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Market Wrap

Summer Rally is Officially Dead! Is The Labor Day Rally Next?

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        WE 8-31          WE 8-24          WE 8-17          WE 8-10
DOW     9949.75 -473.42 10423.17 +182.39 10240.78 -175.47  - 96.53
Nasdaq  1805.43 -111.37  1916.80 + 49.79  1867.01 - 89.24  -109.86
S&P-100  577.40 - 29.31   606.71 + 12.84   593.87 - 17.54  - 12.24
S&P-500 1133.58 - 51.35  1184.93 + 22.96  1161.97 - 28.19  - 24.19
W5000  10515.09 -433.32 10948.41 +188.32 10760.09 -234.36  -248.49
RUT      468.56 - 12.25   480.81 +  5.16   475.65 +   .13  - 11.63
TRAN    2813.41 - 40.98  2854.39 + 29.74  2824.65 - 36.12  - 53.25
VIX       27.85 +  5.56    22.29 -  4.45    26.74 +  3.93  +   .42
VXN       52.86 +  5.16    47.70 -  4.32    52.02 +  3.50    48.52
TRIN        .71              .70             2.67             1.03
TICK        -33              351              201
Put/Call    .82              .56             1.07              .72

The summer rally theory is officially dead at least for this year. The next major urban legend to enter the spotlight is the Labor Day rally and measured by Friday's results it is off to a bad start! While the stock traders almanac shows that historically the first three trading days of September are typically bullish it does not take into account current conditions. Apparently the markets were not impressed by past history in 2000 because the results were far from exciting. On Sept 1st, 2000 the Nasdaq touched 4259 as the high and then sold off to 3054 only 30 days later. The Dow hit a high of 11401 on Sept 6th, 2000 and then dropped -1745 points to the October lows on 10/18. So, is the Labor Day picnic this year going to be hosted by the bulls or the bears?

As relief rallies go, Friday was a two on a scale of 10. I got the feeling that we were saved by the bell not a minute too soon as bulls and bears alike went flat over the weekend. The Dow soared at the open on better than expected economic news to 10036 and traders were ready to pop the Labor Day bubbly only to watch those gains fade again to close just under 9950. This was the second time in two days that the Dow closed under that psychologically important level. The Nasdaq also rallied at the open but then traded sideways to down the rest of the day. Short covering was not as heavy as expected with stocks like SUNW only adding $.38 on one third of Thursday's volume. If shorts decided to hold over the weekend then the odds of a market rebound next week just got slimmer.

The Nasdaq and Dow posted the worst August since the Asian crisis in 1998. This was the third worst August for the Nasdaq in its 30 year history. August has gone into the history books as the worst month of the year for the last ten years. September holds that record however if you include the last 30 years. Not an exciting possibility for the market going forward if the market fails to rally off good economic news in a period that is historically bullish, Labor Day.

The good economic news came in the form of a better than expected Factory Orders report. They posted a miniscule +0.1% gain but much better than the -0.3% loss that was expected. The inventory to shipment ratio did fall to 1.38 from 1.40. Negative internals included a drop in semiconductor orders of -26.1%. Consumer goods including household appliances and autos posted increases. The Chicago PMI index increased to 43.5 in August which was up from last months 38 but extending the decline to eleven straight months. This shows that manufacturing is still contracting and there is no sign of a recovery at the basic level. While the number improved slightly the backlog of orders remained weak.

The headline numbers spurred the markets at the open but any loud noise could have spiked the markets from their oversold conditions. The earnings news and the anticipation of the September warnings period has caused buyers to become catatonic and it may take a flood of positive news before buyers actually believe it. There is considerable reason to be worried about next weeks reports. The NAPM is due on Tuesday along with Construction Spending. Productivity on Wednesday and Wholesale Inventories and Jobs Report on Friday. A drop in spending, increase in inventories or a serious change in the employment numbers along with the expected flurry of early warnings could shock the markets back to the April lows. The U.S. economy may be on life support and maintaining a pulse as evidenced by the +0.2% GDP number but the global economy is still falling. Japan's Nikkei 225 index fell another -225 points on Friday to 10713, a number not seen since August of 1984 when our Dow was only 1200. Japan is the second largest world economy and analysts say a sub 10,000 Nikkei will seriously cripple an already sick banking system. Remember the Asian crisis of 1998? Get ready for 2002 if something does not happen quickly. Japan may be the most visible but there are problems in most European and Asian markets as well. The ECB cut rates for only the second time this year with a statement that the severity of the U.S. problems caught them by surprise. Congratulations, they caught the Fed by surprise as well!

