Option Investor
Index Wrap

The head and tail of two markets

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Something's got to snap, or at least I'd think it would as the very broad NYSE Composite (NYA.X) 6,207.05 +0.56% mustered a new 52-week closing high, and while intra-day internals were not overly strong, there continues to be notable disparity between many 1, 2, and 3-lettered stocks, and those listed on the NASDAQ with 4 and 5-lettered stock symbols.

Go figure it would be the NYSE showing strength in today's session, after the California Public Employees' Retirement Systems, calPERS said it was suing the NYSE Stock Exchange and seven specialist floor-trading firms that do business at the NYSE, for what calPERS is alleging are fraudulent trading practices.

In the lawsuit, Calpers says it sold about three billion shares of stock on the NYSE between October 1998 and October 2003 and lost "millions" of dollars in damages from the specialists' activities at the NYSE.

The suit alleges that the specialist firms, with the "knowledge" and "active participation" of the NYSE, routinely engaged in "inter-positioning," by placing themselves in front of investors when they should have stayed out of the way to allow a natural match to occur between buyers and sellers of stock. The suit also alleges the firms engaged in so-called front-running to trade for their own accounts using confidential knowledge about investors' orders. Another practice alleged in the lawsuit was "freezing" the specialists' books so that they could trade for their own accounts prior to completing investors' orders.

These practices constitute "wide-ranging manipulative, self- dealing, deceptive and misleading conduct," the lawsuit said. As far as Michael LaBranche, "he was an active and knowing participant in the alleged unlawful conduct," the lawsuit said.

CalPERS cites a Wall Street Journal story about a confidential SEC report extensively in its claim against the NYSE, saying it showed that the specialists' activities were only able to continue because the NYSE deliberately failed to halt or discipline the firms for illegal trading practices.

Publicly traded stocks named in the calPERS suit found LaBranche (NYSE:LAB) $9.32 -7.07%, Spear Leeds & Kellogg unit of Goldman Sachs (NYSE:GS) $97.52 -0.23% and the Van Der Moolen Specialists USA unit of Van Der Moolen Holdings NV (NYSE:VDM) $8.12 -6.66% trading lower in the session.

While "market related," the news found the Securities Broker Dealer Index (XBD.X) 631.59 +1.02% matching strong percentage gains in the S&P Banks Index (BIX.X) 332.13 +1.15% and S&P Insurance Index (IUX.X) 291.85 +1.08%, as upbeat economic data, and recent geopolitical news made for a bifurcated trade in the first half of today's session.

In general, I thought the bulk of the economic data released prior to the open was largely positive, with one possible exception being consumer prices falling 0.2%. While the decline in consumer prices will put the Fed at ease concerning "inflation," the decline in prices paid at the consumer level continues to suggest competitive pricing for goods and services.

Housing starts jumped to their highest annual rate in 20-years, and while the Dow Jones Home Construction Index (DJUSHB) 547.75 +0.99% found the homebuilders under selling pressure early, with the DJUSHB slipping to 559.11 in the early morning session, the DJUSHB gathered its footing before testing its rising 50-day SMA of 552.57, as buyers discounted November building permits, which came in at an annualized 1.874 million unit rate and below economists' forecast for 1.901 million units.

The United States trimmed its current account deficit in the third quarter of 2003 after plunging into a record-sized shortfall in the previous three months.

The current account deficit, which tracks foreign trade, income and one-way transfers such as foreign aid, fell 3% to a smaller- than-expected $135.0 billion.

In the second quarter, the United States had suffered a record shortfall of $139.4 billion.

In trade of goods and services, the deficit in the third quarter narrowed to $121.3 billion from US$124.2 billion in the second quarter.

The surplus on foreign income, derived from investments and from compensation for overseas workers, grew to $2.6 billion from $1.7 billion.

One-way transfers led to net outflows of $16.3 billion in the quarter, which was down from an outflow of $16.9 billion in the previous three months.

The narrowing of the U.S.'s current account deficit in the third quarter and falling consumer prices in November put a bid under Treasuries, with the benchmark 10-year YIELD ($TNX.X) trading lower by 4.1 basis points to close at 4.234%. While Treasuries found buyers, the equity side of gold found the AMEX Gold Bugs Index ($HUI.X) 232.32 -3.22% leading today's sector losses, where sector losses diminished markedly by today's close.

Here's an hour-by-hour recap of today's internals and major indices trade. The observation that I would make is that the NYSE may indeed be the head of the snake, where strength built at the mid-point of today's trade, and helped pull the weaker NASDAQ back into positive territory by the close.

Market Snapshot / Internals - 12/16/03 Close

What was it that had the weaker NASDAQ recouping earlier losses by its close, and why such divergence, especially in price action between the NASDAQ, even the Russell-2000 and the other major indices?

As noted later this afternoon, the only observation, or tie, I could make for today's late-session rebound for the NASDAQ and RUT.X was Prime Minister Tony Blair's comments just before 01:00 PM EST market, regarding a U.S.-led Iraq Survey Group, which said it had found a network of biological laboratories in Iraq. It would be impossible to confirm, but when weakness finds strength just after this type of news, which follows a day after Saddam Hussein's capture, this trade smell a bit of short-covering. There was talk yesterday that Saddam's capture was "factored in" to the markets, and while the afternoon bounce came as the NASDAQ-100 Tracking Stock (AMEX:QQQ) $34.85 +0.2% was about to try and retest its WEEKLY S1 of $34.43 for a second time intra- day, the bid formed after Briefing.com headlined the Dow Jones report at 12:45 PM EST.

