Option Investor
Market Wrap

I Want To Believe, I Really Do!

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        WE 8-24          WE 8-17          WE 8-10           WE 8-3
DOW    10423.17 +182.39 10240.78 -175.47 10416.25 - 96.53  + 96.11
Nasdaq  1916.80 + 49.79  1867.01 - 89.24  1956.47 -109.86  + 36.60
S&P-100  606.71 + 12.84   593.87 - 17.54   611.41 - 12.24  +  3.39
S&P-500 1184.93 + 22.96  1161.97 - 28.19  1190.16 - 24.19  +  8.42
W5000  10948.41 +188.32 10760.09 -234.36 10994.45 -248.49  + 76.94
RUT      480.81 +  5.16   475.65 +   .13   475.52 - 11.63  +  2.13
TRAN    2854.39 + 29.74  2824.65 - 36.12  2860.77 - 53.25  +  4.14
VIX       22.29 -  4.45    26.74 +  3.93    22.81 +   .42  -  2.34
VXN       47.70 -  4.32    52.02 +  3.50    48.52
TRIN        .70             2.67             1.03
TICK        351              201
Put/Call    .56             1.07              .72              .76 

Thank you Cisco for the early Christmas present! Let's just hope it does not turn into a Halloween scare instead. If you don't live in a cave you know that Cisco casually mentioned on Thursday night that their business was stabilizing and the shorts ran screaming for cover on Friday. The Dow managed a one day rally of +194 points and the Nasdaq soared +73 points for 4% one day gain. Did traders wake up on Friday in a time warp and relive a fall day from 1999? Not hardly. While stocks were gaining +10% to +15% for the day the moves were measured in cents and not dollars. CSCO, which inspired the monumental rally, gained a whopping +9% or $1.49. NT gained +6.31% or 42 cents. Sigh!

The Cisco rally did power the networking sector as well as some semiconductor stocks off near 52-week lows but investors were not rushing back into the market. AMCC and PMCS were big gainers as traders hoped that a healthy Cisco would mean a resumption of orders to those companies. AMCC gained +11.49% or $1.55 and PMCS gained almost 9% for $2.79. Competitor JNPR barely budged off the bottom with a +1.08 gain.

The Dow was bolstered by tech components MSFT, INTC, IBM and HWP as each rebounded on the Cisco news. More importantly the economic reports gave all but three of the other Dow components big gains as well. The New Home sales came in slightly higher than expected with a +4.9% gain while prices fell to $168,300. Time on the market fell and the Northeast region produced +18% growth over the June levels. No consumer worry in this sector! The growth in new home sales is now expected to hold up the GDP numbers which will be out next week. The jump in home sales show that the lower interest rates are having the desired impact on the economy.

While new home sales are up the Weekly Leading Indicators showed that mortgage applications declined last week to the lowest level since May. Other factors weighed on the WLI as well and it fell for the fourth week in a row indicating that chances for a broad recovery by the end of the year are fading. The WLI tends to lead the business cycle in downturns by ten months and recoveries by three months. The index has been erratic over the last couple of months and recent strength has been fading.

Durable goods did not demonstrate any new strength by falling -0.6% in July. The index was led by a downturn in semiconductors and computer equipment. The PC price war is in full swing with Compaq and Dell slugging it out in the retail sector. Compaq announced a sub $1000 laptop and Dell is hawking a $600 full strength desktop model. This war is depressing the retail stocks like Office Depot, Staples, CompUSA, etc. Shrinking prices mean shrinking margins. The fierce price war indicates that computers are not selling and manufacturers have to keep cutting to the bare bones to entice buyers to part with their money. Once they hit their base cost and cannot cut prices further the consumer may not find any reason to add another PC to their household. You can sell anything as long as you give it away but corporations know that you can't make payroll by losing money on every sale.

Next week we will get to see if the gloom and doom from the Fed minutes are borne out in the GDP reports. GDP for the 2Q had been pegged at +0.7% and well below expectations. Recent developments may have sent that number much lower and should it drop into negative territory on Wednesday all the Cisco optimism Chambers can muster will have no impact on the markets. Investors and economists can fool themselves all they want until the GDP goes negative then all bets are off. Once true negative growth is official, all kinds of new problems will appear. The Consumer Confidence for August will be released on Tuesday and that is almost as critical as the GDP. If confidence begins to fall the Fed may need to fire off another cut to quickly and artificially shore up the consumer mindset and keep them spending.

