Option Investor
Index Wrap

A Bigger Hammer

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        WE 7-06          WE 6-29          WE 6-22         WE 06-15
DOW    10252.68 -249.72 10502.40 -102.19 10604.59 - 19.05  -353.36
Nasdaq  2004.16 -156.38  2160.54 +125.72  2034.82 +  6.39  -186.67
S&P-100  612.95 - 19.07   632.02 -  4.13   636.15 +  9.52  - 25.29
S&P-500 1190.59 - 33.79  1224.38 -   .97  1225.35 + 10.99  - 50.60
W5000  11059.56 -347.59 11407.15 + 94.70 11312.45 + 74.45  -498.70
RUT      483.26 - 29.38   512.64 + 23.99   488.65 -  6.48  - 16.51
TRAN    2748.92 - 81.04  2829.96 +153.47  2676.49 - 17.13  -188.47
VIX       24.97 +  3.34    21.63 -   .87    22.50 -  3.83  +  4.92
Put/Call    .90              .58              .69              

A Bigger Hammer
Austin Passamonte

Part of my misspent youth involved tinkering with late 1960's muscle cars. When we got around to restoring those souped-up models in the early 1980s it usually took plenty of muscle strength to wrest aged parts free. A running joke amongst shade tree mechanics was if a hammer & screwdriver couldn't handle the job, just reach for a bigger hammer and bang away!

Such is the stuff current markets are made of.

Greenspan & Co. have been hammering the persistent bear market with all they've got for six straight months and its resolve just won't break. Frantic, biased bulls like Larry Kudlow of CNBC guest analyst fame have been pounding the table with both hooves for the Fed to continue slashing interest rates down to whatever it takes. "Whatever it takes" is a point at which this economy makes a V-bottom recovery and the historical rally resumes. Perhaps Big Al needs to wield a jackhammer next time around at the August FOMC event.

Excess Competition
Wendy & I spent most of this week on vacation touring some of Colorado's breathtaking scenery. We found our way to a popular tourist trap area on Thursday and spent an hour or two poking around in the local shops.

One Indian jewelry & trinket shop had "Going Out Of Business" signs plastered across every window. When asked, the owner told all who would listen that Bill Clinton ruined his livelihood. Business and tourism had slowed considerably the past two years out of four he had been in existence.

Let's see now... his shop opened in 1998, being one of no fewer than eight Indian jewelry stores on the strip. The mighty bull run that flowed money like water back then sustained too many similar businesses. Reality is now forcing the "sector" back to a more natural carrying capacity of its available market. Sound familiar?

Exact-same dilemma faced within the greater technology arena. Too many players vying for a shrinking pie. The capital spending and business inventory recession dating from year 2000 to now will recover only when natural carrying capacity pares many doomed companies from this equation. Sorry Mr. Kudlow, eternal laws of supply & demand are really that simple. No human force can thwart this inevitable cycle from flushing markets out.

A greater truth than the now invalid cliché, "Don't fight the Fed" might aptly be; "Dear Fed: don't fight Universal Law of Supply & Demand".

The Fed will fail without exception if it hopes to intervene and artificially prop existing supply above long-term demand. Our Fed is comprised of mere mortals and in the end Mother Nature always wins.

Near-Term Trades
Many of us expect the current economic slowdown to post a sustained and deliberate recovery after a period of sideways market action, certainly not what we saw on Friday? Shall we peruse the charts?

(Weekly/Daily Chart: SPX)

The same weekly bear flag pattern depicted last weekend in the Market Wrap (OEX chart) broke down and confirmed that weakness abounds. While we didn't trust it until Friday's clear conviction, I'd look for considerably lower prices over the coming weeks ahead. Not without upside interruption mind you, but just don't expect any miracles of Fed intervention or otherwise to halt what seems inevitable.

The bearish flag above spans 175 index points from high corner to low. Technical convention has it that we subtract this value from the breaking point and that projects an ultimate target from there. The SPX broke near 1225, so simple math and unbiased chart study predicts a visit to the 1050 area before a sustained reversal can be expected.

Not my bias or preference... purely chart pattern study at work for all to see.

(Chart: Dow)

The Dow broke its daily-chart (right) neutral wedge in a major way and blew through 50% retracement value of recent highs to lows on the weekly chart (left) in one fell swoop. 10,164 area is next before we trade in the 9,000s once again.

(Chart: QQQ)

The NDX is trending down this weekly descending channel (bull flag) with no signs of breaking to the upside anytime soon. I expect it will touch the bottom of this channel at 40 or below next week.

(Chart: OEX)

Weekly chart pattern for the OEX is similar to the SPX and also projects a future low near 555 index level before we see "bottom" again. Daily chart on right measures the latest wedge to break as its 600-level offering the next downside target within the greater weekly-chart picture.

(Weekly/Daily Chart: EMC)

Lest we think this simple study doesn't work for stocks, think again! I used to trade EMC in 1999 and never knew exactly what they did. As a matter of fact, I still don't. Couldn't tell you one single fundamental item about this company other than it trades on the NYSE, but what difference does any of that make to a trader? Pure chart action shows us all we ever need to know.

When the weekly chart neutral wedge broke down below $40 in late May, it was a screaming bearish play. Sell covered calls against long term holds would be the least of my choices. Sell the stock to go flat, short it for profit, buy straight puts or bear-put debit spreads are more to my liking.

A second chance to get bearish on the winning side of this stock came a few weeks later in mid-June near $32 area. How would either of these choices have favored stock traders who read these super-simple trading tools, played the downside and let time take over? You be the judge.

Best Laid Plans...
As an employee of IS with content responsibility I must carefully guess my time away from market action. This week seemed ideal for hosting out of town family & friends and I never missed much until Friday's session when all heck broke loose. To be honest I expected price action to break down in a big way next week or soon after earnings season waned at the latest. Surprise!

At this point in time the Fed is dead regardless what they do next. Now we will trade pure economic strength (or lack thereof) on the face of company reports. That should excite the heck out of investors & traders, as the weak and the strong will clearly be exalted or exposed accordingly. Time to separate the grain from chaff begins now.

Clear forward guidance and improving future equals stable to slightly higher prices. No forward guidance and/or bleak news will be met with severe stock price drops from numerous companies still too rich in valuation for future supply & demand markets.

I continue to believe we will test or exceed recent index lows before this year is finished and the muted recovery anticipated for months now will gradually emerge in Q1 or Q2 of 2002. This has been our stance at IS for many months now, archived in past Market Wraps for posterity. Along the way we can expect plenty of volatility and lots of large-range sessions in either direction just like Friday.

From here I'm looking for overall downward direction with chance of technical bounces every session along the way. "The Market" still remains dazed, confused and without knowledge of what the future has in store. I expect bearish plays will continue to pay the bills from now until Christmas and possibly beyond, with a few short-term bullish plays tossed in for good measure.

Option traders hold the distinct advantage of being able to profit nicely to the upside and wildly to the downside, so let's do our very best of staying on the right side of each move more often than not!

Best Trading Wishes,

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