Option Investor
Market Wrap

Finally the shorts covered!

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        WE 2-23          WE 2-16           WE 2-9           WE 2-2
DOW    10441.90 -357.92 10799.82 + 18.37 10781.45 - 99.10  +204.12
Nasdaq  2262.51 -162.87  2425.38 - 45.59  2470.97 - 91.09  -120.80
S&P-100  642.64 - 32.88   675.42 -  6.93   682.35 - 11.97  -  3.58
S&P-500 1245.86 - 55.67  1301.53 - 13.23  1314.76 - 17.77  -  5.48
W5000  11500.70 -528.90 12029.60 - 94.71 12124.31 -169.65  - 77.20
RUT      477.45 - 21.83   499.28 +  2.23   497.05 -  5.84  +  2.82
TRAN    2930.07 - 64.71  2994.78 - 18.64  3013.42 - 11.82  +136.57
VIX       30.34 +  5.26    25.08 -   .07    25.15 +  1.06  -   .39
Put/Call    .71              .89              .73              .60

It was not pretty but we will take everything we can get. At 2:PM Bear Stearns chief economist, Wayne Angell, a former Fed governor, told his staff that the Fed would cut rates by -.50% in the first three days of next week. He gave it better than a 60% chance of happening. Immediately buyers came into the market. Not in volume but most stocks started showing immediate improvement. Once the bounce was definitely underway there were several attempts to sell into the rally but they all failed. Once it was apparent that the rally was going to stick the shorts ran for cover. Most charts show huge gains in the last 30 minutes that are characteristic of short covering, not investor buying. There was a rumor that the Fed was going to cut over the weekend to avoid the irrational exuberance and +300 point gains like we got on Jan-3rd.

I said on Thursday night, "what other bad news can we get that is not already priced into the market?" Okay, how about Motorola and Qualcomm? I give up! Nyse:MOT warned before the opening bell that they could post a loss for the first time in 15 years. That went over really well! The company said it would fall short of estimates and blamed a significant slowdown in orders across all its business lines. Not only kiss off MOT but Nyse:NOK, Nasdaq:ERICY, and Nasdaq:QCOM as guilty by association.

Qualcomm dropped -$17 intraday to $50.13 after it took advantage of the Motorola warning and drop to make an announcement of their own. QCOM said there would be a delay in some third generation deployment in Europe until 2004-2005. European telecommunications operators had forecast that 3G technology would be ready by 2002. The $50.13 low was it's lowest since Oct-1999. Later in the session the company reiterated that demand for the current 2000-CDMA 3G chips was still in line with previous estimates. QCOM regained a substantial portion of the intraday loss and closed the day down only -5.13 at $61.81. Most analysts with a microphone downgraded QCOM but MSDW upgraded the stock to a strong buy from outperform. He said the huge drop in the stock provided an entry point for investors since the new 3G product was not really a factor in current estimates. Good call! I like it when an analyst goes against the trend and draws a line in the sand. $60 had been strong support since last May and many investors made a quick, safe $10 on the drop today.

Nyse:IBM was the biggest loser on the Dow with a drop of -4.90. The culprit was the Nasdaq:SUNW earnings warning. With a drop of -50% in earnings estimates for the largest U.S. server producer, analysts immediately realized that IBM with $88 billion in revenues, and the number one server seller worldwide, was not going to come through the recession unscathed. The broad based drop in computer sales will hit IBM as well. IBM may not drop estimates -50% like SUNW but it will warn analysts say. IBM was one of the few stocks that had held the high ground through the recent weakness but over the last three days IBM has lost almost -$15.

As I said before the catalyst for today's bounce was a note from Wayne Angell at Bear Stearns. He gave a credible voice to what others were wishing more than believing. The flood of negative sentiment had moved from stocks to a Fed that was behind the curve but did not have the guts to admit it. The almost unanimous call for another rate cut quick has escalated into a 60% chance of an intra-meeting cut next week. Critics claim the Fed can't cut for fear the markets will not react and then have egg on their face. I said several times this is totally flawed. The Fed could come right back and cut again and again if needed. They have just gotten started and could cut another 2.0% if needed to jump start the economy and the markets. We are only three weeks away from the Fed meeting so any intra-meeting cut has to come this week to have any real impact. A further cut at the meeting and we would be on an interest rate roll!

A reason given for part of the drop this week was Turkey. The Lira was devalued and there were several rumors that a couple hedge funds were trapped in currency trades. Memories of Long Term Capital and how close we came to a banking system failure were quickly revisited. The Lira was trading at 674,000 to one U.S. dollar. That would make any $40,000 dollar American car about a 26 billion lira investment. Give me a Grand Wagoneer and a two ton truck please. You would need the truck to carry your cash from store to store. A cart with $150 of groceries is worth about a billion lira. Interest rates were running around 6000%. That means it cost 60 lira to borrow 1 lira. So explain to me why a hedge fund would even remotely consider gambling in this currency? I doubt we will see any truth to those rumors. I would however believe it possible that there was some involvement in the South American currencies and possible repercussions from there. Chile and Argentina both suffered fluctuations from the Turkey problems.

The short covering rally may have come too late for many investors. Margin calls are up and as of Thursday were running better than twice the normal rate. With the number of stocks still down on Friday that statistic is probably even worse. Liquidations of stock in lieu of adding cash to already strapped accounts will likely run into Monday and maybe Tuesday. The offset to this is investors that have been waiting for an entry point.

