Option Investor
Index Wrap

Positive, yet cautiously guarded, with a ting of weakness

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The major indexes finished in positive territory despite a Federal Open Market Committee statement that seemed to view positive trends being offset by negative trends, where the future of the economy, at least in the Fed's eyes still remains uncertain.

The Federal Open Market Committee gave the markets little in the form of surprise as the federal funds rate remained unchanged at 1.25%, but provided plenty of confusion toward its views on the economy in its preliminary statement. http://www.federalreserve.gov/boarddocs/press/monetary/2003/20030506/default.htm

Three words regarding the Fed's bias toward the future... "weighted toward weakness" , sent Treasury bond prices surging higher and their yields lower, as well as sending the U.S. Dollar plummeting to another 4-year low against the euro. The U.S. Dollar Index (dx00y) 95.34, which is a basket of seven major foreign currencies. While the weaker dollar should benefit U.S. exporters, prices paid for components manufactured overseas continues to rise.

Positives noted by the FOMC were reflected in the equity indexes by session's end were that weaker production and employment data released in recent weeks, while disappointing to the Fed, were most likely reflecting decisions made before the conclusion of hostilities. However, the calming of geopolitical tensions and rolling back of oil prices, along with a rebound in consumer confidence and strengthening debt and equity markets, give the Fed near-term sign that "no action" was perhaps the best policy from the Fed at this point.

In my view, the dollar selling and Treasury buying is defensive. Trader cited the dollar selling as it relates to a ballooning Federal budget deficit, with a potential tax cut in the wings exacerbating things. This dollar selling is obviously a sign that U.S. assets are being converted back to foreign assets. Currency traders also note that interest rates overseas are higher than here in the U.S.

While the dollar selling would be a sign of "fiscal concern," then the Treasury buying really makes little sense, except as it relates to a purely "defensive" move from some market participants.

The PHLX Gold/Silver Index (XAU.X) 69.34 +0.6% flip-flopped either side of its trying to flatten out 200-day SMA of 68.80, but for the first time since February 28th, closed above this longer-term SMA. Meanwhile, the AMEX Gold Bug Index (HUI.X) 134.38 +0.89% extended gains to the 134.00 level and has now broken above its bearish resistance trend on its point and figure chart and moved well off its rounding out 200-day SMA of 126.00.

An index/sector trader sent me a good e-mail today, and the question asked would have been and perhaps will be an excellent article for an "Ask the Analyst" column. He noted that the PHLX Gold/Silver Index (XAU.X) had been under performing the AMEX Gold Bug Index (HUI.X) and wondered why? The answer I give won't always be the case, but something I've discussed regarding indexes/sector in the past.

The currently "under performing" PHLX Gold/Silver Index (XAU.X) is a capitalization-weighted index of 11 major gold producers. The AMEX Gold Bug Index (HUI.X) is a modified equal-dollar weighted index of 14 companies. In essence, it appears it is the "weighting" (some stocks have more weight than others) in the XAU.X compared to the equal-dollar weighting in the HUI.X (each stock has as much weight as the others) that creates the performance discrepancy.

I'll say something real quick here. I'm not an economist and all be darned if I've ever been able to forecast any type of economic turn without the use of Treasury YIELDS.

A couple of weeks ago I profiled PARTIAL bullish positions for Newmont Mining (NYSE:NEM) $28.45 +1.49% as the stock jumped above the $26.00 level to test its 200-day SMA. I can't say that I "like this sector/stock" based on the thought of economic disaster, but to me, this sector looks well positioned to benefit from just about anything that unfolds on the economic front.

An economic bear doesn't need me to explain how gold stocks and the commodity itself can benefit on concerns about economic weakness, but at this stage of a multi-year economic slowdown, and an aggressively easing Fed, along with a growing deficit further exacerbated by "war with Iraq," a resurgence in economic growth certainly plays into "good inflation." By good inflation, I'm talking about some type of pricing pressure that eventually comes from consumption demand beginning to outstrip production supply. I'm not sure I'd go as far to say, "whatever unfolds, gold will benefit," but right now, this is a sector that I think bullish equity traders should consider.

I've never been a "big believer" that an INVESTOR always needs to have 5 or 10% of their portfolio exposed to gold. There are times to have exposure and times to be rid the sector. Right now, I think gold stocks look to shine.

AMEX Gold Bugs Index ($HUI.X) - 2-point box

I've read several e-mails from what I'd call "died in the wool bears" referencing the bullishness building in gold stocks and perhaps the $HUI.X as being a precursor for "doom and gloom" for equities. I don't know about you, but the rebound in mid-October (after red a, and buy signal just before red b) and resulting bullish vertical count of $158 had the $HUI.X rebounding with the major indexes. The HUI.X did come close to its bullish vertical count nearly 2-months later at 154, but the negating double bottom sell signal (at 140, which created the bearish vertical count of 120), combined with the eventual "bearish triangle" (5- columns of X and O in a series of lower highs and lower highs where resolution is to the downside at 140), and spread-triple- bottom sell signal (trade at 136 broke three prior levels of support from 138) and break of bullish support trend (132) were all negatives, from which the $HUI.X now looks to be recovering from.

