Option Investor
Market Wrap

A fitting end to trading in 2000.

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       WE 12-29         WE 12-22         WE 12-15          WE 12-8
DOW    10786.85 +151.29 10635.56 +200.60 10434.96 -277.95  +339.37
Nasdaq  2470.52 - 46.50  2517.02 -136.25  2653.27 -264.16  +272.14
S&P-100  686.45 +  2.22   684.23 -  5.25   689.48 - 37.58  + 31.07
S&P-500 1320.28 + 14.33  1305.95 -  6.20  1312.15 - 57.74  + 54.66
W5000  12167.00 +185.50 11981.50 -112.40 12093.90 -572.60  +629.10
RUT      483.53 + 20.54   462.99 +  4.96   458.03 - 21.04  + 22.23
TRAN    2946.60 + 96.67  2849.93 +151.25  2698.68 -181.27  +116.80
VIX       30.23 -  1.29    31.52 +   .32    31.20 +  5.07  -  5.46
Put/Call    .67              .61              .94              .59

In a fitting end to trading for 2000 investors threw in the towel at the close and went home in disgust. After struggling all day both major indexes saw selling accelerate as the closing bell approached and huge order imbalances loomed over the markets. The imbalances turned out to be pretty evenly mixed and not a major factor but the selling was still widespread with the exception of biotechs. The tech leaders still up strongly for the year suffered the most with investors trying to take some profits in the same year as losses for tax purposes. JNPR, BEAS, SDLI, BRCM, NTAP, RBAK, JPM all up strongly for the year fell at the close but the volume was light. JNPR -12, BEAS -8, SDLI -9, BRCM -8, NTAP -8. Simply put, investors with losses in other stocks took profits while they could do it tax free.

The year the bubble burst was the name being used by the talking heads on Friday. It fit well with the Nasdaq dropping -39% for the year and wiping out all the gains from the speculative bubble started in 1999. The Nasdaq went into the record books with the biggest loss for a major market index since 1937. The Nasdaq drop took -$3.3 trillion dollars out of investor accounts since Jan-1st. This could have paid off 58% of the national debt and this negative wealth effect is being felt in all areas of the economy.

The Dow finished down -6% and was the first yearly loss for the Dow in ten years. The S&P-500 finished down -10% and the Russell 2000 finished the year with a -4% loss. The transports only lost -1% and the Dow Utilities were up +45%. This was the first time since 1990 that the Dow, Nasdaq and S&P all finished negative for the year. Still the only index most traders care about is the Nasdaq and the frustration Friday was so bad it was like a cloud over traders everywhere.

The lack of a material year end rally and tax selling right up to the bell, soured hopes for a rousing start next week. Traders went home worried that when the earnings warnings start to fly next week the Nasdaq may retest the December lows. What a way to start the New Year! This of course is simply speculation and may be the pessimism we need to close out this sell off.

Traders now fear that the expected January rate cut is now priced into the market with the +300 point Nasdaq bounce and now we will move into a wait and see mode. With earnings dropping to near negative numbers there is nothing to power a January rally. First Call said the earnings estimates for the first quarter have now fallen to only +4% from +28% in the same quarter this year. JPM Chase said on Friday that they were expecting only a +1.8% GDP growth for all of 2001, down from over +5% in 2000. JPM Chase is forecasting a hard landing but no recession AS LONG AS the Fed starts cutting rates in January. This is not my gloom and doom forecast, I am only reporting what happened on Friday.

There was further confirmation of the softening economy with the release of the Help Wanted Index which fell to levels not seen since 1993. Lack of job advertisements indicate that jobs are dropping and unemployment is rising. The Non-Farm Payroll Report will be out next Friday and investors will be watching with great interest. This is a key factor in the Fed's decision to cut rates and traders are hoping for a number that will cause the Fed to cut rates BEFORE the next FOMC meeting on Jan-30th. This could be a pivot point in the market if the report is Fed friendly. In the 1991 recession the Fed cut rates four times between meetings and did so when the payroll numbers were announced.

