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Index Wrap

Some rebalancing and a good fight

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The major indices finished mixed this last trading day of the year, where I think we saw some sign of asset rebalancing, but more than likely, a battle of egos between bulls and bears.

If traders or investors think "psychology" isn't a big part of how or why markets trade like they do, then today's NASDAQ Composite (COMPX) 2,003.37 -0.32% close, which wasn't round at 2,000.00, but strikingly similar to the year 2003 should be ignored. However, if you believe like I do that markets will be manipulated on a short-term basis, then today's trade was just that. Manipulated.

I do think there were some signs of rebalancing that took place with asset allocation models being implemented. We touched on this in this past weekend's Ask the Analyst column.

While a rebalancing isn't expected to be completed in one day, or one week, I made note at 03:15 PM EST, that two of this years (2003) Dow Dogs saw a complete inverse trade in relation to their total year's percentage gain and loss. Caterpillar (CAT) $83.02 -1.24% was today's percentage loser in the Dow Industrials (INDU) 10,453.92 +0.27%, but was this year's biggest percentage gainer for the 10 Dow Dogs, gaining 81.58% on the year (dividends not included). Eastman Kodak (NYSE:EK) $25.67 +1.3% was edged out for today's Dow percentage gainers by Merck (NYSE:MRK) $46.20 +1.53% and AT&T (NYSE:T) $20.30 +1.34%, where EK was the worst performing Dow Dog (-26.7% excluding dividends), while T was the second-worst performing Dow Dog (-22.25% excluding dividends).

In this upcoming weekend's Ask the Analyst column, we'll talk about the Dow Dog theory, which is actually a BULLISH theory based on an investment philosophy that the 10 highest dividend yielding stocks in the Dow, tend to outperform the average itself.

While the above observation that some of this year's weaker Dow components found buyers, while one of the bigger winners found selling, and hints of some asset allocation or rebalancing taking place for a very popular and widely follow investment theory, there was also a good fight, or a battle of egos that took place.

I try to show just how much muscle flexing was trying to be exhibited by bulls and bears as it relates to where the COMPX would close, while at the same time bears trying to make darned sure that after getting their heads handed to them in 2003, the NASDAQ would not finish with an historical bullish gain the day before New Years.

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

As the session progressed, I began to feel like it was a Triple Witch expiration, where the markets might do just about anything, and still make sense! The QQQ extended yesterday's late session gains at the open, then "whack" was sold back lower. Just after 10:00 AM EST, I benchmarked the QQQ at $36.37, when the NASDAQ Composite (COMPX) traded a morning low of 2,001.01.

Oh Gosh! That's were the NASDAQ Composite is going to close I thought. That's the round number! Later in day (11:04 AM EST) I posted in the Market Monitor that the NASDAQ might close at 2,003, a fitting close for a bullish year.

Another observation as it relates to "egos" or the battle between bulls and bears is a comment made by Jim Brown as it relates to a nice short he put on in the S&P e-mini futures just after the open. I consider a short a BEARISH trade and Jim a BEAR. I tied in his market monitor comment at the appropriate 5-minute bar on the QQQ.

Not wanting to keep my foot out of my mouth, I later professed that swing trade bulls weren't complaining when the QQQ inched back into positive territory. Ah.... the historical bullish tendency was going to hold! NOT!

Just as I tend to "scratch" a Triple Witching expiration or option expiration daily trade from my list of "daily importance," today would rank as one of those days.

Still.... the CAT, EK, T type of daily trade does certainly hint that there is some type of asset allocation, or rebalancing taking place, and will most likely impact trade in coming weeks.

Market Snapshot / Internals - 12/31/03 Close

I need to add an index like the small-cap Russell-2000 Index (RUT.X) 556.91 -1.51% to my "Beetles Balanced Benchmark" portfolio this year (2004) and the RUT.X gained 45.37% this year, which compares favorably with the NASDAQ-100 Tracker (QQQ) yearly gain of 49.61% and the NASDAQ Composite's (COMPX) 50.00% gain.

Hey! 50.00%? Another sign perhaps of some artificial manipulation?

Also note, while the NYSE Composite (NYA.X), INDU, SPX and OEX also found nice gains this year, they weren't quite as handsome as those found in the RUT.X, COMPX and NDX/QQQ! By golly some of TODAY'S percentage gain/loss would look rather similar to the rebalancing discussed in last weekend's Ask the Analyst column.

I would have to at least think that rebalancing is indeed a potential scenario that may have some impact on the major indices in coming weeks.

Pivot Analysis Matrix -

I just don't have a good answer as to when, if, or how much a rebalancing type of trade scenario would have on the major indices.

With the new MONTHLY pivot analysis levels now calculated, I really make note of the strong correlations between the current WEEKLY and MONTHLY pivots. My only thought here, is to take a note of these correlations, as they may be some computer derived level for current downside risk assessment.

