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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

For the third week running, a rally on Friday allowed the stock market to put in a decent performance for the week. This one was aided by a combination of two days of stronger-than-expected economic data, coupled with continuing rumors that the U.S. military was closing in on Saddam Hussein. With most earnings data out of the way, the market may start to focus on supposed economic strength.

WHENCE THE ECONOMY?
The data were better than expected last week, pretty much across the board. Unemployment claims fell to their lowest level in several months, and durable goods orders (big-ticket items) ticked up +2.1%. Even if you take out the volatile transportation data, orders rose +1.4%, which marks the best performance since January.

Unfortunately, there will be little in the way of interesting economic data next week, so the markets are going to have to chew on those bits of evidence a little while longer. That is, until Thursday when we will see jobless claims, Q2 GDP and the Chicago Purchasing Managers report. Wednesday will be interesting as well, as the Fed will release its Beige Book. Economists will be looking for hints as to why Alan Greenspan has been so bullish on the economy in recent comments. (Note that GDP is forecast to be near +1.5% for the second quarter, but that forecasts for the second half of the year are much higher.)

I keep seeing this commercial on CNBC where Larry Kudlow keeps saying how higher interest rates will not cause a problem for the stock market and that we should buy the ranch. That's probably because he has one to sell! Interest rates were at unnaturally low levels, but this sort of spike will not help growth, and rising interest rates are not priced into the numbers. The housing market, which saw existing home sales weaken (new home sales rose), also saw the inventory of homes on the market at its highest in several years. This is what I call the Wiley E. Coyote effect, when he runs off a cliff, realizes he's off it, waits a second and then tumbles. Homeowners don't realize that their homes are not worth what they were a few months ago, but the buyers do. These homes are not going to sell until reality sets in for the sellers.

As that kind of information starts creeping out, the happy talk on CNBC is not going to be enough to boost the stock market anymore, and news that (for the umpteenth time) the second-half recovery forgot to show up, will take stocks lower yet again.

TRIANGLES ARE US
The stock market has been stuck in a tight trading range ever since it topped in mid-June. The pattern it has formed is called an ascending triangle (some have called it a double top, but that is unlikely). There is a chance of slight gains, and yet another dip, but the direction of the next move will most likely be a breakout higher. My only concern, for the short-term at least, is that volume has been weak on up days and stronger on down days. It was weak on Friday and we haven't had strong follow-through higher on recent Monday's either. We probably won't this Monday, but I would use the dip to buy for a FINAL move up in this bull market.

THE BOTTOM LINE
If I have any concern regarding the direction of the stock market right now, it is that there is one neural net (a sophisticated computer model that forecasts stock prices) that I closely track which had a turn date for last Friday. With prices so close to a high, that is a concern. However, a turn date is really a change in trend, and the change may have been from sideway to up. I continue to see at least another +4% upside potential in the broad market, and maybe even about +7%. The only market I'm very concerned about is Japan, where I still hold a short position (much to my chagrin after Friday's rally). When it comes to U.S. stocks, buy on the dips but watch carefully for a move below the recent 962 low on increasing volume, as that would likely mark the beginning of a sharp market reversal.

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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.)

Canada WEBS (EWC, $11.92), aided by a strong rally in the Canadian dollar, jumped +3.29% last week, garnering the top spot among the 23 ETFs that I follow. Number two on the hit list was the Semiconductor HOLDR (SMH, $32.34), which gained +2.83% and was the subject of my "Trade of the Week." I also hold this fund in our Model ETF Portfolio. Last week was not all roses for that portfolio, however, as EWJ was a strong performer as well, gaining +1.83% (I hold it as a short, but the trade is still ahead +2.5%). As I will note below in our continued guidance section, I continue to expect another leg lower in Japanese stocks.

I have recommended purchasing the Software HOLDR (SWH, $32.23) for the "Trade of the Week," as that fund has jumped 10 places in the rankings and is ahead a respectable +15.56% over the past 13 weeks. The big loser last week (after hitting number one a week ago) was OIH, which tumbled -5.87%. Only three of 19 stock funds fell last week, while three of the four debt funds lost ground.

I continue to see the upcoming rally as an end game. Although the tech sector might not trade as well as it has in the past, it continues to outperform other areas and is near overhead resistance, which should permit it to surge further on a breakout. It's worth noting that cyclical industries acted well last week, but unfortunately there is no way of playing that sector among the actively traded ETFs.

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

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(4.)  MODEL ETF PORTFOLIO

Summary:  (began trading on May 19, 2003)

                    Last Week   Since Inception 
S&P 500               +0.57%      +6.06%
Model Portfolio       +0.56%      +6.94%        

I was well ahead of the market until Friday afternoon, when somebody told all the bulls that they were in Pamplona. Suddenly, our Japan WEBS (EWJ, $7.78) short position took it on the chin and my high cash ratio basically pushed us down to even with the S&P 500 (even though my two long positions easily out performed the overall market). In fact, the Semiconductor HOLDR (SMH, $32.34) was the second best performing ETF last week. Only the Canada WEBS (EWC, $11.92), which surged +3.29%, performed better.

