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Market Wrap

Our soft landing is becoming painful.

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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

Just another fun Friday? Not in my book. This September is starting to look more like an October instead. Institutional investors have a long memory, unlike retail investors, and this long memory leads to earlier decisions based on previous pain. We tend to play more loose with our own money but those whose are held accountable for investing the savings of others tend to be more careful as markets become unstable. Especially in times of historical instability, like September and October, they are far more focused on potential problems instead of potential profits. The converging market stories are now coming together like the different plot lines in a Steve Clancy novel. Oil prices at $36, power shortages driving prices up, the Euro going down faster than the Titanic, the Thai Bot at a two year low, Iraq declaring war on Kuwait (deja vu), bonds falling on weaker than expected economic data (twilight zone?), tech stocks warning, bulls turning bearish. Do you see a common thread here? Investors did and the move to the sidelines accelerated.

The fall rally came early this week, everything was falling. Bad joke, sorry. It was not a pretty sight. OptionInvestor readers still profited nicely from some big winners like call plays ITWO, CFLO, CHKP and put plays SCMR and CMTN. The very positive CPI report acted like a catalyst but in the wrong direction. The CPI headline number was -0.1% and well below the estimates for a +0.2% gain. The core rate was unchanged at +0.2%. The drop in the headline number was the first time in 14 years and the market should have soared on friendly economic data which has put the Fed on hold for at least six months according to analysts. So what happened? All of a sudden the soft landing engineered by the Fed is starting to look more like an impending train wreck. Factors out of Fed control have suddenly mushroomed into serious challenges.

The oil problem is refusing to die. Oil futures hit $36 Friday even after OPEC has said production will be increased. The tropical storm in the Gulf of Mexico, a huge oil and natural gas production area, has buyers running to cover requirements quickly. As in any supply and demand equation the market prices are reflecting the imbalance. These higher prices, three times higher than just a year ago, are starting to be seen in the profit warnings in many companies. One oil analyst forecast $41 oil before increased production drops prices. Commodities, the raw materials companies need to make their products, are soaring due to the higher energy costs required to produce them. Another vicious cycle as every higher price in the supply chain begets yet another higher price on the finished product. Add to this the shortage of natural gas and even, believe it or not, a shortage of electrical power has sent the Dow Jones Utility average to an all time high in September. Increasing the oil tensions IRAQ said Kuwait was stealing oil from IRAQ by drilling along its borders and warned that it was going to take action. And that action would be what? Saddam is going to moon a picture of the Kuwait royal family? With the U.S. still bombing anything military that appears in the southern half of the country the biggest weapon he has close to Kuwait is probably a mail truck.

The Euro hit another all time low against the dollar and every penny it drops is another penny that the multinationals will lose in profits. The non-stop drop is putting pressure on the earnings and every day we are getting closer to a major earnings warning from some company that will shift the current market sentiment from concerned into full panic. The front page of "Economist Magazine" this week shouts "Euro Shambles" and the inside article shows that inflation is rampant in Europe and the Euro still has no bottom.

The rebalancing of the S&P indexes on Friday created the third day this week where the volume on the NYSE exceeded one billion shares. Friday 1.23 bil shares traded and the Nasdaq volume at 1.75 billion was also very heavy. Advances lagged declines by almost 1:2 on both indexes. Without the strong buy on close orders due to the rebalancing both indexes would have closed on the lows of the day. The Dow closed below 11,000 for the first time since August 10th and is exactly where it was in May of 1999. The Nasdaq did manage to hold at 3800 again and closed at 3835. This is the same area we were breaking out of on August 14th. We have now given back all of the August gains and the index is down -9.8% from the September high of 4252 on Sept-1st. The Dow lost -293 for the week and the Nasdaq -143.

The individual big cap stocks on the Nasdaq were looking pretty grim. The down trend for the week showed no letup. Intel fell to a new five month low of $57.50. Dell finished only fractionally above its low for the day of $35.25 and is only $.69 above a 52 week low. Microsoft traded as low as $63.31 and only $3 from a 52 week low. WCOM finally broke under $30. Oracle pulled a classic post earnings announcement drop losing -$6.63 to $78.31 even after posting blowout earnings and a 2:1 split. The bright spot on the Nasdaq was CSCO which gained +1.50 but don't start cheering yet. A rumor hit the market just before the bell that NTOP and CSCO were going to announce a joint venture and create a new company called ADIR Technology. Over 11 million shares of CSCO traded in the last 30 min and CSCO spiked +2.50 on the news. After the bell the story became clearer and it appears that NTOP will spin off the company and CSCO will only be a minority investor in the new effort. This brief rally could only be a spike as these same speculators bail out on Monday.

