Option Investor
Market Wrap

Where did the relief rally go?

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         WE 6-25          WE 6-18          WE 6-11           WE 6-4
DOW     10552.56 -303.00 10855.56 +365.06 10490.50 -309.34  +240.10  
Nasdaq   2552.65 - 10.79  2563.44 +115.64  2447.80 - 30.54  +  7.82  
S&P-100   671.29 - 12.18   683.47 + 28.60   654.87 - 17.55  + 13.76  
S&P-500  1315.31 - 27.53  1342.84 + 49.20  1293.64 - 34.11  + 25.91  
RUT       443.11 -  1.94   445.05 +  7.04   438.01 -  4.32  +  3.65  
TRAN     3316.11 - 80.23  3396.34 + 51.87  3344.47 -118.26  + 47.03  
VIX        22.61            22.34            27.01            23.45
Put/Call     .53              .43              .64              .56

Where did the relief rally go?

If you went to lunch Friday with the Dow up +100 points and the Nasdaq up +30 you were probably smiling. When you got back, indigestion promptly took over. The markets soared at the open on Friday after the existing home sales were announced to have dropped -4% in May. This was much stronger than the .8% drop expected. Also the GDP only gained a slightly higher 4.3% than the 4.1% previous estimate.

As you can see by the charts the Dow has been range bound the last several weeks and is currently sitting almost on the bottom of it's trading range. At only 100 points off the bottom we still have room to move in either direction. The Nasdaq however has pulled back slightly from the upper end of it's range. Both appear poised to make a strong move with the right Fed decision on Wednesday. The Dow, sitting near support, could explode with a strong run and cover the 400 points to the top of the range easily. The Nasdaq, which is lingering near it's recent highs could easily execute a breakout run with only a +100 point gain. These ten day charts graphically illustrate our current position.

The intraday pullback on Friday was simply due to a lack of buyers and cautious investors selling into the rally to protect profits in front of the Fed meeting this week. The NYSE only traded 612 mln shares which was the lightest volume day this year. Investors are just extremely worried about the possible Fed moves. Here is the possible outcomes when the Fed announces the decision on Wednesday at 2:PM ET.

.00% rate increase, leave bias at tighten. About 5% chance.
.25% rate increase, reduce bias to neutral. About 25% chance.
.25% rate increase, leave bias at tighten. About 55% chance.
.50% rate increase, reduce bias to neutral. About 10% chance.
.50% rate increase, leave bias at tighten. About 5% chance.

No rate increase would cause a brief rally but the lingering fear of an increase in August would be a wet blanket for the market for the next six weeks.

The .25% and neutral would be highly desirable. Only .25% would be a token raise and it would normally take two Fed meetings to raise again. The markets would react very positively and we could hit new highs.

The .25% and tighten would not be exciting. A token raise but the fear of another rate increase at any time would make any coming economic report a potential disaster. At any sign of inflation the Fed could raise rates on a moments notice. This would keep a lid on any upside potential to the market and cause a very bad summer. It would be one way for the Fed to control the markets without actually slamming interest rates.

The .50% and neutral would be good for the market. Many think the .50% increase is already 80% factored into the market and we would not see any significant drop. The larger than expected raise with a reduction to neutral would be seen as a flu shot and nobody would expect another raise unless serious signs of inflation became apparent. It would be a green light for several months of rally unless economic reports started coming in strongly over estimates.

The .50% and tighten would be a disaster. A stronger than expected increase and then the specter of another increase at any time would signal the end of this bull market as we know it. Lest we forget, the current rally was started last fall when the Fed "rescued" the market from a serious slide with three back to back rate cuts for a total of -.75%. By taking back two thirds of the cuts and leaving the possibility of more the market would react very negatively.

Almost nobody expects the stronger actions with Y2K lingering only six months away. While the actual impact to the markets has yet to be seen, we could start to see some cautious investors withdrawing funds after this earnings period. The real race to cash out will probably not start until after the OCT earnings. Since nobody wants to be the last person in the market the Fed will want to avoid leaning on the prices and rates during the next six months. This is why we think this is the only rate increase we will see this year without RAMPANT inflation in future economic reports.

