Friday's Action:   Stocks finished mostly higher despite a negative capacity utilization number that pushed the market lower in early trading. The mixed economic data lessened fears of inflation and allowed interest-rate sensitive shares to recover. Major world markets closed mostly higher. London's FTSE closed up 0.71%; Frankfurt's DAX closed up 0.73%, and Paris' CAC 40 closed up 0.77%. Japan's Nikkei closed up 0.20%, Hong Kong's Hang Seng closed down 0.17%, and Sydney's All Ordinaries Index closed down 0.04%. In economic news, Building Permits in March rose 1.9% and Housing Starts rose 6.4% to 2.0 mil units, higher than expected. Industrial Production declined 0.2% while Capacity Utilization fell to 76.5% down from 76.7%. Finally, Consumer Sentiment for April decreased to 93.2 from 95.8. Volume came in at 1.49 billion shares traded on the NYSE and 1.88 billion shares traded on the Nasdaq. Market breadth was positive, with NYSE advancing issues over declining issues by 2.71, and up volume over down volume by 1.87; Nasdaq advancing issues over declining issues by 1.07, and down volume over up volume by 2.40. Leading sectors were REITs, + 1.79%, Banks,+1.38% and Gold Bugs, +1.23%. Laggards were Internets, -3.48%, Disk Drives, -2.88% and Semiconductors, -1.76%. Nasdaq 100 futures closed 2.50 pts lower to settle at 1453.50, while the S&P's settled up 9.10 pts at 1134.10.

Weekly Recap:   Stocks struggled last week, hit by concerns over rising interest rates. On Friday, Richmond Fed President Broaddus tried to allay those fears with dovish commentary on inflation and the Fed's willingness to remain patient before pulling the tightening trigger. With weaker than expected industrial production, capacity utilization and consumer sentiment reports, the market looked as if it half-believed him. When the retail sales and CPI reports for March checked in this week stronger than expected, it simply fanned the flames. Rate concerns settled down somewhat in the latter part of the week, but overall, the prospect of a higher interest rate environment clearly bothered investors.

Rate-sensitive sectors like financials, utilities, and home building were among the biggest laggards, along with the semiconductor and telecom equipment groups, which were hit by valuation concerns and some uninspiring earnings reports from Intel and Nokia. The Dow outperformed the more volatile Nasdaq Composite and Russell 2000 by a wide margin, suggesting that investors were more risk averse this past week. Those concerns prompted a rotation into more defensive-oriented groups like drugs, biotechs, and tobacco. Buying interest was also seen in the energy and basic materials sectors.

For the week, the Dow edged up 0.1%, the S&P 500 finished -0.4% lower and the Nasdaq fell -2.8%. The small cap Russell 2000 lost -2.4%. Next week, more than 500 companies are scheduled to release their results, including 11 Dow components. A G-7 meeting is also scheduled, and there are a number of Fed speakers on the docket, including Alan Greenspan who will testify before the Senate Banking Committee and the Joint Economic Committee. All in all, there shouldn't be any shortage of trading catalysts.

The Reluctant Fed:   Although the Fed Funds Futures are indicating a very low probability of a rate hike occurring within the next month (Fed Funds Futures are currently pricing in just 8% odds of a 1/4 point hike at the May 4th, 2004 FOMC meeting), shorter-term yields have risen sharply relative to longer-term yields over the past two weeks. The chart of the 5-year yield index divided by the 30-year yield index illustrates this. The recent sharp rise in the FVX:TYX ratio is probably a sign that the market is beginning to discount a hike in the Fed Funds Rate, which may help to explain the recent plunge in the gold price.

But the upward trend of inflation-protected securities, represented by the Vanguard Inflation Protected Securities Fund, relative to the performance of the non-inflation-protected 30-year T-Bond indicates an increasing desire by investors to pay for inflation protection. The chart below shows that investors are concerned about future inflation and are willing to pay up for that protection.

The Fed will most likely wait to hike interest rates once bond prices break decisively lower, regardless of what is happening with GDP growth, employment growth, or the presidential election. The only question is how much of a decline in the bond market will be needed before the Fed is forced to act. They probably won't act until the pressure becomes a lot greater than it is right now, most likely not until T-Bonds drop below their August, 2003 low of 102.50.

The Peak Open Interest Indicator:   The Peak Open Interest Indicator (POI) has predicted where the S&P 100 Index (OEX) will close on options expiration day with a high degree of accuracy. The OEX tends to be attracted to price levels where the largest amount of open interest exists. The indicator is simply a chart showing the amount of call and put options open at each strike price in any given expiration month. Typically, a stock or index will be attracted to the strike price that has the most combined open options contracts for the front month, or the month closest to expiring. What makes this indicator particularly useful for the OEX is its low implied options volatility index. Below is a chart of the POI for the April OEX options contracts with one week to go before expiration.