Financial stocks have been a major component in the recent Dow rise and most of that rise was fueled by the JPM rumors. Alright already! JPM has been a rumor for two years since Citicorp bought Travlers. It is over, done, finished, kaput. Don't expect help from financials as long as the "R" word is being whispered. A recession may or may not be in our future but we have been hearing it several times a day this week. The combination of falling merger speculation and the possibility of a recessionary crash instead of a soft landing, cratered these brokerage stocks on Friday. Lehman -7.50, MER -2.75, GS -4.12, BSC -5, MWD -6.44. Brokers don't do well in bear markets.

The economic reports scared the bond market into swapping yield curves for the first time in the last two months. The 30 yr bond is now yielding more than the shorter term notes and closed the day with a 5.90% yield. With the recent forecast of lower interest rates ahead the bond yields had been falling. Now that the future landing may be a crash the bond is falling as the future becomes more cloudy. Over 6% yields will start pulling cash out of stocks and into the safe haven until the markets recover.

Good news, bad news, there seems to be no difference. Good news about earnings is being looked at with skepticism and bad news is being dealt with harshly. A perfect picture of a wall of worry building. The fact that tech stocks are not immune to earnings problems in a slowing economy has finally struck home to some newer traders. When the economy is slowing, PE ratios shrink due to decreased expectations. A stock with a PE of 12 has very little risk but a tech stock with a PE in the triple digits can move in increments more appropriate to the Richter Scale. The bad news continued on Friday with AMSY, ANAD and MUI warning about slowing profits. We have two weeks left in the warning season and we can expect next week to increase in intensity.

The outlook is still mixed for those of us who are permanently bullish. When the markets are being driven by events not market related the standard technical analysis is less reliable. What was support weeks ago when global events were not a factor is not really support. It was support where buyers and sellers had arrived at a standoff based on market factors then, not now. Yes, CSCO has bounced off support at $60 for four months but factors are different now. Real support for CSCO may be $50 not $60. Support in a falling (not slowing) economy is when investors with cash decide it is too good a deal to pass up. The key here is "cash." Where is support on Intel? That depends. Support in a rising economy or a slowing economy. If Intel chips are going to sit on a shelf unsold then support will be much lower than when Intel could not make them fast enough. Which is it now? A month ago Intel said they could not make them fast enough and it was setting a new all time high. Sept-5th Ashok downgraded INTC and said PC sales would be falling with the economy and pricing would become malignant, his words. That means excess supply would cause price cutting and profit margin erosion. Everybody else disagreed but Intel fell -23% since that downgrade. Friday after the close Gateway sliced prices on its most popular models and increased the CPU speed as well as doubled the memory. They are spending more on components and selling them for less. Was Ashok right? We will not know for some time but the question now is "what is support for Intel now?" The strongest past support is $54 and that is not far away from the $57.50 Friday close.

The point I am trying to make here is the standard "retest recent lows" rhetoric may be accurate but they may not be looking at the correct lows. The lows in a Goldilocks economy are not the same as the lows in a possible recessionary economy. Before you toss this article in the trash can, rest assured I am still bullish. My personal bias of course has no impact on reality. I just feel that all this gloom and doom is over done. I would point to the current well being of the American consumer, the very recent earning cycle where beating the estimates was the norm and the Fed on hold for the next several months. Oil will eventually fall simply from OPEC cheaters if for no other reason. This is normally the gloom and doom season. One only has to look at this period in the last four years for proof. I keep warning that September is historically the worst month over the last 49 years. I just don't think saying "worst month" translates into "markets will fall for four weeks" when people read it in print. That is like saying oil went from $35 to $36 per barrel. You see the numbers but you don't immediately think that gas will go up another nickel. We get so used to hearing oil will go up/down that we don't actually think through the process to cost per gallon, dollars per tank, cost per week, monthly Texaco bill, ouch! It comes to you when you stop for a fill up three weeks from now and it costs you twice what you expected. Reality check! The reality of September, for whatever the yearly reason, is that investors lose money because the market goes down. When we read "worst month" we should think "my options may go down, I should set stops."

