Get out your checkbook and prepare to back up the truck.
Can you say profit taking? 1999 Tax deferred selling? Fear of the Fed? Buying opportunity? Now which one of those do we care most about? Buying opportunity of course! I warned last week about buying the first dip and if you bought the -139 on Monday then you woke up to a nightmare on Wall Street this morning. The number one question on everybody's mind now of course is "are we there yet?" Have we hit bottom?
On the Dow we dropped all the way back to 11,000, the first level of support from our previous advance. 11,000 although a key psychological level is not a very strong support level. The first real support is just below 10850 with our strongest support level all the way back at 10600. I do not think we will see the 10600 level or anything close to it but that is the worst case. Part of the technical wreck today was the Dow's close under the previous low after a new record high. This is a clear reversal signal and could presage a new series of lower lows.
On the Nasdaq, only one day after the index set an all time high of almost 4200, the index suffered the worst point loss ever of -229. While the number was staggering, it was actually only the eighth worst percentage loss ever. As I stated last week, 3900 was the support level we were looking for when the profit taking started. I just did not expect it to happen in just one day. The carnage was severe in all the fast movers. QCOM -17, YHOO -32, JDSU -17 even after announcing another 2:1 split yesterday. The big five leaders on the Nasdaq all lost big bucks with DELL -4, INTC -4, MSFT -4, CSCO -6, ORCL -10. The next technical support level is the 21 DMA around 3800 and we could see that on Wednesday. In terms of percentages we have lost -6.5% from the intraday high on Monday. Using the time tested first bounce point of -10% we could touch 3760 before the buying begins again. In reality, I think there is too much liquidity for the market to reach those levels. The post Y2K cash inflows and year end retirement contributions will eventually float the market again. The tax deferred selling, which drove us down this week, has a positive side as well. These same investors, flush with new cash, will put the majority of it back to work again quickly.
The drop today may seem severe but in reality it was simply a compressed version of the profit taking that everyone has been expecting for at least a month. Without this blow off we had no chance of moving much higher. Remember last week I related that in the first few trading days of 1999 the Dow lost -600 points and the Nasdaq -200? Don't look now but we just equaled the Jan 1999 profit taking performance in only two days.
The market internals today were extremely bad. The decliners beat advancers across all three exchanges by 5798 to 2427 or better than 2:1 negative. This is actually improved from the intraday totals when the ratio was 3:1 for some time. The S&P Futures were lock limit down at -35 several times today. Traders worry when the markets drop significantly on strong volume and today was very heavy with the NYSE trading over 1 bln shares and the Nasdaq over 1.5 bln. Not a good sign normally but it can also signal a capitalization event as well.
The profit taking was aggravated by fears of the Fed and the specter of rising interest rates. There is a 125% chance of a +.25% interest rate increase on Feb-2nd and a 40% chance of a +.50% rate increase as measured by the Fed funds futures. Tech stocks are most impacted by rising interest rates since their high PE ratios are so fragile to outside costs such as interest. While techs are the first to suffer, they are also first to recover when investors come back into the market. Investors got some good news today when Clinton announced he was nominating Greenspan for another term as Fed Chairman. We may make fun of him and criticize his actions but he is probably the most important person in keeping this bull market economy on track. Without his regular vaccinations and booster shots we would have derailed long ago. Mr G. declined to comment on the stock market drop when asked by a reporter at the news conference. He said, "you don't really want me to answer that do you?" You are right Alan, we don't.
The good news, yes there was some, came in the form of a bottom in some of the bank stocks and a drop in interest rates as evidenced by the bond yields. After trading as high as 6.59% intraday on Monday the yields closed today at 6.53%. Thirdly, the VIX is approaching historic levels that indicate a market bottom. Only six times in the last year has the VIX traded over 32 and each time it has been a market bottom. In Feb, May, Aug, Sep and Oct the markets bounced when 32 was hit. Ironically in the second week of January last year the VIX spiked as high as 36.75 before the market reversed its fall. This was the high for the year! The VIX closed today at 30 and another drop at the open tomorrow could push it over the 32 level. Hopefully we will not need to see 36 again this year but with the Nasdaq up +85% over the last 12 months we could see another leg down before we get back on track again.
I think the most important thing about today's drop is how you handled it as traders. If you did not have stops set and just sat there all day long thinking "it will bounce here" at every -$2 increment, then you are a very unhappy camper. I know several people who own deep in the money Yahoo calls and they watched them decline -$30 today thinking, "they will come back". I don't care how good a chance any stock has of "coming back" it may not come back before you run out of time. Why would you let any stock or option decline -$30 while you watched it? In reality they let the stock drop -$57 from the high of the day to the close of $443. $57 REAL AMERICAN DOLLARS !! $5700 per contract.
As you sit home tonight and read this, you belong on one of two sides of this issue. You are either thinking, "darn, if I had sold at $XX I could have bought back at the close for $YY. That would be the equivalent of a $ZZ profit. WoW!! I am not going to do this again! AhHa - a convert! If you are on the other side of the fence you are trying to justify why you think your stock will come back. Earnings are next week, they may announce a split, maybe they will announce record results, etc... Maybe they will but what is the market going to do between now and then? What if the market drops another -10%? Do you think your option will recover in the face of a serious market sell off? I doubt it! Now, even if you are married to this position, and if you still own it tonight you are, you would still have been better off being stopped out with a large profit this morning and be ready with cash to buy them back WHEN the market recovers. This kind of thinking is suicide. Markets/stocks don't always come back. Trust me, been there, done that and it is a painful experience. I have watched $100,000 positions expire worthless because IT DOES NOT ALWAYS COME BACK! Decide now where you will draw the line tomorrow. Tomorrow is too late.
Wednesday should be exciting. The odds are we will see another drop at the open or shortly after the open. If we get a drop then we want to look for a capitulation event. A quick, sharp drop that takes out all the remaining stops and establishes another base for a rebound. 3800-3850 would be the best range on the Nasdaq and 10850-10900 on the Dow. Wait for the rebound. Tomorrow we could also see a bear trap rally as well. That is a quick bounce after a short sell off as the overly eager buyers jump onto the train just before it crashes again. If you do buy this bounce and it turns out being a false rally then you must be very reactive to bail out again quick.
At this point cash is king, there is no time decay on cash and all the options (pun) are in your favor. I can't tell you how many times I have watched prime opportunities pass me by while I was nursing a losing position because I did not have any funds available in my account to invest. Those of you in cash now are in the drivers seat. When the bottom comes there should be a strong rally into earnings which start next week. Profit from it! The next pothole is the Jobs report on Friday and there is nothing in the Fed rules that prohibits a rate increase before the Fed meeting on Feb-1st. Be careful!
Good Luck, Sell Too Soon.
Starting tomorrow we will have an entirely new section which will run every Wednesday. Due to many reader requests we will be producing a large cap covered call and naked put section. Stocks with big premiums and fast movement. Check out the newsletter on Wednesday and look at the new plays available.