Other levels I've marked in solid green squares are most likely levels on FRIDAY, if broken to the downside would be near-term alerts that asset re-allocation is taking hold as the New Year begins.

Other than today's highs, which were largely 52-week highs, would be resistance levels.

In last night's Index Trader Wrap, I posed the Devil's Advocate scenario that there might not be any asset allocation early in the year.

I'm not big on trying to forecast where a market might tend to trade under certain scenarios, but Jim Brown sent me a quick e- mail today where an analyst noted that the Dow Industrials had broken above their model's 10,400 resistance and that the INDU could head higher, but their model now suggested their biggest near-term upside target would be 10,490 and a mild correction back to 9,600 or 9,000 at worst might be found. The caveat was if the Dow broke above 10,500, then the model would have to be adjusted.

You and I know that there are probably 5,000 different forecasts of what is going to take place, but after calculating the new MONTHLY pivot level, I did see some correlation at MONTHLY S2 of 9,556.81.

You know me though. It's my logic that to get to 9,600, then the INDU would have to break below its MONTHLY Pivot first!

The point I would like to make here is that any forecast is simply a scenario, which must be tested. I heard on CNBC today that at the beginning of the year, somebody (I think a market analyst) said the QQQ was a very good short for 2004. I'll raise my right hand that I thought the QQQ was a very good put this past summer!

My forecast for 2004 if you must know, is that the major averages will finish higher than they are today. I'll stick with my annual renewal special forecast.

"The second-leg of the greatest bull market in U.S. history looks to have unfolded in early September, when the S&P 500 Index (SPX.X) broke above major resistance that had formed below 1,020, which then served support on a recent pullback, as market participants learned the U.S. economy had grown at an a 7.2% annual rate, which was later revised upward to an 8.2% annual growth rate, its highest pace of growth in over 20-years!

I would be tempted to call for a pullback of 7% in the first quarter of 2004 as bulls look to lock in taxable gains for this year in early 2005, where from current 1,070 levels of trade would bring the SPX right back into the upper-end of a massive base of 4-month support (965-1,010), but current demand building (columns of X) still show rather strong underlying bid to the markets."

When I wrote that forecast earlier this month, the SPX was trading 1,070!

Now... I want YOU to truthfully do a self mental check RIGHT NOW. Are you WORRIED about a potential asset allocation shift, which might have the major indices falling?

Or do you think a lack of any asset shift could send the major indices higher still with short interest being so high?

To tell you the truth, I was "worried" what an asset allocation trade might do to my BULLISH swing trade in the QQQ. Then I looked at this chart of the SPX, with new MONTHLY Pivot retracement overlaid.

All I (or you) have to do is NOT WORRY, but trade your levels.

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

I can't say that I would be comfortable if I were short these technical at this point. See that new MONTHLY R1 level up at 1,131.85. That's pretty close to that 1,132 level I drew on the SPX's chart in the 12/29/03 Index Trader Wrap http://members.OptionInvestor.com/Itrader/marketwrap/iw_122903_1.ASP as being the only technical level of resistance I could find other than the WEEKLY/MONTHLY pivot levels we use to break up these wider ranges.

Already I might have to revise my 2004 forecast of a 7% pullback from 1,070. But a 7% pullback in the SPX, which I feel would be HEALTHY and normal for a digesting of gains, ties in rather nice with the new MONTHLY S2.

The only scenario I can think of for being short the SPX right now is that the trader must be rather certain that some type of asset allocation/rebalancing is going to take place.

NASDAQ-100 Tracking Stock (QQQ) - Daily Intervals

The QQQ bullish side of me would have preferred to see the Q's close above the $36.58 level discussed last night, make a clean break of things to the upside, and it is difficult to analyze today's trade, as it seemed highly manipulated with the NASDAQ Composite (COMPX) to get a 2003.00 close.

An immediate, or early January allocation/rebalancing among large-cap technology could have the QQQ pulling back to the correlative WEEKLY/MONTHLY Pivots of $35.74, so I'm going to raise my swing trade bullish play stop in the underlying QQQ to $36.16. If little asset rebalance is seen in early January, then with such high short interest, Q's may be vulnerable to a squeeze up to that $37.29-$37.36 level.

If the latter happens, then I'm going to probably need every single day of February $36 QQQ put expiration!

Dow Industrials (INDU) Chart - Daily Intervals

The only thing I see as technically "bearish" in any of the above charts is that Stochastics are "overbought," but as we've noted before, Stochastics work better in RANGE-BOUND market environment. For INDU, only near-term resistance comes from my newly added regression channel, which on Friday is about 10,520, while aside from WEEKLY R1, that congestion just above 10,290 would be viewed near-term support.

I'll follow with the OEX chart Friday morning. I've run way late and it is tough to get the MONTHLY Pivots placed on the chart in midweek updates.

Jeff Bailey

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