Now, the above observations don't necessarily give credence to a gold bidding on thoughts of economic doom does it? Sure! There are times when the sector will DIVERGE from the major indexes, but the last bullish and bearish cycle sure doesn't seem to show divergence does it? Certainly NOT!

So why the renewed "bid" in gold stocks? It certainly doesn't make sense that INFLATION would be the cause. Nope. The Fed will raise rates if it FEARS inflation. Treasuries are usually "flushed" when under thoughts of INFLATION, which would have the Fed raising rates.

What "has" to be in play right now is some type of ROTATION. Ah... an economic BEAR will say.... "no, no, no.... it's DEFLATION!" Hmmmm, the NASDAQ Composite (COMPX) 1,523.71 +1.3% and the NASDAQ-100 Index (NDX.X) 1,152.78 +1.45% both broke above and managed to close above their December (red C on a point and figure chart) highs! Deflation? Don't tell the equity markets that, because they aren't "buying it!" Or should I say... "selling it."

On December 31st, I set up a little pretend fund called the "Beetle's Balanced Benchmark Fund." In recent weeks, I got the bright idea of adding the recently discussed "junk bond" sector as depicted by the Pacholder High Yield Fund (NYSE:PFH) $8.11 -0.49%.

I think it important tonight, with the May FOMC meeting as a benchmark, to review how things are going in the "fund" so far this year. Just imagine that at the close of trading December 31, 2002, you equally divided (I hate weighted indexes) $10,000.00 and BOUGHT the U.S. Dollar Index (dx00y), Lehman 1-3 year Treasury Ishares (SHY), Lehman 7-10 year Treasury Ishares (IEF), Lehman 20+ year Treasury Ishares (TLT), Corporate Bond Ishares (LQD) and some "junk bonds" as depicted by the Pacholder High Yield Fund (PFH). For equity exposure, the AMEX Gold Bugs Index (HUI.X), Dow Diamonds (DIA), S&P Depository Receipts (SPY) and NASDAQ-100 Index Tracking Stock (QQQ).

Please note: Subtotals do not account for any income or dividends received from 12/31/02 benchmarking.

Beetle's Balanced Benchmark - From 12/31/02

I keep this little portfolio open in my q-charts trade station and review it from time to time. I like to treat it as a benchmark and try and see where money is or has been going into, and where it has been going out of as time passes.

I consider the "upper" part of the portfolio as more of a "safer" type of investment selection. You know, the good old greenback (the U.S. Dollar (dx00y)) along with my shorter-dated basket of Treasuries (SHY) and build out my RISK from there in the 7-10 year maturities, then 20+ and further RISK to higher-grade corporate bonds (LQD) and HIGHEST RISK "junk" in the fixed income category. Not to be overly "safe" I throw in equity exposure.

I can't say that the current "subtotals" of my "bond" and "stock" groups really means anything, but what a great day to benchmark from with both categories of the portfolio showing almost identical P/L % gains of 4.84% and 4.85%.

I've highlighted in "red" the two things that really don't make sense to me as it relates to what the MARKET has done since the end of the year. If its true that the dollar weakness is attributed to a rising Federal budget deficit, then I would have thought the Gold Bugs Index (HUI.X) might be up 6.49%, instead of being down 7.4%.

While the recent couple of week's trade in Treasuries concerns me for equities, the P&Ls (profit and losses) between equities and bonds aren't that out of whack on the cover do they? At least not in the Treasury groups.

The 17.4% gain in the QQQ, which I would deem the "riskiest" of the DIA/SPY comparison, is notable, as is the "risk" found in the bond market side of things and the 31.66% gain found in the Pacholder High Yield Fund (PFH).

Now, I'm doing a little seed planting here, but I'd best do it now instead of months from now. In my Stock Trader's Almanac for Tuesday May 6th, I'm writing... "watch/be alert for asset allocation and shifting/redistribution of risk."

I personally need to make these notes, so that I'm not "freaking out," if in a couple of months, the current BULLISH tone for the major equity indexes has shifted a bit.

Again... I see NOTHING right now that says anything about doom and gloom for equities. I do see and have noted that the Treasury bond market action and recent higher levels of bullish % in the NASDAQ-100 are alerts to me, that equity bulls need to be careful and not overly enthusiastic with things.

The bullish side of me is VERY HAPPY with the NASDAQ Composite (COMPX) 1,523.71 +1.3% and NASDAQ-100 Index (NDX.X) 1,152.78 +1.45% trading above their December highs. To me, this now gives NEW OPTIMISM not seen in over two years to these two markets! I KNOW, that at some point in the future, the bullish % will again reverse lower to a much LOWER risk level for bullish entry, and when they do, the BEST bullish entry points will be had! The best in roughly three-years at least.

