Option Investor
Market Wrap

Why buy?

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         WE 7-23          WE 7-16          WE 7-9           WE 7-2
DOW     10910.96 -298.88 11209.84 + 16.14 11193.70 + 54.46  +586.68 
Nasdaq   2692.40 -172.08  2864.48 + 71.41  2793.07 + 52.05  +188.37 
S&P-100   698.88 - 34.91   733.79 + 10.91   722.88 +  6.66  + 44.99 
S&P-500  1356.94 - 61.48  1418.78 + 15.50  1403.28 + 12.06  + 75.91 
RUT       448.38 - 16.88   465.26 +  7.28   457.98 +  1.47  + 13.40 
TRAN     3381.49 - 20.38  3401.87 - 25.45  3427.32 - 88.67  +199.88 
VIX        23.76            18.13            19.09            18.85
Put/Call     .58              .46              .46              .47

Why buy?

The market finished up the week leaning over the cliff. The worry I spoke about last weekend came to pass and things are not looking up for the near future. It is hard to visualize by looking at these charts but the Dow, Nasdaq, OEX and SPX were all setting new highs just last Monday. What a difference a week makes. Note also the advance/decline line which has accelerated downward and is looking very grim.

The tech stocks took it the hardest but you know the rules. Tech is always first up and first down. They are most impacted by higher interest rates because of their high PE values. The Dow finished the week down about -2.8% but the Nasdaq suffered the worst, down -6.1%. I wish I could say the troubles are over but I think they are just beginning.

The market spike upward on Monday was textbook and many readers have emailed us with thank you letters and profit examples. You subscribe to this newsletter not just for the wit and humor and not just for the prescreened stocks. You should be more focused on the actual market commentary and forecasts. These alone should stand above the picks. The picks are the ammunition you use when the time is right. The market commentary is to tell you when to pull the trigger. Granted, nobody can forecast the future 100% but more often than not we are very close. We received many emails this week claiming we were the first newsletter to call the peak and drop last week, in advance. If you were acting on the recommendations in the commentary the last two weeks you profited well. The point. I am not writing this just to pat ourselves on the back but to get your attention about the next several weeks. The market has a very good chance of a significant decline ahead and I will explain that shortly. However, we are still recommending calls. Why? Because 90% of our readers are call only players. Would I go out and blindly buy calls next week? Not hardly. However, there will be stocks that go up and they may be good call plays. If our market outlook was totally negative and we did not list any call plays this week, we would lose half our subscribers. Really! We have found that most readers are in denial of market trends and want to play calls even in the worst conditions. Can you make money doing this? Sure but only if you do it correctly. Nothing goes down in a straight line. Everything cycles. Two, Three, Four days down and one, two days up. (reverse the cycle for an advancing stock) If you must play calls then focus on buying the dips and focus even harder on getting out early. Enough preaching but you really need to focus on the next segment.

Why Buy?

What causes stocks (markets) to go up? News. News about earnings to be exact. Positive earnings growth causes stock in IBM for instance to have more value. As the company creates more assets the value of the stock goes up. What causes markets to go down? News. Lack of earnings news, economic news, interest rate news, global news. During an earnings cycle the "positive expectation" causes investors to ignore the negative news and buy stock hoping for news of more value. (positive earnings growth) The second quarters earnings, which are now almost over, is normally a strong quarter and investors reap profits from buying stocks over the previous 90-120 days. The third quarter, which reports in October, is not normally an outstanding quarter. The economy is largely seasonal and results from summer months are normally mediocre at best. If you are a professional money manager and you get paid for results then you are aware of these trends. Tech stocks for instance were up about +28% last week since the January lows. We all know that profit is not profit until you sell the stock. Astute money managers who can read historical charts know that they can buy these same stocks back later in the year for less money and start the cycle all over again. So here is the question. Why buy now? Earnings expectations are over. The Fed is on inflation alert and almost surely will raise rates again in August. The Y2K exodus is slowly starting to be seen. The economic news has been so strong recently that traders are beginning to think it can't get any better and the Fed is ready to raise rates to keep it that way. There is just no reason to buy stocks NOW.

Psychologists claim we are destined to relive the past if we do not learn from it. Fortunately as traders we have a wealth of historical information available at our finger tips. Take these two charts. The top one is from Nov 1997 to July 20th 1998. The bottom chart is from Nov 1998 to July 23rd. Do you see any patterns?

