Here Comes Santa … With His Santa Claus Rally?

DJIA:  33,027

Here comes Santa … with his Santa Claus rally?  Santa Claus rally, oversold rally, for now it’s all the same.  Since there usually isn’t much weakness in December, markets usually don’t get oversold in December.  A reflection of the recent weakness, at least by our measure, this market was more oversold than any time since September.  This may well have prompted the recent rally, but it is itself not a wonderful sign – good markets don’t become too oversold.  And just last week, the market did become a not so good market as the Advance-Decline numbers and new Highs /Lows turned negative.  Last week also saw outside down weeks in the averages – a higher high and lower low than the prior week.  And the S&P and NAZ slipped below their 50-day averages.  Not an auspicious start to any rally, but sufficient until the day. 

If it’s unusual to see a deeply oversold market in December, it is similarly unusual to see investor bearishness in this historically positive month.  Yet option traders have placed record bets against stocks.  A couple of months ago there was a surge in option bets against stocks greater than anything since the financial crisis.  This preceded an S&P rally of some 13%.  According to, large traders have bought to open the fewest equity Call options relative to Put options since 2009.  Some $1.1 billion Call options were bought while $19 billion Put options were bought.  It is among the largest net bet against stocks, and this in December.  Put-Call ratios among stocks in the NASDAQ 100, S&P Technology sector and Financials all hit records last week. 

Suddenly everyone is a monetary expert.  Investors dislike the current monetary policy thinking it’s a mistake.  The consensus of fund managers and certainly commentators, is fixed on lower inflation and a recession next year.  Higher rates in the short term will only make things worse, or so the view goes.  As the mistake grows clear, central banks will be forced to pivot.  A monthly Bank of America Fund Manager Survey found that investors expect government bonds to be next year’s best performing asset.  Meanwhile, equity bearishness is no mystery.  It’s understood by most that a profits recession is at hand.  According to the survey, bearishness among fund managers when it comes to earnings is the highest on record, even higher than 2009.  Hence the Fund Manager Survey showing them the most overweight bonds compared to stocks since 2009.  What followed back then, of course, was the great rally in equities.

It’s that time of year when it’s nice to have your Deere (436) ones around you – even the Caterpillars (238).  These would be among our choices for next year as well, together with names like Home Depot (316), McDonald’s (266) and General Mills (85).  A bit less familiar would be names like AXON Enterprise (168), the former Taser, ETSY (127), and Sarepta (132).  We’re trying to be bullish on Oil, but most are still correcting.  As it happens, some of the equipment names like Halliburton (38) and Transocean (4) seem to be acting better than the rest.  Pharma is more than holding its own, particularly those middlemen like McKesson (382), Amerisource (169), and Cardinal Health (81).  Finally, there’s Gold, where hope springs eternal.  All the miners were below their 200-day in October.  Half are now above that level, an important momentum shift.  If they’re able to hold together into the New Year, it may finally be a good one.

The average investor is said to be wrong at the extremes, but right in between.  Contrary opinion is always useful, provided you pick the right time and place to be contrary.  Certainly poor earnings and/or the looming recession are among the things to consider here.  They might already be discounted by this year’s bear market.  With a recession looming it’s surprising the number of industrial stocks that have been acting better than you might have expected.  As always, it’s best to let the market tell the story.  It is after all, the market where we are investing, not the economy.  And the market should not be confused with the market averages.  Rather, the market is the average stock, where the averages eventually follow.  Strength in the averages needs participation, that is, comparable strength in the Advance-Decline numbers.

Frank D. Gretz

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Sell the News …Especially Good News

DJIA:  33,202

Sell the news …especially good news.  That proved true to an extreme on Tuesday, but in this market follow-through has been hard to come by any old time.  There are plenty of good charts, but good charts not doing much of anything.  Then, too, it’s a positive time of year, but a time of year when you don’t typically expect the dramatic.  Tuesday’s reversal was rather dramatic.  We had our 500-point rally on Monday, so some of the good news arguably was already in.  And a somewhat overlooked part of the Tuesday drama was that Advance-Declines were close to 3-to-1 up.  The previous month’s CPI held onto an 800-point Dow gain, but with A/Ds only a little better than 2-to-1.  We’ll take the better A/D numbers anytime.