For this week, I am going to stick with all of my current positions, but will add 25 more shares of the Dow Diamonds (DIA, $92.91) on a pullback to $92.26 (if it happens on Monday only). In addition, I'm going to buy 100 shares of the Software HOLDR (SWH, $32.23) on a pullback to $31.75 (again, on Monday only). I will also buy if Microsoft (MSFT, $26.89) closes above trendline resistance at $27.04.

This week's instructions are:

• Buy 100 shares of SWH on a pullback to $31.75 on Monday only. If not filled on that trade, then buy 100 shares if MSFT closes above $27.05. Place stops at $31.04.
• Hold EWJ stop at $7.89.
• Buy 25 more shares of DIA if it falls to $92.26 on Monday only.
• Trail stop loss on SMH to $30.40.

MODEL ETF PORTFOLIO

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(5.)  TRADE OF THE WEEK

BUY 100 SHARES SOFTWARE HOLDR (SWH, $32.23) ON A PULLBACK TO $31.75 ON MONDAY ONLY

Please note that this is not the exact same recommendation that I have provided in our Model ETF Portfolio above, where I recommended buying if Microsoft breaks higher as well. This is because I typically hold Model ETF Portfolio positions longer, while a failure at resistance for a "Trade of the Week" would usually have me exit more quickly.

SWH rallied to a minor new high late on Friday, but the fund does appear set to correct on Monday. I would use that opportunity to enter long positions, as the fund should soon exceed its June $33.95 peak. Microsoft (MSFT, $26.89), which accounts for 24.95% of the value of SWH, has briefly traded above a down trendline several times, and is again poised to challenge it. With a very long-term resistance line at about 10% above current prices, I expect MSFT to make a run at those levels soon.

However, MSFT alone is not a good enough reason to purchase SWH. MACD is readying for a bullish crossover, prices completed a nearly perfect a-b-c fourth=wave lower at the bottom last Monday, and RSI bounced off a similar level to its launching point at the end of last March. A close above the 20-day moving average (closed Friday at $32.34) would permit a quick run at gap resistance standing at $32.98.

Our reasons for buying SWH are as follows:

• MSFT is attacking key trendline resistance.
• RSI turn at similar level to late March.
• Clearly completed a-b-c fourth-wave fall.
• MACD poised to cross positively.

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RECOMMENDATION:

BUY 100 SHARES SWH ON A DIP TO $31.75 ON MONDAY ONLY.  DO NOT EXECUTE OTHERWISE.

TARGET:  $33.98
STOP:  $31.04

Assuming a purchase at $31.75 and sale at $33.98, you will make $223 from this trade, or +7.0%.

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(6.)  CONTINUED GUIDANCE ON PREVIOUS TRADES

SHORT 500 SHARES JAPAN iSHARES MSCI WEBS (EWJ, $7.78) AT $7.98

Japanese shares rose more than I had forecast, but the pattern lower continues to be bearish, especially in the Nikkei itself. Stick with current stops and targets.

RECOMMENDATION:
DATE ENTERED:  7/14/03
SOLD SHORT 500 SHARES EWJ AT $7.98
TARGET:  $7.16
STOP:  $7.89 (Revised)

Assuming we close the trade at our $7.16 target, we will make $420, or +10.3%. If EWJ hits our stop, then we will still post a small profit of $45, or +1.1%.

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BOUGHT 100 SHARES SEMICONDUCTOR HOLDR (SMH, $32.34) AT $31.55

There is a tiny chance we are in a more extended minor fourth-wave consolidation (wave-iv shown on the chart below is still active), but the late recovery on Friday was a good sign. If SMH can continue to mount gains on Monday and can make a new high above $32.95, then I will bring my stops somewhat closer to current prices.

RECOMMENDATION:
DATE ENTERED:  7/21/03
BOUGHT 100 SHARES SMH AT $31.55
TARGET:  $34.04
STOP:  $30.40

Assuming we close the trade at our $34.04 target, we will earn $249 on this trade, or +7.9%.

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(7.)  ETF SPOTLIGHT -- THE TREASURY BOND MARKET ETFS

iSHARES Lehman 20+ Year Tsy Bond Fund (TLT, $85.56)
iSHARES Lehman 7-10 Year Tsy Bond Fund (IEF, $84.71)
iSHARES Lehman 1-3 Year Tsy Bond Fund (SHY, $82.42)

To date, I have focused our "ETF Spotlight" section of this newsletter on the stock market-linked ETFs. However, you can also trade the bond market with ETFs (and you will soon be able to dabble in gold as well).

