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Index Wrap

No amount of paint could cover up Merck's declines

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The major indices finished mixed as the third-quarter comes to a close. If drug giant Merck (NYSE:MRK) $33.00 -26.78% wasn't a component of an index or sector, bulls found gains.

But no amount of last minute window dressing could offset the sharp declines brought on by Merck after the company said it was pulling one of its largest revenue and earnings producing drugs from global markets.

It was a tough month and quarter for Dow bulls and today's drubbing that Merck took was an extra layer of bad icing applied to the third quarter. The Dow Industrials finished down 94 points, or 0.9% for the month of September, and fell 355 points, or 3.4% on the quarter.

The S&P 100 Index (OEX.X), of which Merck is/was a top market cap weighted stock finished the month down 3.9 points, or 0.7%, and dropped 19 points, or 3.4% for the quarter.

The broader S&P 500 Index (SPX.X) did manage to hold a gain for the month, rising 10 points or 0.9%, but fell 26 points or 2.3% at quarter's close.

The tech-heavy NASDAQ-100 (NDX.X) gained 44 points, or 3.2% in the month of September, and helped soften what ended up being a 6.9% decline on the quarter. The SOX.X matched the NDX's monthly percentage gain by rising 13 points, but served as an anchor on the quarter, shedding 101 point, or 20.8%.

The benchmark 10-year Treasury Yield ($TNX.X) fell 13 basis points for the month, but bond bulls made out like a bandit as the 10-year yield fell 49.3 basis points on the quarter.

The U.S. Dollar Index (dx00y) 87.41 -0.78% fell sharply in today's session, but the decline came well after this morning's economic data was released to give some credence to the thought that traders reacted negatively a NY Times article where James Turk alluded that international central bankers wanted the U.S. to devalue the dollar by 20%.

I (Jeff Bailey) would note that "devalue the dollar" rumors have has expressed by others for more than three years as the economy slipped into its early stages of recession. However, traders may have reacted to the news. Perhaps accelerating a dollar sell move was yesterday's plea from George Soros' (a known short of the dollar) for voters to not reelect President Bush.

Another thought that comes to me for the dollar's decline today would be dollar weakness ahead of tonight's debate between President Bush and Senator John Kerry. Several weeks ago The Department of Homeland Security had alerted us that it received credible intelligence that terrorists might attack specific targets in the U.S.

Market Snapshot / Internals - 09/30/04 Close

Volumes were brisk, once again hinting that institutions were busy at quarter's end. While not every share Merck was traded on the floor of the NYSE, where some undoubtedly passed through the NASDAQ's electronic systems, Merck's single-day record of 145 million had the NYSE turning its heavies volume of the month.

For the month of September daily volume averaged 1.28 billion shares on the NYSE, while NASDAQ's average daily volume totaled 1.49 billion. Both were up from their respective August average daily volumes of 1.21 billion and 1.40 billion as traders began to return from summer longer summer vacations.

U.S. Market Watch - 09/20/04 Close

Is the dollar going to be devalued? While dollar trader's may have reacted to this type of news, Treasuries reversed earlier losses, with YIELD across the major maturities higher, but well off their yield highs of the session. In essence, it would be my observation from today, that the Treasury market didn't show a "dollar devaluation" type of response.

World banking giant Citigroup (NYSE:C) $44.12 -1.29% has issues in Japan and was the second-biggest percentage loser to MBNA Corp. (NYSE:KRB) $25.20 -1.36% among the KBW Bank Index (BKX.X) 97.58 -0.15% components. JP Morgan (NYSE:JPM) $39.73 +0.12%, also a dominant player in global banking traded between $39.42 and $39.79 in today's session, which doesn't look like an unusual trade.

I'll make a trader's logbook note of today's option activity for JPM where the Jan. $32.50 calls (JPM-AZ) traded 2,192 contracts (OI 13,817), the March $40 calls (JPM-CH) traded 2,190 contracts (OI 9,000), the Jan. $30 calls (JPM-AF) traded 2,000 calls (OI 22,060), the Dec. $45 puts (JPM-XI) traded 1,837 contracts (OI 2,554), while the fifth-most-actively traded option for JPM was the Jan. $30 puts at 1,600 contracts (OI 94.462).