Now, what are we going to do about it. Sit on the sidelines and wait, (heresy I know) or trade smarter. (oh sure another glib answer) No seriously. In theory we will see a market bottom sometime in the next four weeks. That depends of course on the soft landing scenario regaining some credibility. Still in any market there are trading rallies. With the Nasdaq at 3800 and holding we could see another trading rally as soon as Monday. Nothing goes down in a straight line and even if we are going to 3500 again there are plenty of opportunities to make $2-3 two or three times a week. No, I don't see those $20-30 gains from long steady moves over the next four weeks but I can see several opportunities for playing over sold events while we are waiting for the October bottom. I was encouraged by the Nasdaq hold over 3800. I was encouraged by the lack of major losers on the Nasdaq. Of the 300 stocks I watch every day there are normally dozens with double digit losses on a day like Friday. There were only two on Friday, EPNY -10, AVNX -11. The majority of the losers were in the -2 to -3 range. Big deal. I did look at charts on all 300 and there was no real trend. Not a large group of big drops at the close but also very few with gains into the close. Just no direction. The biggest trend I saw was a fall back to previous support over the last week and then a slowing of movement. This means there is no big selling crush. Momentum traders are waiting and buy and holders are doing just that. We have not fallen far enough to create that selling climax as people throw in the towel. That means we could fall some more. Still, the greed principle is still in effect. Traders have become accustomed to buying the dips over the last several years and they have also developed very little patience when it comes to staying out of the market. This creates the strong trading rallies like the two we had in the last two weeks. We just have to be more proactive in cutting our trades short and getting out with a profit on any big move. We need to be more aggressive in picking stocks that hold up on bad days and move fast on good days. We need to anticipate support levels and be ready with limit orders when those selling dips occur.

The Nasdaq held twice last week right on ascending support at 3800. This support dates back to May-24th. There was no capitulation on Friday so we cannot accurately call this a bottom. It may be but we won't know until a week from now. The best scenario for Monday would be a huge downward spike with heavy selling in all the big caps. A rebound from that spike would be a buying opportunity. The volatility is normally higher on the Monday after a triple witch options expiration as traders square positions from option assignments. The most probable scenario will be continued weakness but no heavy selling. This may lead to a low volatility Nasdaq rally like we had in August. Steady gains with minor routine profit taking. The Nasdaq is on the verge of oversold and a trading rally by Tuesday is a good possibility. I do not expect any big rally before the October surprise but there is a lot of cash on the sidelines and the term "burning a hole in their pocket" certainly applies. This cash may trickle into the market as individual stocks start showing positive trends. I would suggest opening smaller positions than usual and wait to see what the market is going to give us. Cash is king for the next four weeks. Cash gives us options whenever there is a serious dip. (yes, a weak pun) If you are stuck in a losing position and the market dips you are more concerned about the loser and unable to profit from the dip. I am hoarding cash but getting very restless. I feel like a hunter two weeks before opening day. Guns have been cleaned several times, all the gear has been pack and repacked, several times. I find myself looking at charts on companies I have no interest in trading just like a hunter trolling through sporting goods stores looking for that special item that he does not need but must have on opening morning. My advice, spend the next week reviewing your trading plan and making preparations for the fall rally. The yearly super bowl of investing is about to begin. Profit from it!

I received an email this week that caused me to reevaluate what I have been doing in the editors plays section. Some time ago I had switched from writing about my personal plays because my personal strategies are different than most of our readers. I had switched to choosing several current OIN plays and trying to educate the readers on how I would play them, entry points, exit points, etc. To put it into this readers words, "boring." Actually his words were much stronger than that and not printable. Still he made a good case that readers of this section wanted to see the real stuff, good or bad. Win some, lose some, but go for the gusto. So be it. starting this weekend I will go back to the scorched earth reality concept and simply warn you, "do as I say, not as I do."

OIN has gone global with our regional seminars. We are announcing this weekend a four day seminar in Dubai, UAE for November. Due to the new rules concerning private ownership of stock in that area, trading is now gaining favor. Chris Verhaegh just came back from a two week trip to the UAE and the demand is incredible. He visited the new stock exchange in Dubai and they had 12 listed stocks, 14 brokers and traded by fax. This is what it means by getting in on the ground floor! November 20-23, Dubai, if you live there, and we have many readers that do, you should come. If you know somebody in the Dubai area then please tell them we are coming. We should have the Australia date locked in by Tuesday now that post Olympics bookings are available and we will be updating the schedule accordingly.

Join us for lunch and a free trading seminar!

Boston - Tuesday September-19th. Charlotte - Wednesday - September-27th. San Francisco - Wednesday - October-4th

OptionInvestor.com, Preferred Trade and A-T Attitude will hold a FREE seminar complete with handouts, freebies, door prizes and over six hours of solid information which can improve your trading results. Lightning trades, real time quotes, the best option strategies and a FREE BREAKFAST and LUNCH! How can you go wrong? It is free but you have to register so we can order food.

http://www.OptionInvestor.com/seminar/dtn

Trade smart, sell too soon.

Jim Brown
Editor

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