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Market Outlook
The Week Beginning Monday,
October 18, 2010



Preface

I believe that it is important to point out to all my readers, especially those who are not already members of S.O.M.E. (as members are already well-aware of my trading strategy!), that the more volatile the market becomes, whether it trades up or down, is more beneficial to us, as the returns on our options increase dramatically, as observed throughout June and July, so far.

I must say I am a great supporter of the bulls, but will play-along with the bears to extract as much value from our options plays, as possible. I am a great believer in things moving forward and improving as time progresses but I also know that we have to play-the-game to extend our profits. The only catch in this type of market is “knowing” or realizing in which direction it will take, and it seems that we have been able to fulfill this decision in most cases, to gain our profitability.

Key Events This Week



up and coming

Note:-All earnings dates listed below are tentative and subject to change.

This Week’s Economic Reports

There are still quite a few major economic indicators available this week, which are:-

Monday –

  • Industrial production numbers for September,

  • October Housing Market Index.

Tuesday –

  • Housing starts and building permits for September.

Wednesday –

  • Weekly report on U.S. petroleum supplies, and

  • Fed's Beige Book for October

Thursday –

  • Weekly initial jobless claims, and

  • September leading indicators, and

  • The Philadelphia Fed manufacturing in October

Friday –

  • There are no major economic reports scheduled for Friday.



This Week’s Major Earnings Reports

earnings

Monday –

  • Citigroup Inc. (C),

  • Halliburton Co. (HAL),

  • Hasbro Inc. (HAS),

  • McMoRan Exploration Co. (MMR),

  • Apple Inc. (AAPL),

  • IBM Corp. (IBM),

  • VMware Inc. (VMW), and

  • Zions Bancorporation (ZION)

Tuesday –

• American Electric Power Co. Inc. (AEP), Bank of America Corp. (BAC), The Bank of New York Mellon Corp. (BK), The Coca-Cola Company (KO), EMC Corp. (EMC), Goldman Sachs Group Inc. (GS), Harley-Davidson Inc. (HOG), Illinois Tool Works Inc. (ITW), Johnson & Johnson (JNJ), Lockheed Martin Corp. (LMT), The New York Times Co. (NYT), Occidental Petroleum Corp. (OXY), Parker-Hannifin Corp. (PH), Peabody Energy Corp. (BTU), State Street Corp. (STT), Supervalu Inc. (SVU), UnitedHealth Group Inc. (UNH), Weatherford International Ltd. (WFT), Altera Corp. (ALTR), Boston Scientific Corp. (BSX), Intuitive Surgical Inc. (ISRG), Juniper Networks Inc. (JNPR), SLM Corp. (SLM), Tupperware Brands Corp. (TUP), Western Digital Corp. (WDC), and Yahoo! Inc. (YHOO).

Wednesday –

• Abbott Laboratories (ABT), BlackRock Inc. (BLK), The Boeing Co. ( BA), Comerica Inc. (CMA) Delta Air Lines Inc. (DAL), Eaton Corp. (ETN), Genzyme Corp. (GENZ), Manpower Inc. (MAN), Media General Inc. (MEG), Stanley Black & Decker Inc. (SWK), US Airways Group Inc. (LCC), U.S. Bancorp (USB), Wells Fargo & Co. (WFC), E*Trade Financial Corp. (ETFC), eBay Inc. (EBAY), Netflix Inc. (NFLX), Seagate Technology plc (STX), and Xilinx Inc. (XLNX).

Thursday –

• Alaska Air Group Inc. (ALK), AT&T Inc. (T), BB&T Corp. (BBT), Caterpillar Inc. (CAT), Freeport-McMoran Copper & Gold Inc. (FCX), Cirrus Logic Inc. (CRUS), Danaher Corp. (DHR), Eli Lilly & Co. (LLY), Entergy Corp. (ETR), Fifth Third Bancorp (FITB), Goodrich Corp. (GR), The Hershey Co. (HSY), Huntington Bancshares Inc. (HBAN), ITT Educational Services Inc. (ESI), JetBlue Airways Corp. (JBLU), Patriot Coal Corp. (PCX), Philip Morris International Inc. (PM), PNC Financial Services (PNC), PPG Industries Inc. (PPG), Southwest Airlines Co. (LUV), SunTrust Banks Inc. (STI), The Travelers Companies Inc. (TRV), Union Pacific Corp. (UNP) United Parcel Service Inc. (UPS), W.R. Grace & Co. (GRA) Xerox Corp. (XRX), Amazon.com Inc. (AMZN), American Express Co. (AXP), Capital One Financial Corp. (COF), The Cheesecake Factory Inc. (CAKE), Chipotle Mexican Grill Inc. (CMG), The Chubb Corp. (CB), Citrix Systems Inc. (CTXS), NCR Corp. (NCR), and SanDisk Corp. (SNDK).