The thought process behind making some quick notes of a money center bank option action is this. IF a scenario of dollar devaluation were in play, then "smart money" that is CERTAIN of this type of doom and gloom might be initiation bearish positions on the large money center banks by selling calls and buying puts. Time will tell, but now you and I have a benchmark to some unusual dollar action.

One thing I noticed in today's trade was that the spread between November and December Crude Oil futures narrowed rather notably from yesterday's 53 cents to 40 cents.

Why is this? It could be some end of quarter rolling and balancing taking place, but I think it may also be related to today's stronger than expected Chicago PMI figures, specifically the rise in new orders. We could be seeing some slight mindset change that a steady, if not slightly stronger economy will have demand strong for oil.

Over the years, I have made mental note that when the further-out months energy contracts trade a higher price than nearer-month contracts, it can be a sign from the market that the trend for prices is higher, rather than lower.

I don't have the time at this point to find some commentary I wrote a couple of years ago, where at the time I noted that natural gas futures had shifted where further out futures contracts were starting to turn higher than the near-month contracts. I thought it could be a market signal that the economy was about to take a turn for the better, as that heavily used industrial energy resource might have been forecasting a demand build after falling during the recession.

Today, November Natural Gas futures (ng04x) fell 20 cents to $6.595, while December Natural Gas futures (ng04z) were down 15.5 cents at $7.480. Inventory data released today showed natural gas inventories rising by 69 billion cubic feet (bcf).

Pivot Matrix -

By the time the clock struck 09:05 AM EDT the U.S. Dollar Index (dx00y) was "opening" the 09:05-03:00 EDT session at 87.69 and it is notable to this pivot matrix follower that the session high from then on was WEEKLY S1. A quarterly readjustment? A pre- determined institutional trade? A short-squeeze in gold, that triggers dollar selling?

When Goldman Sachs (NYSE:GS) $93.24 -0.04% and Lehman Brothers (NYSE:LEH) $79.72 -0.58% recently reported quarterly results, both firms mentioned that accurate assessment and trade revenue from bond, currency and commodities had attributed to their upside earnings surprises. Could it be possible that both firms were long the dollar, short gold and gold equities, but have been unwinding that type of hedge, and cleaned it up a bit as the calendar quarter ends?

In the 09/22/04 Index Trader Wrap "When Morgan Stanley talks, trader's might want to listen," I noted that Morgan Stanley was on the wrong side of the bond trade, and may have been on the wrong side of a dollar/gold trade too.

I can't say that anything other than what I've discussed tonight, would mark any change from what I discussed/covered in last night's Index Trader Wrap.

I'll tell you this though. Today's debacle from Merck (NYSE:MRK) may complicate things as it relates to end of quarter window dressing, where the BEST LAID PLANS by institutions were suddenly changed.

It would have been "too easy" if Merck (MRK) hadn't gotten crushed to try and line things up for some benchmark closes and quarterly rebalancing.

If institutions did indeed turn to Dow heavyweights United Technologies (NYSE:UTX) $93.38 +0.67% and IBM (NYSE:IBM) $85.74 +0.89% and did a little more buying in these two stocks to try and compensate for MRK's decline, we could see a notable decline tomorrow if some overbuying in certain stocks comes off as the quarter is now over.

But I will also add that MRK's decline may be further bullish, if there was perhaps a higher INDU or OEX type of quarterly settlement that was NOT achieved due to MRK's weakness, where today's weakness in MRK creates a near-term bullish prospect for other INDU/OEX stocks, that simply couldn't be re-weighted today.

The "key levels" as I see it tomorrow would be marked as the DAILY S1's for the NDX/QQQ and SOX. This gets us away from the MRK trade to a degree, unless some overbuying was done among some tech names in the OEX to offset MRK's weakness.

Resistance as I see it is SPX 1,117, or its WEEKLY Pivot. If some excessive shorting was implemented to protect against further MRK downfall (who knows what type of litigation exposure MRK has), and MRK get a "dead cat bounce" (you've followed Altria's (MO) trade history being very news driven regarding tobacco litigation), we could see some follow through upside, or relief upside on some type of short covering event.

Good gravy! Look at that VIX.X at 13.34 +0.98%. Remember the comments I reported just days ago from the CBOE options traders that was buying "low volatility" above 14? If the other side of the trade suddenly capitulates on that we could still unwind some higher trade.

Jeff Bailey

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