Option Investor
Market Wrap

Another Day, Another Downgrade

HAVING TROUBLE PRINTING?
Printer friendly version

        11-20-2000        High      Low     Volume Advance/Decline
DJIA    10462.60 -167.30 10624.30 10449.30  953 mln    976/1848
NASDAQ   2875.64 -151.55  2949.50  2860.49 1.72 bln    972/2998
S&P 100   710.04 - 15.05   719.55   709.16   totals   1948/4846
S&P 500  1342.62 - 25.10  1360.31  1341.67           28.7%/71.3%
RUS 2000  470.24 - 12.37   482.69   469.41
DJ TRANS 2795.86 - 21.44  2818.20  2785.28
VIX        30.33 +  2.48    30.99    29.26
Put/Call Ratio      0.76

Another Day, Another Downgrade

Today it was the Networkers who got bad-mouthed and the effect rippled throughout the tech sector. Telecoms, telecom equipment providers, and fiber stocks felt the heat, bringing the NASDAQ back down to painful levels. The longer this investor "fear factor" continues, the harder it becomes for the markets to snap out of the trance. Yet, the concern about earnings growth is warranted: the economy is slowing. No doubt about that. Throw in the volatility, courtesy of the Presidential battle, and this market leaves something to be desired.

Valuation still is, and always will be, the determining factor in the markets. If a stock is perceived to be overvalued, investors sell it. If it seems undervalued, investors buy it. It is as simple as that. We are currently in a market environment where everyone is asking the question: can the market sustain these valuations? This is directly related to the earnings outlook. With the economy slowing and every other company revising there future earnings growth figures to the downside, one only needs to look at the NASDAQ to see the effect. Those high-dollar, high fliers have come down from their lofty valuations: BRCD, BRCM, JNPR, VRSN, and SDLI to name a few. Investors, especially institutions, are reassessing whether those stocks are good values in relation to projected earnings growth. Most of the analysts that I hear on CNBC preach "lightening up on positions" in the rallies. Then, I hear the fund managers calling the same stocks "good values." So which is it? For the latter, considering the size of their positions and available cash, they can afford to take that capital risk. They buy on the way down and sell on the way up. But for us individual traders, you have got to go with the trend.

Each rally we have seen recently has created a bull trap, sucking in those longs thinking that the last spike down was it. These moves are entirely tradable however. Just make sure you keep your eyes on the screen, along with a short term time horizon. As much as we all want to put in the bottom on the NASDAQ, it hasn't happened. Characteristics of a downtrend are lower highs. That's what we've got. In the chart below, when the bottom was thought to be in place at 3000, buyers couldn't take the index over 3550, conceding to the sellers and establishing a major failure. The bounce from 2859 was merely a bounce: a lower low, another characteristic of a downtrend. That second rally topped out at 3200, establishing the lower high, and another bull trap. It is important to realize this so that we can take advantage of this short term trading moves. It doesn't have to be a total market reversal to make money. It takes discipline. Today's failure to sustain the late-day rally resulted in another dead cat bounce.

Yet, just because the NASDAQ is trending lower doesn't mean we can't make money. As option traders, the put plays can be our best friends, making money on the intrinsic side and on the expanding volatility in the put as the underlying goes lower. The best of both worlds. Have you taken a look at our put list lately?

Rally failures at key resistance levels have provided ideal entries into put plays. Think about it. The failure on the NASDAQ at 3200 was only four trading sessions and 325 points ago. That's big money to be made on puts. It has been very tough psychologically to watch this market day in and day out when everyone has grow so accustomed to astronomical bullish moves. We need to remember that each day the NASDAQ becomes more and more oversold. It will come back eventually. In the meantime, like the old adage, the trend is your friend. Same as when the trend was going towards 5000. Don't be afraid to play what the market gives you.

The major catalyst to the downside was a downgrade of the entire Networking sector by Morgan Stanley Dean Witter. They cut their rating on CSCO, RBAK, JNPR, and EXTR to an Outperform from a Strong Buy. Morgan Stanley cited current valuations, the economic slowdown, moderating telecom growth, and seasonally weak demand as its reasons for the call. This put pressure on many other telecom related issues, especially CIEN, a telecom equipment provider. SG Cowen stepped up to defend CSCO and RBAK by reiterating their Strong Buy recommendation on the two. On a different sector note, Lehman Internet analyst Holly Becker downgraded EBAY to a Neutral from a Buy, concerned that the company's core collectible business is slowing.

Once again, the Presidential-Elect litigation has caused minor gyrations in the market, and major volatility. When the Florida Supreme Justices took there seats for the hearings today, the market perked up and rallied. Yet, it was just another short-lived rally attempt. The result of today's hearing was that the Supreme Court will rule quickly in the fate of the 1.6 mln manually counted ballots. Until then, the volatility will continue as the markets hang onto each press conference.

As for the INDU, it sold off along with the tech index. Dragging the INDU down were two of the old economy companies, GM and KO. KO sold off on news that it would acquire Quaker Oats(OAT) in what is expected to be a $16 bln deal. KO will get its hands on the Gatorade brand name and improve its position in the Beverage arena. This talk comes just weeks after OAT spurned a $13.7 bln offer from rival Pepsi(PEP). KO was down $4.88 to $56.56, while OAT closed at $95, up $4.69. GM fell today $4.31 and JPM lost $4.06, accounting for a large portion of the INDU's losses.

Technically, the INDU is in better shape than the NASDAQ in that it has put in a bottom at the sub-10000 level. The support at 10369 will likely be retested. Yet, tomorrow will probably have a relief rally given the oversold conditions. Watch to see if any rally can be sustained or if it turns into another bull trap.

Looking ahead, the markets are very oversold. Look for a relief rally tomorrow. Let's not forget that tomorrow will probably be the last day of decent volume, and therefore liquidity, before the Thanksgiving holiday. Traders will probably take off on Wednesday. This will take us clear until next week since Friday will only be a half day of trading. Hopefully by that time we will have a Presidential-Elect. Remember that trading opportunities lie on both the up and the downside, so any failure of a relief rally could very well provide put entries. At the same time, with the markets being closed for a day and a half this week, there will be some additional time decay. Use prudence when trading and be sure that you have stops in place if you're not glued to the monitor. Have a Happy Thanksgiving!

Matt Russ
Editor

Market Wrap Archives