Option Investor
Market Wrap

End of Week, Month, Quarter, Half and Bear Market?

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         WE 6-29          WE 6-22         WE 06-15          WE 6-08
DOW    10502.40 -102.19 10604.59 - 19.05 10623.64 -353.36  - 13.41
Nasdaq  2160.54 +125.72  2034.82 +  6.39  2028.43 -186.67  + 65.66
S&P-100  632.02 -  4.13   636.15 +  9.52   626.63 - 25.29  +  2.31
S&P-500 1224.38 -   .97  1225.35 + 10.99  1214.36 - 50.60  +  4.28
W5000  11407.15 + 94.70 11312.45 + 74.45 11238.00 -498.70  + 65.13
RUT      512.64 + 23.99   488.65 -  6.48   495.13 - 16.51  +  9.92
TRAN    2829.96 +153.47  2676.49 - 17.13  2693.62 -188.47  -  4.96
VIX       21.63 -   .87    22.50 -  3.83    26.33 +  4.92  -  2.55
Put/Call    .58              .69              .73              .54

Friday was the end of everything if you are a calendar watcher. The end of the week, month, quarter, the first half of the year and some analysts think it may have signaled the end of the bear market as well. Whoa! What happened to the worsening economy? The alignment of the calendar dates was too much for the Nasdaq and their systems crashed in late afternoon due to human error and Murphy's Law. One of the laws as we know it states that the worst possible outcome will always occur at the worst possible moment. The Russell shuffle, technical problems and calendar alignment all converged at the same point in time and you know the rest.

Friday was a record day on the Nasdaq, a record for problems! About 2:30 someone working on the Worldcom network over which the Selectnet and SOES systems operate, started a diagnostic program which took down the network and prevented it from coming back up. In an astounding move based on this being the month end, quarter end and Russell rebalancing day, the Nasdaq extended trading one hour until 5:PM ET. With huge market on close orders not able to be executed there were dozens of problems created. There was no immediate closing number on the Dow since Dow components MSFT and INTC were still trading. Futures markets at the Chicago Mercantile were forced to remain open to allow institutions to cover positions in case of a disaster. This unprecendented move by the Nasdaq was not without problems. There were limitations and ECNs got the bulk of the trades and market makers like Merrill Lynch were shut out. Basically it was a scene out of the three stooges or more like the keystone cops running in circles. You can bet there will be some burning of the midnight oil for weeks to come by the Nasdaq as well as the major dealers to decide what changes should be made to prevent this from happening in the future. With literally almost 500 million shares trading in the last hour on both major exchanges some analysts speculated that 250-300 million shares did not trade due to failed systems, the impact was in the billions. Consider what would have happened had the market been moving in a high rate of speed in one direction! Fortunately it was range bound and there was no major movement in individual stocks other than drugs.

Drugs bore the brunt of the market on close orders on the NYSE. Pfizer had more than 6.5 million shares to sell and lost almost $2 as the volume increased. Other drugs included AHP 2 mil to sell, ABT 2.5 mil, FRX 1 mil and the winner JNJ with almost 8 million shares to be sold. Funds really wanted out of drugs at the end of the quarter.

In the extended trading on the Nasdaq it also appeared that there were some funds that wanted out of tech as well. CSCO traded close to 10 million shares and fell from a 4:PM price of $19.31 to a low of $18.05. Dell dropped about -$3 on volume of almost 10 million shares but recovered about half before the numbers finally settled. JDSU, ORCL and INTC all traded lower on heavy volume, SUNW dropped slightly and MSFT bucked the trend rising +1.50 to a high of $73.50 on only about 4 million shares. Where it first looked like techs would be the winners as money poured out of drugs, the heavy volume and drops in techs in the hour of extended trading make a direct correlation less clear.

Part of the problem aggravating the Friday close was the absence of the major players. Trading desks staffed by second and third string traders were frantically trying to reach the decision makers by cell phone for instructions when unable to execute end of quarter trades. The vacations and long holiday weekends had already begun and nobody was prepared for this type of disaster.

The annual Russell shuffle made the problem worse with extremely high volumes of stocks to buy and sell by the index funds. Here are the links of all the stocks added and deleted from the Russell indexes.

http://www.russell.com/us/indexes/us/membership/recon_additions.asp
http://www.russell.com/us/indexes/us/membership/recon_deletions.asp

Warning season is almost over. Friday provided us with several but nothing market shaking. Parker Hanifin (Nyse:PH) said depressed shipments in North American markets would miss estimates by about ten cents. Agere, (Nyse:AGR.A), the semiconductor business recently spun off from Lucent announced on Friday that it would slash an additional 4000 jobs to cope with a downturn in the communications market. They would take a charge of $900 million to cover the cost of restructuring. They said the market is continuing to deteriorate and they would close the Madrid Spain plant to reduce costs. Dow Chemical also warned that demand was lower than expected and even though they had cut 4500 jobs they would miss earnings estimates.

The GE/HON deal continues to make news but the divorce is all but over. HON suggested in a letter to Jack Welch at GE that they would take up to $2 billion less to get the deal done and Jack sent back a tersely worded one sentence reply saying something like "you must be kidding, thanks anyway, Jack." Sounds like there is no love left in that engagement. HON lost -3.30 on the news and GE gained over $1 until the close when massive sell on close orders took it back to only fractionally positive for the day.

Cisco gained during the day on positive comments at a conference in Europe which gave indications that inventory surpluses were going away. The results of the excess inventory being sold would likely be seen in the coming quarter as new equipment moves into the sales cycle and cash received for the obsolete inventory shows up on the balance sheets. Banc of America said this would be market positive although the company and sector had a long road ahead of it.

