Option Investor
Market Wrap

Enter The Fed

Printer friendly version
        01-29-2001        High      Low     Volume Advance/Decline
DJIA    10702.20 + 42.20 10725.10 10612.50 1.03 bln   1970/1170
NASDAQ   2838.34 + 57.04  2840.02  2742.50 1.97 bln   2322/1572
S&P 100   711.55 +  2.44   712.56   705.71   totals   4292/2742
S&P 500  1364.17 +  9.22  1365.54  1350.36           61.0%/39.0%
RUS 2000  507.91 +  9.23   507.91   498.67
DJ TRANS 3001.33 + 45.14  3012.89  2955.01 
VIX        24.93 -  0.21    25.76    24.80
Put/Call Ratio      0.48

Enter The Fed

For the second time this month, John Chambers, CEO of Cisco Systems (NASDAQ:CSCO), warned of a possible slowdown in business. As a result of Chambers' guidance, Lehman Brothers lowered its revenue estimates and price target on shares of the leading networking gear maker this morning. Chambers attended the World Economic Forum over the weekend, held in Davos, Switzerland, where he made the remarks concerning a possible slowdown in business due to lower cap-ex spending by major telecom carriers. Earlier this month, Chambers presented to analysts at a tech conference and warned in a similar fashion.

The cautious comments from Chambers over the weekend were not all that surprising. After all, PMC Sierra (NASDAQ:PMCS), one of Cisco's key suppliers, guided lower during the company's conference call last Thursday evening. So it makes sense that if PMC Sierra is experience a slowdown, its largest customer in Cisco should also be experiencing a slowdown.

However, what was surprising in today's trading was the market's recently-acquired ability to shrug off bearish news. Amid the disconcerting tones of Chambers and Lehman Brothers this morning, the broader networking sector as measured by the AMEX Networking Index (NWX.X), was able to shrug off the bears and pair the majority of its earlier losses into the close of trading. In fact, several of Cisco's competitors finished with substantial gains, including shares of CIENA (NASDAQ:CIEN) and Redback Networks (NASDAQ:RBAK). Had Cisco warned a month or two ago, during the peak of the great bear market of 2000, its stock would have been taken apart. However, for shares of Cisco to finish only -$1.13 lower on a day its CEO effectively warned is a testament to the shift in market sentiment and psychology, which has everything to do with the Federal Reserve.

Alan Greenspan, and his soldiers at the FOMC, effectively killed the Bear of 2000 with their surprise rate cut earlier this month. And the bulls will turn to Greenspan again this week as the FOMC conveys for its two-day meeting, which begins tomorrow and culminates with an official announcement on interest rates Wednesday afternoon. At this point, a cut in rates is next to guaranteed. What's uncertain, however, is the magnitude of the expected rate cut. The majority of market participants and economists expect the Fed to cut by another 50 basis points. To emphasize that view, the fed funds futures are currently discounting a 90 percent chance of the Fed cutting by 50 basis points. With that said, if the Fed only moves by 25 basis points, I would expect the market to substantially sell-off on disappointment. But that's rather obvious.

What's not obvious is how to trade around a 50 basis point cut. Jim is of the belief that if the Fed does cut by 50 basis points the market will pullback on a "sell the news" thesis. Whereupon the dip can be bought. I tend to lean towards Jim's beliefs. However, I do think there exists the possibility of the market substantially rallying on the news of a 50 basis point cut. And I believe that for two reasons. The first reason is that the Fed announcement will take place on the last day of the month - a time when fund managers are particularly cognizant of end-of-the month performance reports. The second reason the market might rally on a 50 basis point cut is because of the large amount of cash sitting on the sidelines and the continued influx of cash into equity mutual funds. And after last year's drubbing, fund managers are very willing to put that cash to work in an attempt to NOT miss any big advance in the broader market averages.

In short, if the Fed only cuts by 25 basis points it'll probably be safe to hit some bids or enter some puts for the near-term disappointment reaction. However, if the 50 basis point cut is realized, it's going to be harder to game. And when uncertainty exists, the only thing any trader should employ is discipline. And if that means standing aside and waiting for an edge, so be it!

