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Building a Lower Range

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Following a fairly flat open this morning, the broad markets just couldn't gain any traction and reverted into their familiar pattern of dropping back from resistance again. By the end of the first hour of trading, the DOW was resting near the 7925 level and the OEX had fallen back to solid support near 425. Note that these levels had acted as price magnets for much of last week, so holding above these levels is pivotal to any continuation of last week's bullishness. Rather than the prior range of 7950-8150, the DOW now seems to be settling into a slightly lower range between 7900-8050.

While the weakness seemed to be fairly evenly spread across the major sectors of the market, the Semiconductor index (SOX.X) was notable in that it held onto positive territory, currently trading at $294.52, just barely above the close from last Friday. If there is to be a return to the bearishness that prevailed from mid-January through mid-February in the broad market, the SOX is going to have to show significantly more weakness by breaking down below the $185 level, currently the site of the exponential 21-dma.

Leading the way on the downside are the Dow Transports ($TRAN), which were immediately under pressure this morning following the Bear Stearns downgrade of the Trucking stocks. Prior to the open this morning, the firm lowered its rating on truckers CVTI, HTLD, JBHT, KNGT, SWFT and WERN from Outperform to Peer Perform. Citing the fact that this group underperformed at the beginning of the last Gulf War as oil prices spiked, the firm expects similar action if the U.S. does attack Iraq.

As of this writing, all of the stocks listed above were trading deep in the red, leading the TRAN to break below the 2050 level for the first time since early October. The October low of 2008 is going to be critical to those that follow Dow Theory, as a break below the October lows would be an important indication that the DOW Industrials should follow suit to confirm the persistence of the 3-year bear market.

Showing a notable lack of fear late last week, the VIX finally broke below the 35 level, just fractionally dropping under the venerable 200-dma (then at 34.35). With the broad market showing significant weakness this morning, the VIX is starting to show renewed life, now sitting at 36.02. There has been a notable divergence between the action of the VIX and the OEX in recent weeks, as the VIX has refused to push through and hold above the 40 level. In the August-October timeframe, every time the OEX fell below the 430 level, the VIX pushed convincingly above 40. And the VIX was unable to drop back under 40 until the OEX was well over 430.

But look at what transpired during the second week of February. The OEX plunged to as low as 408, but the VIX just couldn't manage a close over the 40 level and with the subsequent market rebound, the VIX drifted down from that level again, culminating with Friday's close at 34.14. This is a notable divergence from what we've seen in the recent past. The question is "what does it mean". Are investors becoming foolishly complacent, or has the market factored in all the attendant war risks and decided that it won't be that bad? Questions, questions everywhere and few answers to be found. With the DOW now starting to break lower (now at 7907), it looks like the bears are gaining some traction and with the VIX still showing a rise in fear, the direction (at least for the next couple of hours) appears to be down.

Mark Phillips

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