NASDAQ-100 Tracking Stock (QQQ) - Daily Interval

With buying in Treasuries after the FOMC decision on interest rates and the now 77% bullish % ($BPNDX), I profiled an additional partial position in the QQQ September puts in today's Market Monitor (15:01:10 ; QQQ= $28.59. On Thursday of last week, I profiled first partial for the $27 and $28 strikes.

I will be in remote areas of western Kansas starting tomorrow until next Wednesday and have no stops on my own QQQ September puts. The QQQ remains technically strong, traded through our "zone of resistance" on an intra-day basis, but did fade a little bit into its close and just back below our WEEKLY R1 of $28.73. For underlying QQQ traders, I would have to assess upside risk right now to the MONTHLY R2 of $29.73. First sign of any technical weakness would be if the QQQ were to fall and close back below the "upper-most" downward trend of $28.00.

Do NOT think for a minute, that I'm one of these options traders just "throwing money around" and not caring what happens to a trade while I'm on vacation is some creek bottom in western Kansas. I'm looking to SELL RISK at these higher levels of bullish % in the QQQ. Those traders that may not have the "confidence" that the bullish % might reverse lower from current levels of bullish %, and are perhaps more "risk averse" right now, then I'd WAIT for some type of close back below $28.00 or even $27.58 at this point.

If I were a trader that was FULL POSITION short/put from Thursday's profile, I would SERIOUSLY CONSIDER taking 1/2 position off the table on any decline back into the $26.92-$27.06 area, and then look for new entry back near $28.00, preferably on some type of reversal having taken place in the bullish %.

Today's action saw a net gain of 1 stock to a new point and figure buy signal in the NASDAQ-100 Bullish % ($BPNDX). This has the bullish % growing to a bullish cycle high of 77%, but still off of December's relative high reading of 82%.

S&P 500 Index (SPX.X) Chart - Daily Intervals

The SPX traded strong today and came close to trading its WEEKLY R1 of 940.82. The internals for the SPX remain strong and today's 2% net gain for the bullish % has 10 stocks generating new point and figure buy signals and has the bullish % ($BPSPX) growing to 62.8%. Since the SPX closed below the 927.34 level and took out yesterday's high, I'd have to consider near-term support at 920, but I like the 913 area for bullish entries on a pullback with a trader's target back up near current levels of trade.

If I look for risk, then the 62.8% bullishness is "less" than the NASDAQ-100's 77%, while the "Beetles Balanced" shows the SPY up just 6.44% compared to the QQQ's 17.4%.

I should probably clarify my thinking of just what I view "selling risk" as being. Right now, I'd consider the "selling of risk" being the taking of profits by bulls, and not being characterized as an all out BEAR shorting opportunity.

S&P 100 Index (OEX.X) Chart - 2.5-box scale

Last night we looked at the SPX's point and figure chart on conventional 5-point box and to get a "similar" look at the narrower S&P 100, we like to look at the unconventional 2.5-point scale. We would see in both that the little "wedge" from WEEKLY R1 and our "bullish resistance" (trending higher pink line) creates some crisscrossing resistance near today's highs. As we look back at this "bullish resistance trend" and as the bull move grows a little more mature, both the OEX and SPX have tended to violate this trend by a box or two, then pullback 3 or 4 boxes as it digests its gains. I'd expect support to come in on a near- term basis at the WEEKLY pivot of 466.8, which isn't too far off from the triple-top buy signal on the 2.5 box scale. Simply using the PnF chart a bull's stop could be placed just below the weekly S1 at 457.50.

Dow Industrials (INDU) Chart - Daily Interval

The Dow does seem to find sellers at the 8,600 level and I've had a tough time figuring out why. I've left my original regression channel in place and find the mid-point starting to serve support the past two sessions. First sign of near-term weakness would be a move back below 8,475, with solid support forming at 8,315- 8,340. First sign of trouble on the point and figure chart would be a double-bottom sell signal at 8,300.

Today's action saw no net change in the Dow Industrials Bullish % ($BPINDU). Still "bull alert" status at 56.67%.

Pivot Analysis Matrix

My major observation from the pivot matrix would be that the 10- year YIELD ($TNX.X) saw its YIELD fall back to 3.814% and trade its WEEKLY S1. I don't recall the 10-year YIELD trading this much out of whack relative to the equity indexes and still troubles me for the major indexes.

Again. I will be out of the office from Wednesday May 7th until Wednesday May 14th, but will be back early Thursday morning.

I believe that Linda Piazza will be covering the indexes while I'm gone, and I think she does a great job not only in the Market Monitor during the day, but other articles she has written. I think she will offer some great insight into things!

Jeff Bailey

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