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Sunday, June 17, 2007

Weekly Market Update - Inflation OK, Markets Pop

Weekly Market Call

This past week was filled with economic data that turned out to be mostly positive. Whereas the previous week saw a significant rise in interest rates and a corresponding drop in the market averages, this week saw reports of minimal inflation that caused rates to ease a bit. Nevertheless, it's been a wild week or two in the bond market. On Friday, the yield on the 10-year Treasury note fell to 5.15% from 5.22% on Thursday and a high of 5.31% reached on Tuesday.

Investors, who were beginning to fear the Fed might have to raise rates, came to the conclusion that the Goldilocks economy was still alive and bid up stocks aggressively. The PPI and CPI numbers that were announced on Thursday and Friday, respectively, showed that core rates were very close to the Fed comfort zone.

May retail sales also came in reasonably strong and supported the expectation that the economy continues to grow though at a rate that is below long-term trends.

The market call for the coming week is therefore positive. We can expect new highs though they may not be significantly above the recent highs. Rates are still well above 5% and market participants are still digesting this fact and trying to determine if it will derail the M&A activity that has been providing so much support for the market lately. On the other hand, sentiment has turned positive again and investors are looking forward to earnings season. The way of least resistance, it seems, is up.

ETF Comments

Indexes: The previous week I set all the indicators in the Weekly Market Call section to question marks. The market did drop but has since recovered and the Market Call indicators are once again set to up arrows. The large-cap indexes DIA and SPY have rallied but did not quite set new highs this week. Still, they each had a good week with 1.6% and 1.7% gains, respectively. The small stock Russell 2000 ETF (IWM) also missed setting a new high but turned in a respectable 1.5% gain. The NASDAQ, as represented by QQQQ, turned in the best performance with a 2.1% gain on the week. All of the averages featured a gap up on Friday. With the positive sentiment in the market now, I can't imagine these being exhaustion gaps, hence, my expectation for new highs.

Real Estate: REITs enjoyed a bit of a rally this week as the Fed Beige Book painted a picture of reasonable strength in the commercial real estate market. Nevertheless, the recent rise in interest rates remains a troublesome factor and REITs lagged the overall market this week. The iShares US Real Estate ETF (IYR) remains deep in the TradeRadar SELL zone and looks weak on traditional charts, as well. The home builders ETF, XHB, also lagged the market. Not only were interest rates a negative factor but the Beige Book also showed that the residential real estate market is still very much struggling.

Financials: the picture is getting murky here. Interest rates are a driver in this sector also. The higher rates may provide greater profit margins but will have the negative effect of reducing demand for loan products. Indeed, while the rest of the market rallied on Friday, the SPDR Financial Sector ETF (XLF) actually dropped a few cents. As mentioned previously, recent rate increases cast doubt on the continued robustness of M&A activity that has done much to bolster the income statements of the broker-dealers. Though XLF remains above its 50-day moving average, it has been unable to close above its 2o-day MA for the last two weeks. There is still the danger of a top forming and the daily chart's TradeRadar SELL signal is indicating caution. The streetTracks KBW Bank Index (KBE) has been in the SELL zone since March but Friday saw some scary action with the ETF falling 1.4% on a downward gap while the rest of the market rallied strongly. Avoid KBE at all costs.

Energy: I haven't written about energy ETFs in a while but I thought I would introduce readers to a new ETF in this sector that is showing some promising action. It is the PowerShares DB Energy ETF (DBE). It is a fairly new ETF that started trading at the beginning of this year. It is unique in that rather than focusing on oil as the United States Oil ETF (USO) does, it is comprised of crude oil, heating oil, gasoline and natural gas. As such it is a play on the energy sector in general. DBE set a new high this week and its recent trend has been solidly upward as opposed to USO which has been choppy and has underperformed its underlying benchmark. As for the Energy Select SPDR XLE, which we used to write about here, they also set a new high this week, trading over $70. Energy prices show no signs of abating and the sector remains a promising one for investors especially with hurricane season coming, political instability in Nigeria, etc. Note that the one area of significantly rising inflation in this week's PPI and CPI reports was energy.

TradeRadar Stock Picks

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