Option Investor
Market Wrap

Who's afraid of the big, bad Fed? Obviously nobody!

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          WE 8-20          WE 8-13          WE 8-6          WE 7-30
DOW      11100.61 +126.96 10973.65 +259.62 10714.03 + 58.88 -255.81
Nasdaq    2648.33 + 10.52  2637.81 + 89.84  2547.97 - 90.52 - 53.91
S&P-100    696.59 +  7.77   688.82 + 14.69   674.13 -  9.16 - 15.59
S&P-500   1336.61 +  8.93  1327.68 + 27.39  1300.29 - 28.43 - 28.22
RUT        434.38 +  0.33   434.05 +  6.01   428.04 - 16.73 -  3.61
TRAN      3150.73 - 28.34  3179.07 - 40.96  3220.03 -113.21 - 48.25
VIX         24.06 +  1.68    22.38 -  4.98    27.36           25.83
Put/Call      .69              .72              .72             .72

Who's afraid of the big, bad Fed? Obviously nobody!

With the Fed meeting only two days away, the market looks like it is celebrating in advance. Contrary to all market logic the markets should not be going up. The week before a Fed meeting is reserved for worry warts and vacations. If you were on vacation this week you are probably going to be surprised when you see the Dow only -150 points from its all time high only two days before a rate increase.

Before you get too excited check out the advance/decline line in the first chart. Yes, the market is going up but the line is only going sideways. Granted the steep drop was halted but I am still not convinced. Also, on Friday, a good day in the markets, there were only 57 new highs compared to 72 new lows on the NYSE. Not earth shaking but the broader market is still not participating in the rally. Volume was also very light in front of the Fed meeting with the NYSE only posting 662 mln shares compared to the Nasdaq with 792 mln shares. The NYSE went from the 2nd lowest volume day of the year to about tenth in the last five minutes. The same was true of the Nasdaq, jumping from 3rd lowest to about tenth in the last five minutes. Many analysts felt the options expiration Friday was the reason for the last minute surge. Speculation that many traders were caught unprepared for the unexpected market rally and were caught short and had to cover at the close.

After almost two weeks of gains the Nasdaq finished the week flat, even with the +26 gain at the close. Stocks within the index were really mixed with some Internets up, some down, and some stocks up strong like QCOM +10. The four horsemen were split with DELL and MSFT down and INTC and CSCO up. There is no pattern and it appears that rotation is taking place within the tech sector. Investors should be cautious in trading during a rotation cycle. Stocks in favor one day are thrown out the next. Some traders are still taking advantage of the rally to lighten up on their positions in an orderly manner.

Two sectors hard hit were semiconductors and telecom. Sprint got hammered after analysts turned down on the outlook for the sector. They feel the profit potential is slipping with increased competition. After AMAT and MU had some cautious things to say this week the reports showing the decreasing book to bill ratios falling just added further worries to semi stocks.

The wildcard this week was the dollar/yen war with the dollar losing the battle. With the dollar dropping, rumors that Japanese investors are starting to pull dollars out of the market and treasuries, abound. Must be a slow news week! Seriously, if they did start repatriating money from the U.S. to Japan it would impact our markets dramatically. Japanese investors own more than 10% of our stock market and more than 33% of our treasury bonds. There was even a popular fiction novel several years ago where Japan declared war on the U.S. by dumping their investments and causing a run on our markets. We won in the end, but it was only fiction.

If Japan was dumping bonds it was well hidden as the yield on the long bond dropped to 5.98%. This is the number one reason why the stock market is gaining ground. The bond market is widely seen as the best forecaster of Fed policy and dropping yields seem to be saying that the Fed is not going to raise rates again. This is good news for stocks but we will hold our opinion until AFTER the Fed meeting on Tuesday.

All in all, I am impressed with the market strength last week. We are getting close enough to the expected Labor Day rally that anxious investors appear to be buying early. The market recovered over +225 points from the bottom of the drop on Thursday, 10875, on the strength of the bargain hunters.

Where to from here? We need to retest the 11,250 high to confirm an upward direction. If we fail on Monday from here, 11100, we could have a "lower high" scenario and drop back to our recent trading range. The reasons we could fail are a pullback from the options related close on Friday and Fed worry. If we can just hold our ground here until after the Fed meeting then things will be looking up. My market view is still up after Labor Day and into the first week of October. Between now and Labor day we will suffer from weaker and weaker volume as traders try to squeeze remaining vacations in before summer expires worthless. Weak volume means high volatility and possible wide market swings.

The gamblers among us will probably roll the dice before the Fed meeting but those of us that have been burned by unexpected Fed results in the past will be comfortable in waiting for a sure thing before risking capital. We could be setting up for a "buy the rumor, sell the news" event after the results are known. I am hoping for at least one more downdraft before Labor Day to open positions for the next earnings cycle coming in September. (Yes, Sept. Earnings are in October but the rally should be in September.) Remember, expectation causes the gains, not the announcement. To paraphrase Spock in a Star Trek movie, "expectation of an event is sometimes better than the event. It is not logical but it is true."

Live long and prosper by selling too soon.

Jim Brown

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