But for those unable to stand still (myself included) before the Fed's announcement Wednesday, we should address a few points. The Nasdaq Composite's (COMPX) impressive rebound this morning and subsequent advance above the 2800 level set the tech-heavy index to retest resistance at 2840. That level has been a site of resistance on three occasions in the past two weeks, with today's intraday high of 2840.02 marking the third test. If the COMPX clears 2840 early tomorrow, it might make a run for 2900, especially if the anticipatory Fed-related buying continues. As I've mentioned before, after 2900, it's a clear shot to 3000 for the COMPX. And if the COMPX breaks 2900, some of those fund managers I alluded to earlier may be induced to step in and buy.

If the COMPX is going to breakout above 2900 anytime soon, I feel that the Philadelphia Semi Index (SOX.X) will need to cooperate. The SOX.X acted very well in today's session despite the Cisco-related ramifications. The chip index has been consolidating for about two weeks, after staging a nice run in the first half of the month. The SOX.X has had trouble with resistance between roughly 725 and 735. If the SOX.X can hurdle that range of resistance, it will then have to clear major resistance at 750. And if that happens, the SOX.X should trade up to 800 and carry the COMPX well above 2900.

Along with the tech sector, traders might want to take a look at two very interest rate dependent sectors ahead of the FOMC announcement Wednesday. The two sectors I'm think of are the banks and brokers. Both groups of stocks staged a solid performance today, and both are poised to breakout above key resistance levels. Traders might consider zoning in on the S&P Banks Index (BIX.X) tomorrow and Wednesday morning as it approaches resistance at the 680 level. One stock in the group that has been acting well, hence its inclusion on the OI call list, is J.P. Morgan Chase (NYSE:JPM).

Like the bank index, the AMEX Securities Broker/Dealer Index (XBD.X) is approaching a key resistance level. Traders might want to pay attention to the XBD.X as it approaches the 650 level. And a stock in this group that has been acting well, hence the inclusion on the OI call list, is Goldman Sachs (NYSE:GS).

I'm by no means suggesting to our readers to recklessly enter into any of the sectors or individual issues I've mentioned this evening. My intentions, however, are to give our readers several variables to watch for ahead of the FOMC announcement on Wednesday. Furthermore, the tech and finance sectors typically dictate the direction of the broader market averages. And if traders have a handle on those two sectors the plan of attack should be made much easier.

So now that I've given our readers a few metrics to monitor before the Fed announcement, I must reiterate my stance on trading at the actual time of the announcement. When the Fed releases its move in interest rates, liquidity will be very thin, at best! That said, it'll probably be best to stand aside after the initial reaction to the news and wait for the real trend to show itself - whether it be up or down.

Looking beyond the Fed announcement this week (it's hard to do that, I know) I see very encouraging signs. The merger and acquisition space is beginning to pick up. Just this morning, Ariba (NASDAQ:ARBA) agreed to pay a hefty premium for Agile Software (NASDAQ:AGIL) - unfortunately and coincidentally, OI was on the wrong side of that announcement. Also, Maxim Integrated (NASDAQ:MXIM) said it would buy Dallas Semiconductor (NASDAQ:DS). There's nothing like a little consolidation to get the tech bulls running!

Furthermore, the equity and debt markets have welcomed new issues with open arms. Most recently, Peet's Coffee (NASDAQ: PEET) debuted last week with a warm reception. The stock was offered in the secondary market for $8.13 - it closed at $16.13 today. Not too bad for a coffee maker!

Finally, and most importantly, the Fed is on the move. If Greenspan delivers the expected 50 basis point cut this Wednesday and promises subsequent cuts, the broader market averages could be set to rally BIG! Reflecting on the action in Cisco Systems today, it sure is nice to have the Fed back on the bulls' side.

Make sure to tune in Tuesday evening to get Jim's take on the tape and how to trade around the Fed's announcement the following day (Wednesday).

Eric Utley
Assistant Editor

Market Wrap Archives