Option Investor
Market Wrap

10,001.78 but where's the rally?

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        3-16-99          High     Low     Volume   Advances Decline
DOW     9930.47 - 28.30 10001.78  9926.58  744,858k  1,299   1,664
Nasdaq  2439.27 +  7.83  2450.01  2423.81  979,824k  1,703   2,278 
S&P-100  655.64 +   .16   658.68   653.04   Totals   3,002   3,942
S&P-500 1306.36 -   .90  1311.13  1302.37            43.2%   56.8%
$RUT     399.17 -  1.67   401.80   399.10
$TRAN   3388.56 - 16.09  3401.02  3374.55
VIX       26.19 +   .07    27.41    26.02
Put/Call Ratio      .52

10,001.78 but where's the rally?

Yes, the DOW tagged 10K this morning but immediately ran for cover. As if shrinking back into the safety of sub 9950 levels to wait for the smoke to clear the Dow languished for the remainder of the day. While everyone expected the break through to come today the follow through may not come for sometime. Actually now that the emotional barrier has been broken we could see some profit taking at this level. The blazing +750 run the last two weeks has got to take a pause to refresh soon.

The big push to D10K was helped this morning by several earnings upgrades and analyst upgrades. Union Carbide (UK) announced they expected earnings to come in at the high end of analysts estimates. Merck (MRK) was upgraded after the FDA announced they had approved their cholesterol drug Mevacor for wider use to prevent first heart attacks. Boeing (BA) announced that they were forming a new division to modify existing planes and were upbeat about the wave of new business expected. Merrill Lynch (MER) was upgraded along with a host of online brokers. The new price target on MER is $105, a rise of +$15.

With all the positive news you would have thought the D10K would have been history and we would be talking about 10100 instead. The old market breath problem lurking on the sidelines was the culprit again. The decliners beat advancers 3,942 to 3,002. While bulls are trumpeting the market euphoria the broader market is slowly selling off. The DOW continues to be carried by a select few stocks and the Russell 2000 again fell under 400.

The outlook is not bright. Until the market internals improve, any number the Dow reaches this week is simply a number we will have to pass again after the coming sell off. Ralph Acompora was on CNBC again today saying glowing things about his Dow 11,500 prediction. As I watched him talking about GE, MRK, UTX, and how impressed he was at the new individual highs, I got the impression he was nervous. Kind of like a new car salesman trying to sell the highest dollar car on the lot. I did not see any confidence in his demeanor or his voice. Remember last year when he was on CNBC predicting D10K in 1998 and then three days later he reversed and predicted 8500. He almost had the same "look", like he was trying to talk the market back up quick so he would not look bad. Just an impression.

While I am bullish about this market through April, I am cautious about the next week or so. Earnings warning season is upon us and we could get some negative news any day. I love the positive earnings upgrades like today but bad news seems to have more impact after a big run. The prospects of positive tech announcements are good compared with the first quarter of last year. Last year was not a particularly good quarter and estimates are running about +35% higher for this quarter. If they hold, the tech sector should continue to hold up the Dow well into April.

I get a lot of email about why the Dow controls our fate when it is only 30 stocks. I wish the answer was easy. Basically the Dow has been the pulse of the market for so long that it is has become a historical icon and pivotal focus point. When it comes to market indexes, it pays to be first and have your own newspaper. The first Dow only had 12 stocks and the 30 stock index did not happen until 1928. The editors of the Wall Street Journal have not changed the number since. You would think an index of 30 companies would be a strange way to measure a market of more than 10,000 stocks. The Dow companies represent a combined market value of more than $2.5 trillion, or about one-fifth of the $12 trillion value of all U.S. stocks. The 30 Dow stocks actually represent over 70 different companies. General Electric alone is a leader in a dozen different industries. Despite the difference in size the Dow 30 and the S&P-500 almost always move in the same direction. The difference is more apparent the farther away from blue chips you get. While the Dow has been led this year by eight stocks accounting for over 80% of the +750 points since Jan 1st, the S&P has been led by a like group of 25 blue chips. The blue chip indexes have been moving upward while the non-blue chip companies are slowly drifting down.

The answer is liquidity. Funds can move in and out of blue chips quickly (relatively speaking) without impacting the price. When a fund tries to reduce a large position in a smaller company the impact can be disastrous. The point of this topic is the Dow may control our fate because of the visibility but it does not represent the real market. We are all focused on the D10K spectacle but we should be focused on the other signals as well. With Y2K slowly approaching, we could be lulled into a false sense of security with the Dow at record levels. The broader market is selling off as evidenced by the declining advances and increasing decliners. It is a stealth sell off and could be portfolio managers taking advantage of the focus on the Dow to liquidate big positions in small to mid-cap stocks. They are moving funds into the big blue chips because of the appearance of liquidity. Trust me, if they all decided to leave at once it would not be a pretty picture.

The Dow is calculated by a divisor rather than by the number of shares or the stock price in each company. If it was just the stock price then Dow 10,000 would be the total of the stock prices of all 30 stocks. Because of stock splits and adjustments the divisor is currently 0.225. If the Dow was exactly 10,000 then the share prices of all 30 stocks would add up to $2,250. (dividing $2,250 by 0.225 equals 10,000) Using the same math, every time a stock in the Dow moves up or down $1.00 the Dow moves 4.5 points in the same direction. Wal-Mart and IBM are both splitting their shares 2:1 soon. The divisor after the split will shrink to about 0.215. Any $1 move by a Dow stock would be a 5-point move in the Dow. Why the lesson? If every Dow stock dropped $2 on the same day (after the splits) the Dow would drop -300 points. 300 points for only a $2 move each. Obviously if we had a sell off, big stocks like IBM at $180 will drop more than $2. An average drop of $5 would be a 750 point drop in the DOW. 750 points? That is the amount the Dow is up for the year. That means that the average rise in the Dow stocks has only been $5.00. Do you now understand how fragile the Dow is at 10,000? Even more fragile if you remember that only eight of the Dow stocks are responsible for the move. That is an average rise by eight stocks of $18.75 each while the rest were asleep. Profit taking anyone?

The market was unaffected by Mr. Greenspan today but he gets another chance on Friday.

Friday is also a triple witching option expiration day. The market bias for expiration weeks is normally up as traders cover their short positions. The recent market rise may have already cleared most of them so the expiration impact may be muted. If you are not out of March positions yet you obviously are living dangerously. S&P futures are down about -2.00 at 8:30 so we could see a soft open in the morning.

Sell too soon!

Jim Brown

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