Option Investor
Market Wrap

What a difference a week makes!

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        WE 4-20           WE 4-14            WE 4-7         WE 3-31
 DOW    10844.05 +538.28 10305.77 - 805.71 11111.48 +189.56 -190.80
 Nasdaq  3643.88 +322.59  3321.29 -1125.16  4446.45 -126.44 -390.04
 S&P-100  777.12 + 45.18   731.94 -  89.58   821.52 +  6.46 - 17.59
 S&P-500 1434.54 + 77.23  1357.31 - 159.04  1516.35 + 17.77 - 28.88
 RUT      481.84 + 28.12   453.72 -  89.27   542.99 +  3.90 - 34.93
 TRAN    2833.25 +106.21  2727.04 - 100.68  2827.72 + 64.48 + 75.09
 VIX       28.41 - 10.92    39.33 +  12.39    26.94 -   .27 +  1.40
 Put/Call            .75      .94               .37             .48

What a difference a week makes!

Friday of last week was a lesson in terror for many new traders as market makers stepped aside and ignored sell offers for many Nasdaq stocks causing the biggest point drop in Nasdaq history. The last day of this week was a sleeper. (yawn!) The Dow charged off at the open and got stronger as the day progressed. After dipping to a low of 10635 on both Tuesday and Wednesday the Thursday close of 10840 was confirmation of a renewed rally in the Dow. The drop last Friday back to 10200 seems a distant memory as money continued to flow into the old economy stocks. The tech contingent on the Dow was no help with MSFT flat in front of earnings and Intel wiping out the HWP gain of +3.69 with an identical loss. Volume was a weak 894 mln shares.

The Nasdaq finished the week with a whimper but on increasing strength. The Volume was VERY light with only 1.3bln shares trading compared to well over 2 bln on a "normal" day. Still the profit taking on Wednesday was orderly and minimal with the index giving back only -87 points of the almost +500 points gained on Monday and Tuesday. Thursday the Nasdaq started out higher but quickly sold off to 3600 or -109 but then trended higher the rest of the day. Twice it tried to go back to 3600 again but failed each time with a higher low. The high just before the close was only -39 and I was encouraged even though it closed negative.

The fuel for the rally continues to be earnings. The results coming in are truly amazing. 75% of the companies reported have beaten estimates. 56% of the S&P-500 companies have reported and earnings are up +21.4% over last year. Not only are earnings beating last year but are also beating estimates for this year by +6.3%. This is over twice the average from last year of only +2.8%. There have been substantially fewer pre-warnings and only a few companies have announced less than expected. This is a cruel good news bad news joke. The much stronger than anticipated earnings only mean that the economy is much stronger and with the Fed waiting in the wings with a May-16th meeting date the worry of a stronger than expected rate increase is growing.

Microsoft announced earnings after the bell today and it is probably a good thing we have three days before the markets get to trade on the news. They beat the estimates of $.41 with $.43 per share but the revenue numbers were lower than even the reduced estimates from the Goldman Sachs from last week. Official estimates were $5.9 bln and the GS estimate was $5.75 bln. Actual revenue was only $5.66 bln but net profits were $2.39 bln. With margins running 42% even after increased legal expenses and higher employee costs it is still an incredible profit machine. Microsoft agreed PC demand was slow this quarter but indicated it had been getting stronger in recent weeks. Still, more bad news Microsoft guided analysts to only single digit growth for next quarter.

The biotech sector was a strong contributor to the Nasdaq weakness today. With several promising drugs removed from the market this week and a conference call warning from AFFX, investors decided to take profits and move into other sectors. Some of the losers included MLNM -3, PEB -4.13, ENMD -6, HGSI -6.13, PDLI -6.44, DNA -6.88, INCY -9, AFFX -11, ABGX -12.25.