Friday –

  • Honeywell International Inc. (HON),

    KeyCorp (KEY), Schlumberger Limited (SLB), and

    Verizon Communications Inc. (VZ)



the week ahead



Outlook for This Week

The stock market's run since the end of August is the best of the year. The market ended higher for the sixth week in the last seven.

The Dow Jones industrials ($INDU) are up nearly 11% since closing at 9,986 on Aug. 26. The Standard & Poor's 500 Index ($INX) is up 11.8%, with the Nasdaq Composite Index ($COMPX) up 16.5%.

The Dow in the past week gained a half percent to 11,062, and the S&P 500 gained 11 points, or nearly 1 percent to 1176. The Nasdaq, boosted by a tech rally, climbed 2.8 percent to 2468. Banks were the week's losers, dragging the S&P financial sector down 2.4 percent for the week, on worries the mortgage crisis will bite into bank profits.

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There is a tidal wave of earnings due this week which certainly overwhelms economic reports, and shifts investor focus temporarily to the health of corporate balance sheets.

More than a fifth of the S&P 500 report, including financial, tech and industrial companies, like American Express (AXP) , Apple (AAPL) and Boeing (BA), are scheduled this week. There is also a steady stream of Fed officials speaking every day, keeping the markets focused on the prospects for more Fed easing.

The weakening dollar will also stay a driver, and foreign exchange traders are watching for comments from central bankers and finance ministers meeting in Korea at the end of the week, ahead of the November G-20 meeting.

"We might just get fundamental reasoning in the market place, as we get a look at earnings," said Jefferies managing director Art Hogan. "...how much good news is already priced in? Are we pricing in QE (quantitative easing)? Are we pricing in midterm elections? Or are we pricing in earnings growth? The last one is what we're going to find out next week."

The big banks reporting include Citigroup on Monday; Bank of America Tuesday and Wells Fargo Wednesday, following on J.P. Morgan's report this past week. Bank stocks started to tank after 50 states launched an investigation into foreclosure practices. But the major banks were also hit by concerns that they could be on the hook for problems in the securitization market, where the pooled mortgages may not have been exactly what investors were promised.

"It's the dark cloud that is going to hang over the sector until we get some clarity," said Hogan. "Quite candidly, you may look at these banks, like Citigroup, and when they report they may have fine numbers, but you may not get any lift because you still have this great unknown."

Hogan said financials are expected to show the biggest earnings gain of any sector this quarter. The S&P 500 financials are expected to be up 70 percent, because of last year's depressed results. The entire S&P 500 is expected to be up 24 percent over last year's third quarter.

Jack Ablin, chief investment officer with Harris Private Bank, said he increased his equities holdings in the past couple days, in part because of earnings. "I was concerned that analysts' estimates were too high. I thought we'd get preannouncements. We didn't get much, and it said to me companies are prepared to beat," he said.

Ablin said valuations and momentum made him more bullish on stocks.

"I can't stand here and tell you we're at the precipice of a multi-year bull market. I think that as long as we've got stability, then the cheap valuations in stocks should sustain. There are obviously a couple of wild cards. One I think this quantitative easing is probably the biggest financial experiment in the history of the Fed. We think we know what will happen. We have no idea how much it takes. We don't know the cause and effect, and we don't know the timing," said Ablin.