Valuation is often cited as a reason for the recent NASDAQ weakness relative the other major indices. I would also add that options expiration may be having some impact on trade, especially in the NASDAQ-100 Tracking Stock (AMEX:QQQ).

One item here is notes we made intra-day back on October 15th, regarding a large institutional buyer that day (as the QQQ was spiking to a 52-week high) in the December $34 puts. I made note of this in the Market Monitor and then again in the October 15th wrap.

With open interest in the QQQ heaviest at the $34 puts for December expiration, we should well expect volatility. The reason I bring this note up tonight, is that in the October 15th wrap, it was probably a "gutsy" trade to be buying QQQ $34 puts for $1.05 or $1.10. While the QQQ did see a low of $33.49 days after our notes, $1.05 either side of $34 is $35-$33, where QQQ traders might indeed note MONTHLY S1 of $34.05 (pretty close to $34) and MONTHLY Pivot ($35.11).

Since I'm discussing the QQQ, I should note that I profiled a swing trade bearish trade in the QQQ today at $34.51, stop $35.12, target $34.11. This trade was profiled at 12:33:38, and was after the QQQ's initial test of DAILY S1. I had set some "tests" for this trade in today's market monitor, and when I look at the pivot matrix for tomorrow, the bearish side of me, which profiled the trade, doesn't feel comfortable at tonight's close.

Pivot Analysis Matrix -

When I profile the QQQ bearish trade, market internals were weakening at the NASDAQ, and the QQQ had just started to reverse back from the $34.77 level, as the Dow Industrials (INDU) was trading either side its MONTHLY R2 of 10,075.25. Surely the market was set to sell off, with the QQQ more than likely falling to my target of $34.11. While this may still happen, one of my tests was that the leadership Dow Industrials (INDU) would certainly find sellers at its WEEKLY R1 to keep things in check for the QQQ.

Nope! The INDU, not only broke back above its WEEKLY R1 of 10,109.30, when it did, it kissed that level as support before making a new session high.

Two things now concern me about my QQQ trade. How many traders shorted the QQQ on thought that Saddam's capture was fully baked into the cake, or had NO IMPACT on financial markets (remember investor psychology)? While "max pain" for the QQQ is $34.00, how many traders have shorted this market (QQQ) on the certainty that the QQQ would trade $34.00 by expiration?

Ugh! There's no way I thought the QQQ would trade as it did toward the close today (this is the bear in me) and now I've PROFILED a stop at $35.12, which is directly above WEEKLY Pivot and DAILY R1. Traders that are short my profiled bearish trade may want to make a slight adjustment to their stop of $34.15, try and build some room above this correlation in the matrix, but I now feel that I'm counting on computer selling to hold back an angry mob of bears, if this level is broken to the upside. The ability for the Dow Industrials to continue to march higher has the QQQ bear in me very concerned about POSITIVE market psychology.

The two levels highlighted in PINK on the INDU at DAILY S1, was a level that after the first 25-minutes of trade today, NEVER saw the INDU fall back below the 10,060 level, where this 10,060 INDU held firm as the QQQ tested its WEEKLY S1 with a session low of $34.42. The PINK box at WEEKLY R1 in the INDU is a level of trade where I thought this might give strength to the QQQ from the bottom. Both of these PINK levels in the INDU were mentioned at the end of today's 01:00 PM EST update.

Dow Industrials Chart - 5-minute intervals

The Dow Industrials (INDU) traded inside of yesterday's range, so I thought I'd show two day's trading on the 5-minute bar chart, where the stronger INDU was quick to gravitate back higher to its MONTHLY R2 of 10,075.29, then make a late afternoon move back above 10,109.30.

I've marked a spot on the INDU intra-day chart, where the QQQ had just traded its WEEKLY S1 and lows of the session. This intra- day chart may begin to disprove that Saddam's capture was fully factored into the market, shows Dow leadership, and may well serve importance as to how higher price action in the Dow, may also be lifting to market psychology, and give even the weakest of indices a lift.

NASDAQ-100 Tracking Stock (AMEX:QQQ) - 5-minute intervals

While the INDU didn't trade below yesterday's lows, the QQQ did. I've marked my last three trades on the QQQ where we raised stops in a bullish trade early morning to our target of $34.75, and were stopped out with a nice gain. Then I profiled a bullish trade back at $35.12 in the QQQ on Monday, as while we did see a bounce from the MONTHLY Pivot of $35.11, the Q's turned south and stopped that bullish trade out at $34.79. Then today, I was "certain" the QQQ was going to lead lower once again below the WEEKLY S1 and fall to a decent target of $34.11, where a scenario of "max pain" at $34 by expiration would be an easy bearish trade. It's not looking that way, and as a bearish trader in the QQQ, I could blame the INDU for its strength, which gives bullish lift to the QQQ. Just as I've marked QQQ levels, which might be correlative to INDU levels of trade near-term, I marked INDU levels which I associate with the QQQ.

Guess which two indices are right in the middle?

S&P 500 Index Chart - 5-minute intervals

It becomes rather apparent that the SPX is stuck right in the middle of the INDU/QQQ trade, where it would certainly behoove an SPX trader to keep an eye on both ends of the snake, or the inchworm. I would say the SPX looks very strong and should hold above WEEKLY Pivot of 1,067, which I might correlate with QQQ WEEKLY S1.

While the internals of the NASDAQ strongly suggest weakness, it is price action that matters most. Do NOT be lulled into complacency with thoughts that "max pain" will be achieved, or that "Saddam was factored into things."

For those wondering what "max pain" is for the SPX, were not even close at 1,025.

Jeff Bailey

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