As it happens, NYSE Advance-Decline numbers have been disappointing of late, having peaked three weeks ago.  An adjusted measure of A/Ds turned negative just a few days ago, worrisome in that this measure pretty much nailed the low in mid-October.  A cumulative measure of new highs/lows also called the October low pretty well and now is teetering on a sell signal.  So some technical concerns have arisen, against the always to be respected December seasonal pattern.  The second half of the month, and certainly that last week of the year, tends to be particularly positive.  Even here, however, it’s important to keep an eye on those A/D numbers, especially on up days.  You don’t want to see poor participation when the market is up.

If not one thing it’s another for Cathie Wood.  She just spent a couple of years suffering with an array of stay-at-home stocks whose time has passed, but her portfolios were somewhat held together by Tesla (158).  Now most of the losers at least have stopped going down, but it has been Tesla’s turn.  And it’s not just that it’s down in some sort of normal correction, a look at the monthly charge is worrisome.  Meta (116) of course is another name seemingly passed its glory days market-wise, although a banning of TikTok, if it comes to pass, should help there.  Another over-owned stock not acting so well is Apple (137), which as yet has no serious break.  It’s hard to stay on top, just ask Cisco Systems (48) or GE (79), both once the largest stocks by market cap.  Meanwhile, we have touted McDonald’s (272) versus Microsoft (249).  We still like McDonald’s, but have come around to Microsoft.  Like the S&P, it too may have difficulty with its 200-day, as it did in August.

Bad news from Wall Street often isn’t bad news at all.  Bloomberg recently pointed out that Wall Street strategists are the most pessimistic in 22 years, calling for a decline in the S&P next year.  Most have turned progressively more negative in this worst year since the financial crisis.  Strategists take a top down view while analysts do pretty much the opposite, focusing on individual company earnings prospects.  Despite the different approach, their analysis has been just as negative.  A few weeks ago there were a net 150 downgrades in a single day, the third most in 12 years.  Other times of record downgrades coincided with important lows, according to  There is a small sample size here, but Wall Street pessimism often has been a good sign for the market.

It’s a tough time of the year to be bearish.  Unfortunately, that’s not to say it’s wrong to be bearish.  The technical backdrop has shown deterioration and the market didn’t exactly ignore Powell’s revisit of Jackson Hole.  As always, it’s not the news, it’s what the market does with it.  Wednesday’s reaction wasn’t terrible, in fact it looked more undecided.  As often happens after these events, the real reaction comes the day after, and that did look terrible.  We were a bit surprised at the market’s surprise, as we have come to think more hikes were priced in and recession is the worry, a worry made clear by oil’s failure to respond to the China reopening.  We all know year-end is favorable and the New Year likely weak.  When it comes to the stock market, however, what we all know isn’t worth knowing.  There’s a catch here somewhere.  The way they’re acting, it could be here at year-end.

Frank D. Gretz

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US Strategy Weekly: Preparing for a Recession

Stocks have seen a year-end rally in each of the last six years and this phenomenon can be explained by a number of seasonal factors such as the end of tax-loss selling, mutual fund window dressing, and stock purchases due to liquidity from year-end and Christmas bonuses, among other things. However, we believe a year-end rally may be less robust than usual since thoughts of 2023 and its various hurdles could weigh on investor sentiment.

Recent market action suggests that investors are very willing to look on the bright side of the street. We prefer to be optimistic ourselves, however, the financial media is persistently focused on news that would suggest peak interest rates are directly ahead. This is viewed as a reason to expect the worst to be over and that a market advance is at hand. In some situations, it might be profitable to look past the economic valley of 2023 and look to invest for the longer term; but this time we think the valley may be deeper and wider than expected. For this reason, we remain prudent and look to keep our portfolio concentrated in necessities, recession resistant companies and sectors and stocks with predictable earnings streams and above average dividend yields.

Lowering Earnings Forecasts

The probability of higher interest rates and the likelihood of a recession in 2023 is high, in our opinion. Though we have been expecting a recession, we have not fully addressed it in our earnings forecasts. Our economic forecast included a weak first half of 2023 followed by an economic rebound, but even that may be too hopeful. This week we are lowering this year’s S&P 500 earnings forecast from $202 to $200 to reflect the decline seen in the third quarter earnings results. And since the typical recession results in a 10% decline in corporate earnings, we are lowering our 2023 estimate from $204 to $180.

