Option Investor
Market Wrap

Techs, drugs and Rock and Roll....

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        WE 4-16           WE 4-9           WE 4-2           WE 3-26
DOW    10493.89 +320.05 10173.84 +341.33  9832.51 + 10.27   - 81.31  
Nasdaq  2484.04 -109.01  2593.05 + 99.68  2493.37 + 74.20   -  2.10  
S&P-100  668.65 - 12.69   681.34 + 31.42   649.92 +  6.24   -  6.43  
S&P-500 1319.00 - 29.35  1348.35 + 54.63  1293.72 + 10.92   - 16.49  
RUT      421.58 + 15.72   405.86 +  7.12   398.74 +  4.82   -  2.66  
TRAN    3528.70 +158.30  3370.40 + 61.24  3309.16 + 49.05   - 78.37  
VIX       25.48            22.91            23.34            25.83
Put/Call    .63              .54              .62              .50

Techs, drugs and Rock and Roll....

Three of the sectors that took some serious hits last week. The drug sector on the heals of the Pfizer earnings and lower guidance, the tech sector on weak earnings by SunMicro and the entertainment sector even after Time Warner posted earnings of +$.10 when estimates were for a -$.04. TWX dropped -$12 after the incredible earnings performance and the Fidelity Magellan fund said they were going to add to their already large position in the solid company. Go figure? When sectors rotate no stock is a safe haven.

That was the key for the week, rotation. Investors moved out of everything tech and internet and into anything with a low double digit PE that had been beaten down for the last few months. What prompted the flight from tech stocks with +30-40-50% earnings to cyclical and economically sensitive stocks with +10% earnings is still a mystery. Did I miss the email that finally convinced traders that triple digit PE ratios were bad? Value investors have been scratching their heads and trying to convince the momentum players for years that the PE bubble was going to burst someday. Did I miss the pop or is that hissing sound coming from the Nasdaq last week the beginning of a slow leak?

The news and warnings by several companies of Y2K concerns, and dwindling PC sales driven by companies working on the problems, may have finally pushed investors over the edge. What has been the major factor driving new tech sales for the last two years, other than the Internet, appears to have finally run it's course. Brokerages are downgrading tech stocks daily and the dog pile has begun. One of the best this week was from Merrill Lynch. On Friday they cut SUNW strictly on price. Stating they love the stock but can't support their buy recommendation at these lofty levels they dropped their buy to an accumulate. Why is this strange? When SUNW was trading at $145 two weeks ago they had a buy rating. Now that they are trading at $109 it is too high! A -25% drop in price but it is now too high. Come on guys, admit it. You are just trying to let your investors down easy and not open yourself up to any complaints from your clients.

With SUNW warning that the fourth quarter will not be seasonably strong and the recent leaders being taken out and shot, the title for next weeks trading could be "The Search for Leadership." On Friday the Nasdaq 100 only had 28 stocks closing positive and it was definitely not the usual suspects. Only eight were up more than $1.00. The "leaders" on Friday were TLAB +5.56, ADBE +3.06, CEFT +1.75, BBBY +1.63, ADSK +1.38, CTXS +1.31, STEI +1.19, AMFM +1.13. Not exactly an inspiring group. TLAB was a dead cat bounce from a -16 drop the two days before. ADSK was bouncing from a -50% drop in the last two weeks. CTXS is at a six month low. ADBE is on a plateau at a six month high, CEFT and STEI actually look decent climbing out of a long declines. BBBY and AMFM were neutral in my opinion. Compared with the recent big Nasdaq gainers they all would have been play rejects.

Don't think just because the Dow set it's fifth record in a row on Friday that it just qualified in the iron man contest either. Fridays performance was purely on the backs of only three stocks. Eastman Kodak, on a positive earnings announcement AND an announced buyback of $2 billion in stock. The other two were the oil sector giants Chevron and Exxon, both riding the heals of the $17.33 oil. The gains of these three EK +6.44, CHV +3.13, XON +2.38 accounted for +53.77 Dow points. The Dow closed up only +31.20. Without these three stocks we would have been negative -22.57.

The recent rise of the cyclical stocks may have run its course. Almost everyone we looked at this weekend appeared to have topped on Friday. This could have been just profit taking from the big gains last week or just a reluctance to apply more money before the weekend but still a cause for concern.

The liquidity driven rally from the last month may be coming to a penny pinching halt. The pre-tax retirement fund deposits have now passed and their may be selling to cover the tax bills of the last minute filers. The earnings season is in full bloom with this coming week the most active for the month. Since most investors understand the concept that you should not hold over earnings then it stands to reason that the biggest earnings weeks would be the biggest selling weeks as well. Investors will move into stocks that announce in May for a final earnings bump before the summer doldrums drop appears. It is entirely possible that the more cautious stock (not option) investors will start moving to the safety of money markets well in advance of the coming Y2K period.