Expectations for this Week

Hedge Funds and Their Importance

Introduction

"Hedge Fund Investors Turn Bullish on Stock Market" --Reuters headline, Oct. 13, 2010

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The Reuters headline is no surprise, as noted by the analysis of buy-to-open option activity on major exchange-traded funds (ETFs), where the increasing put volume relative to call volume amid market strength was, and continues to be, a strong indication that hedge funds are in accumulation mode. With retail mutual fund investors largely disengaged from the stock market, it is likely that hedge fund managers are dictating the market's direction.

Therefore, the buy-to-open put/call volume ratio on ETFs such as the SPDR S&P 500 ETF Trust (SPY), iShares Russell 2000 Index Fund (IWM), and PowerShares QQQ Trust (QQQQ), continues to be one of the main focuses as we move through earnings season and into other market-moving events in early November, such as the midterm elections and the Federal Open Market Committee meeting.

Equity Accumulation

Of particular interest is that hedge fund managers could be in the early stages of equity accumulation, after an absence that lasted from May through much of August. Per the chart below, note how low the 20-day buy-to-open put/call volume ratio was prior to turning higher at the beginning of September. Our theory is that the lower this ratio, the less exposed hedge funds are to equities (and vice versa when the ratio is high). So, even though we are seeing evidence that hedge funds are becoming more bullish, the ratio is not at levels that would suggest they are "over-the-top" bullish, suggesting there is a healthy degree of buying power from this group at present.

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VIX

Some professional traders continue to express caution as it relates to the current level of the CBOE Market Volatility Index (VIX) and the term structure of VIX futures. This concern – which has been apparent in the market for weeks - suggests that there is still the potential for short covering, the unwinding of hedges, or sideline money that can drive stocks higher.

Additionally, research suggests the perceived "low level" of the VIX is not reason to be concerned. For example, this is evident by monitoring the VIX with respect to the S&P 500 Index's (SPX) 20-day historical volatility, and with reference to the percentage that the VIX is trading above the SPX's 20-day historical volatility as the "VIX premium." When the VIX is trading below the SPX's 20-day historical volatility, I refer to this scenario as the "VIX discount."

During the past couple of years, when the VIX and SPX 20-day historical volatility converge, it has presented a buying opportunity, like the buy signal that occurred in early September. At the other extreme, when the VIX reading is double the SPX's 20-day historical volatility, the market has become vulnerable to correction. At present, and per the chart below, the "VIX premium" is not yet flashing a caution signal.

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Immediate Risks to the Market

First, next week is the first week of a five-week option expiration cycle. Since 2006, the probability of these weeks producing a positive return is lower than that of the first week of a four-week expiration cycle and all other weeks.

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Another risk is that potentially stiff overhead resistance on the SPX lies just overhead in the 1,200-1,230 area. The 1,205 level is the site of the longer-term, 80-month moving average, which contained the September 2001 low on a monthly closing basis and, when breached on a monthly closing basis in June 2002 and September 2008, signaled major trouble ahead. Moreover, this trendline acted as resistance for several months in 2004 and again in April of this year. Moreover, 1,230 is the site of a 61.8% Fibonacci retracement of the 2007 peak and March 2009 low.

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Conclusion

With technical resistance looming overhead as earnings season gets into full swing, midterm elections just around the corner, lots of buzz surrounding another round of quantitative easing, the next several weeks could prove to be extremely pivotal.

The Banks

Introduction

Everyone's going to want to know two things:

1. Are loan losses falling and,

2. What is a company's exposure to the mortgage foreclosure mess?

This has just erupted in the last few weeks as charges have risen that documentation on mortgages made during the housing bubble is flawed. So flawed that it's not clear in many cases if a loan that was sold by a lender and placed in, say, the trust backing a mortgage security is properly documented.

If it isn't, someone facing foreclosure can -- and is -- using the problems to fight being evicted. There's another problem: The documentation on some properties is so bad, foreclosures are being started that should not be.

Either way, the risk for banks -- and why their stocks were hammered -- is that investors in the mortgage securities might sue and force the banks to take back the loans, which, of course, are worth much less today than when they were made originally.

More importantly, it would stall the process of selling off foreclosed properties and delay the housing recovery and the economic recovery.

The Size of the Problem

What isn't known is how big the problem could be. Barbara Desower, Bank of America's head of home lending, thinks the issues will affect fewer than 30,000 of the 1.4 million mortgages the bank owns or services.