Looking for an Average Recession

Since WWII, the last twelve recessions have persisted for an average of 10 months, have generated a 2% decline in real GDP, resulted in a loss of an average of 4 million jobs and led to a 10% decline in corporate earnings. Few recessions “match” the average, however, we believe inflation is more embedded in the economy than even the Fed would like to admit. If so, it means interest rates will remain higher for longer than expected. Chairman Jerome Powell was late to address inflation; however, we expect he has studied the last inflationary cycle that began in 1968 and continued until 1982. The error that Federal Reserve Chairman Arthur Burns made in the 1970 decade was to not keep interest rates high enough or long enough to get control over inflation. As a result, there were four recessions between 1970 and 1982, until inflation finally began to recede.

With this in mind, it follows that interest rates will remain higher for longer next year than many expect. If so, the 2023 recession may last for more than two quarters and have a more debilitating impact on corporate earnings. For all these reasons, we are lowering our earnings estimate once again.

The Inflation Problem

November’s CPI came in softer than expectations, and while the peak level of inflation may be behind us, the underlying details of November’s report are not as favorable as some market commentators seem to believe. Much of the decline in prices is the result of decelerating energy prices (which are still rising 13.1% YOY!); meanwhile, food and beverage prices are rising at a double-digit pace, and housing, transportation, and “other goods and services” inflation are increasing 7% YOY or more. See page 3.

It is very likely that headline inflation peaked at 9% YOY in April 2022, but the Fed’s lack of attention in 2021 to stimulus-driven inflation allowed price increases to become embedded in the economy. This is making inflation difficult to combat. As a result, core CPI has been hovering between 6.0% YOY and 6.5% YOY for several months — the highest in 40 years — and is far from the 2% target rate indicated by the Fed. See page 4. And inflation is no longer driven solely by the price of energy, nor is it a problem linked primarily to the rise in owners’ equivalent rent. The current drivers of the CPI include food and beverage pricing and a wide range of consumer services. See page 5.

It should be noted that prices for services have been on the rise since early 2021. The composite service component of the CPI rose 7.2% YOY in November, rose 7.2% YOY in October, and fell only slightly from the peak rate of 7.4% YOY recorded in September. With inflation now embedded in the largest segment of the economy, the Fed’s job has become more difficult than most expect. And as seen in the chart on page 6, the price of WTI crude oil has typically had a direct impact on inflation when it rises but has had less of an impact when prices fall. In our view, the consensus remains too sanguine about the path of inflation over the next 12 months. 

Moreover, 32% of small business owners indicated that inflation was their single biggest problem. The small business optimism index rose 0.6 points in November to 91.9, but this is the 11th month below the 49-year average of 98. Of the 10 components, 6 increased and 4 decreased in November. The percentage of owners that plan to raise prices was more than 50% earlier in the year but now sits at 35%. Owners who think it is a good time to expand improved one point to six in November, but this is well below the long-term average of 13. See page 7.

2023: The Year of Earnings Adjustment

In 2022, investors began to take inflation seriously and focused on tightening monetary policy. As a result, there has been a steady decline in price earnings multiples this year. But the adjustments are not over. In our view, the challenge in 2023 will be the reality of a recession and the negative impact it will have on earnings.

As noted, we are lowering our S&P 500 2022 earnings estimate slightly to $200 and taking our 2023 estimate down $180 to reflect a 10% decline. However, even without a recession in 2023, S&P 500 earnings have been extremely high relative to the trend in nominal GDP. Earnings growth and nominal GDP tend to be highly correlated and the relative outperformance of S&P earnings versus economic activity in 2021 and 2022 is an unsustainable trend. A period of earnings outperformance has usually been followed by a decline in earnings. See page 8.

The recent earnings outperformance in this cycle is easily explained by the historic level of stimulus pumped into the economy both during and after the Covid shutdown. In short, corporate earnings were artificially elevated. As stimulus fades, earnings are apt to underperform, even without a recession in 2023. However, we expect the Fed will remain on track to raise short-term rates to 5% or higher next year and this makes a recession a high probability in the next twelve months. As we have often noted, inflation in excess of 4% has characteristically resulted in a recession. Double-digit inflation has historically been followed by multi-year rolling recessions. In sum, 2022 was a year of multiple compression and 2023 is apt to be the year of earnings deterioration. We remain cautious.

