturing ISM this morning to 51.2% (anything below 50% indicates contraction), there are fears that perhaps the economy may be slowing a bit too much.  That provided an excuse to lock in some nice profits and that trend should continue over the next couple weeks. 

It should be noted that the Nasdaq led the way down today, with semiconductors providing leadership to the downside.  Distribution (institutional selling) occurred in the Nasdaq, but not in the S&P and Dow.  Technically, the Nasdaq is currently sitting right on support of its upward trend line but has the momentum to take out that level and ultimately test the area around 2250, where the 50 and 200 day moving averages converge.  Both the Dow and the S&P looked relatively healthy today, despite the selling and have some room to run before testing their upward trend lines. 

Here’s a look at the charts of the major indices:

The Nasdaq still has support at the first support area of the upward trend line (in black), but the intensity of today’s selling (distribution) would indicate that level won’t hold.  I’m looking for a much larger drop to the area around where the 50 and 200 day moving averages converge (~ 2250).  Note the failure at resistance of the April highs.

You can see that the Dow remains the strongest of the indices and the selling wasn’t nearly as intense in the big blue chips as it was in the smaller, tech oriented names.  There is a considerable amount of room to run before the Dow even touches its upward trend line.  It’s too soon to tell if it will hold that line, but if I were to guess I’d say it eventually takes out that level and retests the previous all time highs around 11,700.

The S&P looks very similar to the Dow and has some room to run before testing first level support at the upward trend line at around 1360.  If it can’t hold there, expect a retest of the previous highs around 1330.

Leading Stocks Deteriorate

The action in the Nasdaq is a concern, but more concerning is the action of leading stocks.  The Self Investors Leading Stocks Index, which is an index comprised of 360 (it fluctuates between 300 – 400) of the fastest growing companies leading the market higher.  They did not fare well today.  In fact it was one of the worst performances in a few months.  If you’ve been following some of the earnings reports recently, you’ve seen the carnage in even the best companies.  Garmin (GRMN), Encore Wire (WIRE), TheStreet.com (TSCM), Ansoft (ANST), and on and on.  The performance of leading stocks is something that I monitor every day (you can too over in the right column of this blog) and the trend over the past several days clearly indicates leading stocks are faltering.  The following table shows the performance of the Leading Stocks index over the past 20 days with its corresponding DI scores.  I’ve mentioned those scores here before, but basically they are Demand Indicator scores (a measurement that I formulated to track demand in a stock or index based on price and volume movements – the higher the score, the greater the demand).  Registered members of SelfInvestors.com will have access to this historical data once the new site is released in just a couple weeks!  Stay tuned.

Notice the steady trend  lower in the demand, particularly in the shorter time frame of 15 days.  In the middle of October, the DI 15 score was averaging around 7-8, but in the last several days it’s been hovering around 2, before dropping to negative today for the first time in several weeks.

Just as the S&P did more than one month ago, the Nasdaq too has cleared multi year highs with sights set on much loftier goals of following in the footsteps Dow and taking out all time highs (a long ways to go!).  Yet again, the bulls got what they wanted today.. a dovish Fed and more solid earnings results, which led to a day where the big fellas put more cash (in the tech heavy Nasdaq) to work despite an overstretched market.  Going into tomorrow mornings GDP report, the Nasdaq has considerable momentum but will need to hold above the April highs to keep the vertical ascent intatct.  I think tomorrow’s action will be very telling about where we go from here over the next couple weeks.

I’ve included the weekly chart of the Nasdaq too, which provides a better look at the overall volume/price trend and indicates some hesitancy on the part of buyers in the past couple weeks.  By the end of the trading tomorrow, we’ll know if the Nasdaq puts in a 3rd week of weakening action.  I have a feeling we may run at the the open and sell off in the afternoon.. we’ll see!

Christmas has come early for the Bulls.  Over the past several weeks it seems that just about every economic report, Fed speech and recently earnings reports (most notably from consumer related stocks) have been just what the Bulls have asked for.  Commodities are off their highs, the consumer is strong, manufacturing robust, inflation in check, all while the housing market cools providing the perfect "goldilocks" situation.  With that, the market is priced for perfection and ripe for a fall.  Will traders "sell the news" after tomorrow mornings PPI data? The charts would indicate that scenario is highly likely.