There's one last thought, one hammered repeatedly this week by Barry Ritholtz on his blog The Big Picture: If the documentation procedures on loans sold into mortgage pools are so bad, titles to properties everywhere could be threatened.

The Bank Schedule:

Analysts expect mostly better third-quarter results from major U.S. banks, many of which release third-quarter results next week. The improvement continues a trend as the sector recovers from dismal financial-crisis levels. But the banks are facing a probe of foreclosure practices as well as new financial regulations and a return to a stagnant housing market after expiration of a first-time homebuyer tax credit that had spurred sales.

Monday: Citigroup, which may not have a particularly large exposure to the foreclosure problem and may actually be on the mend from its virtual collapse in 2008 and 2009. Shares fell 5.7% this week to $3.95.

Tuesday: Bank of America. Arguably, this is the most vulnerable bank stock because it is the largest servicer of mortgage loans, thanks to its 2008 acquisition of Countrywide Financial. Shares fell 9.1% this week to $11.98.

Goldman Sachs. Mortgages may be an issue. Trading volume may also be a question. Shares fell 1.3% on the week to $150.69.

Wednesday: Morgan Stanley, Wells Fargo and US Bancorp. Wells Fargo may have the most vulnerability to the foreclosure mess. Its shares fell 9.1% to $23.58 on the week. Morgan Stanley was off 1.2% to $25.02. US Bancorp was up 1% to $22.54.

Thursday: American Express (AXP). The credit card company probably has little exposure to the problem. Shares rose 2.9% this past week to $39.03.

Options Market

Signs in the options market suggest more volatility next week as the recent trend of a continuous slide in the volatility index seems to be coming to an end.

"There is more call buying on the VIX now than put selling, which suggests that traders see a spike in VIX in the near term," said Randy Frederick, director of trading and derivatives at the Schwab Center for Financial Research in Austin, Texas.

The Chicago Board Options Exchange Volatility Index, or VIX VIX.N, closed on Friday at 19.03, down 4.3 percent, after rising above 21 during the day.

The S&P 500 and the “Golden Cross”

The market has continued to move higher since the S&P 500 broke a resistance level at around 1,130 in the middle of September. Some chartists are now looking at an upside target of 1,228.74, the 61.8 percent Fibonacci retracement from the 2007 high.

Next week may also see a so-called "golden cross" in the S&P 500 if the 50-day moving average rises above the 200-day -- a bullish sign for some traders. The 14-day moving average moved above the 50-day and the 200-day averages in September.

Economic News

Election Campaigning

President Barack Obama continues campaigning for Democrats next week, just two weeks before the mid-term elections. He will speak Sunday at a rally in Ohio, where two former Republican congressmen look likely to win races for governor and an open U.S. Senate seat Nov. 2. Former Rep. Rob Portman, who also served as U.S. Trade Representative and budget director in the Bush administration, is leading Lt. Gov. Lee Fisher by some 15 points in the Senate race. John Kasich, who was in the leadership for many of his 18 years in Congress, has a small lead over incumbent Gov. Ted Strickland.

Economic Reports

The week is relatively light on the economic reports, and, sadly, they won't be cheery.

Housing reports and the Beige Book

The most important report will come at 2 p.m. Wednesday when the Federal Reserve will release its Beige Book report, a narrative look at the economy.

This will affect the Fed's decision on how big a program to buy in Treasury securities to try to shift the economy into a higher gear.

The report will probably suggest some growth in jobs, retail sales and auto sales. It will sketch in a picture of a stagnant housing market.

Industrial Production

Industrial production is due Monday. Expect a small increase as U.S. manufacturing continues to strength.

Housing Starts and Building Permits

Housing starts and building permits are due Tuesday from the Commerce Department. These will continue to be severely depressed, although permits may show some growth. The weakness will turn up a day earlier in the National Association of Home Builders' builder sentiment index. The problem is continued weakness in job growth.

A weak housing number could rattle investors at a time when they're already anxious about the housing sector. Housing starts are seen slipping to an annualized rate of 580,000 units, according to economists polled by Reuters.

Initial Jobless Claims

Jobless claims are due Thursday from the Labor Department. Claims rose this past week slightly, but Nomura Securities believes claims have stabilized at around 455,000 -- "consistent with positive, but relatively low, private payroll growth."