Money flow into equity funds amounted to $6 bln for the week ending on Wednesday with 60% going into growth funds as reported by AMG Data. Index funds lost money for the seventh week out of the last nine. CNBC reported that a total of $16 bln flowed into all funds which included bond funds and international funds.

The wall of worry is building and should provide a strong hurdle to a market rebound. The unemployment claims for the week announced on Thursday morning showed only 257,000 new claims for benefits. This was the lowest number since Dec-1st, 1973 and down -9,000 from the prior week. This again is not good news for the Fed. This news along with the stronger than expected CPI report last week will be combined with the Employment Cost Report and GDP numbers next week to determine rate policy for May. Worst case we could see a pre-meeting increase next week if either report is overly strong. I think the pre-meeting hike concept is gaining momentum. Greenspan does not want to tank the market with a stronger then expected +.50% hike at the May meeting but he may feel he can get away with a +.25% hike next week and then another +.25% at the May meeting. The market would react less with the two hike scenario than a single aggressive hike.

While I was somewhat encouraged by the move off the lows by the Nasdaq on Thursday, it was still a down day only made better by the big Dow gains pulling it up. I struggled with my charting program trying to find a view that would make it look more positive (the optimist in me) but I could not make the outcome different. On the positive side of the ledger is the end of tax selling. Investors who needed to sell to raise tax money should have already sold and settled by now. The margin calls caused by the April tax selling are now over. Most investors are probably licking their wounds and not too anxious to rush back into battle just yet. On the negative side there is a slowing of money into retirement accounts and fund money still on the sidelines is waiting on the next retest before committing funds. The Nasdaq has resistance at 3900-4000 which will take a strong commitment by investors to penetrate. The Dow is entering a broad zone of resistance as well. We have negative economic events in our immediate future and the earnings currently powering the rally are now half over and many investors will be moving to the sidelines until the market stabilizes. This is not a pretty picture. On the other hand the Nasdaq is still terribly oversold and could benefit from traders who left for the holiday moving back into the market the first of next week.

Unless somebody of importance goes on CNBC and says BOTTOM real loud we are doomed to suffer the "we have to retest eventually" mantra from every technical analyst that can find a microphone. This may be the equivalent of a self-fulfilling prophecy. This is only going to add to the wall of worry that the markets will have to climb. If John Q. Investor decides to buck the analyst and buy some of the recent high flyers while they are cheap then the Nasdaq could slowly build support and once a new trend is seen the institutional money may be forced to start chasing stocks as well which would create the beginnings of a nice rally.

I think the key here is valuations, or more correctly pricing. Look at the prices of the recent high flyers. Many have dropped from +$200 ranges to sub $50 levels. To the retail investor this represents major bargains on high priced stocks. It makes no difference to most that the PE dropped from 400 to only 200 or that most of these stocks have no PE at all. They are $200 stocks on sale for less than $50 and now that taxes are over the urge to shop will begin. For the cigarette smoker it is the equivalent of $2.50 a pack smokes now selling for $.50 simply because fewer people bought last month. After paying $2.50 the $.50 is a bargain. One out of three smokers will still die from them but at least they can get their thrills cheaper temporarily. For non-smokers insert your own analogy here, 60 watt light bulbs, Duracell-D batteries, cans of beer or Charmin bathroom tissue. Would your buy more next week at $.10 per item? I can hear you now, "but these things have real value!" Yes, but how much is a D battery or a roll of toilet paper going to be worth a year from now? The retail investor will convince himself that his undervalued, tech stock bargain will regain its former glory and split several times allowing them to buy truckloads of beer, batteries or light bulbs two or three years from now because they were smart enough to buy the dip. Is that not what it is all about? Perception? If it appears to be a bargain to enough people then they will buy and the price will go up prompting others to buy and the greater fool theory will reign supreme again.

