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IN THIS WEEK'S ISSUE:

1.  MARKET SUMMARY  
2.  WEEKLY ETF PERFORMANCE  
3.  ETF RELATIVE STRENGTH MONITOR  
4.  MODEL ETF PORTFOLIO   
5.  TRADE OF THE WEEK  
6.  CONTINUED GUIDANCE ON PREVIOUS TRADES  
7.  ETF SPOTLIGHT  
8.  WEEKLY EDUCATIONAL BONUS  

We urge all readers to print out this newsletter each week for maximum benefit...
           

(1.)  MARKET SUMMARY

The only ETF to show a gain last week was the Nasdaq Biotech iShares (IBB, $67.84). Although I was short the fund in our model portfolio, I closed half of the position early in the week near the weekly low and thus showed a good profit for that part of our portfolio last week.

Possible Turning Point
We are at or near a possible medium-term turning point in the stock market. The rate cut on Wednesday by the Federal Reserve Board, the Central Bank of the United States, has been seen by some as the Fed's last move to lower interest rates. The key interest rate that they cut, known as the Federal funds rate, now sits at just 1.00%. The Fed has shown concern recently that the U.S. could enter into a period of deflation (falling prices), which hasn't been seen in the U.S. since the Great Depression (this began in 1929). Japan has been in a deflationary spiral for years (and stocks may have finally turned higher there after more than 13 years of losses).

Moving Average Breached
Technically, prices have now slipped to their lowest levels since early June. However, as of yet they have not taken out any important support levels (except for the 20-day moving average, which was broken earlier in the week and tested on Friday from below). A move beneath 972.59 for the S&P 500 Index would be more damaging, as it would break the uptrend and would put us into a period of market consolidation. With sentiment at its highest level since the stock market topped in 2000, the risk is for a substantial correction.

Trend Change Not Yet Confirmed in Stocks, But Has Been In The Bond Market
Until the equity market actually breaks down, we need to give it the benefit of the doubt. Meanwhile, the trend to higher prices in the bond market has clearly been broken. A head and shoulders reversal pattern was confirmed when bond prices tumbled last week. In the shorter-term, however, we are nearing short-term support in the bond market, and with a five-wave pattern near completion in stocks (to lower prices), a bounce in the bond market is likely by the middle of the week.

Cycle Dates and Turn Dates
I had a turn date (a projected date on which the market might reverse course) for the stock market for Thursday, June 26th, and various reckonings of the highly regarded Bradley Model show a turn possible for June 30th and July 2nd. A neural net (a computer program that can teach itself how to trade effectively, or other scientific facts) that I closely follow had last week as a possible turn period as well. Although the equity market has been weakening for the past week or two, the bigger picture has been higher, and if there is a change in trend it will more likely be from up/consolidating to consolidating/down.

End-Of-Quarter Window Dressing
Equity prices moved sharply higher last quarter, and mutual funds will want to show how smart they are by scooping up shares of the best-performing stocks. This should help the strongest sectors to trade higher on Monday, and we could see some carryover during the first part of the week. The annual rebalancing of the Russell 2000 Index should also add to market volatility. Once all of these factors are behind us, however, the underlying trends should once again resurface.

THE WEEK IN REVIEW
The main event last week was the Fed's rate cut. Even though the U.S. central bank only shaved the key Federal Funds rate by 0.25% (25 basis points) to 1.00% (my forecast), the stock market, after initially selling off, rallied after that. There are some initial signs that the dollar is turning higher, and the bond market appears to have topped.

In a statement following its two-day meeting, the Fed warned that it still sees no sign of a sustainable recovery. However, the Fed's lack of clarion calls for concern regarding deflation, and its statement that there are some signs of improving conditions, were enough to send the bond market sharply lower. Considering the fact that interest rates are now at multi-generational lows, there is really little reason to be terribly surprised by the market's reaction to the statement. While it is not clear that the Fed has finished cutting rates, the fixed-income (debt) markets will start to assume that rates have bottomed unless we see a plethora of data signifying a severe weakening in the economy.

ECONOMIC ANALYSIS
Until Wednesday's Fed action, the economic data were starting to spook an already overbought market. Durable goods orders came in far weaker than expected, and although consumer confidence was stronger than expected, stocks were unable to show any real strength. Once the Fed announced that the economy was only in bad -- rather than dire -- straits, stocks ignored a downward revision to Gross Domestic Product (not a big surprise since it is very old data) and instead focused on a miniscule improvement in the weekly unemployment claims data.

