Option Investor
Market Wrap

Eyewitnesses to History

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         WE 4-14            WE 4-7          WE 3-31          WE 3-24
 DOW    10305.77 - 805.71 11111.48 +189.56 10921.92 -190.80  +517.49
 Nasdaq  3321.29 -1125.16  4446.45 -126.44  4572.89 -390.04  +164.90
 S&P-100  731.94 -  89.58   821.52 +  6.46   815.06 - 17.59  + 45.91
 S&P-500 1357.31 - 159.04  1516.35 + 17.77  1498.58 - 28.88  + 62.99
 RUT      453.72 -  89.27   542.99 +  3.90   539.09 - 34.93  -  0.76
 TRAN    2727.04 - 100.68  2827.72 + 64.48  2763.24 + 75.09  + 64.32
 VIX       39.33 +  12.39    26.94 -   .27    27.21 +  1.40  +  2.14
 Put/Call    .94               .37              .48              .42

Eyewitnesses to History

It was bad, real bad! The worst I heard was Bill Gates from MSFT. He lost $11.1 bln in net worth due to the drop in MSFT stock. Don't start feeling sorry for him, he still has gas money.

As investors today we had a birds eye view of history in the making. The Dow was down over -720 points late in the afternoon and only rebounded slightly to close at -617 for the worst single day point loss ever. The next three biggest losses were -554 12/27/97, -512 8/31/98, -508 10/19/87. Yes, Friday was even bigger than the 1987 drop in terms of points. Only -5.6% today compared to -19.10% then. All 30 of the Dow stocks were down for the day.

The Nasdaq was not any better and Friday capped off a week of days traders would rather forget. Friday's closing drop of -355 was only slightly less than the -400 point deficit late in the afternoon. That loss ended a string that started on Monday with -258, -132, -286, -93 bringing the total for the week to -1125 or -25%. This brought the total drop from the recent high to -35%. Friday was the second largest volume day with 2.5 bln shares traded and the second largest percentage drop ever. The next three biggest point drops were -349 4/3/00, -286 4/12/00, -258, 4/10/00, two of which were also this week. Yep, three of the top four point drop days were this week. Volatility anyone?

The carnage is incredible but if your 401k was turned into a 201K this week then you are already feeling the pain. The wealth effect Greenspan is always referring to became the debt effect this week. The $1.4 trillion that investors made all last year was shredded as more than $2.1 trillion was lost in the market this week alone. Margin investors are feeling more than pain as margin call after margin call has wiped out many over leveraged accounts. If you think this week was bad for margin calls the don't get out of bed on Monday. The huge losses Friday will produce record margin calls again for investors still hanging on by their fingernails rather than take the loss. Market cap was bleeding at record rates. Microsoft lost -$239 bln this week, CSCO -$167 bln, INTC -$100 bln. This was not simply a big cap problem. For example Akamai has lost -$25 bln from its high and now has a market cap of only $500 mln. Down from a high of $345 AKAM is now only $64. Microstrategy had a high of $335 and is now selling for $33.

The brokerage community came under pressure this week and Friday turned into a real rout. Many brokers make a substantial portion of their profits off margin interest. Ameritrade for instance counts on margin interest for 25% of their total revenue. As investors accounts are liquidated to cover falling stock prices the brokers are exposed to margin shortfalls and then the loss of the margin income. Thirdly, they lose the trading commissions as accounts are closed or go quiet in the reaction to the losses. The major brokers all took big hits on Friday. LEH -17, SCH -12, MWD -8, MER -8.

The surface trigger for today's sell off was blamed on the CPI but in reality the CPI just added speed to the downward slide. The base rate was much higher than expected at +0.7%, the highest in a year. The core rate was also much higher at +0.4% which was the highest in the last five years. This was twice the expected rate and puts the projected annual inflation increase at +3.2% which is much higher than the +1.9% rate from last year. The inflation monster suddenly became visible and bidders quickly evaporated as fears of a stronger than expected rate hike flared. There was significant worry that the Fed could raise immediately and not wait for the next meeting in May. In reality the Fed could have pulled the trigger today except for the market crash already in progress. Not wanting to be accused of pouring gas on the fire there was no announcement. Greenspan spoke at a noon luncheon and again was quiet on the markets and on economic matters that would have fueled the fire. Financial stocks took the change in Fed sentiment hard and many were double digit losers. AXP -12, JPM -7, GS -12. Another reason for the drop was comments attributed to a Fed governor on Thursday which were very bearish and set the tone for the CPI backlash.

Declines continued to beat advancers substantially and this string on the Nasdaq stretched to ten days. Stocks previously immune to major selling events are now just another symbol on the ticker. Stocks like AOL, EBAY, YHOO, AMZN, PCLN have all lost more than 50% of their value. Entire sectors are on the endangered species list with major drops from their recent highs. For instance the Semiconductor sector (SOX) lost -33%, the Internet sector (IIX) -37% and the Biotech sector (BTK) -48% just to name a few. With the Dow, Nasdaq and S&P all managing their biggest point losses ever there were very few stocks untouched. To add insult to injury Microsoft not only is on trial, lost $239 bln in market cap but finished at a 52 week low of $74 as well. The Nasdaq managed to drop not only -1125 points last week but also brought the PE ratios of the Nasdaq stocks down from their stratospheric heights. On March 10th the Nasdaq PE was a soaring 264. To put this in perspective the ten year average PE of the Dow stocks amounts to only 54 and the current Dow PE is even less than that. If you are waiting for the Nasdaq PE to reach Dow levels then you are in the wrong lifetime. This would require the Nasdaq to drop to something like 1030 and I hope we don't see it any time soon. Even after the historic drop this week the Nasdaq PE is still a lofty but more realistic 174. Compared to the S&P PE of 28 even the Dow seems lofty. You can easily see why many old time analysts still feel the Nasdaq is grossly overvalued.

