Option Investor
Index Wrap

DISRUPTION

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Stocks ended on a slight up note Friday after a day of very light trading in the wake of widespread power outages across the Northeast. The Dow closed up 11.13 points to 9321.5 - biggest gainers were Hewlett-Packard, Home Depot and General Electric. Trading volume was thin -- only 560.6 million shares traded on the NYSE. The Nasdaq Composite (COMPX) was up a scant 1.7 points to 1,702 and the S&P 500 (SPX) Index was up a fraction of a point (.16) to 990.67.

Without options expiration on Friday, we might have seen the powers that be closing more markets. And power was the problem of course. Economic impact? - probably not more than a big East coast blizzard that shut down things for a day or two. The drama of all those New Yorkers walking down 5th Ave for a change masked the boost that some good economic data might have provided otherwise.

By the way, having been a city rat for umpteen years in New York, I can say for certain that it's no fun there when the power goes off, especially in August. Without air conditioning, its brutal cause it just doesn't cool down that much at night - I used to be able to say, unlike say England. But with recent highs in Paris and London hitting 100 degrees - well, time to move to Iceland.

THE BOTTOM LINE -

A sideways move after a sizable advance is neither bullish or bearish although traders tend to take it one way or the other. In technical analysis terms, the benefit of which way next is said to go to an eventual continuation of the preceding trend. A sideways narrow range trend is assumed to be a consolidation - as in a pattern of "consolidating" prior gains. I think this is the case here, but the economic data is tough to call.

An example of this is the gain in U.S. Industrial Production announced Friday at up a half percent, stronger than the expected 0.2%. Capacity utilization increased to 74.5%. However, as Jeff (Bailey) rightly pointed out in his intraday notes, this gain may not have much impact on hiring back of workers in the industrial/manufacturing sectors. This relates to recent economic data also indicating that the average workweek is down to 33.6 hours, below a 40-hour workweek. Hence, what companies are going to do on a pickup of orders is increase hours of existing employees, not hire new ones.

You can see examples of the underlying economics in the release of Applied Materials (AMAT) earnings last week - while their earnings where a penny better than expected, revenues were down 25% from a year ago. How do they increase earnings on much less revenue? Cut costs and the biggest cost cutting measure is to shed workers. The gains in productivity means that investment is made in things that allow fewer workers to turn out more goods.

Bottom line - Q3 job growth is needed to kick the economy into second (third?) gear and fuel a next up leg. Otherwise, the consolidation underway will turn out to be the building of a top. Meanwhile, options traders can continue to trade a tight range, by waiting for prices to get to extremes before entering a new position that is long calls or puts. Otherwise, of course, sell premium, as it continues to slip slide away as prices fail to break out the box or relatively tight range.

LAST WEEK -

The Fed heads decided to keep its funds target unchanged at 1.0%, saying that low inflation, stability in spending and still weak labor markets were calling for a still-accommodative monetary policy.

In the Federal Open Market Committee release, the FMOC indicated that it believes upside and downside risks to the sustainable growth is EQUAL (my caps) for the next few quarters. They also said that the probability of deflation (a downward price spiral) is greater than an inflationary rise, from an already low level. In Fed speak the Committee noted "that its policy of accommodation can be maintained for a considerable period".

In other words, we're still in a mess for some time to come, but we hope that we can muddle through.

June business inventories rose slightly - 0.1%. Sales in June rose a substantial 1.1%, which put the inventory-to-sales ratio, down to 1.38 months from May's 1.4 months. This is how long it would take to work down inventories to zero. Businesses are keeping to a tight production schedule with substantial production capacity in reserve.

Retail sales rose 1.4% in July as the consumer continued to spend. Makes you wonder if spending is a way to stave off anxiety about not having a paycheck down the road. So, how is the consumer feeling these days? - well, the University of Michigan release of its survey of consumer "sentiment" is put off to Tuesday, thanks to lights out in Michigan.

By the way, July sales strength was said to be broad-based. Building materials and garden supplies rose 1.3%, electronics sales were up by 1.2%, general merchandise was up 1.1% and gasoline station intake gained 1.6%, reflecting a rise in pump prices - tell me about it! In troubled California, where I had to move from troubled New York, premium was running close to 2.20 a gallon. Of course, I have to drive a high performance car - time for that new Toyota hybrid?

FRIDAY'S TRADING & ECONOMIC NEWS -

I mentioned already release of U.S. industrial output in July - the increase taken as further evidence that manufacturing is picking up. However, a very warm July resulted in total electric utility output increasing by 3.9%, after a 3.3% drop in June. This sector lifted overall industrial production to an unexpectedly large gain. Peak electric demand is seasonal - cooler fall weather is near, which will cause less use.

