Option Investor
Market Wrap

When in doubt, sit out!

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        7-29-99          High     Low     Volume   Advances Decline
DOW    10791.29 -180.78 10971.36 10714.03  766,699k    805   2,227
Nasdaq  2640.01 - 65.83  2672.51  2627.80  913,879k  1,349   2,591
S&P-100  690.40 - 12.64   703.04   685.76   Totals   2,154   4,818
S&P-500 1341.03 - 24.37  1365.40  1332.82            30.9%   69.1%
$RUT     441.58 -  5.03   446.61   439.80
$TRAN   3348.95 - 69.44  3417.32  3342.21
VIX       25.08 +  1.88    26.98    24.62
Put/Call Ratio      .74

When in doubt, sit out!

Just when you think the doom and gloom at OIN is simply bull the market does another swan dive on economic news. The Employment Cost Index rose +1.1% for the biggest jump in eight years. The signs of inflation were flashing red today as the bond market tanked on the strong inflation news. Bond yields closed off the highs but still a hefty 6.08%. The Dow went into panic mode at the open and promptly dropped -130 points within several minutes. The worst was not over and after resting at 10800 for awhile it fell to the afternoon low of 10714. Bargain hunters in denial of the market pull back jumped in to buy the dip again. The Dow closed +76 points off its lows but the ticks were still not showing any signs of life. The advance/decline line was severely negative with decliners beating advancers 7:3. The Nasdaq was looking worse, down -65, but dropping again at the close.

These charts do not paint a pretty picture. Just Monday of last week we were setting new highs but how quickly the economic picture can change. Just a week after Greenspan warned the Fed would act "promptly and forcefully" and a day after he repeated his warning, the signs of strong inflation appeared as if to say "oh yeah? I dare you!" The challenge has been made and the bond market analysts say it is now better than an 80% chance that the Fed will raise rates again in August. While the actual raising of rates another +.25% is hardly a big deal, the worry that the hike could be higher or more than one, put the old fear of uncertainty back into the markets.

The GDP numbers released today were non-inflammatory at +2.3% but the ECI blowout completely overshadowed the news. With the ECI showing the biggest increase in eight years there was no doubt at all that the results of the tight labor market had finally made itself felt. Wage prices make up 66% of the cost of most goods. If wages continue to climb, inflation cannot be ignored. The few reasons for continuing to buy stocks just got smaller. Bulls who had been using the weakness from the last week as buying opportunities may be rethinking their positions. Bonds are starting to look very attractive at 6.1%, the high of the day, especially with Y2K uncertainty growing. Did you hear Y2K mentioned today? I did several times by analysts claiming part of the sell off to be Y2K related as well. Whatever your feeling about Y2K it is only 108 trading days away.

Funds are bleeding cash as cautious investors are moving money out of stock funds and while there is not a lot of selling by funds there is a lack of buying. If you remember my "Why Buy" article last week there is just no compelling reason to buy stocks right now. Earnings expectations are over. 83% of the S&P-500 have reported and the remaining 17% are spread out over the next several weeks. Of the companies reported, 66% beat estimates, 22% were on target and only 12% reported less than estimates. A very good season, but it is over. No reason there. Interest rates are more than likely to go up which impacts future earnings. No reason here. Third quarter earnings are not normally great so expectations are not high. August is not normally a banner month so no reason to jump in now. There is just no reason to expect the market to move up from here.

I know this is heresy but as traders we need to face facts even if we don't like the facts. The best scenario I can picture for the next two weeks would be a range bound market. Definitely not a positive for traders. The most likely scenario is a continued downtrending market. Bulls are pointing to the last ECI report of .4% as abnormally low and today's ECI of 1.1% as abnormally high. Averaged together at .75% you get a normal reading. I can see their point but remember Greenspan is looking for any reason to justify the next rate increase. They try to anticipate future inflation and be pre-emptive NOT chase after inflation with a leaky hose.

Another bullish sign today was the lack of volume. At 766 mln on the NYSE there was no panic driven rush to the exits. Either the bulls are still in denial or most investors think the reaction was overblown. Another bullish sign was the spike in the put/call ratio to .74. Normal is .50 and market bottoms are formed when large numbers of traders buy puts to protect positions. This is sometimes a last ditch effort which slows market declines and is viewed positively. These bullish signs may contribute to the next bounce but in the end I think the direction is down. The technical bounce after the last –400 points on Tuesday, came true only to become another rally for investors to sell into. I expect the next bounce to be the same.

The next major economic report is the July jobs report next Friday. If we can make it to then without a surprise rate increase then our fate will hinge on the unemployment rate. With employment in some states as low as 2.4% and employers offering large cash signing bonuses it is not likely that the U.S. rate went up. This will be another wall of worry that the market and Fed will have to climb.

In stock news today the 800lb software gorilla. MSFT, may end up being several smaller ones. A Justice Dept spokeswoman said the agency had "made preliminary inquires to experts that might assist us in evaluating an array of remedy options" if the U.S. wins the antitrust case. Bankers at two investment banks, which declined to take on the project, said the government wanted to know how a breakup would be done and how the market would react. While I don't think this will happen I can believe this was a trial balloon to create anxiety on the part of MSFT and make them more reasonable at the negotiating table. Time will tell.

If you are not in the market today, and I hope you are not stuck trying to "hope" up some positions tonight, I would suggest that cash is king and sleeping is much easier on pillow of cash in your account. Waking up to markets gapping down is not good for your health. Our motto is "when in doubt sit out" and this would be our directive for tomorrow.

Good Luck, Sell too soon.

Jim Brown

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