Remember, most current investors have never seen a dip that did not bounce. There is no such thing as a bear market and only those who turned their accounts into black holes of debt over the last few weeks are now believers. Those that only lost a couple months profits are clicking on charts every night as they pursue the new national pastime of point and click wealth. Try explaining to the reader who turned a $25 million account into a $2 million account last week with margin calls that he could not meet that there is no bear market. I doubt he will listen long. Still he is shopping again this weekend and that is my point. As long as the "Internet investor" has money he will be addicted to the game and the game will go on.

The most immediate challenge will be on Thursday. The Employment Cost Index and the GDP numbers will be announced. Two very big economic factors to watch. More importantly Greenspan will have a major speech on Thursday also. What is key here is Greenspeak. Since everyone expects a +.25% rate hike at the May meeting, if Greenspan intends to hike more aggressively, he will have to tell the market in advance that is his plan. The Fed never raises rates without telegraphing those increases well in advance so the market does not over react. Especially with the market so fragile at this point Greenspan will have to make his plans known to avoid disaster in an election year. Of course he will not say "I am going to raise rates +.50% at the May meeting." That would only accomplish the same disaster three weeks earlier. He will form his words as only Greenspan can, in as vague but precise a context, that it will take several days for you to decide what you heard. By the time all the analysts spread their version of the event, days have passed and the pain is not as noticeable. If the Fed raises rates +.50% and the market heads for 9000 again then they cannot raise rates again at the next meeting. If they over react and tighten too much then the economy can crash just as fast as the market. Since rate increases take 6-9 months to show up in the economy, the impact of the last six increases has yet to be felt. They do not want to be faced with having to cut rates by summer because they over reacted and now they have to fix it quick. I think Greenspan would have to believe he has lost control before raising more than +.25% and the market would react badly to an out of control Fed. In reality the Fed is our safety net and we know that they will keep the economic engine running at maximum safe speed much longer than if we were in control of the throttle. The greed factor in all of us would have us hitting the wall at full speed and the paramedics would be picking up pieces and trying to patch together the economy for years to come.

The week ahead could be really rocky but what else is new? The Microsoft revenue shortfall is going to impact both the Nasdaq and the Dow at the open on Monday. MSFT traded down almost -$5 in after hours on Thursday and without any new news over the weekend Monday morning will be the same. Looks like another good week to watch from the sidelines unless you are very skill full at jumping out quickly. Should we get the proverbial retest of the Nasdaq lows of 3200 again, be VERY CAREFUL about buying that dip. I would really want to see a strong bounce to convince me it was not just a head fake. Remember, Ralph Acompora, (Acomporaspan) said we could see 2900 again. Now that would be really painful but a killer buying opportunity for those with money left. A suggestion for the wise....have money! Historically the next real rally is not until June so plan on being a trader not a holder on any bounce.

A good way to play the bounce without having to be right about picking specific stocks on the spur of the moment is the QQQ. When these crashes occur they typically have climatic dips and then charge off again. You can't be sure that the stock you chose beforehand is going to be one of the bouncers. By playing the bottom with the QQQ you get the benefit of the entire Nasdaq 100 movement. You can catch the immediate bounce and then decide over the next several days which individual stocks you want to move into. The QQQ has only been under 80 once since December and that was last Friday. If we have another market event and it dips under $80 again, it probably will not go much farther. I would look to buy any bounce under $80 and either buy the stock or the options. If you buy the options I would buy the May calls as deep ITM as you can, $10-$12, to remove as much time premium and maximize the bounce. A bounce would likely be back into the $87 range and you should be able to capture $5 of the $7 move.

Normally late April and May are very choppy months and require a much higher skill level for successful investors. Many experienced investors simply sit out until the first of June and save their capital for the next earnings run. There will still be bargains and trading rallies but finding a trend that is tradeable for more than a couple days could be a problem. The wild card is the recent crash and the "normal cycle" could have been impacted by the premature drop.

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

Jim Brown
Editor

Disclosure:
My current long positions: VIGN, NTAP, BRCM, SCMR, ARBA, TIBX

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