The markets on Friday had trouble picking a direction but after trading on both sides of the line the major indexes finished the day with decent gains. The S&P and the Dow both finished near the highs of the day. The bulls were encouraged but the bears were not convinced. Volume was decent and advances beat declines by a 2:1 margin on both the Nasdaq and the NYSE. A collective sigh of relief was heard by all at the closing bell. Volatility collapsed with the VIX falling back under 35 and Abbey Cohen was pounding the table again about the techs being undervalued. What else could we ask for?
That was obviously a trick question. We could ask for more volume, a stronger Nasdaq, cancellation of the coming earnings warning season and a BMW in every garage. About the only one of those items we are guaranteed to get is the stronger volume. The question of course is whether it will be up volume or down volume. Next week is the start of the three week earnings warning period where those companies who have not confessed for this quarter will do the dirty deed. You may be thinking that there are none left that have not warned but in reality there are quite a few. We will get to suffer through the anxiety of waiting and guessing. Will they or won't they and will the market care? IBM for instance has not yet warned and after holding $88 all week turned in a big gain, +4.58, on Friday. The reason for the bounce was the announcement of some new server hardware. With analysts dueling over the possibility of an IBM warning I was surprised by the reaction to the news.
One of the other factors that will impact next weeks trading is the end of the quarter window dressing by mutual funds. The million dollar question is what stocks will they want to add to their portfolios and which ones will they drop to appear more attractive to their clients. Do they want tech names like CSCO, INTC, ORCL, HWP and IBM or blue chip names like MRK, GE, MMM and WMT. Are financials like JPM, C, BAC to be avoided like the plague because of the worry over recession loan worries? Obviously if we had the answer to these questions we could profit handsomely over the next week.
Financials were strong on Friday after a 10 day drop. This could simply be an oversold bounce or it could be the start of fund buying with the expectations of continued Fed rate cuts. If the recession fears continue, the lure of cheaper interest rates will not be able to overpower the worry about loan losses. Still with financial equity prices dropping back to levels of 6-12 months ago they are a compelling value to funds with billions of dollars to spend. In any real market rally the financial stocks are expected to lead and institutional traders will be looking at this sector for rally confirmation.
Another small indication that we could see some buying next week was the bond market on Friday. Investors sold bonds to raise cash. Billions of dollars had been parked in bonds during the tech crash over the last few months. Some of this money started flowing backwards on Friday. Defensive stocks like Philip Morris and drug stocks like PFE and MRK have also been selling off as institutions raised cash to put back into the tech sector if the rally proves to have legs. Some funds were forced to sell winners to raise cash because recent redemptions had put a drain on their available funds.
The Nasdaq has performed admirably for the last three days considering the Dow's action. Since the end of the Fed meeting on Tuesday to Thursday's low the Dow fell almost -900 points. This is a huge drop even in modern day terms. The close Friday was +402 points off the Thursday low. The Nasdaq in this same period is only -40 points below Tuesday's high. This was the first positive week for the Nasdaq in the last seven weeks and the Dow was dying. This is a good sign. A reader emailed me to note the extreme volume on the QQQ. Over 95 million shares traded on Friday which was about twice the average volume from early February. However there have been five days with over 100 million in the last month and Thursday traded over 129 million shares. The most important fact in this scenario to me was that the QQQ closed unchanged. A dead heat between the shorts and the longs. I would have preferred to see some upside pressure but it failed to appear. Don't get me wrong, compared to the last seven weeks I will take a stand off every time.
The Dow Diamonds had their highest volume day ever on Thursday with more than double their average volume. Several analysts are now calling Thursday the capitulation day everyone wanted while others are holding their breath hoping there is not a bigger pothole in our future. Some of the selling pressure Friday was prompted by margin calls from Thursday's drop. The 570 new lows on the Nasdaq finally pushed many investors to the breaking point which is the sign of a near bottom. Many of those investors were either forced to close tech positions of did so out of disgust only to see those same stocks rise on Friday.
Hope is also riding on the sector that is seen as a leading indicator for economic cycles. The semiconductor sector continued to post gains even after Motorola said they were going to cut jobs again. Rambus was by far the biggest gainer with a +63% rise from last Fridays close under $16. Not everything was rosy however with AMCC, PMCS and BRCM giving back their gains from the short covering on Thursday. Part of the semiconductor rebound was based on the Micron Electronics claim that PC component inventory problems were over and orders were starting to return. This claim is being met with skepticism by some. Part of the news released on Friday revealed that the PC business that Micron claimed was bottoming is now being sold for an undisclosed amount. The company is essentially discontinuing operations and chose to provide no data about the sale. The businesses they are selling had sales of about $300 million and lost about -$159 million. They also announced they were merging with Interland Inc, a web hosting company. The combined company will be called Interland and be based in Atlanta. Nothing was said about what would happen to the 2,700 employees in Idaho.