Not only are the big cap stocks taking a hit in their stock prices but they are also taking a hit in their profits. Many large companies have huge stock holding of other listed companies. Intel for instance has over $8 bln in stock holdings and reported $327 mln in profits from these holdings in January. They expect to report $500 mln in this qtr. Compaq held $8.3 bln in publicly traded stocks in January and Microsoft had a portfolio of almost $20 bln. Now if their portfolios took the same hit that yours did then how do you think that will impact their earnings for the current quarter when reported in July? Most of these companies use these surplus profits to pad their balance sheets when times are rough and they need another penny or two per share to keep from missing estimates. If the correction continued there would be some negative surprises next quarter. Many of these large companies may warn in their earnings conference calls next week that the market may impact their next quarter profits. Do you see the circle forming here?

Another assault on the web is taking its toll on the web retailers. A report from Forrester Research suggests that as many as 25,000 etailers of the more than 30,000 currently on the web will be bankrupt by year end. The stiff competition by hundreds of clones in the same product category and the click and motar stores as well is named as the cause. Sites like Etoys are being targeted by Toys-R-Us and general retailers like Walmart and JC Pennys. The promise of instant riches by selling to the masses on the Internet has put many mom and pop sites with several thousand dollars of capital up against sites with tens of millions of venture capital. When it gets right down to it how many ways can you sell books and music anyway? Sites like Etoys, CDNow, Peapod, Webvan have seen their stocks drop faster than they could say MasterCard or Visa? and some are now in the low single digits. This is not new news to investors but just another factor in the decline of the Internet sector as a whole over the last several weeks.

With both the major indexes dropping more than -1000 points this week you would think the carnage would be over. There were reports of huge numbers of OEX calls being purchased just before the close on Friday with one transaction for 1600 contracts. The QQQ calls were also in high demand. While almost everyone expects a rebound soon there is still more selling to come. Greenspan said in his speech today that the "extended leverage in the markets is all too evident" and warned of the associated problems. The leverage he spoke of includes the excessive use of margin. In March the total margin debt was over $278 billion and was up +78% from the year before. After Friday margin users will have to pay the piper his due. According to several brokers margin calls were up over twice the normal rate and many investors will get that unwelcome notice in their email this weekend. Sell stock or be liquidated. While the -1000 point drop this week may have been due to seasonal trends and tax selling there are repercussions that will carry over to next week. We are likely to see a bounce at the open on Monday followed by another bout of margin selling. The selling could drag over the next three days as investors decide to wire money or take the loss.

The selling this week was not the panic selling you see in times of economic crisis. All the portfolio managers knew that the April depression was coming and they simply stood aside as the tax selling began. With no buyers the simple act of selling only a few shares coupled with others trying to turn stocks into tax cash pushes prices downward. Market makers faced with no buyers continually adjust the prices lower and lower. Sellers faced with bleeding stock prices are caught chasing the bid with each modified order. Not that there was a rush to sell this week, there just was not any buyers. The midnight oil will be burned this weekend as each portfolio manager tries to decide what to buy when faced with the large number of incredible choices. Still they are likely to wait until the margin selling stops and an upward trend is established again.

I want to congratulate Molly Evans, a new staff writer that started this week. In her article on Thursday she extrapolated a closing price for Friday of 3320.78 through simple technical analysis of the Nasdaq chart. The actual closing price on Friday was 3321.29. She missed it by only .49 and that was from 355 points and a day away. Good detective work Molly! Now can you tell us the close in advance for next Thursday? We would all love to know!

This was not a week I want to repeat but it seared into my brain once again that trying to pick the bottom is an expensive proposition. After deciding Thursday to sit out on Friday I did not even set the alarm clock. (The market opens at 7:30 here.) Of course once I did wake up and turn on CNBC I ran straight to the PC and remained glued to the screen the rest of the day. Did I break my vow to sit out and open new positions? You have to read Jim's Plays for the answer.

Next week should be real exciting. We have a four day week due to the market closure on Friday and it is also an options expiration week. Add to those factors the -1000 drop and the expected margin selling on Monday and the word volatility should come immediately to mind. Hopefully we can get past the selling on Monday and get a big enough spike to send the shorts running for cover. If volume picks up then maybe this train wreck will stop.

The two major indicators I follow are both screaming buy. The VIX at 39.33 is the highest it has been since Oct-1998 and we all know what a buying opportunity we had then. The other indicator is the TRIN or the Short Term Trading Index also known as the Arms Index. This is calculated by dividing the advance/decline volume into the advance/decline ratio. It is also called the fear or panic index. The TRIN normally hovers around the 1.00 level and anything over 2.00 represents a strong buying opportunity. Currently the TRIN is at 4.48. The only time it has been this high in the last two years was in Oct-1999 and Oct-1998. Dates that will live in our collective memory forever. I know people who live by the TRIN and people who live by the VIX. When they both line up you should buy a lottery ticket. As you can see by the two charts below we should currently be at the mother of all buying opportunities. These indicator levels and $3.00 will get you a cup of coffee at Starbucks but will not guarantee that there is not another day or two of selling in our future. Still, don't let anybody tell you there is not enough fear in the markets to create a bottom. (These are available on Qcharts or Interquote as $TRIN and $VIX)

Trade smart, wait for the bounce, don't buy too soon.

Jim Brown

My current long positions: see Jim's Plays

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