Long, Hot Summer Day
The major market averages slipped at the open Thursday, subsequently taking out the key support levels we've been monitoring this week. What was more disconcerting about Thursday's decline was that volume measurably increased. About 1.2 billion shares accompanied the slide on the New York Stock Exchange (NYSE), while roughly 1.7 billion shares were exchanged en route to the Nasdaq's decline.
The current market environment might be best described as fragile. And if you agree with that premise, then you might also agree that uncertainty is an element the market can currently do without. But news from across the Atlantic this morning, which had been surfacing earlier in the week, injected a fair amount of uncertainty into the market. The European Commission (EC) had been scrutinizing the proposed merger between General Electric (NYSE:GE) and Honeywell (NYSE:HON), and that scrutiny surfaced in a bad way Thursday. Sources close to the deal quoted GE officials as saying they were "not optimistic" on the completion of the merger and that the demands for divestitures from the EC were "extraordinary."
Needless to say, the reports from Europe this morning cast a shadow of doubt over the impending merger, which caused shares of the to-be-acquired Honeywell to plunge more than $5. What's more, prior to General Electric's bid, United Technologies (NYSE:UTX) had been looking to acquire Honeywell. And as the reports sailed across the Atlantic Thursday morning, arbitrageurs began to sell shares of United Tech as the expectation for the company to step in and buy Honeywell grew. Shares of United Tech finished more than $3 lower in the wake of the arbitrage-related selling. One bright note is that the arbitrageurs who sold United Tech short were forced to cover their similar short positions in General Electric, which is currently on the OIN call list. Nevertheless, all three stocks are components of the Dow Jones Industrial Average (INDU) and the losses in shares of Honeywell and United Tech were responsible for the lion's share of its losses Thursday.
In addition to the General Electric-Honeywell uncertainty, several downgrades in the tech sector pressured the Nasdaq Composite (COMPX). Most notably, Merrill Lynch (NYSE:MER) analysts cut their rating on optical cable maker Corning (NYSE:GLW) along with reducing earnings estimates.
The aforementioned events caused the Nasdaq to open right at our critical 2100 level Thursday morning. Following the expiry of amateur hour, the COMPX took a turn for the worse and traded lower throughout the day. On both the daily chart below and the point & figure chart, I don't see much significant support for the COMPX until the psychological level of 2000.
Readers of this column will note on the chart below that I've laid a different retracement bracket over the COMPX. I've simply retraced the COMPX's advance in early April in an attempt to better measure risk/reward and determine new support and resistance levels following the COMPX's break and subsequent close below 2100. The first level I'd like to point out is 2060, which is the 38.2 percent retracement level from the COMPX's trough at 1619 to its peak around 2330. The COMPX bounced around this level Thursday afternoon, but later fell and closed below it. As such, 2060 may become an area of resistance in the near-term and traders with a bearish stance may look to short weak Nasdaq stocks on any advance up to that level. Of course, the BIG resistance level now becomes 2100, but 2060 may serve that purpose in the very short-term. On the downside, our new retracement bracket yields support around 1975, which is close enough to the 2000 level to add credence.
Unless traders already got short on the break below 2100 Thursday morning, I feel that it may be best to stand on the sidelines for the time being because at its current levels, the COMPX is rather difficult to gauge from a purely technical perspective. Perhaps the best risk/reward in the short-term would be to short any advance up to 2060 or 2100. But, momentum-based strategies might be rather difficult to manage in light of the COMPX's current levels.
I'd like to point out one more quick observation I made this afternoon concerning the Nasdaq. The Nasdaq-100 (NDX.X), which is a measure of the largest 100 companies in the Nasdaq Stock Market by market capitalization and also the source of the QQQs (AMEX:QQQ), stopped right at a significant retracement level Thursday afternoon. The chart below illustrates a similar retracement we viewed on the COMPX above: an ascending retracement, from trough to peak. You'll note that the Nasdaq- 100 stopped right at its 50 percent retracement at roughly 1710, which is also the site of its gap higher in early April. This development is both interesting and not by any stretch of the imagination a coincidence. Of course, if the Nasdaq-100 were to break below 1710 in the very short-term, it may offer some shorting opportunities in weak Nasdaq stocks. But, then again, a bounce from this level is certainly possible. Stay tuned!!!
