Option Investor
Market Wrap

The Nasdaq slowly rises from the ashes.

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        WE 4-28           WE 4-20          WE 4-14           WE 4-7
 DOW    10733.91 -110.14 10844.05 +538.28 10305.77 - 805.71 +189.56
 Nasdaq  3860.66 +216.78  3643.88 +322.59  3321.29 -1125.16 -126.44
 S&P-100  781.42 +  4.30   777.12 + 45.18   731.94 -  89.58 +  6.46
 S&P-500 1452.43 + 17.89  1434.54 + 77.23  1357.31 - 159.04 + 17.77
 RUT      506.25 + 24.41   481.84 + 28.12   453.72 -  89.27 +  3.90
 TRAN    2850.01 + 16.76  2833.25 +106.21  2727.04 - 100.68 + 64.48
 VIX       28.78 +   .37    28.41 - 10.92    39.33 +  12.39 -   .27
 Put/Call    .51              .75              .94              .37

The Nasdaq slowly rises from the ashes.

I think I can, I think I can, I think I can. Just like the well worn phrase from a children's book the Nasdaq is the market that thought it could. This week has been one of building strength. Just like a punch drunk Rocky the Nasdaq has been up, down and sideways all week but the strength is coming back noticeably. The drop at the open on Thursday after the bad ECI report was only momentary and the trend was steadily upward after the first ten minutes. The recovery was not helped by the Dow which has lost -400 points since breaking 11100 on Wednesday.

Techs are back and old economy stocks are suffering from investor flight as confidence in the tech sector returns. The financial stocks took it on the chin on fears that the Fed will see the inflation monster and raise rates more aggressively two weeks from now. The drop in financial stocks put the skids on the Dow and there were no earnings left to hold it up.

We are now entering the twilight zone. The two week period before the Fed meeting filled with more potential disasters. Between now and May 16th we will have to overcome a flurry of economic reports with the largest being April Non-farm payrolls next Friday and the PPI/CPI duo doing the tag team thing beginning the following Friday. The Fed will have all the economic data they could ever want when they meet and many analysts are now claiming they may take the bigger +.50 step if the markets appear to be firming. Talk about a good news/bad news joke. Good news the markets are rallying! Bad news, the markets are rallying and the Fed gets to take a bigger bite. I still think Greenspan wants to be an incrementalist and continue stacking the +.25% hikes but the more aggressive members of the board are becoming more vocal.

The hot news for Friday (yawn) was of course the Justice Dept recommendation of splitting Microsoft into two companies. One which would focus on operating systems and the other would handle application software like Word, Excel, Explorer, etc. The two companies could not rejoin for at least ten years. The states joining forces on the trial split on the decision to break up the software giant. Several states disagreed with the plan but nobody broke ranks to support the Microsoft position. One of the major points of the plan would prohibit Gates from owning stock in more than one of the two companies. I wonder how that would work? Would Bill just sell his stock on the open market or maybe just tender his stock to some other third party, say Oracle CEO Larry Ellison? I am sure Larry does not currently own any. Maybe Larry would just swap an equal number shares of Oracle for the MSFT shares? Nope, that would not work because Gates would then be a monopoly again. Of course with Bill and Larry as equals on each board absolutely nothing would ever get done. Of course the board meetings would be very well attended. The eventual outcome could still be years from now and Bush has said he would take a personal interest in cases like this. Should it drag into the next presidency and Bush wins the odds of a breakup are slim. Either way we think there is no downside at this point. After the drop to $65 last week there are simply no sellers left. MSFT actually traded up after hours today after the verdict. If you want a good long term play this week then leaps on MSFT would be a good call. For free money the May $70 puts are $3.50 and put sellers could go naked here with minimal risk.

The Nasdaq finally confirmed the +3800 break a week ago Thursday with a close over 3800 on Friday. This is the first step in the bullish scenario of establishing a higher high. The higher lows set on the 17th, 24th and 27th are a positive sign as well. With the Dow still suffering ECI sticker shock the Nasdaq is having to go it alone. The Dow is drifting downward with the next support at 10650, about 90 points away, but the next support after that is under 10400. We know from previous experience that a continued divergence of the two indexes will eventually drag on the one moving upward. Just look at April 12th for confirmation of this.

Where normally I would be very bullish today based on the higher close over 3800 I am still suspicious of the rally. There are many good signs like the number of 52 week lows dropping and advances strongly over declines. Even though the Dow was down -154 on Friday the NYSE advancers beat decliners by +415 issues. If this was May-17th I would be screaming buy but with the Fed ahead there is still a possibility of another dip between now and then. Many, many Nasdaq stocks have had some huge gains since the April 14th drop. PMCS for instance has gained over $70, AMCC +$50 and neither has had any serious profit taking. The bounce on many of the leaders has been very strong and many investors may be leery of taking a position until there is some profit taking. The market is still not healthy even though the Nasdaq is making good strides. 30-40 Initial Public Offerings have been cancelled and many others are waiting for market strength to return before setting dates. Cash is still on the sidelines but it is not rushing into the battle. The higher the Nasdaq leaders go the more resistance we will see. The "if only it gets back to $xxx I can sell and get my money back" concept is alive and well. Investors down -20%, -30%, -50% are all cussing themselves for not selling when the drop began and they are making promises to their creator, themselves and their wives about what they will do "if only" they get their money back. This creeping resistance will be with us for sometime and could cause a lot of aggravation in the form of failed rallies in the future.

I really hate to keep repeating this but over 80% of companies have reported earnings already. If the Nasdaq was not already so far down we would be at the historical post earnings sell off point. The only thing that will move the markets up next week is the fear that the sell off was overdone and the train is about to leave the station. A lot of traders will be looking at the Nasdaq chart this weekend and pointing to the close over 3800 as the confirmation trigger. A positive open on Monday could be the spark that we need. If we fall back under 3800 the money on the sidelines will breathe a sigh of relief and start plotting entry points for a post Fed rally. If the Nasdaq moves up strongly on Monday and posts another higher high then money will start flowing. It is simply a technical and sentiment trigger coming together at the same point and the results could be incredible. That is my bullish side hoping the rally has begun. My bearish side is still looking at the dozen or so economic reports before the Fed meeting and telling me to wait patiently. You never lose money in cash.

Our challenge is to ignore what our biases and emotions are trying to tell us and simply trade what the market gives us. If you are bullish and the market is trending down you will repeat the April losses. A simple indicator for us next week would be - go long if the Nasdaq is over 3800 and go short or flat if the Nasdaq is under 3800. Your decision process is over. All you have to do is execute.

Trade smart, don't buy too soon.

Jim Brown
Editor

Disclosure:
My current long positions: NTAP, RAMP

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