The Fed chairman himself opened the Jackson Hole conference on Friday and in his speech he expressed concern over the net worth of the U.S. consumer. He said the capital gains from their homes was continuing to fund spending and holding the economy just above recession. He did express concern that the average household net worth had soared in the last ten years and fueled the rapid growth but that same net worth had "retraced some of its earlier gains." In English it means most households are now on the verge of broke after losing all of their money in the Nasdaq bubble. They are having to sell their homes to pay off bills and taxes incurred when the markets were hot. Yes, there is cash to be spent when homes are sold but I don't think distressed selling is the way to support the economy. He danced around the subject as always and said the Fed was developing some new indicators for future policy changes. In English, they got caught raising interest rates aggressively while the economy was going through cardiac arrest from an overdose of irrational exuberance. All of this points to a Fed that will cut rates again on October 2nd but nobody will care. After seven rate cuts the markets are still tanking and showing a growing resistance to the rate cut antibiotic. Several noted analysts have suggested in public recently that Greenspan may have passed his prime and new blood may be needed to inspire confidence in investors that the Fed is in control.

The positive ending for the markets on Friday came on very weak volume. The NYSE only managed 900 million and the Nasdaq 1.2 billion. Advancers only barely beat decliners and the amount of the average advance was only a few cents. Definitely not a buying frenzy. When deciding what the markets will do next week you have to think about the psychology of fund managers and institutional traders when they come back from their holiday. What has changed to make them want to buy? There was no capitulation sell off this week. Despite the three days of triple digit drops on the Dow it was on only moderate volume. Earnings have not improved overnight. Warnings still continue daily and the biggest warning from Friday night was of all things a chip stock. LRCX warned that it was cutting another 10% of its workforce and implementing company-wide shutdown days along with voluntary pay cuts. LRCX makes equipment for chipmakers and they said the slowdown in orders was continuing. So much for chips leading any recovery next week. Intel will also keep the lid on any chip rally with its version of the SUNW business update on Thursday. They will tell analysts how business is progressing and tout new products. They could take this opportunity to warn as SUNW did and set the tone for September at an early date. Hitachi announced another 15000 layoffs this week due to slowing global demand and Intel could be facing the same order pressures.

For next week traders should be very careful. Even on good years September tends to favor sellers after the first couple of days. There has been no capitulation on the down side and we are still quite a ways from touching the April lows. There is a growing group of analysts that think those lows will not hold due to the worsening global economic environment. Not a pleasant thought! Still as option traders we should "trade what we see, not what we believe." Just because we believe the market is oversold and the mythical Labor Day rally is about to break out all over, we should still only place those trades when we see it come to pass. Many traders from the last three years are employees again because they just "knew" the market was going to bounce soon. Many retirees are rejoining the workforce because the "market always goes up". As investors we need to trade the trend or not trade at all. Literally billions have been lost over the last three months because of the old adage, "don't fight the Fed." Whenever the Fed cuts rates the market goes up, or so the saying goes. You probably remember the various charts that analysts used on stock TV several months ago to illustrate the gains after specific numbers of rate cuts. Have you seen any recently?

The point I am trying to make here is that market history is just that, market history. The market is alive and well and deciding its own direction on a daily basis as news and events by the thousands color investor decisions. Opinions are as numerous as analysts and change with the wind. My opinion is September will be difficult. We are at the point economically where ANY further negative news will send the remaining stock traders running into bonds. Sorry, that is already happening! Any further negative news will push the Fed's economic plan over the cliff and all the kings men will not be able to put it back together again. The fate of the U.S. economy may not even be in our own hands. If Japan continues to spiral down into economic oblivion the whirlpool will take many others with it including the U.S. As bear markets go this one has already overstayed its welcome. Since the market top in March of 2000 we have seen 17 months of drops which included dozens of bear trap rallies. What has changed in the last week that will cause September to perform different than August? What will make it break the 30 year pattern as the worst month of the year? in my opinion, nothing!

You hear all the bullish analysts saying this year is different. The sell off has already run its course and we have no where to go but up. They say this is not a normal year and the bargains will lure buyers out early in anticipation of the 4Q rally. Some are actually putting their money where their mouth is. Commercial traders are actually net long and approaching the most bullish numbers of the year. This may be contrary to current market direction but shows they are "buying stocks when nobody else wants them", another market adage. This is a positive sign but when added to the other indicators it means less. The VIX is holding just below 28 and the put/call ratio is only .82. The TRIN fell from very oversold at 2.28 on Thursday back down to a normal reading at .71. These are not rally numbers but they also are not pointing to a major drop on Tuesday. The answer to this puzzle is likely a continued down trending market until some real evidence of a recovery appears. This means we need to trade the trend or wait patiently for the trend to change. We loaded the play list this weekend with puts after watching the market rebound fail on Friday. Hopefully history will repeat and we will get some follow through to the upside on Tuesday and give us some good entry points for those puts. Trade the trend or don't trade at all!

Remember these charts from last Sunday? I was making a point that the VIX was indicating a possible sell off in the making for the Dow. History is a good teacher is we choose to learn. The Dow dropped -473 points for the week.

Definitely, enter passively, exit aggressively!

Jim Brown

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