I have been dying to be bullish for a week. The key word here is "dying." What a depressing week. I am going to take one of my tag lines of "don't buy too soon" and have it etched on my monitor in big block letters. I have been telling investors to wait for the bounce for two weeks and then I bought the dip instead. Have you ever opened a position only to look back the next day and wonder what you were thinking? I am sure that never happened to anyone but me. I mean we were very oversold and everybody just knew the SUNW news was already priced in, right? Fortunately Wayne Angell came to our rescue. Or did he? Does anybody think Alan Greenspan is a stubborn guy? Do you think maybe he took offense at a former Fed governor making a public call like that and stealing the Fed Head's thunder? What do you think will happen to the markets now if there is no rate cut by the close on Wednesday as forecasted by Angell? You got it, retest the lows again.

So Greenspan is in a box again. Cut rates the first three days and it looks like somebody else is pulling your strings. Don't cut rates and the market tanks again. Catch 22. I am glad it is his job and not mine. Another analyst was saying today that Alan can't cut rates just to bail out the stocks market. The Fed has said on numerous occasions that equity prices have no impact on Fed policy. Alan however has taken great pains to talk down the last couple of bubbles as we all know. I believe the "stock prices are not important" mantra is bull. Greenspan has said that consumer confidence is very important to the health of the economy. There are 66 million brokerage accounts in the U.S. plus untold millions of fund/retirement accounts. It would probably not be out of line to say more than half of the U.S. population has a direct interest in the stock market.

What happens to consumer confidence when they get their statements at the end of each month? I will give you a clue, it is not going up. Investors are not taking their profits out to buy new houses, cars, boats or retirement property. Plans to do those things are on hold and investors are frustrated and scared. I think the stock market is the prime mover for consumer confidence. Now, do you really think Alan does not care about stock prices? How much of the budget surplus last year was funded by windfall profits from the 1999 Internet bubble? The Nasdaq alone rose over $3 trillion. Not everybody sold but many people sold over and over. Do the math using your capital gains rate or even worse your personal tax rate. I will save you the trouble, it was billions. Now how much do you think the last 12 months of the bear market have contributed to the surplus? I would think significantly less. In my humble opinion Alan actually cares a lot about equity prices. Now, if you were Greenspan would you bite the bullet and cut in the next three days anyway and make Angell a hero or would you risk waiting until Thursday or Friday and risk the market falling again?

Make no mistake about it. The rally on Friday afternoon was a short covering rally only. I saw no evidence of investors rushing into stocks because they were excited about earnings. This was simply a technical short covering. Traders who had been short all week and seeing a good possibility of a rate cut early next week, took profits and closed positions. The rumor of a weekend rate cut was discounted on the surface but many short traders probably thought twice about closing just in case. Here we are again at a crucial point in the markets. The Nasdaq has now closed three days straight within 20 points of 2250. (2269, 2246, 2262) Resistance is at 2280-2300. Volume on Friday, in spite of the rally, was lighter than the previous down day. No confirmation of the rally came from any internals. Decliners beat advancers and down volume beat up volume 2:1. Sound like a real rally to you?

While I may sound bearish I don't want to alarm you. I am just reporting the facts as I see them. My bias is still for the Nasdaq to move up on an oversold rally soon. The 2250 level has been broken but basically is still a price magnet. However there are still quite a few analysts saying we have not seen the wash out yet. They are forecasting 2050 as the next support level with some calling for sub 2000 numbers soon. There will always be bears and if we fell to 1500 they would be saying 1200. The truth will not be known until it happens. How much lower can it go? There is $4 trillion currently invested in stock funds. There is over $2 trillion parked in money market funds. This does not count idle cash in brokerage accounts already. If investors felt the urge to invest in cheap stocks there is more than enough money available to power a monster rally. Luring this cash off the sidelines is the problem.

The reality for Monday is a war between the bulls and the bears. Bears will be cautious with a possible rate cut announcement in every news bulletin. This may give the bulls an edge and allow them to take back some ground. Remember, the market hates uncertainty and we will be up to our ears in it. There will be more earnings warnings and more downgrades. The only positive catalyst we have to look forward to is the rate cut. The economic calendar is loaded with problems for the week. Tuesday has Durable Goods, New Home Sales and Consumer Confidence. Wednesday we get the Q4 GDP and Chicago PMI. Thursday is Personal Income and Spending, Construction Spending and NAPM. Friday is the all important Michigan Sentiment again. Even worse than the economic reports is the Greenspan calendar. Wednesday he testifies on Monetary Policy before the House Financial Services Committee at 9:30AM and Friday he testifies on Current Fiscal Issues before the House Budget Committee at 10:AM. Those two appearances could have a block buster impact on the markets. Another Bear Stearns analyst said that if Alan does not cut rates before his testimony then the markets will assume the Fed has backed off their aggressive stance and probably head even lower. A cheerful thought!

I would caution investors about rushing into the market next week unless your plan is to trade it. You must also decide before going long if you want to be long during the Greenspan speeches. Those have proven hazardous in the past. Remember we only want to trade in a stable environment and in the direction of the trend and right now the trend is still down. If we can get back over 2300 and hold it then join the party. This goes for conservative traders also. Because we are so oversold there is the possibility of a couple hundred point bounce on good news. To repeat, the plan I am suggesting for long call traders is to go long over 2300 and stay flat under 2300. Let the market make the decision for you. Take the stress out of trading by planning your trades and sticking to the plan.

Trade smart, enter passively, exit aggressively!

Jim Brown

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