Option Investor
Market Wrap

Internet stocks cash burn torches Nasdaq.

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        WE 6-23          WE 6-16          WE 6-9           WE 6-2
DOW    10404.75 - 44.55 10449.30 -164.76 10614.06 -180.70 +495.52
Nasdaq  3845.34 - 15.22  3860.56 - 14.28  3874.84 + 61.46 +608.27
S&P-100  781.07 -  7.67   788.74 +  9.04   779.70 - 12.99 + 56.61
S&P-500 1441.48 - 22.98  1464.46 +  7.51  1456.95 - 20.31 + 99.24
RUT      510.41 -  3.33   513.74 -  9.32   523.06 + 10.03 + 55.66
TRAN    2630.71 - 42.48  2673.19 -116.98  2790.17 - 39.19 +141.81
VIX       25.89 +  2.34    23.55 -  1.64    25.19 +  1.08 -  3.38
Put/Call    .61              .53              .45             .41

Internet stocks cash burn torches Nasdaq.

Just another exciting day in the Internet world with yet another round of bad mouthing by the Internet analysts. The spark for the session was comments from Lehman Brothers analyst Navi Suria who questioned Amazon.com's credit worthiness. In 1999 Amazon lost an average of nearly $2 million per day. Navi claimed Amazon was burning cash at a record pace and sales were only expected to be up +2% from the first quarter of this year putting revenue at $600 million. On Thursday Goldman Sachs analyst Anthony Noto also predicted similar numbers. Lehman Brothers release a research note telling bond traders that the company's credit was "weak and deteriorating." Of the 33 firms making recommendations on Amazon 15 list it as a strong buy, 9 suggest a buy and 9 recommend a hold which is a polite way of saying "avoid." Since 1997 Amazon has received $2.8 billion in bond funding which amounts to .95 cents for every dollar of merchandise sold. Mary Meeker, Internet analyst at Morgan Stanley, said Q3 and Q4 revenues would probably not top her estimates and "there could be some modest downside."

Amazon was not the only Internet scapegoat on Friday. Ebay took its share of licks as WR Hambrecht downgraded Ebay to a "buy" from "strong buy" saying that there was no compelling reason to buy the stock at this time. Ebay has had very strong growth but the space is full and growth of new auction junkies is slowing as the fad passes. While he expected Ebay to be a core holding and to post solid Q2 results of +$.03 per share he felt the story was fading. Ebay lost -$4 and closed at an eleven month low on the news.

With all the negative news Nasdaq traders ran for cover as Internet stocks gave back recent gains. The Dow managed to recover some of the recent losses as tech money eased back into old economy stocks which were perceived as values after their recent drops. EK gained +1.19, KO +1.75, GM +1.44, JNJ +1.19, MCD +1.19, WMT +1.25. Even JPM got into the act with a +1.19 gain after being severely beaten up for -$15 over the last two weeks.

Rambus continued to be a stellar performer on the Nasdaq after settling the suit with Hitachi. Although it closed about -$14 off its high the gain for the day was still a very respectable +$17. One analyst set a new price target for Rambus of $165 but several others are warning that all the good news may be priced in already. The settlement with Hitachi and Toshiba will give Rambus a 1%-2% royalty on about 12% of the DRAM industry. The majority share however will not be as easy to capture with over 50% of the market controlled by Samsung, Hyundai and Micron. Jeremy Lopez at Moringstar said it would be highly unlikely that Rambus could capture that share and that the Rambus risk/reward ratio was unquestionably skewed toward risk at this point. He compared RMBS rocket rise to the QCOM spike last year when it appeared CDMA would be the world winner in cellular access. As we can see from recent events the domination of the world by QCOM is far from certain just as domination of the DRAM business by RMBS is the "least likely outcome" per Jeremy.

Trading still lacked conviction with lackluster volume again and the internal market factors were negative. On the NYSE there were only 25 new highs compared to 62 new 52 week lows. The advance decline ratios continued to be negative on both the Nasdaq and NYSE. The key here is still the Fed meeting next week. This is a two day meeting and while all 29 analysts that track the Fed rate policy are calling for no hike there is still the worry that the Fed would rather hike once more now instead of passing now and having to raise again just before the elections. Many feel the market has already priced in a "no hike" scenario with the rally over the last two weeks and any negative news would be met with selling.