Philadelphia Fed Survey

Philadelphia Fed survey is due Thursday from the Philadelphia Federal Reserve Bank. This measures manufacturing in the bank's region. It's expected to show some growth after a slide in August and stabilization in September.

Events of Importance

Conferences

Among the significant conferences next week are:

• The Consumer Electronics Association Industry Forum from Sunday through next Friday in San Francisco;

• Digital Hollywood Fall Conference from Monday through Thursday in Santa Monica, Calif.;

• William Blair & Co. Private Equity Conference on Tuesday and Wednesday in Chicago; and

• BioCentury's NewsMakers in the Biotech Industry Conference next Friday in New York.

Appearances by Federal Reserve Officials

Among appearances by Federal Reserve officials:

• Treasury Secretary Timothy Geithner will speak Monday in Palo Alto, Calif.

• Boston Fed President Eric Rosengren speaks Saturday in Boston;

• Chicago Fed President Charles Evans speaks Saturday in Boston and Tuesday in Evanston, Ill.;

• Atlanta Fed President Dennis Lockhart speaks Monday in Savannah, Ga., and Tuesday in Nashville, Tenn.;

• Federal Governor Elizabeth Duke speaks Tuesday in New York;

• Dallas Fed President Richard Fisher speaks Tuesday in New York;

• Minneapolis Fed President Narayana Kocherlakota speaks Tuesday in Fargo, N.D.;

• Philadelphia Fed President Charles Plosser speaks Wednesday in Philadelphia;

• Richmond Fed President Jeffrey Lacker speaks Wednesday in Washington, D.C.;

• St. Louis Fed President James Bullard speaks Thursday in St. Louis; and

• Kansas City Fed President Thomas Hoenig speaks Thursday in Albuquerque.

COMPANY NEWS

This Week’s Earnings Expectations

As noted, this is a big week for big, important companies.

Here's what to look for:

Monday

Apple: Apple is expected to issue another strong quarterly earnings report Monday, a few days before it takes the wraps off the latest iteration of its widely praised operating system. The consumer electronics giant is seen posting earnings of $4.06 a share on sales of nearly $19 billion in its fiscal fourth quarter, according to a survey of analysts by Thomson Reuters. In particular, analysts expect sales of the company's iPad tablet computer, which beat many industry watcher's expectations in its April debut, to accelerate because it is available in more countries. Fiscal-year earnings are expected to top $13 billion on sales of nearly $64 billion. Investors will be looking for news about the iPhone 4, which is selling well despite complaints about its antenna.

Separately, Apple is holding an event Wednesday at its headquarters to offer a peek at the software powering its computers. Though Apple's computers have been eclipsed by the popularity and profits of the iPhone and iPad, the company's enthusiasts and competitors will be watching for dramatic changes or unusual refinements in the software, called "OS X."

IBM: reports after Monday's close. Big Blue is expected to earn $2.75 a share in the third quarter, up 14.5% from a year ago. Revenue is expected to hit $24.1 billion, up from $23.6 billion.

Tuesday

Johnson & Johnson (JNJ) on Tuesday kicks off what is expected to be a mixed third-quarter earnings reporting season for major U.S. pharmaceutical companies. Industry sales are under pressure from the U.S. health-care overhaul and the imposition of price cuts by European national health programs. At the same time, companies continue to cut costs to prop up earnings, and they are tapping their cash war chests to strike deals to bolster drug-research pipelines and diversify operations.

J&J, which also has major medical-device and consumer-health operations, is grappling with a series of recalls of over-the-counter medicines such as Tylenol due to quality problems. Wall Street expects J&J to report a 4% decline in earnings to $1.15 a share, excluding one-time items, on 1% sales growth to $15.2 billion. Executives also will provide analysts with an update of J&J's pharmaceutical unit at a meeting in New York.

Coca-Cola: reports before Tuesday's open. It's expected to earn 89 cents a share in the quarter, up from 82 cents a year ago. Revenue should rise 3% to $8.3 billion.

Harley Davidson (HOG): reports before Tuesday's open. The big question is the motorcycle maker's outlook after a disappointing summer.

