What a Week: Early Lead Lets Bulls Finish Ahead

One day does not a market week make. But Monday's upward surge was enough to make this a winning week on Wall Street, even if it didn't feel that way as the weekend beckoned.

For the week, the Dow Jones Industrial Average rose 0.9%, the S&P 500 gained 0.7% and the Nasdaq Composite climbed 1.1%.

Those gains notwithstanding, weakness on Thursday, intraday Friday and among momentum favorites throughout the week left some participants with that sinking feeling.

"All rallies have to come to an end and some cracks are beginning to appear in this one," Martin Pring, editor of The Intermarket Report, commented Friday. Major averages are significantly overbought and sentiment "extremely bullish," he noted, leaving stocks vulnerable to "near-term technical damage." (On Wednesday, Chartcraft.com Investors' Intelligence survey showed bearish sentiment at a 16-year low.)

However, Pring believes "pretty well all of the technical evidence points to a primary bull market and that any correction is likely to represent a good buying opportunity." (Most notably, major averages remain above their 200-day moving averages, and those moving averages are turning upward.)

Still, a notable subplot to the week's action was waning strength in groups that previously had been leaders, including biotech, Internet, energy and broker/dealers. Additionally, homebuilding stocks fell sharply in conjunction with the bond market's slide.

For the week, the yield on the benchmark 10-year Treasury note -- to which many mortgage rates are pegged -- rose 27 basis points to 3.38%. In conjunction, the S&P Homebuilding Index fell 5.6%, despite better-than-expected earnings from KB Homes ( KBH) and Tuesday's report showing strong housing starts and permits for May.

Limping to the Finish Line

On Monday, the Dow closed at its highest level since July 5, 2002, and the S&P 500 above 1000 for the first time since June 20, 2002. The Comp established its best finish since May 23, 2002.

The remainder of the week proved to be a struggle to sustain those levels amid warnings from firms such as Eastman Kodak ( EK) and Halliburton ( HAL), as well as disappointing guidance from firms such as Morgan Stanley ( MWD). Alternatively, General Electric ( GE) reaffirmed its guidance Friday, after stumbling Thursday amid evidence of weakness in its plastics division.

Major averages finished mixed Friday after suffering a midday decline that some attributed to warnings of potential terror attacks against U.S. interests in Africa. Certainly the so-called quadruple witching expiration of futures and options also contributed to the volatility on Friday, and for the week overall.

The Dow finished up 0.2% to 9200.12 Friday vs. its early high of 9276.51; the S&P rose 0.1% to 995.72 vs. its intraday best of 1002.09. Meanwhile, the Comp dipped 0.2% to 1645.03 vs. its high of 1660.50.

In addition to some negative corporate news, the week's early momentum was dampened by uninspiring economic data. Most notably, shares fell sharply Thursday after a weaker-than-expected Philadelphia Fed survey undermined excitement generated by Monday's Empire State Manufacturing Index.

Elsewhere on the economic front, Tuesday's stronger-than-expected consumer price index report relieved concern about deflation, triggering a weeklong debate about whether the Federal Reserve will ease by 25 or 50 basis points next week.

On Friday, the Economic Cycle Research Institute said its weekly leading index rose to 123.4 from 123.2 the prior week, although its four-week moving average rose to a four-year high of 6.1% vs. 5.5%.

Uncovering the Recovery

The mixed economic data and 100% certainty among financial market indicators that the Fed will ease by some amount next week are indications the recovery remains tenuous.

Still, the bond market's tumble and rising yields partially reflected a sense that things are improving, even if slowly.

On Friday, Goldman Sachs' economics team of Bill Dudley, Jan Hatzius and Ed McKelvey suggested GDP will grow between 3% and 4% in the next year and raised their GDP forecast for 2004 to 3.3% from 2.5%.

"The data themselves provide only grudging evidence that a rebound is taking shape," Goldman's economists wrote, noting industrial production rose a meager 0.1% in May while capacity utilization remained at a 20-year low. Still, the firm is "growing more optimistic about the U.S. growth outlook" due largely to the "front-loaded" fiscal stimulus, i.e., tax cuts, and the "regime shift" within the Fed.

The central bank's focus from fighting inflation to forestalling deflation "makes it more likely that the recent easing in financial conditions -- unlike those during previous bear market rallies -- will be sustained," the firm explained. Goldman expects the Fed will ease by 50 basis points next week and thereafter "stay on hold" through 2004.

A prolonged period of low rates, "underpins valuations in the bond and equity markets and is consistent with further dollar depreciation," Goldman added.

Although shares held up, things didn't exactly work out that way this week for Treasuries. Meanwhile, the dollar put on a pretty strong performance this week, especially vs. the euro, which was trading at $1.1606 late Friday vs. $1.1863 a week ago. Meanwhile, the dollar was at 118.34 yen vs. 117.48 yen a week prior.

There is, of course, a different, more cynical view to all this, which as examined here Thursday: While many financial market participants cheer the aggressive monetary and fiscal stimuli, some believe they are serving only to fuel speculation without materially effecting the "real economy."

The optimistic view is that improvements in financial markets will spur more confidence among consumers and business leaders. That view holds that ultimately it will lead to improvements in the real economy, notably labor markets and capital expenditures. Skeptics believe the recent Fed-induced splurge in financial assets will end as badly as the last one, if not worse.

The optimists maintained the upper hand this week but little that occurred resolved that debate, which is unlikely to go away anytime soon.

Tune-In TaskMaster

I'll be back on WABC radio's Batchelor & Alexander show Friday evening, around 9 p.m. PDT/12 a.m. EDT. (OK, that's really Saturday morning for East Coasters). The show is nationally syndicated, so check wabcradio.com for local listings or Webcast options.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.

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