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Bulls Beguiled By Bonds

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        07-09-2001        High      Low     Volume Advance/Decline
DJIA    10299.40 + 46.72 10323.11 10222.24 1.04 bln   1589/1476	
NASDAQ   2026.71 + 22.55  2038.17  2000.08 1.39 bln   2027/1717
S&P 100   618.29 +  5.34   620.19   612.86   totals   3616/3193
S&P 500  1198.78 +  8.19  1201.76  1189.75           53.1%/46.9%
RUS 2000  485.98 +  2.72   487.24   480.98
DJ TRANS 2774.71 + 25.79  2775.35  2740.20
VIX        24.55 -  0.42    25.84    24.42
Put/Call Ratio      0.63

Bulls Beguiled By Bonds

Does the answer to the conundrum lie in the bond market? Perhaps it lies within the hallowed halls of corporate America, which continue to crumble. Either way, the broader market averages appear to be approaching a pivotal action point.

The yield of the 30-year Treasury Bond (TYX.X) has spent the last two weeks creeping higher, which means bond market participants have been selling bonds. The same yield action has been observed across the gamut of treasuries, including the 5- and 10-year Notes. Perhaps the rise in yield over the last two weeks can be attributed to weak economic data, such as the horrid payrolls report last Friday. Or, perhaps that capital in the bond market is ready to work its way into equities in a big way. I have the feeling we'll find out, either way, in the next two weeks.

Bond market participants are often smarter than those in equities, and their actions often lead the broader market averages. For example, the buying of bonds (Read: Falling Yields) abated on March 22, about nine days prior to the Nasdaq Composite (COMPX) hitting bottom on April 4 and subsequently advancing sharply, following the lead of yields. Conversely, the yield of the 30-year Bond peaked (Read: Falling Prices) on May 15, about six days prior to the COMPX tracing its relative high at 2328 on May 22 and subsequently following yields lower. Let me make it clear, that in the short-term, rising yields are good for stocks and falling yields are bad for stocks. Supply and demand, baby, it's that simple.

Back to the 30-year yield...The TYX advanced last week while the broader markets sold-off rather sharply. Yields reached as high as 57.71 (5.77%), falling just short of a very pivotal resistance point at 58.00. This level is significant for several reasons, including its positioning on the point & figure chart, as well as the retracement levels that the ever-astute Jeff Bailey has pointed out. Without getting too complicated, however, let me make this simple and actionable. Bullish traders will want to see the TYX break above the 58.00 level, which could unleash stocks. Bearish traders, on the other hand, will look for the TYX to continue weakening from current levels, which could lead to a lack of bids for stocks.

The TYX is not the only major market average that is hovering near a pivotal point. The COMPX continues to toy with the 2000 psychological support level with reckless regularity. Its day low Monday: 2000.08. If the COMPX breaks below 2000 in the coming sessions, however, keep in mind that our significant support level at 1975 lies just below. Therefore, bearish traders can use 1975 as confirmation when shorting stocks.

In terms of resistance, our all-too-familiar 2060 level is about 30 points above the COMPX's current levels. (By the way, and not by coincidence, the COMPX opened last Friday at the 2060 level and subsequently sank.) Therefore, bullish traders at current levels might keep a close watch on 2060 as confirmation.

The Nasdaq-100 (NDX.X) confirmed twice Monday that the 1710 retracement level would serve as near-term resistance. It bumped against that level twice Monday, before fading into the close. Here again with the NDX and 1710, bullish traders and bearish traders alike can monitor this level to assess short-term market risk and conviction. (It's worth while to mention that Microsoft (NASDAQ:MSFT) currently sits on a very critical support level around $65.25 and accounts for roughly 11 percent of the Nasdaq-100.)

Like the COMPX and NDX, the S&P 500 (SPX.X) is hovering around a most critical level at 1200. Recall last week that we were monitoring support around 1210, which had propped the S&P up prior to last Friday's steep sell-off that dragged the broad market index below its 50 percent retracement level at 1200. The 1200 level, once support, now serves as resistance, which was clearly evident Monday noting the SPX's intraday high of 1201. Below the S&P's relative low at 1190, I don't see much support on the daily chart until the 1170 - 1180 range. (Worth mentioning concerning the S&P is that its largest component in General Electric (NYSE:GE) recently broke down in bearish fashion and traded heavily Monday.)

Meanwhile, the Dow Jones Industrial Average (INDU) is working off its previously overbought condition and is now approaching historically oversold conditions. Furthermore, the Dow bounced from its 50 percent retracement level last Friday and again Monday, which lies around the 10235 are. (Random Observation: It's uncanny how these retracement brackets work!)

Should we witness a breakdown in the Dow below its retracement level, the index should eventually work its way down to the psychologically significant 10,000 level, which by coincidence is reinforced by the 61.8 percent retracement level. That site would mark a solid exit point for those traders short Dow stocks, such as OI's current Boeing (NYSE:BA) put play.

On the upside, the Dow had some trouble settling above the 10,300 level Monday but could work its way up to 10,400 this week provided the right catalyst. Thereafter, it's 10,500 in terms of resistance

With our technical levels set forth, we should revisit the idea laid out in my introduction. It feels as if the broader market averages are setting up for a big move in one direction or another, based upon the behavior of the 30-year yield and that fact that the major indices are trading near pivotal levels. The obvious variable we're missing is the direction in which the broader market averages will break.

I believe much of that variable is predicated upon second-quarter earnings, which begin in earnest this week. But judging by the oversold conditions in the Dow and Nasdaq, the spike higher in the CBOE Market Volatility Index (VIX.X) and bond yields on the verge of breaking higher, I would suggest that the probability favors an advance over a decline. The difficulty, however, is the timing and execution of any trade to the upside. We can be correct about the direction, but a poor entry at the wrong time can run any trade a foul.

The only major flaw that I can find in my bullish thesis is that the S&P 500 is sitting at mid-field in terms of risk versus reward. Or, in other words, overbought versus oversold. And, after all, IT is the broad market index so this flaw is worth mentioning. Furthermore, it's certainly acceptable that both the Dow and Nasdaq can grow more oversold and pullback from current levels.

But I believe that if we keep a close watch on bond yields and levels across the broader market averages, we can therefore find profits in this market. Although my bias is slanted to the bullish side, bond yields could start falling and support levels can start giving away. Therefore, traders need to remain flexible in this market and willing to trade both sides. On a final strategy-related note, the current risk versus reward dynamic may lend to entering long plays near support levels (i.e. COMPX at 2000), while entering short plays on breakdowns below support levels (i.e. Dow below 10235).

In earnings news, Corning (NYSE:GLW) - the optical cable maker - warned after the bell that it would fall short of estimates, cut jobs and close plants - the usual mantra. The stock shed about 50 cents in after hours. This warning was not unexpected and fits nicely into the trouble in the tech/telecom related complex. Its impact is likely to be minimal, but keep in mind the market's reception of that Marconi (NASDAQ:MONI) blow-up last week.

This week kicks off second-quarter earnings season, and on deck Tuesday include DoubleClick (NASDAQ:DCLK) and Rational Software (NASDAQ:RATL), followed by Motorola (NYSE:MOT) and Yahoo (NASDAQ:YHOO) Wednesday, and Juniper Networks (NASDAQ:JNPR) Thursday.

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Eric Utley
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