The risk/reward dynamic in the Dow is currently very similar to the Nasdaq's. The Dow broke below our key 10,800 support level en route to closing right around 10,700. The latter level did act as price magnet near the close of trading Thursday, so traders might watch that area closely in the near-term. But aside from 10,700, the Dow doesn't have real support until 10,500. Here again with the Dow, however, it's in between key levels which can make it rather difficult to discern an edge and gauge risk/reward.
The observation we made concerning the S&P 500 (SPX.X) in Wednesday's Market Wrap proved to be a telling indicator for the broader market. Readers might recall that the S&P broke below its ascending neckline (support) Wednesday, which resulted in the broad market index taking out yet another support level at 1225 Thursday. On the downside, the S&P now has support right around 1200, which like 2000 for the COMPX, is psychologically significant.
The news after the bell Thursday echoed the price action in the broader markets. JDS Uniphase (NASDAQ:JDSU) issued a horrific earnings warning. I won't go into too much detail about JDS Uniphase's warning, but I will highlight the fact the company guided down to a loss of 5 to 8 cents per share for its June quarter, while previous estimates had the company pegged to earn 5 cents. That's bad! JDS Uniphase was one of the stocks we highlighted last Sunday as a candidate to warn, and I can assure you a lot of other market participants were expecting the same. So the impact of JDS Uniphase's warning Friday remains a variable. Although shares of JDS were down about $1.50 in the after hours session following its warning, the Nasdaq futures were slightly higher???
Yes, you read that correctly. Futures were higher at time of writing. Even though the major market averages closed below their respective critical support levels, and JDS warned, there's the distinct possibility that the market attracts buyers Friday for several reasons. First, the expiration of equity options, index options and futures contracts - also known as triple witching - takes place Friday. This phenomenon can impact the market in wild ways, especially in light of the volatility this week. Speaking of volatility, the CBOE Market Volatility Index (VIX.X) continued along its near-parabolic path higher Thursday, closing at 26.20. The VIX has jumped by 14 percent in just the last two days, which signals fear is on the rise. Finally, point & figure aficionados should make note that the Bullish Percent reading for the Nasdaq-100 is quickly approaching OVERSOLD levels.
In short, keep in mind that the market tries to confound the largest number of participants at any given time. And judging by, among other indicators, the spike in the PUT/CALL ratio Thursday, a lot more participants are bearish. (The PUT/CALL ratio measures the number of puts versus calls and jumped more than 40 percent Thursday to 0.73.) Having said all of that, there exists a possibility that the market bounces Friday, which should concern the trader types among our readers. (Remember what happened Tuesday following Nokia's (NYSE:NOK) warning...)
Insofar as investor types are concerned, Thursday's action is very, very difficult to digest. Although my sense is that the broader market averages will fall a bit further over the near- or intermediate-term, the bigger picture is beginning to make sense. Let's keep in mind that the Nasdaq staged one of its greatest one-month rallies ever during April. Those gains need to be digested, and they currently are. But, what's the likelihood that the markets trade sideways, or slightly lower through the summer, the economic recovery in the U.S. is pushed back to late 2001 or early 2002, which sets the stage for a prolonged, sustained rally into the fall? From where I sit, that's the bigger picture.
Both investor and trader types can benefit from our online seminar series. We have a great line-up for the latter-half of June, including presentations by Jim Brown, our all-star analyst, Jeff Bailey, appearances by our combos gurus, Mark and Ray, and a few appearances by yours truly.
As always, questions are more than welcome: Contact Support