Separately, fewer U.S. banks tightened business-loan standards over the past three months and banks had greater demand for consumer and mortgage loans, the Federal Reserve said.

Consumer prices rose by a slight 0.2% in July for the second month in a row, according to the Labor Department on Friday. The latest CPI (Consumer Price Index), the most closely watched inflation barometer, suggested prices are fairly stable as they were in the June report.

The Institute for Supply Management said manufacturing activity grew for the first time in five months in July. The purchasing managers index rose to 51.8 from a previous reading of 49.8 in June. Readings above 50 indicate expansion of activity and prices in the manufacturing sector, while readings under 50 are defined as evidence of contraction.

Also, the New York Federal Reserve said its manufacturing survey there has shown growing activity for the past several months. In the most recent index reading, the Empire State Manufacturing Survey slowed to 10 in August, down from 20.8 in July. Any number above zero means more manufacturers say business conditions are improving than say they are worsening.

As noted elsewhere, recent reports suggest that total U.S. manufacturing has stabilized and may be recovering. Within the industrial production report, it was indicated that manufacturing output rose 0.2%, after a revised 0.3% rise in June.

Auto production for example, rose for the second straight month. The mining industry experienced a July decline, as production fell 0.4% after a 1.2% rise in June. Price related? - Gold demand may have fallen due to higher prices. Mining capacity use sank to a level of 84.6% in July from 84.9% the month before. Less supply could also be one reason that the Philly Gold & Silver Index (XAU) has finally re-tested its prior peak? See chart -

On XAU - if the Index gets above 89, a potential upside objective is to around 110 based on the breakout above the symmetrical triangle.

Related to earnings, Dell Computer (DELL) rallied some 3% after posting a Q2 profit late Thursday that matched Street consensus estimates. Looking ahead, Dell said it expects to report a Q3 profit that's in line with analysts' current estimates. This may have been a factor in the firm close for Nasdaq for the week. More on that below -

OTHER MARKETS -

Treasury bonds closed lower. Often there will be "safe-haven" buyers coming in, in reaction to a crisis like the power outage. However, early on government officials noted that there was no terrorism link to the shutdown.

The 10-year Treasury note was down a substantial 18/32 to yield 4.53%. Yields over 4.5% offer competition to equities in that this is a guaranteed return, versus further upside appreciation potential in stocks - who knows what that is this year with the market already up over 20% from the low in the S&P. A "normal" year historically will see appreciation of 10-15%. Of course, year to date, which is a more fair comparison, has the benchmark SPX up something closer to 8%.

In the currency market, the U.S. dollar was steady against its major trading partners. The greenback was up 0.1% to 119.15 yen. The Euro lost 0.2% to close in New York trading at $1.1252.

INDEX OUTLOOKS -

SOX ROCKS -
If you want to know why the Nasdaq, Nas 100 and QQQ rebounded, I see it as the influence of the chip stocks. To revisit the Semiconductor stock index or SOX chart, see the chart below.

The Index rebounded back above its 50-day average, which was a near-term plus. I thought that the SOX might move down to retest the up trendline dating from February and closer to its 200-day average. It may still, but last week, the Index caught support offered by a trendline off the top as noted.

The even more key factor is that the recent reaction low occurred above the prior downswing bottom. Lower (reaction) lows and higher highs - that's amori - no, that's an UPtrend. Of course, yet to come is a higher high above 400.

S&P 500 (SPX) - Hourly chart:

The benchmark S&P 500 (SPX) had to clear the two trendlines that intersect in the 992-995 area to suggest a re-emerging uptrend. Then of course there is anticipated resistance at 1000 - this is more psychological than based on prior highs and chart considerations in my estimation.

Based on prior highs, resistance can be assumed to come in at 1005, then 1015. Paraphrasing the way that Secretary Rumsfield asks himself questions that he then answers: "would I love to buy puts if SPX was at 1015? - indeed I would."

Market psychology is not something I under-estimate as I pay attention to how bullish or bearish ("sentiment") traders get as a contrary indicator. I still figure that a breakout move is not going to happen yet and I base this partially on the fact that my equities call to put ratio shot up on Friday. Yes, I know it was options expiration Friday but still, I figure that all that call activity suggests a bit too much bullishness around.

