Option Investor
Market Wrap

Ugly, really ugly?

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        03-20-2001          High     Low    Volume Advance/Decline
DJIA     9720.80 - 238.30 10019.90 9718.20 1.23 bln   1301/1759	
NASDAQ   1857.48 -  93.72  2004.09 1922.78 2.15 bln   1374/2257
S&P 100   581.93 -  15.74     4.06  581.65   totals   2675/4016
S&P 500  1142.62 -  28.20  1180.56 1142.19           40.0%/60.0%
RUS 2000  444.48 -   6.79   456.17  444.36 
DJ TRANS 2675.86 -   5.80  2717.02 2672.44 
VIX        35.04 +   1.69    36.18   32.62
Put/Call Ratio       0.61

Ugly, really ugly?

Let me clarify something. They CUT rates by half a point! C-U-T ! The market reacted like the Fed raised rates instead. Traders sold into the news like they expected a -1.50 cut instead of -.50. Was it something they said? Maybe, "global weakness", "may last for some time." What ever the reason the remaining bulls were shredded into hamburger by the bears as strong volume knocked -300 points off the Dow's high and pushed both major indexes to new lows.

What happened to the three cuts and a bump theory? Three big cuts at that! 12 of the last 13 times the Fed has cut rates three times the market has rallied and moved upward. Could we be looking at that rare occasion where the markets continue down? It is too soon to tell but things are not looking good based on today's action.

The Dow's high today was 10028, 310 points above the close. This -300 point drop occurred in only an hour and forty minutes after the Fed announcement. The Dow closed at 9718 and at the lowest level since March of 1999. Volume on the NYSE was high at 1.23 million shares. The Nasdaq faired no better dropping -117 points from its high and closing at 1859 or the lowest point since Nov-13th 1998. Volume was strong at 2 billion shares but not excessive.

The big news of course was the Fed rate cut and the language they used in the announcement. The big key to me was the global reference. With Japan continuing to tank and Korea showing weakness for the first time in seven years, it appears that the U.S. is not the only weak spot. If our weakness ripples out to the rest of the world through a lack of orders for components and materials then what we get back as these other economies weaken in turn may be worse. The Fed acknowledged that "excess capacity may last for some time" meaning the end is not yet in sight. The stated reason for the cut was a "weak economy risk" but they also said the drop in the stock market was impacting investments into the business community. Now, it does not take a very high IQ to understand the need to conserve cash if your cash cow brokerage account from two years ago is now a cash drain every time you have to cover a losing position. Companies have seen investment income disappear and asset balances drop as much as -75%. The question of "do we upgrade equipment on a the assembly line" turns into "if I layoff those employees how much can I get for that excess equipment?" This dramatic change in the business climate shows that the Fed over reacted in their rate hikes last year and they are behind the curve now in trying to correct the problem.

The echo of the announcement had not even died before investors started calling for another intra-meeting rate cut of -.50% This may be wishful thinking but the next meeting is not until May-15th so there is plenty of time for economic reports to impact the Fed thinking. The meetings after that are June-26th and Aug-21st. The Fed may be forced to react early if the global economy continues to weaken.

Warnings, downgrades, layoffs and bad news continued to flow today with Oracle announcing a 5% cut in staff. Solectron warned that earnings would drop by more than half and took a charge for cutting 8200 jobs. PWAV warned that it would post a loss when analysts were expecting a +.06 cent gain. There were many more but you have heard the same sad story many times already this month. Ten companies warned after the bell tonight. Is there more ahead? You bet! Some said a Fed rate cut of 75 basis points would have jump started the market and sent buyers into a frenzy. Wrong! At this point there is no reason to buy stocks. With every major company saying that there is "zero visibility" going forward there is nothing that will make investors race into the fog with no idea of what is lurking there. Until we get to a level where all the bad news is priced in, we will fall farther.