Gail Dudack

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Now There’s a Pivot… But It’s in China

DJIA:  33,781

Now there’s a pivot… but it’s in China.  It’s not the much vaunted Fed pivot most are hoping for, but it suddenly made China not non-investable again.  You might recall just a couple of weeks ago protests there jolted our market some 500 Dow points.  Markets there, however, not only didn’t flinch, until Wednesday they never looked back.  Nearly all Chinese technology stocks have moved above their 50-day averages, and more than half are above their 200-day averages.  As we’ve seen in other areas like Materials, for example, surges to all up from all down have medium and even longer term implications.  Stocks like (60) and BABA (94) are up 60 to 70% just since their October low.  Of course you have to wonder what happens when Covid numbers start increasing.

As you would imagine, better news out of China is better news for most of the commodities complex.  Nonetheless, the better action in steel stocks is a bit of a surprise.  As it happens, there’s an ETF here which pretty much captures the spirit of the move, though many of the top 10 holdings are not exactly household names.  We would point to Steel Dynamics (110) as an interesting chart, though Nucor (151) seems everyone’s go-to steel, and is also technically positive.  Conspicuous in not responding has been oil.  The stocks not only have not rallied, in some cases they’ve turned weak enough to test their 50-day averages.  That’s now likely to require some rebuilding before any resumption of the overall uptrends.  Meanwhile, more to do with dollar weakness, gold shares have acted well.

We haven’t favored Tech, and so far rightly so.  Of course, not all Tech is the same and to that point, not all semiconductors are the same.  While the AMDs (70) and Microns (55) struggle, the guys that make the stuff that make the stuff, the equipment manufacturers, have acted quite well.  We’re thinking here of stocks like AMAT (109), ASML (607) and KLA Corp. (396).  On the other end of the product spectrum, soup seems good food, at least to judge by Campbell’s (57) recent numbers and its stock performance.  Our pick might be General Mills (88) based on the overall chart, but once again it’s the concept that seems important here.  These defensive/slow growth names have performed quite well.  It’s sort of that MCD (273) versus MSFT (247) idea.

Pity the poor DJIA.  It’s outperforming and still it’s maligned.  Could it just be Shakespeare’s green-eyed monster?  After all, the S&P is down some 17%, the NASDAQ 30% and the Dow only about 5%.  Meanwhile, Wall Street benchmarks to the S&P, for them in this case a good thing.  In reality, of course, they might benchmark to the S&P but they own the NASDAQ.  It’s those Tech stocks that are stinking up the place.  The Dow now has its Salesforce (130), down close to 50% this year, while even Microsoft is off close to 30%.  We often wondered if the nice people at Dow Jones are just bad stock pickers.  Then it was explained they simply try to choose stocks representative of the market or economy at the time.  The problem is things change, and when it comes to Tech nothing changes faster.

Year end is all you can imagine, literally.  There are, as they like to say, cross currents and as you’ve noticed, a tendency for weakness early on.  The S&P still struggles with its 200-day average, but unlike August when that recovery died, this time far more S&P components are above their own 200-day averages, an important difference.  Meanwhile, stocks above their 50-day average have cycled from 3% to 90%, a momentum change with positive 6-to-12 implications.  If you simply look at volume on days when the market rallies, it tends to expand and contract into weakness.  That’s not the most sophisticated insight you’ll find, but sometimes the simple things work.  Probably the most positive week of the year is that between Christmas and New Year’s, but with one of our favorite cautionary notes.  If Santa Claus should fail to call, bears will come to Broad and Wall.

Frank D. Gretz

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US Strategy Weekly: A Recession Ahead

When we look at the history of inflation, the history of Federal Reserve policy, and recent economic data, it is easy to conclude that a recession is either at hand, or at least on the horizon. But before we explain why we believe a recession is likely, it is also important to point out that the next recession should be different than those recently experienced, and hopefully more manageable. The main reason for this optimism is the healthy financial condition of the US banking sector. Just the opposite was true of the 2008 financial crisis and the severely weakened state of the US banking system was a major risk for the overall economy. Today, not only are the banks’ balance sheets in good condition, but we find that household balance sheets are also in fine shape. And even though corporate debt has been on the rise, corporate America is not overextended. This is important since it suggests that any recession should be relatively short and contained.  