For a day that was supposed to be fairly quiet before the long weekend the volume was huge. The Nasdaq managed almost 2.5 billion shares and the NYSE over 1 billion. Advance/declines were dead even on both exchanges but of the 300 stocks I follow on a daily basis only 37 were positive. I view that as positive because it means money was flowing into stocks that are not market leaders. Near the close there was a flood of money into low priced biotech stocks. Almost every biotech under $20 experienced a significant spike of several dollars. This was obviously window dressing by funds trying to show diversification out of techs on their year end statements.

The Nasdaq has been having trouble for two days now because of weakness in the big cap leaders. CSCO pulled back to within $2 of its 52-week low of $35.63. Same with MSFT at $42. Dell fell within .75 of its low at $16.25. SUNW closed down -$5 from the $32 bounce of last Monday and only $1 off its 52-week low. INTC did close at a new 52-week low of $30.13 after trading under $30 intraday. Even ORCL which had been holding up well after a strong earnings report earlier in the month also fell almost -$3 from the intraday high of almost $32. Nothing was sacred with JDSU slipping another -2.44 at the close. This weakness in the big caps is especially disturbing to traders. The big caps should hold up best since they are the most liquid. When funds decide to move back into the markets the big caps will be consume a large amount of their cash. They can move in and out with relative ease should their entry point prove wrong. As long as big caps are showing weakness these funds will stay on the sidelines. Sure there is nibbling around the tech edges but nobody is seeing money flow into the big techs yet.

The good news is still the speed at which this can all change. There is literally hundreds of billions in cash sitting on the sidelines. Once the starting gun is heard this money will be invested and stocks will go up. My view is that all the bad news is priced into the market already. 4% earnings, 1.8% GDP, how much worse can it get short of a real economic disaster? Do you think the Fed will let it get much worse before they act aggressively? I doubt it. They are already behind the curve and are likely to try and catch up in the first quarter. Stocks would react strongly to several back to back rate cuts. The biggest bad news already priced in is the earnings. Many feel that with Reg-FD in force companies have been warning more than before in order to protect themselves from shareholder lawsuits. Many of these warnings and lowered estimates have been more severe than necessary. This has set the stage for a lot of upside surprises. Upside surprises will produce higher earnings estimates for the next quarter and the cycle will start over.

As investors going forward into 2001 we should be very excited. At 2400 the Nasdaq is back at June 1999 levels and we have the opportunity to buy stocks at a very reasonable price. The huge speculative excesses from the Internet bubble have been eliminated. We have had some huge moves in almost every stock on the Nasdaq and nobody can complain that there was not any trading opportunities. Volatility was huge. In 1999 there were only 10 days that the Nasdaq traded in over a 100 point range. In 2000 there were 160 days of triple digit ranges. As traders anything that does not bankrupt us makes us stronger. After the market moves in 2000 we should be Olympic class traders. In 1998/1999 you could pick almost any Nasdaq stock, buy calls and have a 75% chance of making money. Many investors felt they were market gurus based on their returns during this period. After 2000 many of these "experts" are no longer investors, having busted out trying to apply bull market strategies in a bear market.

If you are reading this you have not busted out. You have not given up. You should be excited about 2001 and you are making plans to be even more successful than you were in 1998/1999. Is it possible? You bet! You are at the right place at the right time with the right plan. Will it be easy? Not hardly. The Nasdaq ran up +100% from 1999 lows on the Internet bubble. That bubble is over just like all the other bubbles before it. The next driving force has yet to appear. Maybe it will be biotechs, maybe a new wave of Internet appliances like smarter PDAs or smaller portable computers. Whatever it is we need to be ready to capitalize on it. Will the Nasdaq hit 5000 again in 2001? Most doubt it. Historically it takes 2-3 years to recover old highs after a major tech wreck. Most estimates for Nasdaq 2001 follow historical norms and fall into the +25% to +30% gains. This would put the index in the 3100-3400 range. After 5000 even 3400 sounds really boring but did investors become millionaires in the past with even smaller moves? You bet!