I track four bond market funds. The three I've listed above invest only in bonds issued by the U.S. Government. (I will cover the fourth, which invests in corporate bonds, in a separate Spotlight at a later date.) These bonds are backed by the government and can never default (remember: the government can always print more money to pay you back, which is a nice thing to be able to do). You may also recall that the interest you receive from U.S. Treasury bonds is free from STATE income taxes. You still need to pay tax on any capital gains, and you also are liable to the IRS for Federal taxes on interest payments.

What is the difference among the funds?
The answer to that is just one thing: the time to maturity for the underlying bonds that each fund invests in. For example, TLT only invests in bonds that mature (pay back their principal) in 20 years or more. IEF invests in bonds that mature in seven to ten years. And finally, SHY holds very short maturity bonds -- those that pay off in one to three years.

The longer the time to maturity, the more volatile the price of the fund will be. As you can see from the tables below, the average daily price range for TLT is almost double that of IEF and approaches four times that of SHY. However, these ranges pale in comparison to the typical equity-linked fund.

How much price action is there in the funds?
That does not mean there aren't any opportunities in these funds. TLT has fallen more than -12% in the past month (although it did pay a dividend during that time), yet had risen more than that between early April and mid-June. Both of these moves are probably a bit larger than you'd normally see in this fund, but that's what happens as a bubble inflates and pops!

Please be aware that all three of these funds pay dividends each and every month. TLT and IEF have been paying about $0.35 at the start of each month, while SHY's dividends have been about $0.10-$0.12. If you decide to short any of these funds, then you will need to pay those dividends out of your pocket (in theory, the price of the fund should fall by the amount of the dividends paid, so you won't lose out here).

Do these funds trade in the same direction as the stock market?
I'm glad you asked that question. Historically, stocks and bonds have periodically moved in the same direction, but at other times have moved in opposite directions (depending on where we were in the business cycle). However, that has changed in recent years because money now flows into and out of assets on a regular basis as investors try to find the hot spot in the world of asset allocation. This has meant that as stock prices rose, bonds fell, and as equities tumbled from 2000 to late-2002, bond prices rallied. What this means is that the correlation between stocks and bonds has been negative (as you can see from the tables below). A negative correlation within a portfolio will lower the variability of your returns, but also will lower your overall returns. Depending on your goals, bonds may belong in your portfolio, but the exact mix of stocks/bonds you choose to invest in is something that only you and your investment advisor can decide.

Recently (as in the last month or so) bonds and stocks have seen this negative correlation break down a bit. The sharp rise in bond market yields has started to cause some concerns in the stock market. We burst the stock market bubble in 2000. We burst the bond bubble in June. The housing bubble is next. Fixed-rate mortgages have soared. This is forcing people into adjustable rate mortgages, which bring much higher risk to the homebuyer.

What makes these funds move?
In short: the economy. If you own or are short these funds, then you should make it your business to understand and know what is happening on the economic front. In doing so, the first step should be to keep track of the scheduled release of various key economic data (you can find this data on the web at any major financial data site). The most important items to be aware of are:

• Non-farm payrolls and the unemployment rate, which are usually released the first Friday of every month.
• Fed meetings, where the U.S. central bank announces whether or not it is changing its interest rate policy. There are eight meetings every year.
• Inflation reports, both consumer (CPI) and producer (PPI).
• Retail sales -- most importantly, the government statistic, though you might also care to follow the auto manufacturers reports and the chain store sales as well. There are also weekly surveys that are widely followed during the Christmas selling season.
• ISM/NAPM Reports are regional and national reports on how manufacturers are faring in the way of orders received and shipped, how much they are paying for goods and charging for them, hiring plans, etc. These tend to come out toward the end of the month and are the first bits of information available for that month.
• Regional Fed surveys, the most popular of which is the Philadelphia Fed survey on manufacturing.
• Weekly unemployment claims (Thursday at 8:30AM EST).
• Durable goods orders (big-ticket items like planes, autos, etc.)
• The Beige Book -- released eight times a year, written by the region Federal Reserve banks and used as input to upcoming Fed meetings.

You also need to know what the market is forecasting. Reading a headline such as: "Unemployment rate surges to 6.9%" might make you think that the bond market would rally (bad news for the economy is good news for the bond market). However, if economists had been forecasting an unemployment rate of 7.2%, then the news could actually send the bond market south.

You must also remember one key fact: Prices and yields move in opposite directions. If you read that interest rates rose sharply on a given day, then that means bond prices (and hence, the value of these bond funds) fell. When I talk about a negative correlation between stocks and bonds, I am referring to prices. As stock prices rise, bond prices fall and bond yields rise.

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