Option Investor
Market Wrap

September is living up to its reputation already.

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        WE 9-8            WE 9-1          WE 8-25          WE 8-18
DOW    11220.65 - 18.13 11238.78 + 46.15 11192.63 +146.15  + 18.68
Nasdaq  3978.41 -255.92  4234.33 +191.65  4042.68 +112.34  +140.87
S&P-100  812.90 - 16.93   829.83 +  6.28   823.55 +  9.91  +  8.89
S&P-500 1494.50 - 26.27  1520.77 + 14.31  1506.46 + 14.74  + 19.88
W5000  14050.20 -279.70 14329.90 +238.70 14091.20 +183.80  +210.60
RUT      535.70 -  6.21   541.91 + 16.80   525.11 +  9.60  +  5.24
TRAN    2732.78 + 19.86  2712.92 - 77.25  2790.17 - 46.97  - 90.36
VIX       20.69 +  1.24    19.45 +   .35    19.10 -   .32  -  1.77
Put/Call    .52              .53              .50              .57

Earnings warning fears routed the markets as chips, networkers, Internet, computers and telecom stocks all headed lower. The rash of prewarnings tipped the balance of power and the Nasdaq support at 4000 fell at the bell. Even the promise of an increase in output by OPEC which dropped oil prices by -1.76 to 33.63 was not able to spark the market. The bullishness from this time last week is all but forgotten and fear is rampant again. A prime example of how quickly market sentiment can change with just one major news event. The Intel downgrade on Tuesday is still moving down through the sectors that depend on PC sales. Thank you again Ashok Kumar.

It was not all due to the Intel downgrade. That was simply the first domino to fall and the rest are following suit. The flurry of warnings on Thursday, TRW, SFAM, ZOOX took the wind out of the chip sector and the networkers. Today the high profile culprit was National Discount Brokers (NDB) who warned that they would report a loss of between -.06 and -.09 when analysts had expected a profit of +.09. OOPS! That was a serious change and NDB dropped -$8 to $27.44 or -22%. Just when you thought the financial sector was bullet proof. EGRP and AMTD had been gaining on upgrades and the NDB warning reversed that trend.

Remember what I said last week about analysts jumping in front of stocks they expect to warn? UBS Warburg went on record that they expect Dow component Honeywell to miss estimates. The key was a warning by Invensys, a British automation company that competes with Honeywell. Analysts are expecting many companies to warn based on the high cost of oil currently making its way through the price chain. Another Dow component that is suspect is MMM. No one has downgraded them but after Dupont this week many feel they are the next confessor.

Oil prices fell on the expectations that OPEC would agree to increase oil production by 500,000 to 700,000 barrels per day at their meeting on Sunday. With world oil consumption running at 75 million barrels per day a 700,000 increase is barely a drop in the huge bucket. The oil price dropped -1.76 to $33.63 but it is not expected to go much further. It takes 60 days for an increase in production show up at the pump and with colder weather coming the increase in consumption is expected to be more than the increase in production. OPEC is expected to try and keep prices in the $28 range and to do that they have to keep supplies tight, just not critical.

The Friday drop was unfortunately on strong volume, again. The NYSE traded 963 million and the Nasdaq 1.5 billion shares. The expected higher post Labor Day volume was expected to be up volume but we got the opposite. One floor trader said he saw more shorts on Friday than he had seen in some time. The Nasdaq closed near the lows of the day for the third time this week. The one day rebound on Thursday was simply an oversold bounce and traders sold into it and ran for cover. The selling intensified into the close and many stocks are showing long red candles in the last few minutes. The chip sector is now down -8.6% for the month followed by the Internet sector at -5.9%. The Nasdaq has dropped -5% for the month. Are we having fun yet?

Don't look now but we are dead in the middle of the worst month for the market historically over the last 49 years and traders are looking for cover. The sell off we had been expecting for next week jumped forward in time four days and caught many traders off guard. The Nasdaq fell under the psychologically important 4000 level and closed at the low of the day. The reason for the drop was a big cap explosion. CSCO, ORCL, WCOM, MSFT, INTC, DELL and SUNW all helped drop the Nasdaq composite. Add in the huge drops in chips, fiber optics and networkers like SDLI -21, CIEN -15, GLW -14, JNPR -17, EXTR -9, AMCC -13, PMCS -10, BRCM -8 and it was amazing the damage was not worse.

The outlook does not look good. The lack of confidence in the market coupled with the huge amounts of cash on the sidelines has the market primed to produce ulcers. Volatility is increasing and the alternating 100 point days we had last fall are returning. Each major drop like Friday's sets us up for a trading rally and then another drop. There are too many sellers dumping good stocks to expect that Friday was a bottom. The extreme short positions by institutional traders are still growing. This, coupled with the expected October drop is scaring investors and prompting them to stay on the sidelines. The majority of the earnings warnings are still ahead of us and we will probably see lower numbers soon.

The coming weeks will test your trading ability and quickness in entering and exiting positions. The Nasdaq is likely to be range bound with large intraday swings. As each warning appears the stocks in that sector will be guilty by association and drop accordingly. Hopefully we will reach a point soon where traders will feel all the bad news is priced into the market and they will start bottom fishing for tech stocks. We all know how powerful tech rebounds can be. We can trade these rebounds but with October in our immediate future we need to trade these rebounds like hit and run bandits. Sometime in the next 50 days the market will form a bottom and the fall rally will emerge. The Fed is on hold, the soft landing is here and oil prices will eventually fall. The outlook is outstanding we just do not know the start date yet. The October low in 1999 was on the 18th, 1998 on the 8th and in 1997 on the 28th. There is no convincing pattern other than October produced the low point in the fourth quarter for the last five years. 1994 was the last year that saw lower numbers after October. Getting from here to October is the challenge.

Next weeks economic reports could take investors focus off the earnings warnings if the reports are good. Monday/Tuesday are report light with the majors coming later in the week. Wednesday we have Import/Export prices, Thursday PPI and Retail Sales and Friday CPI, Business Inventories, Industrial Production. This sets the stage for a rebound on Monday afternoon or Tuesday in anticipation of a rally on good PPI news. September rallies should be viewed with caution. Believe it or not I am still very bullish about the market. I just feel the next four weeks could be very bumpy. Be sure to keep your seat belt fastened and watch for those sharp turns.

Trade smart, sell too soon.

Jim Brown
Editor

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