Option Investor
Market Wrap

Rate Rally on Hold.

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        WE 4-20          WE 4-12           WE 4-6          WE 3-30
DOW    10579.85 +452.91 10126.94 +335.85  9791.09 - 87.69  +374.00
Nasdaq  2163.41 +201.98  1961.43 +241.07  1720.36 -119.90  - 88.42
S&P-100  643.66 + 35.89   607.77 + 30.42   577.35 - 28.23  + 24.87
S&P-500 1242.98 + 60.41  1182.57 + 54.14  1128.43 - 53.74  + 42.34
W5000  11409.77 +557.12 10852.65 +534.25 10318.40 -327.45  +170.55
RUT      466.71 + 11.69   455.02 + 20.36   434.66 - 15.87  +  7.26
TRAN    2861.30 + 94.71  2766.59 + 79.56  2687.03 - 84.33  +126.02
VIX       29.01 -  1.27    30.28 -  6.48    36.76 +  2.94  -  1.09
Put/Call    .48              .91              .76              .52

Dow down -113, Nasdaq -18, who cares! After the week we just had the drop on Friday was pocket change. It is hard to believe we began the week with an enormous warning from CSCO which closed the week at a five week high of $19.15. The Twilight Zone has definitely returned to Wall Street and the bulls are in control.

Cisco started the week by saying what we already knew. They were writing off $2.5 billion in obsolete inventory. The massive inventory problem which would not go away was finally faced by the communications giant. The fears of a lights out event on the Nasdaq prompted by a massive CSCO warning, simply failed to appear and investors rejoiced. Add to this extremely strong market event the fact that Intel was seeing PC demand stabilizing and the euphoria was complete, almost. Greenspan was so excited over the gains in his stock portfolio he decided to play Santa Claus in April and throw in a rate cut for added excitement.

The bears, who have been laughing all the way to the bank for months and rubbing our noses in trap after trap, were not only dropped for steep losses but verbally embarrassed at every turn. Take a deep breath, lean back and savor the good times. You deserve it for suffering through the unending series of bear trap rallies and dashed hopes. For watching your portfolio shrink and your 401K turn into a 201k while every bull predicted a rebound every day. Take a deep breath and cinch that seat belt up yet again. There maybe another pothole in your future.

The earnings parade ended the week with a whimper. Nokia was the big news beating the street with over a $1 billion profit but lowering estimates slightly for the next quarter. Sales rose +35% last quarter despite the weak market and sales for the coming quarter were still expected to increase +25% to +30%. Not a bad quarter for the cell phone business if you are Nokia. If you are Ericsson or Motorola things look grim. Ericsson posted a bigger than expected loss and said they were going to lay off another 12,000 workers. This brings the total layoffs to 22,000 or one-fifth of its work force. There is a slow down but quality companies who execute well are still being rewarded.

Sector rotation was moving at full speed on Friday on negative drug and biotech news. Those stocks that had been gaining ground as the tech stocks plummeted suddenly attracted more sellers than buyers as tech stocks exploded with more than +25% gains. The selling picked up speed on Friday as news of slowing drug sales hit Merck. MRK said profits rose +11% but admitted that sales of its top five drugs was slowing. MRK warned that sales next qtr would not match the current period and could be half of last years rate. Several analysts downgraded the stock. Boston Scientific helped sink the biotechs when they stopped trials of a new stent because of "unacceptable cardiac events" connected with the device. The Biotech Index is up +25% since April-4th.

Proving that investor sentiment has changed, Brocade gained +5.44 after warning for the second time in the quarter. After saying that earnings would be less than half of the current estimates they also said their competitive position has "never been stronger." They said they would continue to hire engineers and sales staff on the expectation that customer purchases would pick up in the second half of the year. PMCS which had warned with their earnings announcement also gained another +3.57 and BRCM, which also warned with earnings, gained +2.61. The new market sentiment is "ALL the bad news is priced in and the Fed is still a player." With those two factors on everybody's mind the downside would appear limited. Is it?

The traders on the floor of the NYSE think all the volume this week was institutions covering positions. Several hedge funds, which were very short, were hurt severely by the triple whammy of no CSCO crash, good Intel earnings and a surprise rate cut. It has been reported that orders to buy S&P stocks went from a quiet tens of thousands of shares bid to over a million shares in less than 60 seconds on Wednesday. Art Cashin attributes this to institutional traders with pre-programmed trading scenarios which were hit by the surprise rate cut. Just like when stocks are falling, stops are hit triggering new selling which triggers more stops, etc. When stocks soar unexpectedly stop losses on shorts are hit which trigger new buys which triggers new stops, etc. Add to this the buy programs that were pre-programmed by funds wanting to buy into any rally and you got a domino like computer generated event.

The profit taking on Friday provided a cooling off period going into the weekend and a chance for traders to re-evaluate the market direction and start to cleanup the disasters in their portfolios. After spending three days reacting to price events they will reset all their stops and reprogram their computers based on their market analysis. They may decide the market is now oversold and try to re-establish their short positions going into the summer. They may decide the tide has turned and bite the bullet on Monday by closing losing short positions. We do not know what next week will bring but I think everyone will agree that a +1200 point gain in 12 trading days on the Dow is extreme. Likewise a +550 point gain on the Nasdaq could see some further profit taking.

There is not much in market moving events on the calendar for next week with Consumer Confidence on Tuesday, Durable Goods on Wednesday, Employment Cost Index on Thursday and Sentiment on Friday. None of these are majors assuming there is not a blowout in either direction. The Fed just cut rates so another cut is not in the cards. Stocks will be left to rise and fall on fundamentals alone and an entirely new set of earnings will provide the explosive power.

With the earnings from the biggest tech movers out of the way or already known as in IBM, SUNW, MSFT, INTC, CSCO, GTW and others, the possibility of major tech disappointments is limited. There are however hundreds of smaller earnings reports that will continue to provide sentiment and direction. I stated on Thursday that I was going to wait until next week to open any new long positions and my plans have not changed. The pullback on Friday was insignificant even though the volume was decent. At 2.5 bil on the Nasdaq and 1.3 bil on the NYSE, I was encouraged that there was not a bigger drop. Still, like I said above, portfolio managers will spend the weekend deciding if the move was for real or just a mammoth short squeeze. If it was just a squeeze then they will take profits and sell the rally. If they see weakness they will definitely sell it. This brings up the catch-22. There are buyers on the sidelines waiting for a pullback because they missed the move. The war will be waged between these buyers and sellers who think it was just a short squeeze. The winners will decide the future market direction. Historically the post April earnings direction is down so we want to root for the buyers to win decisively. Wednesday should be direction day. Traders will have squared positions and formed a bias for the next market cycle. Wednesday is when these positions will be tested. The strength of their resolve will determine our fate.

Trade smart, enter passively, exit aggressively!

Jim Brown

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