The one area of concern is the federal government where stimulus packages have added trillions of dollars to the national debt in a short period of time. Congress approved the $2 trillion CARES Act in March 2020, which was followed by a $900 billion Covid-19 relief package in December 2020. Some of this was necessary. During the mandatory shut down of the economy very few Americans could go back to work and collect a paycheck. Businesses were forced to remain closed. Plus, the mandatory Covid vaccinations and tests were paid for by the US government to prevent the spread of the virus.

This was less true in 2021, yet in March 2021 President Biden’s Build Back Better plan became the American Rescue Plan Act of 2021 which was an additional $1.9 trillion stimulus package. In total, the national debt increased by nearly $5 trillion, or nearly 25% of GDP, in a short 12-month period. As of October, the US debt stands at $31.12 trillion, which means the federal debt load is currently more than 120% of GDP — estimated to be $25.7 trillion at the end of the third quarter.

Unfortunately, interest rates are now on the rise and the cost of carrying this debt will become ever more costly. And the US is not the only country that increased its national debt during the pandemic. This was true of many countries impacted by Covid-19. In short, if there is a weakness, or a problem in the next recession it could be centered in the sovereign debt markets.

Inflation and Recession

We have written in previous weeklies that whenever inflation has been above average (3.5%), an economic recession has followed. More worrisome is the fact that the last time inflation was as high as it is in the current cycle, or a standard deviation above the norm (6.2%), the economy suffered a series of recessions. This is best represented by the 1968-1982 era. In the current cycle, the Federal Reserve has been very tardy in addressing inflation and as a result, a recession has been delayed. But this may only make inflation more difficult to tame today and keep interest rates higher for longer than expected. Historically, the fed funds rate rose ahead of, or in line with, inflation. See page 3. In our view, this is why it is imperative that the Federal Reserve Board be an independent, nonpolitical body. Raising interest rates during a presidential election year, for example, might be a difficult policy to follow; but failure to do so could be debilitating for many American households in the longer run.

Inflation is deceptive because it silently diminishes the purchasing power of households. Some economists worry that hourly earnings rose 0.6% in November; however, average weekly earnings rose 4.9% YOY in November while inflation rose 7.8% YOY in October. In short, inflation has exceeded the growth in wages for most of the last 18 months. Rising wages are not a source of inflation in our view. In fact, the fact that real hourly earnings are negative on a year-over-year basis is another indication a recession is ahead. See page 4.

Personal income has been in a steady uptrend for the last two years, but due to soaring inflation, just the opposite is true of disposable income or real disposable income. As a result, as of October, personal consumption expenditures have been exceeding income for 19 straight months. It is an unsustainable situation. See page 5. Not surprisingly, the savings rate declined to 2.3% in November, which is the lowest rate recorded by the BLS since the 2.1% reported in July 2005. However, in 2005, the savings rate quickly rebounded to 2.6% in August. We doubt that will happen in this cycle. Also noteworthy is the fact that the unemployment rate was unchanged in November at 3.7%, a historically low number. This gives the appearance of a strong economy, but we believe it is an economy of the haves and have-nots. Middle America is struggling. See page 6.

This combination of data suggests to us that the Federal Reserve will continue to raise interest rates in order to battle the now-ingrained inflation seen in this cycle. As a result, the economy is apt to slip into a recession in 2023. In recent months the Treasury yield curve has become inverted which is a classic financial sign of a recession on the horizon. See page 8.

Inflation and Equity Performance

We often look at history to see how stocks have performed whenever inflation has remained above average for a lengthy period of time. The most instructive period of time would be the 1968-to-1982-time frame when headline CPI remained consistently above 4%. The chart on page 9 is a quarterly chart and only records the S&P 500 index at the end of each quarter. But what it shows is that the S&P 500 Composite closed at 103.86 in December 1968 and closed at 102.09 in March 1980. In other words, the index was in a broad trading range and made no upward progress for over eleven years — or until inflation was brought back under control.

