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STOCK MARKET DIRECTION by Steve Zito Newsletter with 20 Stock Picks
Technical Indicator Analysis of the Dow and Nasdaq Composite Index
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STOCK MARKET DIRECTION by Steve Zito Newsletter

Information in this newsletter based on prices from Monday, May 9, 2005
Dow Jones Industrial Average
---------------------------------------- 10,384.34 +38.94 (+0.38%)
Nasdaq Composite Index
----------------------------------------- 1,979.67 +12.32 (+0.63%)
Standard and Poors 500 Index
----------------------------------------- 1,178.84 + 7.49 (+0.64%)
10-Year Treasury Note yield
-------------------------------------------- 4.278% +0.01

The Dow closed at 10,384.34 +38.94 at 0.68% above its short-term moving average.
It was the 6th day of rising prices, all in the month of May, and attributable to
mutual fund cash inflows from the end of April after investors filed income taxes.

Once middle-class Americans figured how much they owed the government for Federal
and state income taxes by the April 15 filing deadline, they knew how much was
left over to play the stock market. That money should be fully invested by now.

Mutual funds take checks they get at the end of each month and put that money in
the market in the first 4 trading days of the following month, that is, May 2-5.
Notice the market weakened May 6, and only takeover deals sent it higher May 9.

Dow stochastics rose from 69%/79% to 80%/76% in quickly approaching overbought.
After becoming overbought last Wednesday, when the Dow exceeded 10,400 intraday,
stochastics had weakened to just below overbought as the Dow has gone sideways.
Somewhere between Dow 10,400 and Dow 10,500 should become a short-term ceiling.

First quarter earnings reports have come and gone, and 17% growth in net income
for industrial stocks has only moved the Dow from 10,500 to 10,000 and back up.
If the earnings growth predictions by market bulls determined stock prices, the
Dow would easily be riding over 11,000 by now. Other concerns are more damaging.

The worst factor is a rise in inflation, which forces the Federal Reserve to hike
interest rates, which they have done 8 times the past year. An interest rate rise
is meant to slow down the velocity of money, that is, the turnover from bank to
borrower, into the economy, and eventually back to the bank. Much of the lending
finds its way into the stock market with online brokers like Schwab only asking
for 4.49% for margin interest. When the FED tightens, loans decline, less money
finds its way to the market, there is less buying of stocks on margin, and so on.
This multiplier effect worked great in the 1990's as interest rates came down from
the high rates of the first Bush presidency in 1991. Liquidity boosted that market.

Since the second coming of Bush circa 2000-2001, rates were pushed down until
they went so low that the 2002 economy was awash with dollars, forcing money into
stocks in Oct. 2002, and while stocks staged a recovery since 2002, the value of
the U.S. dollar against the Euro and Yen has been trashed, negating 1/2 the gains.

A U.S. investor has no idea the value of his dollar went from 1.18 to 0.75 Euros
while the Fed was lowering rates 2002 to 2004. Only when the FED stopped lowering
did US dollar stabilize in late 2004, but then the US stock market stopped rising.
What's the point? Lower interest rates boost stocks and sink the dollar and then a
sinking dollar boosts profits of multinational Dow Industrial firms. Higher rates
hurt stocks and support the US dollar, which lowers the profits of multinationals.
Anyone telling you to buy the Dow stocks in periods of rising rates is dead wrong.

The current rally is only 6 days old, and has more to do with General Motors GM
takeover news and mutual fund inflows, than jobs growth and consumer confidence.
Yet the past 2 session gains were attributed to the latest reports of the latter.

What of those with wasting assets such as puts on the DJX which are sliding fast?
One, at Dow 10,000 I advised to cash out at least 1/2 of the winning DJX puts to
recover their original cost. Two, the remaining puts should always be considered
a gamble, and like any wager, can be lost instantly. Unlike casino wagers, there
is thinking involved, and experienced thought will always lead to winning trades.
Don't forget. At Dow 10,000, no one expected a recovery to current levels in May.