Next week will be a busy one on the economic front. For starters, the Chicago Purchasing Managers Index (PMI) is due out on Monday. Consensus expectations call for little change in that figure from May, but I suspect the actual data will come in ahead of expectations. The national Institute for Supply Management (ISM) Manufacturing report is due out on Tuesday and should move past 50, which would signify an expanding manufacturing sector (rather than contracting). Note that the Chicago PMI is a regional version of the ISM. The two reports are surveys of people responsible for purchasing goods for manufacturing companies. There is a similar survey of purchasing managers of services companies as well (ISM Services), but that report is relatively new and is not as widely followed.

Also due out next week are construction spending (Tuesday at 10:00 AM), weekly jobless claims on Wednesday and the monthly non-farm payrolls and unemployment report. That number will be released a day early (on Thursday, July 3rd) due to Friday's holiday. The markets will be looking for any sign of improvement in the labor market. If we see any such evidence, then the market might start to price in the possibility for a Fed rate INCREASE at some point in the future. Consensus forecasts, however, call for small job losses, although June is always a tough month to estimate due to summer jobs for college students. Teachers do not really show up until the July report.

WHERE DO WE GO FROM HERE?
As I alluded to above, the stock market appears to be forming at least a medium-term top. However, it is very near key support levels. I have often said that the markets are "pain maximizers" -- meaning that they tend to move in such a direction as to cause substantial losses for less sophisticated investors. So, what would maximize pain now? How about a break down below support, rally back higher to test the highs, and then a further drop of another 5% or so? Sounds good to me, and that is what I expect.

Look for losses to continue early on Monday. I will therefore close our short position in IBB in the model portfolio at the opening bell, as a reversal is likely after that. I will hold onto the 20+ Year Lehman Government Bond iShares (TLT, $92.07) in our Model Portfolio, however, as we are likely to see a short-term bounce in the bond market (albeit a small one). However, gains in stocks and bonds will likely peter out before the week is up, so I will provide further updates throughout the week via special News Flashes if necessary.

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(2.)  WEEKLY ETF PERFORMANCE

Below you'll find a table of weekly performance data for all ETFs that I track for this newsletter...

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(3.)  ETF RELATIVE STRENGTH MONITOR                                             

(Note:  If you're a first-time reader or you are otherwise unfamiliar with our proprietary ETF Relative Strength Monitor, then please click here for a brief description.)

When an ETF falls -0.10% for the week, yet jumps to the top of our leader board, you know that it was not a good week for the stock market. But, that is exactly what happened to the Russell 2000 iShares (IWM, $89.18). I would consider buying the fund, but with the annual rebalancing of the Russell 2000 underway, I'd rather stay out of that realm for a little while. Other relatively strong performers include the S&P 400 MidCap Fund (MDY, $88.08), and of course the two Biotech funds I follow, both of which still sport better than +30% gains over the past 13 weeks. (Keep in mind that at one point they were showing +50% increases.)

Bringing up the rear are the 20+ Year iShares Lehman U.S. Government Bond Fund (TLT, $92.07), which fell -1.69% last week (due to an effective revised exit price, however, we still managed to eke out a small gain on TLT in our "Trade of the Week"). Also acting poorly is the whole technology sector, which has been overbought for some time. To me, this is a shift in behavior, and I would use any rally in tech to enter into short positions. The Software HOLDR (SWH, $31.85) fell -2.87% last week, ranking it as the worst performer on our list. Meanwhile, the Semiconductor HOLDR (SMH, $27.49) has given back -5.34% over the past four weeks. Only the Oil Service HOLDR (OIH, $60.75) has done worse in that time frame. OIH also ranks near the bottom in returns over the past 13 weeks.

Here is this week's ETF Relative Strength Monitor...

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(4.)  MODEL ETF PORTFOLIO

                    S&P 500  Model Portfolio 
Last Week            -1.93%     -1.00%
Since Inception      +3.55%     +5.44%       

Although our portfolio outperformed the S&P 500 by a fairly wide margin last week, it still lost money, which does not make me very happy. We got stopped on our long TLT trade on Thursday as the bond market went into freefall. A clear head and shoulders pattern was actuated there. IBB also rallied back after getting annihilated early in the week. I am looking to close that position on Monday morning, hopefully on a small swing lower there. Given that the Biotech sector remains in a medium-term to long-term up trend, and still, even after recent losses, remains strong relative to the rest of the market, I will look for other areas to set shorts while taking a small long position there.