The experience of this previous era of inflation is why we believe the Fed may need to keep interest rates higher for longer than the consensus expects. The failure to get inflation under control in the first tightening cycle could result in multiple Fed tightening cycles — and recessions – like what was seen in the 1968 to 1982 period.

There are some markets that are already warning of a recession. The weakness in crude oil prices implies that traders expect energy demand to weaken as global economies slide into a recession. The decline in the 10-year Treasury bond yield represents a flight to safety in long-duration US Treasury bonds. See page 10. For all of these reasons, we believe the best strategy is to focus on recession resistance companies or areas of the economy that represent “necessities” to households, corporations, and governments. Sectors that represent these characteristics include energy, utilities, food, staples, and aerospace. See page 16.

Gail Dudack

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Toto … I Have a Feeling We’re Not in Jackson Hole Anymore

DJIA:  34,395

Toto … I have a feeling we’re not in Jackson Hole anymore.  Though brief, Powell’s comments back then sent the market reeling some 1000 Dow points just that day, and another 1300 points into the October low.  So what got the market up 700 points on Wednesday?  Granted the speech had a conciliatory tone, but the rally may not have been about the speech at all.  The market, simply put, was loaded for bear.  The Dow had fallen 500 points on Monday, was down most of Tuesday, and was even down 300 points before Powell’s comments.  It’s not exactly a stretch to say expectations were low.  To give the market its due, the overall technical background had seemed sound coming into the week.  And the good news about the speech – it’s over.

Diamonds recently have been everyone’s best friend.  The “diamonds” we are referring to are the ETF for the Dow Jones Industrial Average, the symbol for which is DIA (344), hence diamonds.  It’s surprising to realize the Dow is down only about 5% this year and, therefore, your best friend.  That’s all the more true considering the S&P is off 14% and the NAZ some 30%.  The secret of the Dow’s success is pretty clear, Microsoft (255) is the only Tech among its top 10 holdings.  As you probably know, the Dow has the quirk of being price-weighted, making a $500 stock like United Healthcare (537) its largest holding.  Also among the top 10 holdings are companies like Caterpillar (236) and Honeywell (217).  Meanwhile, the Nasdaq is referred to as “tech heavy,” and Tech has made it just that.  While the S&P obviously is broader and more diversified, it is market cap-weighted making a stock like Apple (148) 7% of the Index.

A few weeks ago, courtesy of, we pointed out that Materials had made a remarkable turnaround.  In less than two months every stock in the group had gone from below its 50-day moving average to above that average.  There is a small sample here, but all of the occurrences showed positive returns in the next 2 to 12 months.  A somewhat similar pattern now has occurred with Industrial stocks.  As of last week nearly all had climbed above their 50-day while less than two months ago only 3% had done so.  A similar pattern occurred in August with poor short-term results, but over the last 70 years the pattern preceded six-month gains every time.  Another positive here is that both XLI (102) and XLB (83) have moved above the 200-day moving average as well.

To look at the SPDR Energy ETF (XLE-91), Oil isn’t what it used to be.  And yet the ETF is simply consolidating, and doing so less than five points from its high.  That said, it is doing so while only just back to the high in June, and that after a couple of nasty drawdowns.  Meanwhile, the January to June rally had been one of the most consistent and orderly uptrends we’ve seen in sometime.  Uptrends, of course, all have their corrections.  The fact that XLE has made it back to the highs seems very positive.  Of late a concern has been the divergence between the stocks and the commodity – down 4% and 40%, respectively.  Some say this reflects a newfound religion among producers.  We say the stocks just might have it right, and the commodity will follow.

News out of China sent markets lower Monday, though we’re not sure that too wasn’t more to do with Powell phobia.  And at least for the S&P and its 200-day, reminiscences of last August could have had something to do with it as well.  There is, however, an important difference between now and last August – S &P stocks are outperforming the S&P Index.  While the Index still struggles with its 200-day, more than 60% of its components are above their 200-day.  Typically, participation is the key, and that’s why 5-to-1 Advance/Declines is important as well.  The number of S&P stocks above the 50-day also is impressive, having cycled from 3% to close to 90%, another pattern with positive 6 – 12 month results.  The shift in momentum for both the XLI and XLB also augers well for year-end results.  As Thursday once again made clear, however, nothing in this market comes easy.

Frank D. Gretz

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