AMD received an upgrade from JPM on Friday. Analyst Chen said that the company will continue to enjoy market share strength because of the trend toward value PCs. However looking out 12 months he believed that Intel has a fairly good chance of getting back market share momentum. He also suggested several of the recently massacred chip stocks, specifically ALTR and XLNX. He feels the programmable logic chip products that these companies produce have a good chance of a strong recovery. Intel lost fractionally on the day and AMD gained +1.47. Almost all the chip stocks gained ground led by VTSS +2.13 or 11% and BRCM +3.83 or +10%. Even PMCS and AMCC which warned this week continued to post strong gains. When semis gain on bad news can the bottom be far away? Check almost any chip chart and you will see strength building.

Several analysts feel that bullish sentiment is building due to the massive cost cutting and restructuring plans underway at almost all tech companies. When the economy returns they will return to profits quickly and be leaner and meaner going forward. Many big companies are trying to cut costs by forcing workers to take vacations on a company wide basis (furloughs) instead of cutting employees that are hard to replace when business returns. SUNW, AMAT, CPQ, NTAP have all closed buildings for a week or more to save money on salaries. Sending 1000's of employees home for a week saves millions of dollars and is easier on morale than layoffs. Carly Fiorina at HWP was told to take a 10% pay cut or 8 days of forced vacation. Let's see, that's a tough one.... She already turned down her $625,000 bonus for last year because her internal targets were not met. I would bet on her taking the pay cut instead of the 8 days because she is a strong leader who sets the example. The company car is another story. All the executive cars must be turned in, including hers, and they will be given to salesmen only. Come on Carly, can't you make a case that you are the best salesman HWP has? All HWP employees are being asked to "voluntarily" give up accrued vacation days or cut their pay -10%. I guess the ones who don't "volunteer" make the involuntary permanent layoff list? (just kidding)

Holiday week trading is a definite wildcard. The big gains in the Russell-2000 last week were due to speculators jumping in front of the index funds and the mid-year rebalancing. The Russell is only five points below resistance and once volume slows we could see some profit taking.

The artificial support under the market from the rebalancing should evaporate over the holiday week. Volume, assuming the exchanges can keep their systems working, should be weak at best. There could be some carry over on Monday from funds that were not able to get trades off at the close or from those which are a little less strict about timing. Nothing says they have to buy exactly on the close but most try to comply since there is no real management required of index funds.

What the rebalancing has done for us is create an artificial bullish sentiment among retail investors. They have seen the Nasdaq rally almost +150 points in the last five days and still remember the upside curbs on the Dow on Thursday. Retail sentiment is high and many feel all the bad news is already priced into the market. With warning season over and real earnings ahead it is actually possible that we could see more companies beat the street than previously thought. We actually ended up with less warnings this quarter than last even though we had a really bad start. Many companies may have given a warning just to be safe and then things did not turn out as bad as they thought. Should a positive string of earnings announcements actually occur this could continue to build a base under the Nasdaq.

If funds were really dumping "defensive" drugs at the close to take positions in a possible tech rally then that cash could be put to work next week. I have to confess, I am not a fan of possible summer rallies. They are normally short, shallow and very hard to trade. I would love to see the markets continue to move on the positive economic data, MSFT verdict, CSCO blue light sale or even Mars aligning with Venus but I will continue to be skeptical until the Nasdaq is over 2250 again. The Dow is sick and after a rate cut series of incredible speed and intensity it is not getting better. The relief rally on Thursday was wishful thinking by many and it failed four times in the 10600 range on Friday. The S&P has been drifting lower since mid-May and is stuck in a trading range just above support at 1200.

I looked at charts on all 400 stocks on my watch list and there were more stocks trending up than down. Semis, networkers, fiber, communications, biotech, finance. This is a positive event except that more than quite a few were approaching resistance. Many had excellent short term trends but were about to run into moving average resistance or down trend lines. Any rally will have to overcome these resistance points eventually but a summer rally has less chance of success than a fall rally.

I want to be bullish. I want to say load up the truck but I am still skeptical. The conditions are ripe to see an explosive rally but the timing is wrong. We have several major economic reports next week that could help fuel the fire or extinguish it. Personal Income/Spending and Construction Spending on Monday and Nonfarm payrolls on Friday with a holiday in between. The following week is end loaded with CPI, PPI, Retail Sales, Wholesale Inventories, Import/Export Prices. With no Fed meeting until late August investors will be watching these reports to see if the Fed is on the right track or still behind the curve.

Is the bear market over? Probably so but that does not mean Nasdaq 5000 is just around the corner. The bottom may be behind us but there may still be potholes in the road ahead. They say don't look a gift horse in the mouth so I will trade the rally as long as it holds. I will keep my stop losses tight until I am profitable and if the Dow falls under 10450 I will close and move to the sidelines on any Nasdaq weakness. Simple plan, now all I have to do is execute on it. I have found that hindsight is always 20:20. We could have made $$$ if only we had done X. Foresight is always colored by our bullish bias and is better than 20:20 until we execute the trade. Once in the trade we are blind. Emotion takes over and we are tossed about by the zigs and zags of every conceivable piece of information we overlooked before pulling the trigger. This is why we have to have a simple plan for each week and learn how follow that plan as long as it works and bail immediately when it turns against us. Of course all the professional traders reading this never have this problem. Your trades always go as planned for doubles and triples. If either of you are ever in Denver you can stop and buy me lunch and tell me other lies about fishing, hunting, golf, racing or such. You probably have some Boone & Crocket records, a string of unwitnessed hole in ones and could have driven in the Indy-500 if you wanted. Us mere mortals will just keep planning to trade a real rally when it appears and move to the sidelines if it fails.

Enter passively, exit aggressively!

Jim Brown
Editor

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