1. You have the December bump, the Jan bump, and the long Feb-May seasonal market run.
2. You have the pull back in June as traders take profits from then long rise BEFORE the actual July earnings.
3. In July you have a market top culminating around the second week of earnings. The expectation is over and profit taking begins.
4. The last week on each chart is the week Greenspan gave his House Banking Committee testimony each year. Coincidence?

I don't have a chart YET to show you for the next 60 days so lets just guess for a second what it might look like by analyzing last years chart. After July earnings expectations were over, the reduced October expectations became the focus. The world economic issues moved to the forefront and every "crisis" became exaggerated and only hastened the downward spiral. This year we have China and Taiwan. We have increased worry over a China devaluation. We have the Argentina elections. And most of all we have Y2K only 150+ days away. We already know the market does not like uncertainty and Y2K could be the most uncertain unknown in recent memory. Our near term future could be very cloudy.

Last year we dropped almost -2000 points between July highs and October lows. This week represented only -300. Care to guess where the bottom might be? That guess and $3 will buy you a cup of coffee at your nearest Starbucks. I will bet however that the number of readers tonight that guessed the market to go higher from here would fit into a Starbucks. Scary! Multiply that percent of pessimism by the estimated 44 million brokerage account holders with stock investments today.

Numerous, previously bullish, analysts have started coming out of the woodwork this week with dire predictions. Ed Kerschner of Paine-Webber, who has been a leading bull, said Friday that stocks were currently over valued at 108% of actual. He advised cutting stock holdings to only 50% of your total portfolio. Another analyst called tech stocks 19% over valued. About this time last year Ralph Acompora did his famous one day about face and changed from Dow 10,000 to Dow 7,500. I would bet he is not sleeping well this week with his Dow 12,500 prediction looking farther away every passing day.

Now that I have painted this bleak picture I have to put in the caveat of "past performance does not indicate future results". Just because the market has done this in the past does not mean sell the farm and buy puts. If it was that easy then every July 20th the market would drop -2000 points and flat line until October. Everyone would wait for July 20th each year and become millionaires over night. There is always a battle between the optimists and pessimists for control of the market direction. There are still a herd of analysts calling for new highs in the next week or two. I would like to think this herd is not headed for slaughter but the facts appear to be different. I would like to think that the place for us to be is on neither side. We should be firmly planted on the sidelines with the realists. We do not care whether the market goes up or down. We only care that we recognize the trend and capture the profits. By showing you the possibilities I am hoping to prevent you from buying the dip blindly and then getting slammed the next day by another dip.

There is a time and a place for everything. On any given week you could make money in either calls OR puts in any stock. Granted one direction will be favored each week but you could make money either way. The trick is in determining your entry point. Remember the cycles. Up some, down some. In a neutral market the number of down days for a stock trending up is about half the number of the recent up days. If the stock went up four days in a row then you could expect it to go down two days. The same thing works in reverse for a down trending stock or market. Four days down, two days up. Now before you start firing off those emails I want to stress that this is just a rule of thumb. The market makes its own rules. Another trend is the "harder they fall the higher they bounce" rule. Obviously if the market drops -500 points in one week the odds of a +200 point technical bounce are very good. This may seem very boring to you but it is reality and failure to observe the laws of reality will make you broke. You can't hope a stock or the market up or down. As we all know nothing "has" to go up or down and holding on to losing plays will only make you a loser eventually.

I will quit on this point. Nobody can tell you what to play or how to play or when to play. We can only give you suggestions and try to help you understand what MAY happen in the future. It is your decision how to invest.

Need I remind you that Greenspan gets to take another shot at the markets this week with his testimony to congress. Another Fed head spoke out Friday and hinted that a rate hike was coming. Richmond Fed President, J. Alfred Broaddus, said "the Fed sees few signs of the economy slowing" and echoing Greenspans "promptly and forcefully" speech on Thursday. The Fed will have more economic reports than they can read this week with ECI, New & Existing Home Sales, APICS Survey, Real GDP, Help Wanted Index, Personal Income and Spending and Chicago PMI. Looks like a minefield and the markets are sure to react to ANY negative info, no matter how slight.

We could possibly have a technical bump Monday morning from the -300 drop last week and if it happens I plan to buy puts again.

Good Luck, Sell too soon.

Jim Brown
Editor

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