What I think we will see in 2001 is a return to a stock pickers market. Those investors that spend the time and effort to find the right stocks at the right time will profit handsomely. Those that simply throw money at the old favorites again will have mixed results. Another by product of a more sedate market will be lower option premiums. The volatility of 2000 placed option premiums on fast moving stocks into the range of margin rates instead of option premiums. Paying $25 for a current month call $15 out of the money is obscene. Many of you remember premiums from say 1996/97 when you could buy calls at or in the money on decent stocks for well under $10. That does not mean you made less money unless of course you were writing covered calls.

I am looking forward to 2001. That is an understatement. I am REALLY looking forward to 2001! A stock pickers market is a gold mine for traders who know how to find good plays and have the time to do the research. For those who don't have the time to do their own research we provide an invaluable team of over 35 researchers which scan thousands of stocks daily for our suite of investment newsletters. There is no reason for any investor to NOT profit handsomely in 2001. Sure there will be losers as well as winners but active traders should easily beat the market substantially. Experienced option traders routinely place in the top 10% of all investors. The leverage is the key. We don't need the $40-$50-$60 moves of 2000 to double and triple our investments. Actually we do our best investing in options that move from $3 to $6, or $5 to $10, not from $25 to $50.

We should not be depressed because the Nasdaq lost -39% in 2000. We should not complain if we get another flood of earnings warnings next week. The market may make the rules but it is how we play the game that counts. We should focus on market cycles, stock cycles, entry points, exit points, money management and diversification. We should practice patience above all else. We should enter trades carefully and only after examining all the factors. We should exit trades aggressively and take profits whenever our targets are hit. We should not be greedy. Above all we should be thankful for the opportunity to be option traders. Many millions of investors are denied the opportunity we take as a right. Whether by account size, experience, broker limitations or risk profile, millions of traders only look into our world and wish. Option traders are the elite and our returns make others pale by comparison. Now shake off that frustration from mistakes made in 2000 and make your first new years resolution not to repeat those same mistakes in 2001. Regardless of your account size today, $10,000, $100,000 or over $1 million, and regardless of where the Nasdaq ends 2001, you have the capability of doubling or tripling those funds next year. Resolve now to 1) set a goal, 2) plan a strategy to hit that goal, 3) execute that plan aggressively.

After that pep talk you would expect me to tell you that the mother of all rallies was going to breakout on Tuesday morning. Sorry, it may not happen. There will be tax selling next week. Surprised? But 2000 is over? Yes, but investors with profits in stocks they do not want to own any longer will put off selling until next week to shift profits and taxes into the new tax year. Hopefully they can sell the stocks they feel have topped out for a profit, invest that profit in hot new candidates and pay their taxes out of profits on the new stocks. It is the eternal circle. Investors have been doing this for years and it is a never ending loop. Can we capitalize on this trend? You bet! The Nasdaq dropped -481 points from the Jan-3rd high to the Jan-7th low this year. But remember the Nasdaq was also up +1560 points in the previous 73 days. With the Nasdaq down -39% for the year at the close on Friday, a drop of the same magnitude is highly unlikely.

So now we are back to the buyer/seller tug of war again. Buyers on the sidelines waiting for a bottom will be looking for entry points next week. Sellers will be hoping that prices hold until they can bail out. The only sure thing is another week of volatility as investors restructure their portfolios to begin the New Year. For the markets the Jobs report on Friday could be the starters gun for a rally on the following Monday. Our task is to line up the stocks we want to play and look for signs next week that a support level for those stocks has been reached. Stocks already beaten severely should not suffer much and may rally right off the bat. Stocks up strongly for 2000, even though they may be well off their highs, will be likely targets for dip buying. An example would be JNPR which started 2000 at $57 and although well off its yearly high of $244 at $126 it is still up over 100% for the year. CIEN started 2000 at $28 and closed the year at $81 for almost a 200% profit. Stocks like this could see tax selling. I would buy either once the selling stops.

To recap I would not be as concerned about market direction on Tuesday as I would be concerned about my trading strategy for the year that begins on Tuesday. Make your first three new years resolutions now to 1) set a goal, 2) plan a strategy to hit that goal, 3) execute that plan aggressively. Once you have a plan you are ready to take the trades the market gives you. Rest assured there will be plenty of trades in 2001! It will be a Happy New Year!

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Trade smart, choose your entry points carefully!

Jim Brown

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