This week's instructions are:

• Buy back remaining 50 shares of IBB at the open on Monday.
• Buy an additional 50 shares of IBB at the open and set a stop at $64.65.
• Cut the S&P 500 SPDRS (SPY, $97.66) position to 50 shares long on a rally to $99.71 or a drop below $96.96.

I will provide additional ideas during the week if my expectation for a rally and subsequent fall are confirmed. If prices continue higher, then I will likely add to longs via IBB or the technology sector.

MODEL ETF PORTFOLIO

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(5.)  TRADE OF THE WEEK

SELL SHORT 100 SHARES PHARMACEUTICAL HOLDR (PPH, $81.43) ON A BOUNCE, AND AT THE SAME TIME BUY 20 SHARES OF ELI LILLY (LLY, $68.12)

Unfortunately, you can only trade HOLDRs in 100-share round lots. Eli Lilly, which comprises nearly 10% of the fund, looks to be in fairly good shape. By shorting 100 shares of PPH and at the same time purchasing 20 shares of LLY, you are actually going short PPH, excluding LLY, plus holding a 10-share long position in that stock (100 shares of PPH includes about 10 shares of LLY).

PPH itself has been one of the weaker performers of late, losing -2.83% last week. This fund is ahead more than +6% in the four-week time frame, which actually ranks it near the top of our relative strength list, but has been weak for most of the year and appears to be breaking down again.

The fund has decent support at $79.99, but with the 20-day moving average ready to break, and the same for a trendline, it is well worth looking to sell this for a quick trade from better levels.

A short sale in PPH looks attractive right now for the following reasons:

• In terms of relative strength, it has been a weak performer for much of the year.
• It appears to have peaked on low volume.
• MACD crossed negatively.
• Expected trendline and moving average breaks are due.
• By holding LLY long, you are reducing your risk because LLY has been stronger than the rest of the fund.

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RECOMMENDATION:

SELL SHORT 100 SHARES OF PPH AT $83.78, LIMIT $84.15
AT THE SAME TIME, BUY 20 SHARES OF LLY AT THE PREVAILING MARKET PRICE
TARGET (PPH):  $79.18
STOP (PPH):  $86.00

Assuming a sale at $83.78, and ignoring LLY, if you buy PPH back at $79.18, you will make $460 from this trade, or +5.5%.

********************************************

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(6.)  CONTINUED GUIDANCE ON PREVIOUS TRADES

BOUGHT 100 SHARES 20+ YEAR iSHARES LEHMAN U.S. GOVT. BOND FUND (TLT, $92.07). CLOSED VIA TRAILING STOP AT $94.00
DATE RECOMMENDED:  06/23/2003
DATE ENTERED:  06/23/2003
PRICE ENTERED:  $93.82
PRICE EXITED:  $94.00 (REVISED STOP VIA NEWS FLASH)
PROFIT:  +0.2%

TLT rallied strongly early in the week, but then turned tail after the Fed failed to cut the funds rate by 0.50% (a number of market watchers were hoping to see this larger rate cut). Some now believe that the Fed is finished cutting rates, although I am not so sure. However, as you can see from the chart, a clear head and shoulders formation was confirmed in TLT last week. Therefore, we're likely to see lower prices in the short term. I will only consider entering into longs here from lower prices, and even then will only do so if stocks accelerate lower. However, the recent correlation between stocks and bonds has been positive (meaning stock and bond prices have recently been moving in the same direction). If that appears likely to continue, then I will not enter longs in TLT even if stocks fall.

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(7.)  ETF SPOTLIGHT

For our second installment of the ETF Spotlight, I've decided to cover the iShares Nasdaq Biotech Fund (IBB, $67.84). I chose this ETF because I recently held a short position in IBB in our model portfolio.

iSHARES NASDAQ BIOTECH FUND (IBB)
The iShares Nasdaq Biotechnology Fund (IBB) is one of the more active ETFs, often exceeding one million shares traded in a day and averaging about 500,000 shares per day. While 500,000 shares in this day and age of two-billion-share days on the Nasdaq does not seem like much, it ranks IBB as a highly-active favorite in the ETF world.

IBB makes a good, volatile alternative to the technology sector funds because it does not necessarily trade along with the rest of the tech sector. Interestingly enough, it doesn't even trade very closely with its healthcare cousins either -- the Pharmaceutical HOLDR (PPH), the Healthcare SPDR (XLV) or the iShares Dow Jones Healthcare Fund (IYH). In fact, IBB trades more closely with the Nasdaq Composite than it does the former two funds. It does closely track the Biotech HOLDR (BBH) with a 94% correlation. This is due in large part to the fact that its largest holding, Amgen accounts for more than 1/3rd of BBH's value (Amgen accounted for 19.15% of IBB as of March 31st, 2003).