The Dow remains the strongest of the major indices and is still showing considerable strength despite kissing the upper reaches of its short term trend line.  Combine the overbought conditions with today’s lack of enthusiastic buying as well as psychological resistance of Dow 12,000 and you have a set up for profit taking.  Considering the amount of strength behind this move, the Dow may just retest the bottom of the channel around 11800 before moving higher.  This is an area I might look to start adding new positions, depending on the amount of sell volume.

The Nasdaq looks mighty tired up here, lacking much conviction to punch through resistance of the April highs.  Notice it’s gotten ahead of itself in the past couple days, by moving ahead of the trend channel.  This has occurred with decreasing buy volume, indicating the big fellas are easing off a bit.  Again, considering the strength of this run, there is a good chance that the Nasdaq will undergo a minor drop to the first level of support around the bottom of the channel (approx 2300).

The S&P won’t face any significant resistance until it tackles all time highs above 1500, but it too has gotten ahead of itself in the past couple days while volume continues to subside.  Look at the bottom of the channel in the 1345  range as a potential area of support.

Don’t mind me I’m just sorting out my thoughts about this current market and how best to play it.  Getting my thoughts down in virtual ink helps put it all in perspective.  Feel free to share your own thoughts!

Once again the market avoided a third consecutive day of declines.  You have to go back to early August to find the last time the market declined for 3 consecutive days.  On August 8th and 9th the market finished the day down to mark the 3rd and 4th consecutive days down.  That is only time that has happened since this rally began on July 18th.  No doubt a fantastic run which has culminated in a record high for the Dow today. 

Admittedly, it’s difficult to come up with a good strategy up here.  Clearly, we are overdue for some significant consolidation and it concerns me that it took a big drop in commodities to propel the market today.  With a soft landing continuing to be priced into this market and oil and commodities feeling out a bottom (which should happen sooner rather than later), just what is going to propel this market higher?  You guessed it – earnings.  Would I be willing to bet the farm that earnings guidance this quarter (for future quarters) is going to be beyond expectations?  Heck no!

On the bullish side, there is one big X factor in play here and that’s retail speculation.  At what point does Uncle Larry take notice that the Dow has made new highs and puts some of that savings to work in the next "Google".  At what point do all those real estate speculators start speculating in stocks and out of work real estate agents become stockbrokers?  Will it happen?  You would see it in the trading numbers out of Etrade, Ameritrade, Charles Schwab, etc.  but it may be most apparent at cocktail party small talk.  When the conversations shift from real estate talk to stock talk you’ll know.  What are you hearing?

All in all I still feel it’s a gamble playing big on the long side up at these levels, but at the same time it doesn’t pay to fight the tape.  I’ll continue to play the long side but choose new long entries with lower risk (ie. initiating positions in high quality stocks with considerable momentum and near major support levels) and maintain a decent cash position with a smattering of shorts).  I’m always comforted by the fact that as an individual investor I can reposition quickly and avoid large losses.  Something large funds can not do (ahemm… Amaranth).

As expected today, the Fed left rates alone following a series of economic data points indicating a soft landing ahead (but with a deteriorating housing market).  The real story of the day and yesterday has been the resiliency of this market.  A sales warning from Yahoo and a Thai coup couldn’t derail the market yesterday.  Today, while initially "selling the news" following the Fed announcement, traders stepped in near the close to propel the market to near intraday highs.  In fact, trading volume rose to levels above yesterday indicating the big fellas putting some more money to work.  Bullish action indeed. 

Looks like traders are continuing to cheer plummeting crude prices and strong earnings.  Today, oil plunged again, briefly slipping below support around 60/barrel after the energy department reported a larger than expected build in weekly distillate supplies to their highest levels since January 99.  In the earnings arena, Oracle made headlines with its blowout numbers which provided another catalyst for the continued flow of cash out of commodities and into tech.

I would expect the Dow to touch all time highs tomorrow and the S&P to clear multi year highs on an intraday basis.  However, the key as always, is how the market finishes.  If we can get a surge tomorrow and hold above these highs, we could be in for a big time end of year rally.  We shall see.