A review of some previous months' options activity illustrates how the indicator functions. February's expiration saw the OEX close at 564.88, only -0.90% from peak open interest at the 570 strike level. In March, the 550 strike held the most open interest. The OEX was once again attracted to that strike level, this time closing at 543.88, or just -1.15% away. In fact, over the past 13 months, only twice (November 2003, and March 2004) did the OEX close more than one percent away from its peak strike price on expiration day. Below is a table of the previous 13 months of data displaying this phenomenon.

The peak strike level will obviously change as expiration draws closer. But that does not diminish the usefulness of this indicator. Of note is the fact that the peak strike level does not normally changed at least one week prior to expiration. One strategy employing this indicator is be to put on either a bearish call spread or bullish put spread. For example, in February, a trader could have put on a bullish put spread, selling the Feb 560 Put and simultaneously buying the Feb 555 Put. The spread credit was good for $190 per contract. Since the OEX closed at 564.88 and above the 560 strike, both puts expired worthless. The trader would have received the full credit amount less commissions. A $5,000 investment (10 contracts) would have returned $1,900 for a 38% gain. The March peak open interest settled at the 550 strike during the last week before expiration. We recommended opening a Bullish Put Spread, selling the Mar 540 Put and buying the Mar 535 Put, for a $1.35 credit. Since the OEX closed at 543.68 on expiration, both of our options expired worthless and we captured the full credit, less commissions. We were only "in the market" for four days and realized a 27% return on the trade.

The April peak open interest settled at the 560 strike during the last week before expiration. We recommended opening a Bullish Put Spread on Tuesday, April 13th, selling the Apr 550 Put and buying the Apr 545 Put, for a $1.30 credit. Since the OEX closed at 554.94 on Friday, both of our options expired worthless and we captured the full credit, less commissions. We were only "in the market" for four days and realized a 26% return on the trade.

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Commercial Hedgers were better buyers in the S&P's last week, but still remain net short. For the intermediate term, their position should be considered a bearish sign.

Sentiment Surveys:   The latest Investors Intelligence survey showed that the percentage of bullish newsletter writers came in at 50%, while the percentage of bears was 22%. The bullish ratio (bulls/bulls +bears) was 69.4%.

The latest AAII survey showed an increase to 64% bulls, and a decrease to just 14% bears. The bullish ratio came in at 82%, while the 4-week moving average remains high at 68%. One thing to note about the AAII survey is that, while membership in this organization is quite large as investor groups go, the number of members that actually participate in the survey is very small. Thus, large fluctuations in survey results from week to week are not uncommon.

The latest Market Vane survey came in at 66%, indicating that the majority of commodity trading advisors (CTA's) remain bullish on the future direction of the S&P's.

The Short Term Outlook; 1-5 Days:   Friday's price action favors making higher highs on Monday. The Semiconductor Index was one of the worst performing sectors Friday, and unfortunately, that was bad news for the Nasdaq once again. The SOX is now testing its 200-day moving average where it has found support in the past. The 5-day RSI closed below 25%, an area from which we would expect to see a short-term bounce. The SOX:NDX is also in oversold territory, closing below its lower bollinger band and with its 5-day RSI at an extreme low of just 17.4%. If the chip stocks can catch a bid on Monday, then the sector should lead the NDX higher, as the SOX front-run the broader based NDX.

The semiconductors have been under pressure by Hong Kong's Hang Seng Index, which has dropped 4.4% in just the past three days. The HSI is heavily weighted with chip stocks, so weakness in that index is often reflected in the SOX. The HSI closed on support and should now either consolidate or move higher.

SMT's Pivot Point Forecast; 1-2 Weeks:   Our Pivot Point indicator on a buy signal. Our next Pivot Point forecast is scheduled to occur on or near April 26th.

The 60-mn NDX chart below shows that the StochRSI indicator is in the NEUTRAL zone. For Monday, resistance for the S&P's comes in at 1140.50 and then 1145. Support lies at 1126.50 and then 11117. For the Naz, resistance comes in at 1463.50 and then 1474. Support lies at 1442.50 and then 1432.

The Intermediate Term Outlook; 2-6 Weeks:   Our Market Trend Indicator (MTI) is currently positive and trended slightly higher on Friday.

od Trading!

Charts and data appearing in today's column are courtesy of:
StockCharts.com

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