Wednesday

Boeing (BA) and United Technologies (UTX): both report before Wednesday's open. They will offer signals about the global economy.

Also reporting: Delta Air Lines and US Airways (LCC) .

Investors will be watching capacity projections as airlines report results for the third quarter, typically the most profitable of the year. The industry has remained disciplined about increasing flights as demand recovered, underpinning higher fares and a return to the black for most carriers. But concerns are mounting about rising fuel costs and the potential expense of proposed consumer-rights legislation.

Thursday

Caterpillar (CAT): due before Thursday's open. This is the poster child for companies with big international presences. Watch for its comments about business prospects in China, India and Latin America.

Freeport-McMoRan Copper & Gold: due before Thursday's open. This is the U.S. stock market's proxy on Chinese economic growth. The stock is up nearly 15% this month alone as the dollar has fallen.

United Parcel Service (UPS): due Thursday before the open. Like FedEx (FDX), this stock is closely watched as a leading indicator on the economy. The company has been saying its foreign business is strong, with its domestic business less so. UPS shares were up 2.6% on the week to $69.31 and are up nearly 21% on the year.

Amazon.com: due after Thursday's close. The stock ended Friday at a record $164.64. It's selling its Kindle reader all over the place. It's expected to report revenue growth of 35% to $7.35 billion, with earnings growth of 6.7% to 48 cents a share.

AT&T and Verizon

The top two U.S. telecommunications companies are expected to see little change in results from a year earlier as they continue to play tug-of-war for contract wireless subscribers in a saturated market by trying to lure them with the latest and greatest in smartphones. AT&T Inc. (T:) and Verizon Communications Inc. (VZ), which report Thursday and next Friday, respectively, also are finding it increasingly difficult to sign customers to long-term contracts, with many moving to prepaid alternatives.

Friday

Schlumberger (SLB): due before Friday's open. This will offer a peak into the energy world ahead of Big Oil. A big question is how fast the company sees a recovery from the moratorium on Gulf of Mexico drilling. The shares finished up 1.7% on Friday to $64.50. They're flat on the year.

Quantitative Easing

Quantitative easing promises to stay in the spotlight, ahead of the Fed's Nov. 2 and 3 meetings. Fed Chairman Ben Bernanke, in a much anticipated speech Friday, made the case for more Fed easing to help boost the economy. He said inflation is below the Fed's targeted 2 percent, and the economy is too sluggish to create jobs.

Fed watchers believe the Fed will likely restart a program to buy Treasury securities, putting more money into the system and theoretically pressuring lending rates and reflating asset prices. The dollar has seen a fairly dramatic decline since the Fed first started seriously talking about easing in late August, and since then, commodities and equities have risen.

To Ablin, this run in commodities has been good and he expects it to continue. "We're still maximum overweight. We put the pedal to the metal in commodities. We got in a little early but we're hanging in with it. While there are certainly some fundamental arguments for a stronger dollar, we think the trend is going to be for a lower dollar," he said.

Robert Sinche, global head of foreign exchange strategy at RBS, said too much of a run up in commodities prices would not be a good thing. "I'm a little concerned the Fed has gotten themselves into the mindset that inflation is good...If they want to keep looking at the core, they have a problem in that people don't shop at the core," said Sinche.

"The purpose is not to create inflation but to create demand growth and employment growth. To generate inflation for the sake of inflation...that's like a tax," he said.

Sinche said the dollar's decline against the euro may be about to stall. The dollar finished the week 0.3 percent lower against the euro, at $1.3976. "This is the second time the euro dollar ventured above 1.40 and it's had a difficult time holding up there. You could be setting up the stage for some stabilization in the dollar," he said.

Another indicator may be a possible bottoming in U.S. interest rate expectations, he said, noting the five-year swap rate backed up 11 basis points this week. He said he will be watching European data as a catalyst for euro/dollar next week. Germany's ZEW business survey is released Tuesday; euro zone PMI is released Wednesday, and the German IFO index Thursday.



