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Market Wrap

The Battle Between Window Dressing and Tax-Loss Selling

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        12-27-2000        High      Low     Volume Advance/Decline
DJIA    10803.20 +110.80 10828.90 10645.00 1.06 bln   2121/ 849
NASDAQ   2539.35 + 45.83  2539.52  2450.22 2.00 bln   2195/1817
S&P 100   691.18 +  4.18   693.38   683.78   totals   4316/2666
S&P 500  1328.92 + 13.73  1332.03  1310.96           61.8%/38.2%
RUS 2000  479.30 + 12.67   479.30   463.42
DJ TRANS 2899.61 + 60.02  2899.83  2828.08
VIX        32.31 -  0.23    33.41    31.95
Put/Call Ratio      0.72

The Battle Between Window Dressing and Tax-Loss Selling

These two year-end phenomena have been in full effect the past two weeks as institutions and retail investors reflect on a difficult year. Window dressing involves mutual funds and hedge funds purchasing strong performing stocks to make the books look better and generally creates an upside bias. Its counterpart is tax-loss selling in which investors dump some of their losers to take the loss against taxable gains for the year 2000. Put both of these market activities together and you have yourself a recipe for volatility.

If you look at the tape today, all indicators point to a lack of selling and accumulation in many issues. The INDU has been hitting on all cylinders for the past four sessions, covering an amazing 500 points in that time. Technically speaking, the INDU is much healthier than the NASDAQ after putting in a convincing bottom on October 18th. On that day, the INDU broke below 10000 and briefly touched 9654. Since then, it has consolidated and many components were sought after as defensive plays, including drug stocks and cyclicals. BA, DD, KO, JNJ, MMM, MRK, PG, MO, IP and UTX have had fantastic runs as investor fled the tech sector. Naturally, fund managers will chase these names into the end of the year to "dress" their books. Notice there's no four lettered symbols. In fact, a year ago most investors wouldn't have even thought about adding these issues to their portfolios. What a year it has been.

As a result of these INDU components performance and their attractiveness, the index has sustained a 12% rally since bottoming in October. Looking at the chart below, we can see that the INDU has rallied itself right into resistance at 10800. Yet, today the INDU broke the trend of lower highs in December. In addition, last Thursday's bounce from 10300 establishes a solid double bottom support for the INDU. It may very well be due for some profit taking but with these aforementioned forces in the market, strong performing issues may continue to have momentum into the end of the year(this Friday). This will likely drive the INDU in the customary Santa Claus rally, and it may test resistance at 11000. Watch some of these stocks for possible trading opportunities in the next two days; MO, C, and UTX are current call plays.

Just as the window dressing enhances the winners for the year, tax-loss selling perpetuates downward momentum in many of the fallen angels of the NASDAQ. It certainly has been a rough year for the tech sector, and much technical damage has been inflicted. Tax-loss selling creates volatility in the market because of the downside pressure. An example of this can be seen in the VIX.X, the CBOE Volatility Index, which spiked up to 37.72 last Thursday when the NASDAQ dipped below 2300 briefly. Strong selling like this causes investors' fears to increase, as well as demand for downside protection, i.e. buying puts. Market makers don't want to sell a ton of puts to the public if the market is going to tank, but as their job title states, they must make markets. The result is higher volatility priced into those puts. Higher premium in return for taking a higher risk.

If you look at the NASDAQ chart since that encounter with sub-2300 levels, it has managed a 250 point rally, albeit over the holiday season. This time of year is typically characterized by lighter volume, but volume has been nothing to scoff at. Last Friday was a strong 2+ bln share day and today was just shy of 2 bln. So don't discount this week's action. But, don't forget that those short players had a heck of a year and are probably enjoying extended vacations. Looking at the technical picture below, the NASDAQ has sold off considerably since hitting 3000 in the second week of December. Given the recovery in the NASDAQ over the past three sessions, much of the tax-loss selling appears to have been done already by institutions. The NASDAQ will find a challenge with 2600, yet it has some room to recover with the downtrend line near 2800. On an intraday basis, the NASDAQ bounced nicely from support at 2450 this morning and staged a rally to close at the day high. Tomorrow's bias is positive. Set up for entries on pullbacks to support and watch for continued buying interest. Technically oversold, the NASDAQ could be setting up for a nice move in early January with expectations of a rate cut and money market funds becoming flush with IRA contributions and Holiday bonuses.

Most of today's high profile movers indeed were tech stocks. AOL and TWX came under selling pressure as news circulated that the FCC is still reviewing the merger, basically delaying the closing of the deal until next year. The company and investors were hoping the merger was completed in 2000 for tax and accounting purposes. As a result, traders sold both stocks with conviction: AOL(-2.75), TWX(-4.75).

The disaster du jour was Network Associates(NETA). The company warned last night that it will report a loss compared to expectations of a 31 cent per share profit. They also expect a dramatic shortfall in revenues from $250 mln to only $55-65 mln in the 4th quarter. To make matters worse, the CEO and COO will step down effective Friday, and the CFO will also step down once a new one is appointed. The company attributes the poor performance to the slowing economy and not the general competitiveness of its products. NETA, an antivirus and internet security company, lost 61% today to close at $4.50.

Strength today was find in the SOX.X, which added almost 5%. Having been sold off dramatically with the NASDAQ, the Semi stocks showed some life today, indicating some buyers nibbling on the beaten down sector. AMCC led the charge with a 12% gain of $8. RFMD, an OI call play picked last Friday, also had a 12% gain today, adding $3.25 to $29. Watch for continued interest in the Semi sector to help buoy the NASDAQ.

Looking forward, the markets look poised to finish the week relatively well, all things considered. The INDU looks very strong as window dressing bids hot stocks higher. While the heaviest of tax-loss selling appears to be over, be aware that Friday will likely be a busy day for year-end positioning. Don't write off the possibility of both retail and institutional investors dumping some of those losers at the last minute. Or adding to those winners. There will be plenty of trading opportunities in the next two days so take a look at the OI play lists and narrow down your choices. Tomorrow morning is Consumer Confidence, expected to be 128. This could move the market early on. So choose your entry points well and best of luck in 2001.

Matt Russ

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