While I do not want to enforce any negative views of the possible negative consequences of the Y2K event, I do feel the need to report on the possibilities. At the recent seminars I had the opportunity to speak with hundreds of investors. MANY expressed a similar view that the market could move downward for the rest of the year after this earnings period. I know many people already converting stocks to cash to protect the investments they have spent years accumulating. While I feel personally that the Y2K event may have no direct impact or at best only minimal inconveniences to most, I also feel the perception of the event will be the major problem. The media is full of dire warnings by thousands of people trying to make a name or a buck out of Y2K. This will only increase in volume and intensity the closer we get. Therefore the perception of the event as a possible catastrophe will grow as well. As an option trader I view any major event that moves the market as a tremendous opportunity. If we do get a major sell off in advance of Y2K I expect to profit well from it. But that is not the point. The point is this. Most investors have been saving for their retirement for many years and have accumulated a large portfolio of stocks. If they become fearful of the future, they will make the phone call to move into the apparent safety of money markets. Funds will start selling stocks to maintain liquidity. When this starts, if at all, is anybody's guess. It is up to us to maintain a watchful eye and NEVER assume the next drop is just a dip. As option traders we are in and out of the market much quicker than stock traders. We can also play either way, up or down, for the same amount of money. After several weeks of rally here we need to be watchful for a trend change.

Now after talking about a possible direction change in the market I must mention the apparent direction change in three of the most watched Dow confirmation indicators. The Russell-2000 the transports and the advance decline line. All have made dramatic moves in the last several weeks. The Russell broke above 400 after two months of unsuccessful attempts.

While I think the RUT is being moved on the surface by the huge increases in the Internet and brokerage stocks I wrote about last week, I do see some movement in the broader and smaller issues. There is new life in the smaller stocks. Why, at this point, is unknown. Maybe it is simply a flight out of the expensive big caps and a broadening of the market brought on by the Dow 10,000 rally. After Dow 10K the general consensus was that the big caps were grossly over valued and this could be the result. In any event, as long as the Russell continues upward it will be hard for the larger averages to go down dramatically.

Secondly the Transports are very close to the all time high set in April of 1998. Dow theorists see the transports confirming the recent Dow rally. This is also amazing in the light of the rise in oil prices from $11 to over $17 in the same period. Oil is a major cost factor in the transportation sector. This transport rally again defies the odds.

Even more amazing is the turnaround in the advance/decline line. On Friday the Dow was up only +31 on the backs of three stocks yet the NYSE advances beat the decliners by the widest margin in recent memory. 2053 to 1005, a more than 2:1 margin.

Since the first week in April the downward trend which began in April of 1998 has reversed. This is very positive for the markets. If this holds then the rally should continue.

The recent Dow movement has been incredible. Up +707 points in the last eleven days. A new Dow record high for seven of the last eight days. A very strong trend but also one that, like Internet stocks, needs to breathe soon. When it does stop for air we will be at a critical juncture. Each broken thousand mark for the last three was followed by a large decline. We have not seen that yet. If it can pause and maintain a level above 10K then the next run could take us to 11K. Because of the previous Y2K paragraph I will remain skeptical until after the pause is over and the rally begins again. If you always remain skeptical of unchecked market advances you will always be ready to bail out to protect your gains when the next correction occurs. My goal of this entire dissertation is to simply make you aware of the possibilities which should make you a better trader.

Last week we posted a readers write about certain hours of the day and we were deluged with email asking for an explanation. We had mentioned this many times in the past but it was just something that was new to our new readers. We strongly advise traders to not place any buys in the first 45-60 minutes of trading each day. This is called amateur hour. Have you ever noticed how the market tends to make sudden moves at the open only to reverse those moves later. Friday was a prime example. The futures were up prior to the open and the market opened up +40 points or so and then sank -114 points to the low of the day, then rebounded +100 points from the low. All this happened in the first hour of trading. This was extreme but an example of the volatility in the first hour. We do recommend placing sells at the open because most often the first movement is upward. If you buy at the open you could be buying at the emotional high of the day more often than not. It is incumbent for us as traders to establish a market direction before we make our plays. The final direction on Friday was not determined until after 11:AM. Trade during amateur hour only if you know what you are doing. The next period is from 1:PM to 2:PM. During this period the market slows as traders try to grab some lunch. It is strictly a human response in this electronic age that we still need to eat. Picture hundreds of thousands of brokers around the country all getting hungry at the same time. Some work through lunch at their desk but there is still market impact. This can be a good chance to buy if the market was up in the morning. Stocks tend to pullback some between 1:00-2:00. Lastly direction for the final hour of trading is normally determined between 2:55 and 3:05. You know the market tends to move big in the closing hour. Your challenge is to decide by 3:10 which way it is going and play accordingly. Disclaimer: These are trends which are true the majority of the time but NOTHING is true ALL the time. Again, play the cards the market deals us and know when to fold.

Good Luck

Jim Brown

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