INDICATORS AND MARKET CONDITIONS

Mutual Fund Flows

Introduction

Despite the strong rally over the last several weeks, mutual fund investors do not seem to believe in the rally. The Investment Company Institute (ICI) says money has been flowing out of U.S. domestic equity funds for 23 weeks in a row. This is evidence that the retail investor is very skeptical of this market. The 2008 crash and then the "flash crash" in May have caused a lot of uneasiness. That's why money is flowing out of equity funds and into bonds, which are perceived to be safer.

12-Month Fund Flows

Below is a long-term chart of the S&P 500 Index (SPX) along with the amount of money flowing into equity mutual funds (green line) and bond mutual funds (red line). Money naturally poured out of equity funds in 2008 when the market crashed. Twelve-month flows turned positive early this year, but turned negative again after September made five straight months of outflows.

Where's the money going? Clearly, much of that is heading into bond funds. More money is flowing into bond funds now than flowed into equity funds at the peak of the dot com bubble. Is that worrying for bond holders?

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Monthly Fund Flows

Below is another chart that helps illustrate what's going on. It shows the monthly inflows and outflows of equity and bond funds. Since 2009, we've seen 11 months of equity outflows and 10 months of inflows. The SPX, up about 75% since the March 2009 low, has been very strong during this period. Despite this market strength, mutual fund investors do not want any part of this market.

This indicates a huge amount of sideline money with the potential to propel this market higher. When this money does finally find its way into equities it can happen very quickly. Don't be left behind or you'll be missing out on some huge gains.

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***Further evidence of market conditions can be seen in representations of charts below.

Tracking of SPY, DIA, IWM and QQQQ

Introduction

In an options expiration week that also kicked off the first full earnings week of the season, the markets continued to inch higher and have now clearly separated themselves from the small consolidation formed in September. As recently as a month ago, many pundits were calling for a resumption of the primary bear market and a possible breach of the recent bear market lows. The current thrust from this summer’s lows has been powerful, despite relatively lackluster volume. Markets have been clearly showing strength; just look at the Nasdaq 100, which surged to new recovery highs this week.

Even more surprising is the fact that tech stocks, as represented by the Powershares QQQ ETF (Nasdaq:QQQQ), have been able to climb above their mid-2008 highs. This was approximately the time when the recent bear market began accelerating and the fact that the Qs have been able to recover is impressive. Much of this move can be attributed to Apple (Nasdaq:AAPL), which has been at all-time highs for several months. This week I am showing a 10-month chart; notice how QQQQ has been able to clear its April highs without much trouble. This group is clearly leading the way right now and market participants should be focused on its behavior moving forward.

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While the S&P 500, as represented by the S&P 500 SPDRS (NYSE:SPY) ETF, is still well below its mid-2008 highs, the group is approaching an important high formed earlier this year. SPY hit a roadblock at $122 in April, and after a swift decline, it chopped around all summer. Despite what looked like a probable breakdown, SPY ended up rallying through some resistance levels and is now a few points from its April highs. The financials continue to act poorly though, and they will need to cooperate at some point if SPY is to make a serious attempt setting this important higher high.

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The Diamonds Trust, Series 1 (NYSE:DIA) ETF, which tracks the Dow Jones Industrial Average, is right at its April highs, and is showing good relative strength to SPY. While DIA has a much smaller number of component stocks, it is highly watched and is an important indicator for the general markets. A breakout above the April highs would technically change the trend on the weekly charts to an uptrend.

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Besides volume, the other disappointment with the current market has been the relative underperformance by the small caps. The group, as represented by the iShares Russell 2000 Index (NYSE:IWM), still remains below its April highs. However, it's interesting to note that on longer term charts, the April highs are actually fairly close to the top of IWM’s 2008 trading range. If IWM were to clear this level, it could set the stage for a strong move higher.

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Implications

The move in QQQQ was an interesting development this week. By clearing its April highs, QQQQ is now in an uptrend on longer time frames due to the fact that it set a higher high on weekly and monthly charts. While many participants remain bearish on the economy, the markets are beginning to introduce some interesting possibilities. If SPY, IWM and DIA follow in QQQQ’s tracks, it would set the stage for a possible end to the primary bear market that began in 2008. There is always the chance that this is a false breakout in tech stocks, and that the broader sectors will drag them back down, but for now, traders should remain open to the idea that higher prices may be on the horizon.