So where is that yellow brick road? Let's review the facts. Investors sold bonds on Friday. Why? To raise cash for stocks? The Nasdaq has performed very well over the last three days in spite of the Dow. Market internals were good on Friday with a 2:1 ratio in favor of advancers. Dead cat bounce? Maybe. Next week is the last week of the quarter and funds are faced with a tougher than normal window dressing event. Tougher because there are no leaders to throw money into. CSCO & SUNW, still weak. IP, AA, DD still weak. CIEN, JDSU, EMLX still weak. XOM, TX, CHV still weak. What is a fund to do? Where is the least risk for the three week earnings warning period that begins on Monday? Techs and financials are so beaten up that the downside risk is minimal. This is where I would expect buying.
Still there is no conviction in the markets. High volume on the buy side should be causing an increase in prices. However, as I mentioned before there was 94 million QQQ shares traded and they closed unchanged. There are still sellers in this market. The sellers may be decreasing however and this basing period is actually the start of a decent bottom. The commercial S&P traders are quietly closing their short positions that had been at historically high levels. For two weeks now those positions have been shrinking. This could be a sign that the bottom on the S&P has been reached. Bear in mind however that just because the commercial traders are taking a profit does not mean they have called a bottom. They have no crystal ball that picks turning points exactly. They do however tend to make these decisions in the general area of a market turning point. Considering the huge paper profits they have booked over the last six months, wouldn't you want to convert that to cash as well? If the market is close to a bottom they need that cash to go long.
I had several emails claiming I was too bearish last week. If I gave that impression I am sorry. I also get emails from readers that thank me for suggesting they stay out after the market drops for several days later. There is no way I can please everyone and it is not my job to predict market direction. It is my job to try and paint the picture to the best of my ability and let the reader make his own investment decisions. We see analysts on CNBC/CNN every day that are wrong and have been wrong for years. We see others that phrase their comments in so much double speak that you are never sure exactly what they said. We see others that change directions weekly. I don't want you to look back on my market wrap the next day and say "Wow, Jim really hit it" or "Jim really blew it." I want you to make your investment decisions based on the facts as we know them, good or bad, positive or negative. I have been saying "don't open long term call positions" on the Nasdaq for the last 700 hundred points. Trading bounces yes but not buy and hold positions. I have people sending me emails for the last six weeks telling me to wake up and saying they were buying every dip and were fully invested for the rally that was starting any day. I wonder if they are still investors?
Every day is a new day in the markets. That is why they show the change for the day on the Nasdaq/Dow and not the change for the week or month. Imagine turning on the news on Monday morning and seeing the Dow at -987 at the open instead of zero. (That is the change for the month of March) It would definitely change the way you looked at the markets. My closing point here is we need to trade the ACTUAL trend next week, not the trend we want to see. There may be a difference. Dick Arms, Market Technician Award winner and market analyst for 35 years, (ArmsInsider.com) says the TRIN indicator hit numbers last week that have only been hit SIX times in the 32 years he has been tracking this data. Each time was a huge buying opportunity followed by a strong rally. Ralph Bloch has used the same indicator twice in the last two weeks to forecast a market bottom on CNBC. Abbey Joseph Cohen was on CNBC yet again on Friday saying the market was severely oversold. She has had so much face time on CNBC in the last two weeks they need to put her on the payroll. Does market bottom calls by major market names mean Monday will be a +500 point day? Of course not. This creates our bias on market direction but does nothing to the actual market.
We need to start each day just like the market averages. Flat. Zero. No bias. Then execute the trades we planned ONLY if the market is going our way. I know I am not the only person who ever planned a bullish play only to have the market go south at the open. Instead of waiting for the market to go my way I simply convinced myself that I was getting a better entry point and played anyway. Until we learn this lesson we are doomed to failure. This is why I "suggest" long call buyers not open new positions until the Nasdaq closes over resistance at 2000. The strategy is simple and requires no degree in market science to implement. A simple red light/green light, go - no go, indicator. Long over 2000, short or flat under 2000. Temporary bounces from oversold conditions have cost dip buyers billions since the January high. Using this very simple benchmark strategy to decide when to go long will save you money.
Market sentiment appears to be bullish and building. Most of this is based on expectations that the Fed will make another rate cut in the next three weeks, the same three weeks that correspond with earnings warning season. There is a strong slate of economic reports over the next two weeks culminating with the non-farm payrolls on Friday April-6th. If the Fed is going to cut again the smart money is betting they will wait until the payroll numbers are known. This sets the market up for failure as well. As each day goes by without a cut and the more earnings warnings we are forced to endure then the greater the chance of another market event. The last three years produced a severe market drop in mid-April corresponding with the actual earnings releases. Institutional investors with long term memories will remember these drops. This memory coupled with the hundreds of expected warnings could keep the lid on any rally. Pick your plays with optimism but execute them ONLY if the market agrees!
Trade smart, enter passively, exit aggressively!