With the dog days of summer rapidly approaching the possibility of a significant rally is dwindling. If the Feds go neutral and fail to raise rates we could see a rally into earnings but the anticipation of a fall off in mid July would likely keep it from being very strong. The Dow has been stuck in a diamond pattern since April 1999 and is currently nearing a breakout. The breakout is caused by the lower highs and higher lows converging with only one winner. The current trend is down which would lead you to expect a breakout to the downside but the last 10 months of the trend has been dominated by an aggressive Fed hiking rates monthly. If the Fed trend changes with the meeting next week that could be the catalyst for a breakout to the upside.

The Nasdaq appears to be forming an inverse head and shoulders pattern but it is really too early to tell. If we assume, and you know what ass-u-me stands for, that the mid July drop will make it three years in a row then the Nasdaq could retest 3500 to 3300 in mid-July. This would provide a strong consolidation base to begin a late summer rally into October earnings. (Ouch, I even hate to write October since that brings up another set of scary comparisons) The period we option traders should focus on is the next two weeks. A neutral, no hike, Fed could give us two weeks to play the long side before a possible July dip. If you are considering long calls please don't get caught thinking "I will buy November so I will have extra time in case something goes wrong." Use the 50-50-90 rule. If there is a 50-50 chance the market will dip in July, there is a 90% chance of it occurring if you go long next week. Do you really want to go long (3-4 months out) only to be locked into the position while the dog days of summer pressure stock prices and premiums OR would you like to open new positions in Late July or August if/when a summer rally really appears?

I know this is heresy. You mean stay out of the market for several weeks? Yes. You mean buy all the time I want, just don't use it? Yes. Do you mean I don't have to be tied to my monitor all summer? Yes. BUT, if a summer rally does appear you will be in cash on the sidelines and ready to jump into action. The alternative is to be in options that are worth half what you paid for them and you spend every day just hoping that they get back close to what you paid for them. (been there, done that?) I hate to be so negative but if you have tried to trade during the summer for the last several years you probably lost money or at least had to fight for every dime you got. I tell people in our seminars that you should have a trading plan. The number one rule in your plan should be "to trade only when profitable." Sounds glib but why would you want to trade any other time? Summer is usually not profitable.

Yale Hirsch in his Stock Traders Almanac shows that since 1950 the months of May to Oct have been very hard to trade. If you had invested $10,000 in the S&P in May of each year and withdrew it in Oct and allowed it to compound for the last 50 years you would now have $11,138. Yep! Absolutely flat and this included the last 10 years of this huge bull market. If you invested $10,000 on Nov-1st and withdrew it on Apr-30th for those same 50 years you would have over $350,000. Now, why was it that you wanted to invest over the summer months again? Now before you decide to go on a four-month vacation from trading you should remember that there are major moves in the market in almost every month regardless of the season. The key is waiting for the move. I think the key to trading in the summer is benchmarks. We should pick a benchmark like Nasdaq 3900 and let it dictate our strategy. Above 3900 we go long, below 3900 we go flat. This is a simple, end of day indicator, that is almost fool proof. Of course if the Nasdaq did retrace to 3300-3500 we would reset our benchmark depending on the market conditions.

I know that 90% of our readers will continue to trade on a daily basis until we get those traders anonymous meetings started in your area. That is ok too as long as you are reactive to the market. With that in mind keep your eyes on the Fed next Wednesday and be ready to move quickly. In the last decade the week after the June triple witching Friday was down 8 of 10 years. Last week made 9 of 11. The next two weeks has historically been bullish when the Fed was not a factor. Lets hope the trend continues. Next week is the end of the quarter and some portfolio balancing may occur as well as in the first week of July. This provides the bullish bias as funds try to dress up their statements for advertising purposes.

You can profit from the dog days of summer by using the time you are not trading to attend one of our regional seminars near you. We had a packed out crowd in the LA 3-day seminar last week. We had so many people who wanted to attend but couldn't that we scheduled another 3-day for Orange county on Aug-10-12th. If you are on the east coast the Washington DC 2-day seminar starts Tuesday but we still have four seats available. 100% money back!

Trade smart, don't buy too soon.

Jim Brown
Editor

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