As if the coming Fed meeting was not enough for the market to worry about we got two bad pieces of news on Friday. Campbell Soup issued an earnings warning and said they would miss estimates by eight to ten cents. The reason given was slow soup sales. No kidding. We were expecting slow car sales maybe?

The second and most critical was a report by Henry Blodget from Merrill Lynch that Internet sector leader AOL and friends could report results in line with estimates this quarter but still be less than previous projections. Just like Dell cannot report 50% increases in sales forever, Internet companies cannot keep reporting triple digit gains in ad revenue and unique visitors. While everyone understands this principle nobody wants to be left holding over priced Internet stocks when this reality strikes. This report was credited for tanking the Internet sector when it was made public at 11:30 AM on Friday. Check out these charts and you can see exactly when it was released.

Other news that AOL may partner with Microworkz to offer a sub-$199 PC complete with AOL access could not hold up AOL stock which closed down -3.94. The product, called IToaster, would be an entry level device and offer AOL another way to tap the new surfer market. The new devices use a non-windows operating system which could have a serious impact on the DOJ/Microsoft trial currently underway. Since combining with Netscape and partnering with SunMicro, AOL is on track to become a fierce competitor to Microsoft and thereby weaken the DOJ case. To show what a lackluster day we had Friday, AOL only traded 17 mln shares on all the news and typical volume is in the 22-26 mln range.

The markets will likely drift aimlessly until after the FOMC meeting. The cash is building up on the sidelines and any rally after the meeting could be strong. There will surely be some bargain hunting this week as the more aggressive traders try to take positions ahead of the Fed decision, just in case.

You need to decide before attempting this tactic if you can afford to lose your investment. Yes, it can be very profitable if you pick the right direction but the market is fickle and does not always react in the expected direction. There can always be complications in the Fed speak surrounding the event. More often than not the market has gone down the day after a Fed meeting EVEN when the outcome was positive. Go figure! We do not expect that this Thursday but then a lot happens that nobody expects. We always advise investors to wait until all the factors line up in your favor before risking your capital. Blindly "betting" on market outcomes is like playing financial Russian roulette with only one empty chamber. Every factor you can get on your side takes one more bullet out of the gun. Meeting over, remove one bullet. Market moving up, remove one more. Positive sector and stock moving up, remove two more. Positive advance/declines and ticks, remove one more. Do we get all the factors on our side often? Nope! But every one you remove increases your possibility of profit.

After just coming back from Vegas I will aggravate you with one more gambling analogy and then I will stop. If you walk up to any game in Vegas and throw down a $100 bill on any bet, the house has better than a 50% chance of keeping your money. They don't build billion dollar hotels on profits from the room rates. Roulette tables for instance keep 35% of all the money bet. Black jack keeps 22%, Craps 15%. If you stand there long enough they will all keep 100% of your money. If you make "bets" on the market/stocks without taking advantage of every possibility and waiting until the time is right, the market will keep 35% of your money. Continue to make emotional decisions and play whenever the market is open and it will take 100% of your money. I guarantee it. It is the only sure bet.

Yes, this is a newsletter night. Yes, there are new plays in the newsletter. Yes, some will go up Monday and some will go down. No, you don't have to start a new position on Monday or Tuesday or Wednesday. You will not make any money if you don't but I can guarantee you will not lose any either. If I could only convince you of one thing it would be, "don't buy options the day after a newsletter." Only buy (sell) options when the timing is right. Otherwise go to Vegas, the result will be the same but you will have more fun losing it. We list new plays in every newsletter so traders can start watching those stocks for an entry point that fits there investing style. How long would you continue to subscribe if we just sent out a blank newsletter that said "wait until after the Fed meeting for picks"? We hope that readers use our newsletter as a starting point for further research and that readers recognize it as that. Just because we look at all the news and events on over 1000 stocks each week, just to bring you a dozen new plays, does not mean you should rush out and buy them at 9:30 Monday morning.

Lest you forget, the coast is not clear after the Fed meeting. The June non-farm payrolls are due out Friday. And you thought it was clear sailing into earnings after the Fed meeting....

Wait for an entry point, Sell too soon!

Jim Brown

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