As you can see from the chart above, IBB certainly offers a plethora of trading opportunities. After nearly doubling from its July 2002 low, the fund tumbled more than -10% in the past two weeks before bouncing substantially. If you can manage to stay on the right side of the trade, IBB certainly offers lots of opportunity.

HOW TO MAKE MONEY IN IBB THIS YEAR
IBB stood at or near the top of our Relative Strength Monitor for several weeks, at one point having increased by more than +50% in a 13-week span. This was followed by a sharp corrective fall, and by the middle of June IBB had tumbled the nether regions of our relative strength rankings. However, last week's Candlestick suggests that we've completed the current downward move, meaning that a run to new highs (likely north of $80) is now possible. In fact, I've decided to move IBB to the long side in our Model ETF Portfolio this week for just that reason.

It is worth noting that IBB, much like many of the technology sector stocks and funds, failed to make a new low last October, even though the broad indices did. This also told me that IBB was likely to exhibit strong relative strength when compared with the overall stock market. Despite last week's apparent key reversal, the losses merely took prices back into the upper regions of a rising channel. And, even though the fund did trade below its 20-day moving average, the average was still rising, which typically means that the sell signal is less reliable. It would take a clean break below the blue up trendline to get me nervous that the current bull move is over.

However, my long-term stock market view does remain somewhat bearish. The recent high occurred on substantially lower volume than the 2002 lows. Although I doubt that IBB will make a new low in the next market downturn, even if the broad market does plumb new depths, I would tend to look for longer-term places to sell IBB from (probably above the mid-$80s), as a fall toward mid-$50 levels is possible by later this year.

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(8.)  WEEKLY EDUCATIONAL BONUS -- THE CONCEPT OF RELATIVE STRENGTH

Each and every week I present to you a table known as the ETF Relative Strength Monitor. Many novices get confused about this term because there are two indicators in technical analysis with nearly identical names, yet these are only related in a very distant manner.

The one I am not going to discuss here is Welles Wilder's Relative Strength Index, or RSI. RSI is a calculation that measures momentum, which we covered last week a bit in our discussion on divergences. I will cover this and other indicators in future issues of this newsletter.

Relative Strength has been popularized by William O'Neill of Investor's Business Daily (IBD). He uses relative strength in his combination technical/fundamental system, CANSLIM, to help select potential stocks for investing purposes.

The usual definition of relative strength compares how a stock, industry or sector's price performance compares with an index, such as the S&P 500 or the Nasdaq Composite. In analyzing relative strength, you might produce a chart that shows how the stock has traded relative to that index. For example, the chart below clearly shows how the iShares Nasdaq Biotech Fund has substantially outperformed the S&P 500 since last July. The price ratio moved from a low near 0.0439 to nearly 0.075.

However, the more common representation of relative strength allows you to compare how a stock, industry or sector is trading, over a period of time, when compared against other stocks, industries or sectors.

This is how IBD uses relative strength, showing the percentile rank a stock's total return stands. For example, if in the universe of all New York Stock Exchange listed operating companies, the shares of IBM are in the 90th percentile over the past year, then that would mean that IBM's shares have out performed 90% of all companies' shares on the exchange.

One method of using relative strength is to attempt to find shares that are not only performing well, but are also moving up in the rankings. In essence, you'd be looking for stocks that are in an uptrend and are performing better than most other companies.

Along those lines, I created a proprietary ranking indicator for the ETFs that I follow for this newsletter. Rather than using percentiles, I just show the rank, with "23" representing the fund with the highest relative strength and "1" the lowest. The indicator is a weighted average of how the fund has performed over the past one, four and 13 weeks.

The key to understanding relative strength is to realize that stocks, industries and sectors often move in cycles. To purchase a stock that sits at the very top of the heap may not be a very good idea for a swing trade, because there is substantial risk that the stock is at least slightly overbought.

In the ETF world, one must use extra caution when examining relative strength. It is unlikely that broad indices will ever rank far from the middle ground, as they include many of the same stocks and funds that other ETFs hold. With this in mind, a good strategy is often to own the indices when they are weak and to exit them when they begin to show up at the top of the rankings.

Thanks again for reading this week's issue, and good trading in the week ahead!

Steven Poser
Editor
The ETF Authority
New York, NY

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