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Third quarter GDP was released this week and was perhaps remarkable, not for declaring a recession, but rather for the almost benign figure of -0.3%. On average analysts had pegged the contraction at 0.5% however many expected an even greater drop in economic activity. This number is naturally the first estimate and later revisions might give justification to those who had predicted a weaker economy especially considering that the average difference between the first estimate and second is approximately 0.5%. After all, consumer spending, formerly the great pillar of strength in the US economy, plunged an inflation-adjusted 3.1%, which to put into proper perspective, was the largest drop in 28 years. In fact, consumer spending over an entire quarter had not even contracted in the previous 17 years in nominal terms. There were quarters where growth in consumer spending had been reduced to near zero but not since 1990 had the percentage reversed course.

The key drivers helping boost the GDP were government spending, exports, and inventory build up. With a stronger dollar, exports could be in for a rough ride moving forward and the inventory build could be either an anomaly or a mistake given that sales have declined appreciably. Nowhere was that more apparent than in the Chicago PMI released on Friday showing a cliff dive from 56.7 in September to 37.8 in October. The national ISM figures to be released this week promise to be equally disastrous.

Regardless of the amplitude of the decline in economic activity, analysts are unanimous in anticipating a much deeper contraction in the current quarter likely extending into the first quarter of 2009. However there are unknowns that are difficult to predict at this time such as the continuing freeze in global credit, the abrupt deflation in commodity pricing and the unwind in the yen carry trade. Over the past twenty years, the economy has morphed from one built on producing to another based on financial engineering. With the sudden collapse of financial engineering, it would seem unlikely that we’re about to see a quick rebound in the country’s economic fortunes.

Technically Speaking

We had preached caution owing to the oversold nature of stocks and last week we saw the rebound that resulted. All stock indices were higher by approximately 11% with gains shared equally between the broader markets and the tech sector. What is immediately noticeable is that trading volumes barely increased on the week despite the oversized jump in equity prices. Normally, an increase on heavier than normal volume would be considered a sign that buyers are stepping up to purchase shares but these subdued levels of buying suggest that what we are seeing here is nothing more than short-covering.

As we had pointed out in the last couple of weeks, the stochastics indicator was flashing oversold on the weekly charts and this was a large factor in the rebound. Looking now at the daily charts, we see a sharp change in stochastics over the course of the week and now all indices are entering into overbought territory though the Nasdaq Composite is lagging slightly in this regard.

At these current levels, support is located at the weekly lows for all indices. Resistance for the Dow Jones Industrials is found around the 9800 level and at 1050 for the S&P 500, in the case of the broader markets. With respect to the tech sector, the Nasdaq-100 meets resistance near 1470 and the Nasdaq Composite has resistance around the 1900 point.

New Buy Recommendations (in order of preference):

None.

New Short Sales

None.

Stock Positions to Sell/Exit:

We were exited from both Tidewater and Ross Stores at their corresponding protective stops. We initiated stops on the three shorts added from last week and have given little wiggle room to PG and WMT in the process as their charts have changed appreciably against us. Strangely, we find this counter-intuitive given the extremely large fall in consumer spending during the last quarter and the unlikelihood of recovery in the medium term.

Portfolio Comments:

New stops have been added in bold to the list while others have been modified. Those that have blanks are being carried unstopped for now. Please see our complete list of stops in the table below.

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

N.B. There are no longer restrictions on foreign stocks held in Canadian retirement savings accounts.

New stops in BOLD

* Stop on a closing basis

** Buy if above entry price

*** Split-adjusted price