Bull breakout or bear trap?
Bungee trading anyone? After trending downward for two weeks the markets finally blew off this morning. This was a classic capitulation event. The drop after the open this morning was the event we have been waiting to see. A classic sharp sell off on strong volume with a bounce off the bottom on strong volume. Sometimes called a "tweezer bottom" the formation normally signals a turning point in the markets.
While the rebound was classic and has everybody excited there were still two major problems. The advance/decline ratios were still terrible. They did improve from a 3:1 decliners to advancers this morning to a 3:2 this afternoon but the technicians were not convinced. The up volume overwhelmed the down volume in late afternoon as traders rushed to take advantage of the bounce. The weak advance/decline breadth showed that the rally was not broad based and only the leaders were benefiting from the cash. The bad breadth was also seen in the number of new highs and new lows. The new lows swamped the highs 224 to 38. This indicator has been getting worse on a daily basis.
One reason for the continued bad breadth is still the non-farm payrolls from July due out in the morning. A really weak number could help the overall market but a really strong number could kill it instantly. Institutional traders were covering their bets with small purchases "just in case" but the heavy money is still sitting on the sidelines. Remember, there is still no reason to buy right now. The rally could simply be a technical bounce but it looks stronger than that. Stocks will have to weather the jobs report tomorrow before any predictions can be made.
The market was helped by the bond market today, as rumors of problems overseas sent cash into the U.S. market instead. The yield dropped to 6.05% and that helped slow the cash inflows from the stock market. 6.05% compared to 6.16% may not sound like much but it is the change of direction that is important. The productivity report this morning came in weaker than expected and could be seen as inflationary. If the productivity gains we have been seeing are starting to taper off then wage inflation may not be farther behind in the Fed's eyes.
Another factor that impacted the market today was the lower than expected retail sales reports. While most companies posted nominal gains they were not the robust numbers of the past. The Gap for instance posted a +10% gain but it was only one third of what analysts expected. This slowdown in retail sales was a good sign that rampant consumer spending was easing and that was a concern for the Fed.
According to analysts the market has already factored in a minimum of a +.25% rate hike for August and a 50% chance for a rate hike at the next meeting as well. With the interest rate burden already priced in, the market has one less reason to hold back.
The climax to the recent "correction", the Nasdaq passed the -10% level making it an official correction, came early this morning as the Internet stocks were hit hard, very hard. The capitulation, traders throwing in the towel on losing trades, was dramatic. This happens only once or twice per year and is a very profitable trading opportunity. One broker that works for us said they could always tell when the crash was over. The retail investors would ALL call in the morning and say sell everything, taking big losses in the process. In the afternoon other investors would call in from their yacht or their vacation homes and say "I will take some of this, and some of that, and what else has been hit hard, give me some of that too. Their accounts would typically be all cash. My question here is "which one do you want to be next time"?
The shopping was fast and furious. AOL traded as low as $76, down from a recent high of $175. It closed at $84, up +$8 from its lows. It would probably have traded back over $90 except for the rumor that Microsoft was going to enter the ISP business in a big way with free Internet service. Just a rumor folks... What Microsoft did say was "AOL has not set the standard for Internet access and Microsoft is researching their options". A far cry from "free access". In reality AOL is not just an ISP and a bad email service. (sorry but I could not resist) The AOL CEO said on a CNBC interview after the close today that based just on price they are not worried. They raised their price last year to $21.95 and still added more subscribers than any other period in their history. They also bought CompuServe and see that as their "discount" service. CompuServe has also added more subscribers at their $9.95 rate than any other period in their history. So AOL has both entry points as well as a strongly loyal following. With 18 mln users they are not going anywhere. Their ICQ product has over 40 mln users. The 800 LB software gorilla is going to have a fight if it goes head to head with the 800 LB ISP gorilla.
By the way, is AOL a buy just because it is cheap at $76, down from $175? Or is it over priced at $84, up from its 52 week low of $17? The Internet pricing argument is in full swing and the action today and the last several weeks is stark evidence of the way the market resolves these questions. It is worth what a willing investor will pay today. Earlier this morning there was a rush for the exits in AOL by a large holder. Forty four trades of 100,000 shares or more were handled in a 45 min period. Bargain hunters snatched up the fire sale merchandise and those sellers are $35 mln poorer than they would have been had they held the stock.
Other big swings today were EBAY with a low of $70 and a close +$23 higher for a gain of +$17.13 for the day. AMZN traded as low as $82 and closed up +8.81 at $97.25. A range of $15.
INKT traded as low as 87.38 before closing up +11.19 at $103.38. DCLK traded as low as 60.50 before closing up +12.69 at $80.38. YHOO had a low of $110, a far cry from my $170 calls I wrote this month, and closed at $128.38. EXDS had a low of 98.63 before closing at $119.38 for an $11.75 gain.
This is the stuff that you wait for all year. Market washouts and great entry points. Of course all will be for nothing if the jobs report blows up in our face tomorrow. I must caution you not to bet the farm either way. There is still two weeks until the Fed meeting and many words will be spoken about the possibilities between now and then. What we will probably see is a small follow through rally and then some more range trading for the next several weeks. I should not have to remind you that there will be some profit taking in the Internet stocks from the big swings of today. Some will hold for a longer term but others will be scared of the dark on Friday afternoon and close their positions for some big gains. The most important thing about today was the trend reversal. We have been seeing traders sell into morning rallies and the markets selling off in the afternoon. Today was reversed. Down strongly early but a continued rise right into the close and a finish right at the highs of the day. The range for the Dow today was 232 points and 91 points for the Nasdaq.
Be on the lookout for the "bear trap". This is a technical bounce after a big decline but with no follow through. With the breadth still very negative this is a real concern. Michael Murphy, the tech investing guru, said this was just another chance to sell Internet stocks into strength. Thanks Mike!
When in doubt you can still sit out. You cannot lose money from the sidelines. If we get favorable jobs numbers tomorrow I would still want to see how the market reacts and if it carries over past amateur hour on Monday before starting any new positions. If you just can't wait then only buy half as much tomorrow and buy the rest on Monday around noon. This way you can only lose half as much if the rally attracts sellers instead of buyers.
We did not drop all the Internet put plays that have been doing so well the last week but we are not advising starting new ones at this time. If the rally holds tomorrow we will drop them on Sunday and overweight calls again. One day does not make a trend.
Please, pick your entry points carefully.
Good Luck, Sell too soon.