More Semiconductors Which May Provide Profit

Introduction

Semiconductors has been one group providing market leadership throughout the past month's rally. The group has recently started to move out of a period of consolidation and has been leading the way through several turning points. As a whole, this group is at a critical area, and what happens next will surely have important implications for the rest of the market.

Analog Devices (NYSE:ADI) for instance, spent the past several months trading sideways as it consolidated its rally from its bear market lows in late 2008. The $31 level had been holding ADI back throughout the entire range. ADI recently started to set higher lows as buyers began stepping up on pullbacks. ADI was able to clear the top of its base in late September and after consolidating just above this level, it appears to be following through. Now that $31 has been cleared, it should be watched as a possible support level on any weakness.

adi101210



Altera Corporation (Nasdaq:ALTR) is another semiconductor stock that recently cleared a consolidation. ALTR didn’t trade in the lengthy base that ADI did, but it did consolidate between the $25 and $29 levels for the past few months. On longer term charts, ALTR has been steadily stair-stepping higher after brief consolidations, and this move appears to be following suit. ALTR was able to clear $29 in late September, and after a brief pullback to the breakout area, it appears to be heading back higher.

altr101210



Silicon Image (Nasdaq:SIMG) has also been able to clear resistance recently. SIMG broke out of a base back in July on a sharp gap higher, and while it pulled back into the gap a month later, it was able to find support and head back higher. The post-July breakout eventually turned into another consolidation, which SIMG was recently able to clear. SIMG cleared the $4.50 level in September, and has formed a flag pattern as it pulls back to test this level for support. If SIMG can bounce from this level and clear the flag, it would validate the breakout.

simg101210



Cypress Semiconductor Corporation (Nasdaq:CY) is another semiconductor that may benefit from Intel’s report. CY is following much the same pattern as the other semis in that it recently cleared a base and is consolidating the breakout. One important difference though, is that CY does have possible resistance near $14-$16 to contend with. However, beyond this resistance area lies the clear blue skies of all-time highs. CY reports on October 21, so it’s possible that it could run higher.

cy101210



Implications

While Intel may not be the trading stock it once was, its earnings report typically carries the most weight in this space. As such, traders should be on high alert for possible trading opportunities in the chip stocks over the next few days as market participants absorb the news. Many of the stocks above are already above recent resistance levels, and if the reaction to Intel’s earnings is positive, these stocks should be able to build on their recent breakouts. If the reaction is negative, then traders should focus on how these stocks behave on a test of their breakout areas. In either case, the stage should be set for some movement in this group.


Check Out Last Weeks Semiconductor Stocks



semiconductor stocks



Conclusion



Earnings

In all, 12 Dow components will report in the coming week along with 109 S&P 500 stocks.

There is a concern that, given the gains since the end of August, the market is getting too heady!

While the Dow closed higher for the week, it did fall Thursday and Friday because of the weakness of banks. That could raise a flag of worry.

Stocks Locked to Bonds!

David Ader, chief Treasury strategist at CRT Capital said the equities market is in some ways taking its cues from the bond market on quantitative easing, and that it may show some concern if bond prices continue to weaken. Bonds lost ground this week after a series of weak auctions. The 10-year was yielding 2.571 percent late Friday. "I think the market is booking some profits because we bought so much of the rumors about the Fed," he said. Ader said a big question for investors is how much easing the bond market has priced in. "Have we priced in $500 billion or $600 billion? Probably not."

Ader said he expects the Fed's beige book on economic activity, released Wednesday, to affirm the need for quantitative easing. There is also industrial production and the National Association of home Builders survey Monday. On that day, the Treasury also releases its report on international capital flows. Weekly jobless claims, the Philadelphia Fed survey and leading indicators are released Thursday.

But Ader said he'll be watching the parade of Fed speakers. "Lockhart, Kocherlakota, Duke Dudley, Evans Plosser. You've got a few Fed guys out there," he said.

"I think they're going to open up to some degree the debate that they are going to be having internally so it will a sort of be an airing of their grievances...clearly some people on the Fed are more in favor of it than others," he said.

"We're going to hear from the hawks but we're also going to hear from some leading doves, and we heard today from the greatest dove in the nest, Bernanke," he said. Friday afternoon.



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