Both the weekly and daily technical data continue to point to an overbought market, indicating investing at current levels remains a dangerous game. While specific stocks may look cheap, the overall markets look expensive. We have been surprised by the staying power of the market, having been in overbought territory for most of the past four months. While there have been corrections, they have generally been shallow and quick. Having now exited the most dangerous season of the year (May to October) and entering the best (November to May) the all clear should be sounded and the march continue. We would be a bit more excited about the favorable seasonality, if the markets were in the doldrums instead of euphoric. Insider selling at the corporate “window” and the commitment of traders also show the largest groups adding to their short positions. Finally, although the Fed is not about to raise rates, monetary growth, across the “M” complex (M1, 2 &3) have turned lower. The market internals have not broken much below overbought territory, however some divergences are beginning to develop. If they persist, we will begin taking money off the table. For now, the trend remains higher, but straining to maintain the positive track. The markets remain about 5-7% above our “momentum” line, so another minor correction would not do damage to the trend, but it will develop the divergences into a more serious issue.

The strength of the economic as well as corporate reports, have pushed treasury yields back up, prices lower. The bond model, after spending September in a positive mode, the model has deteriorated back to a 0/5 reading, indicating rates should continue higher. Gold stocks, while the model has been negative, have been rising – now up 7% since the model turned negative. This is on top of a 10% gain in six weeks, after the last negative reading. The low short rates remain relatively stable, with long rates deteriorating. The short/long spread is back above 425 basis points and has been above 400 bp in 16 of the last 17 weeks. Fears of inflation persist at the long end of the market.

As it has been, as it shall be – once again little movement in the group work, indicating money is happy going into the high from the low momentum sectors. Only two groups in the top 20% fell dramatically, pipelines and airlines. The pipeline group, on the weakness in Kinder Morgan (KMI) and Williams (WMB) dropped to the middle, as did the airlines after their spectacular run. On the bottom, two groups showed some life, both economically sensitive: railroads and chemicals. Norfolk Southern (NSC) and CSX helped the rails, as both broke multi year declining trends. Significantly, they both have increased 10% over the past two weeks on nearly twice-normal volume, and have support from the rest of the sector, indicating the breaks higher are for real. In the chemical group, it seems as if everything but Dupont is moving. Dow Chemical (DOW) is at resistance, matching the highs of 2001, if broken the next stop is 45-47. Georgia Gulf

(GGC) is also nearing long-term resistance that once broken, could propel the stock 30% higher. Finally, one of the largest jumps over the past couple of weeks is in advertising, with Interpublic (IPG) leading the way. Here too, volume has picked up as prices have increased, a sign that the move may have some staying power.

We continue to be cautious, although any correction could be fairly shallow and quick. There exists roughly a 5% margin that the markets could drop before we get very concerned. A light week on economics as well as a partial holiday tomorrow. Company specific news should drive the market. Small stocks should continue their outperformance.