On balance, I would rather own puts or be short SPX futures on a further advance, playing for another downturn ahead and the expectation of still being locked into a trading range

S&P 100 Index (OEX) - Daily and Hourly charts:

Speaking of my principal sentiment indicator, it is found below, under the S&P 100 (OEX) price chart. No doubt some of the unwinding of equities options was related to buying back covered calls and the like, there was this jump in CBOE daily call volume relative to puts. Anyway, it puts this indicator up fairly sharply relative to where it's been. I think the bulls are not worried or not worried enough. Being a contrarian here I still worry a good deal relative to the few stocks I am holding from lower levels, as opposed to ones I strictly "trade".

Anyway, the near chart pattern is slightly bearish judging by the lower rally highs. Could be a triangle that will resolve itself by a next up leg. Time to look at the hourly chart.

The hourly OEX chart pattern is looking like one that is tracing out a downtrend channel. This suggests resistance at 500 - there's one of those even big fat round numbers again! A close above 500 is needed to suggest a breakout above the hourly down trendline. Beyond a breakout OEX should also hold this 500 area on subsequent pullbacks, to suggest renewed upside momentum here in the doldrums of August.

This fact noted for those of you still trading away and not taking August off like the Italians. By the way, the harder working Germans have just seen their economy also slip into recession based on a second consecutive quarter of a lower GDP. Just an aside from a Europhile folks!

Back to levels - above 500, resistance is at 505-506; then, if exceeded, at 510-511. Minor support comes in at 493, but mainly can be expected back in the 485 area, on down to 483 currently gotten by tracing the lower end of the downtrend channel - and, it looks a lot like OEX is in a downtrend channel.

I want to be in puts on further rally attempt, especially on a failure to pierce 500. Stay tuned!

Dow Industrials Index (DJX.X)- Hourly chart:

Well, the moment of truth may be at hand for the Dow Index or DJX as it tests the top end of its recent trading range. I find it suspect that the Stochastic model is not confirming the recent higher high and this is mirrored by the RSI (not shown). This type of technical divergence is usually a good indicator for an upcoming reversal, although it is a more solid signal on a daily chart basis when it (the divergence) develops over a longer time.

Bullish case - a daily close above 93.5 would suggest that at least the narrow Dow was breaking out above its price range. I want to play the odds that the Index is still likely to be range bound. Acting on a trading risk to reward basis, I look to buy puts in the 93.5 area, as I figure downside potential to be at least twice that of a further upside move.

Risk to reward considerations work well as a part of trading strategy provided that the trade is closed if there is a move beyond a "breakout" point, such as here, by exiting above 94.25.

As suggested the week before, long DJX Index calls held from the 90 area met my profit objective on the move above 93 and I exited the trade. (I also noted that puts looked attractive in the 93- 93.5 area.)

Nasdaq Composite (COMPX) - Daily & Hourly charts:

Technically, the rebound in the Composite occurred in a predictable fashion according to the tendency for Indices and stocks to fill prior chart gaps. The one in question is outlined on the daily chart to the left below -

I calculate resistance coming in around 1740-1750 and think that a move to this area is about the best that can be expected for COMPX. Support looks to me to come in around 1650, according the hourly trendline. I continue to suggest playing the expected trading range in the Nasdaq indices by buying puts at the top end and calls at the low end and not in between.

As far as looking to where being long options is favorable, unlike maybe the futures, buying calls or puts in the middle of a relatively narrow expected range doesn't offer the needed potential for a sizable move - unless there is breakout to resolve the trend, but this doesn't seem likely anytime soon.

Nasdaq 100 Tracking Stock (QQQ) - Hourly:

The Q's can be traded of course for smaller moves by buying the stock. I thought QQQ might get down to 29, although the 30 area was support implied by a 50% retracement as noted coming into last week.

I continue to favor shorting the stock around 32 or a bit higher - up to 32.50. Selling the stock in this area if reached, also offers my suggested profit target to those long the stock at 30, for those buying dips only. I bought a little there, but held out for 29 to buy more - WRONG! for now.

Resistance at 31.75-32.25, on an hourly closing basis, is implied first by the trendline drawn on the chart below and by the previous hourly closing high. 32.50-32.60 is the next higher expected resistance.

An hourly, then daily, close above 32.5 would look like a technical breakout. I rate the odds greater for a new low below the recent one at 30, than for a new sustainable high. We'll see if more buying interest comes in early in the coming trading week based on bullish economic news at week's end not realized due to lights out in New York.

The Q's could still get down to the 29 area at some point, assuming they are unable to pierce 32 to the upside. Below 29, next lower technical support comes in around 27.50. Maybe 30 will be the low but buying is lackluster of late and they may drift lower again.

Good Trading Success!

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