Former Fed governor, Lyle Gramley, said he would bet "big money" that the Fed was far from done but he could give no reason to buy stocks yet. Earnings are over, the indexes are setting new lows and the worst six months of the year are ahead. Sound like a buying opportunity to you? Actually it is for aggressive investors. The old adage, "buy stocks when nobody wants them" would certainly apply today. NOBODY wants stocks today. Shorts are increasing positions and there is no end in sight. That is a buy signal for long term buy and holders but nobody is taking the bait. CSCO 19, SUNW 17.50, INTC 24.63, ORCL 14.50, JDSU 21.50, there is a limit to how far these companies can drop but still no takers. The shorts are obviously looking for single digits on these stocks and now that the Dow is well under 10,000 and the Nasdaq well under 2000 we could see that soon. Analysts are scratching their heads trying to find new support levels.

You know we are grasping at straws when the only hope of a rally is now a short covering rally just prior to income tax day. While I am sure there will be some covering to pay the tax man, I doubt it will be material. Most traders lost money last year and wish they had a tax bill instead of a tax loss. However many institutional investors will wait until after the 15th simply to avoid the possibility of further drops.

Capitulation? Not yet! With that label being applied to every major drop for the last week you can see it was not true. If you think this through then there is more red ink in our future. The S&P Tech index is at a 29 month low and still falling. Every stock that has not warned is being shorted aggressively in hopes that they will warn. The put/call ratio is anemic at only .61 and is not showing any signs of serious worry. Only 36% of investors are currently bearish compared to 31% still bullish. Definitely not a bottom indicator. The VIX however is hovering in the 33-36 range which is normally a buy range. Those of us who remember last April remember numbers well over 40. With many investors conditioned to move out of tech stocks over the summer months we could see even higher VIX numbers soon.

When I left to speak at the John Dessauer cruise seminar on Mar-8th the Dow closed at 10846. Today it closed at 9718. That is an -1128 point drop in only a week and there are no buyers in sight. Over -1100 points and no buyers, does that worry anybody? It does me. Is the day-trading era over? Are mutual funds withdrawals increasing? Are we going back to historical PE ratios of 7-12? I think these are the more serious questions we need to worry about, not the difference between 50-75 points. As investors we need to play the trend and not try and buy this dip. Rate sensitive stocks are not reacting to the cuts. Fundamentals are now coming back into vogue and until the market sees the fog clearing they are not going to buy stocks. Investors want to see earnings and positive forecasts before committing what little money they have left.

I relate this to a gambler who walks up to a table with say $2000 and promptly loses half. His bets then decrease, his aggressiveness declines or he quits to wait for another day. If he loses half again he either quits or goes into serious conservation mode. His $50 bet decreases to $25 and then $10 and then $5 as his bankroll decreases. A trader/gambler with only 10%-20% of their beginning investment can no longer capitalize on positive trends. They are beaten mentally. They are too cautious and even bets with good odds are ignored or only taken in minimum amounts.

As traders we need to sit this one out. The risk/reward ratio for puts is no longer in our favor. Stocks that have fallen from $175-$125-$100 to $15-$20 no longer drop in big increments. Calls on these stocks still bleed premium every day. If the trend is still down but stocks are trading in the teens then it is safer to wait. There may be an explosive rally in our future but you would hate to be in puts when it happened. You don't want to be in calls either since it could be weeks or months before it comes. We wait, conserve our cash and look for strong stocks that appear to be putting in bottoms while the market is still tanking. When the market does rebound you are then eager and prepared to go back into battle. Sometimes the best play is no play at all.

It is also entirely possible that the afternoon drop today was simply a "sell the news event" and cooler heads will prevail tomorrow. Don't be fooled by a morning bounce. We have sold off so severely that there is plenty of room above us. We can wait for a trend to appear before committing capital. There have been a dozen or so bear trap rallies in the current down trend. Each were ok for agile traders but costly for the average investor. Nasdaq 2050 is the next level where we would suggest conservative traders should take a long position. After trying for over a week to break out over 2025 we have to recognize that to be significant resistance. Wait for the break out before going long. Aggressive investors will of course be looking for that next bottom and throwing money at anything that resembles a bounce. No amount of caution will change their mind. When was the last time the Fed cut rates three time in a row by 50 points and the market failed to react? This should cause you to rethink any long positions. Investors on the Nasdaq have lost over $4 trillion in the last 12 months. How much more will it take before the carnage is over? Hamburger anyone? There is a world of difference between eating hamburger and being hamburger. You choose.

Enter passively, exit aggressively!

Jim Brown

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