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Market Wrap

No employment disaster but interest rates still went up?

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           WE 5-7           WE 4-30          WE 4-23          WE 4-16
DOW    11031.59 +242.55 10789.04 + 99.37 10689.67 +193.78  +320.05  
Nasdaq  2503.62 - 39.23  2542.85 - 47.84  2590.69 +106.65  -109.01  
S&P-100  681.74 +  6.09   675.65 - 11.76   687.41 + 18.76  - 12.69  
S&P-500 1345.00 +  9.82  1335.18 - 21.67  1356.85 + 37.85  - 29.35  
RUT      436.11 +  3.30   432.81 +  1.08   431.73 + 10.15  + 15.72  
TRAN    3742.83 +95.54   3647.29 + 57.61  3589.68 + 60.98  +158.30  
VIX       26.72            26.07            23.96            25.48
Put/Call    .61              .53              .59              .63

No employment disaster but interest rates still went up?

Just another logic lapse in the markets on Friday as the employment report came in at a very tame +234,000 jobs and only +.2% increase in hourly wages. With unemployment rising to only 4.3% from 4.2% you would have thought the bond bulls would be running to buy bonds and sing the praises of the strong but inflation free economy. No such luck. Like stock traders with huge positions the bond bears sold heavy into the opening rally and kept it up all day. The bond yield actually went up for the day to 5.81% in spite of the great report.

What the heck is going on? It appears the writing is on the wall. The bond junkies think the Fed will eventually have to raise rates regardless of the lack of warning signs in the economy. The specter of a stealth inflation invasion is upon us. Yes, there are no signs yet, but doctor Greenspan is warning that we have the virus already but the symptoms have yet to show. Just like kids that wake up one morning broken out with chicken pox or measles, they had the virus for several days but you just could not see it. The bond junkies are afraid the economy will get a report someday soon that will unexpectedly show inflation gaining speed or worse in full bloom and the Fed action will be fast and harsh. Others are still predicting a pre-emptive strike by the Fed before the actual symptoms show. Either way a +.25% rate increase for August is already factored into the bonds and some are forecasting a +.75% by the end of the year. OOPS! The CEO of Fannie Mae, the home loan bank, said on CNBC on Friday that the FED was likely to raise rates soon. He said it calmly with no worry but CNBC played it over and over all day long increasing the impact. With the repeated emphasis on rates all day long on CNBC I am surprised the market managed any rally in the afternoon. Don't look now but the next hurdle is the PPI on Thursday, the CPI on Friday and the FOMC meeting the next week.

In spite of the doom and gloom from the markets did manage to put in a decent showing after a rocky start. The Dow traded in a narrow range until about 2:PM when the Friday afternoon bargain hunters finally appeared. The afternoon rally weakened after 3:00 but a buy program about 15 min before the close pushed the Dow back to another closing record.

The Nasdaq however struggled all day after looking like another wave of Internet selling would overtake the small amount of tech buying in progress. The tech large caps like DELL, MSFT, INTC, CSCO all finished positive but most of the Internets closed down after a brief rally in the afternoon. An upgrade to EGRP and AMTD kept the Internet brokers afloat all day but they stood alone among the larger net stocks.

The close above 2500 (2503) may have been only mildly psychologically important. After spending so much time under 2500 during the week this level may now become resistance instead of support. It does appear below that the Nasdaq slide may have slowed but there is not a lot of buying pressure to hold it up. The spurt of tech buying on Friday was not convincing with the majors only adding small numbers, some only fractional gains.

This Dow chart however looks like the reversed mirror image of the Nasdaq chart. The Dow finished at the high of the week on the strength of the cyclicals again and one big gainer. IBM soared to a new high adding +$8 after receiving a big upgrade. Other big gainers were ALD +3.06, DD +1.44 and GT +2.13. If you want to really understand what is going on behind the Dow I suggest the DOW-30 Chart link on the newsletter page.


If you want to know where the Dow is going this is a good way to get the "feel" without the hype.

The following chart shows an incredible picture of the recent past and the complete turnaround of the Advance Decline line. This is what is providing the strength behind the rally. In the last five weeks the DOW has added, starting with week ending Apr 9th, +341, +320, +194, +99, +242 for a total of +1200 points without a major sell off or consolidation period. This is what is powering the move into the cyclicals. Traders are scared that the big cap stocks that have gone up so much in the last three months are going to be the worst hit when the selling starts. The move into the apparent safety of the slow moving and recently behind cyclicals represents a value play and a safety play. However, due to the huge rise in the cyclicals lately, some over +30%, they are now becoming risky as traders have huge profits at risk.

Yes, the market is broadening out. It has to! The profits built into the big caps are enormous. The PE for the S&P is now over 29 and still rising. Profits are not profits until you sell the stock. Funds are trying to move money carefully out of the big guys and into the midcaps. They hope the midcaps will be the beneficiaries when the big cap selling starts. Try to take $100 million out of one big cap like Intel that trades 20 million shares a day and then invest it into ten smaller stocks at $10 mln each without broadening the market and inflating the advance decline line. You cannot do it. Multiply this by hundreds of funds. Do not get me wrong, this is great news for the market.

So what is the hurry? Historically, May and June have not been screamers for the averages. Since 1950 May has ranked as the eighth worst month for the Dow and June is even worse at number ten. Thus the term "summer doldrums" is appropriate when applied to the market.

So lets see if you understand my concerns. The market has risen 1200 points in five weeks without any major profit taking and we are entering the two month period that has historically been prone to selling. Earnings are basically over and bond yields are going out of sight. Liquidity in the form of tax deductible contributions and tax refunds is dwindling. Tech stocks are suffering because of the slowing in Y2K buying. Internet stock IPOs are coming out in multiples per day and soaking up available funds. Internet stocks which have been up +100% in just the last two months have now given back half their gains as constant articles on absurd Internet valuations bombard the news services. Sounds pretty ominous.

So why should we not rush out and buy bonds for a safe 5.81% yield? The economy is growing at an astounding rate of 4.4% with zero hint of inflation. The global economy is healing quickly. Consumers are spending at a record pace. There is no disaster on the economic horizon. As Greenspan said last week, this is the new economic paradigm. High productivity, low cost, low unemployment. Our island of prosperity is keeping the entire world economy afloat. The rules have changed. Maybe a PE of 29 is now low. Maybe the new rules are 35, 40, 50! Nobody knows. Maybe all the caution in the sector rotation is misplaced. Stocks are still going up. As option traders we don't care why. Play winners, replace the losers.

The number one reason for investing in this market now is also a cardinal rule. "Don't fight the tape." As option traders we are more nimble than stock holders. You notice I said holders instead of traders. Holders are always worried about things like tax implications of selling. If you bought a stock three years ago at $50 and it moved between $40 and $70 a dozen times to end up at $55 today, the tax implications on your 10% return are painful. To an option trader that owned a $10 option that he sold for $15 two weeks later, it is just a cost of doing business. As the elite of the trading public we do not care which way the market moves as long as we keep our stop losses in place. So let the market move whichever way it wants and we will still make money. Just keep the rules in focus:

1.) Wait for an entry point
2.) Sell too soon

Maintain your focus, don't buy on impulse, have a great week!

Jim Brown

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