Analysts were quick to point out that the rally on Friday had no legs because there was still no volume. With the worst week in August still ahead of us there was no rush to buy from traders on the sidelines. There are more traders on the sidelines every day. According to TrimTabs.com stock funds had a negative outflow of -$3.5 billion for the week ended on Wednesday. This follows -$2.6 billion and -$2.5 billion weeks. Not a good sign for investors hoping the rally is here to stay.

Starting Monday new rules go into effect on the NYSE for daytraders and on Sept 28th for NASD members. "Pattern" daytraders who use margin to buy stock currently only need $2000 in their account. When the rule change occurs they will be required to have $25,000 in their account. A "pattern" daytrader is one who makes four daytrades (open and closed the same day) a week. Daytrading volume has fallen about -30% since last year and some feel that many traders who would have qualified with accounts over $25K last year are now struggling below that number after being pounded by the bear market. Some say that taking those traders out of the market could knock another 10% to 15% of the volume out of the market and prevent them from powering any future rally. That may be an extreme position fostered by the highly vocal daytrading community. Actually there is a portion of the rule that works in the favor of investors that meet the $25K threshold. They get 4:1 margin on their accounts instead of the current 2:1. That means they can leverage $100,000 of stock on margin instead of the current $50,000.

86 million shares of CSCO changed hands and were it not for Friday both major indexes would have closed negative for the week. Even with the CSCO volume the Nasdaq only posted 1.4 billion shares, which is still good for an August Friday, but not strong. The NYSE only managed slightly over one billion. The internals were good but the trading pattern was a big spike up at the open and then another "capitulation" spike by shorts at the close. Why capitulation?

On this chart of LBRT you can clearly see the extreme burst of volume at the open where surprised shorts raced to cover. Those that failed to cover in the morning sat through lunch in denial only to see another wave up start around 2:PM. Those still short finally bit the bullet and bought the close rather than be faced with another possible gap open on Monday morning. They capitulated and threw in the towel after an 18% gain in a $13 stock. The trading pattern is not normal "buying" even in a bull market.

The same time frame for IDPH shows the exact same pattern for Friday and they are not a tech stock. Simply a broad market relief rally fueled by bullish sentiment on reactions to the Cisco statement. IDPH shows the same pattern for Thursday as well when the biotech sector was getting so much air time on stock TV. A $10 move (20%) in two days! Look for a new put play in today's newsletter.

Where do we go from here? Most of Friday afternoon the markets held EXACTLY at resistance of 10400 and 1900. Literally only 2-3 points away for quite a while. Only the capitulation at the close powered them over those levels. 1935-1950 is strong resistance on the Nasdaq and the Dow has been topped out in the 10400-10450 range for all of August. The bulls have their work cut out for them next week and this is typically the worst week of August. Once through this week however the post Labor Day holiday week is normally bullish. Will traders anticipate that bullish week and put in a bottom here or will the month end portfolio shuffling prevent that? No one can tell. Institutional traders will wait until the following week to decide if the market is stable before committing funds. September brings earnings warning season again and then October and the tax selling. We have to remember the name of the game is capturing profits from stock movement not making the most trades.

The VIX closed at a two month low of 22.21, a number not seen since July 5th, the day before the Dow started a -250 point drop. John Murphy said it very cautiously on Friday. "There is too much bullishness in the markets for this time of year". Of analysts surveyed, 47% are bullish and only 32% are bearish. Considering that Sept and Oct are still in front of us this is very unusual and not a likely base from which to rally. Remember the money flow out of the markets in the last three weeks, -$8.6 billion. This money is not going to just magically reappear just because Cisco says the networking business MAY be stabilizing. The markets were deeply oversold and shorted and begging for a relief bounce. We got it and my two cents says "continue to be patient" and even if we do not get a better entry point I doubt the markets will go much higher before Labor Day. (famous last words - right?)

Definitely, enter passively, exit aggressively!

Jim Brown

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