As for individual Dow stocks, the takeover news whipped the GM puts, but there is
time left, and if Kirk Kerkorian is satisfied with the $6 per share he made on his
5% of GM bought under 26, there may be news a month from now, he has sold it all.
That could send GM right back to $26, and readers are holding July puts with time.

Likewise PG puts did not cost much, since expectations are low that PG will drop.
Proctor and Gamble is big in Asia with shampoos, soap, and diapers. Have to try
to imagine what happens to PG's China profits if China floats its currency and the
Chinese Yuan moves substantially higher against the US dollar. Could happen anytime.

That leaves Intel. As Intel moves up toward $25, readers are begging for reasons.
Dell is Intel's largest customer. Dell is slashing prices on product lines, such
as Dell Dimension, pricing at $399 with a sale that was supposed to end April 29.
That sale is still going, extended a week at a time, and some models are now $299.
That's right, PC, monitor and keyboard from Dell for $299, each with Intel in it.

Intel is not cutting prices to Dell, but Dell is selling a lot more PC's this year.
So Intel is getting a lot more unit sales volume from Dell cutting PC sales prices.
Dell may be less interested in making profits and more in being the leader in sales.
That's his ego, the CEO of Dell wants to be known as selling more PC's than anyone.
Will it last? Dell advertises PC's as "awesome" backed by "award winning support."
I don't know anyone who's a repeat buyer of their mediocre quality "award winners."
DJX closed at 103.84 +0.39 (+0.38%) opened 103.46 range 103.20 to 103.85
June 100 put DJVRV last 0.60 -0.10 Bid 0.50 Ask 0.65 vol 256 oi 29216
June 104 put DJVRZ last 1.80 -0.05 Bid 1.65 Ask 1.80 vol 1120 oi 21505
Open interest is barely expanding, which is bullish for DJX put prices.
It means floor traders are reluctant to write (sell) new DJX put positions.
XAU closed at 85.96 +0.29 (+0.34%) opened 85.78 range 85.37 to 85.97
and the XAU has revived from below 83 a week ago to get back above 85.50.
Hold June 95 call XAUFS last 0.50 no trade Bid 0.55 Ask 0.70 vol 0 oi 1404.
Readers bought XAU June 95 XAUFS call when XAUFS opened at 0.85 on April 29.
Newmont Mining NEM closed 38.29 +0.17 (+0.45%) June 45 call NEMFI last 0.10.
Nasdaq Composite closed 1,979.67 +12.32 at 1.10% above its 7-day moving average.
Like the Dow, the Nasdaq moving average had been sideways until the FED's hike.

Since the FED raised interest rates 1/4 point, Nasdaq has gained 2.7% and rallied
for the first 6 trading days of May. The rally is identical to the Nasdaq rally
for the first 6 trading days of both March and April, each of which was followed
by substantial market declines for the remainder of March and April. Why is that?

Mutual fund cash inflows, as fund managers buy Dell, Intel, Microsoft and Cisco,
the stocks people love to own, evidenced by the number of shareholders, not the
number of shares. These four have more individual shareholders than all others.
Not surprisingly, these four are the largest capitalization stocks in the Nasdaq,
a market cap weighted Index, so their movement skews the index more than others.
Nasdaq stochastics are very overbought, rising from 88%/92% Friday to 100%/92%.

There is an extremely high correlation between the direction of these top weighted
stocks and the index. Only Intel is moving up, the 3 other leaders act like dogs.
Intel is moving in the wrong direction. Most of the time, summer brings selling.
Attribute Intel's surprise upswing to Dell's price cutting market share grabbing.
That Dell sale at $399 for desktops was due to end April 28, it will end soon.

INTC closed at 24.80 +0.31 (+1.27%) opened 24.42 range 24.34 to 24.80
July 20.00 put NQSD last 0.10 unch. Bid 0.05 Ask 0.10 volum 2 oi 17,492
July 22.50 put NQSX last 0.20 -0.05 Bid 0.20 Ask 0.25 vol 841 oi 59,456
If everyone is bullish on Intel, this stock may be 5 points overvalued.

Thanks for reading this edition of Stock Market Direction by Steve Zito.
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