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Market Wrap

April Lows Bring Retest Woes

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      09-05-2001          High      Low     Volume Advance/Decline
DJIA    10033.27 + 35.78 10066.69  9885.88 1.36 bln   1248/1874	
NASDAQ   1759.01 - 11.77  1782.50  1715.86 1.92 bln   1319/2308
S&P 100   578.89 +  0.85   581.01   568.92   Totals   2952/3750
S&P 500  1131.74 -  1.20  1135.52  1114.86             
RUS 2000  462.51 -  4.45   466.95   458.78 
DJ TRANS 2835.17 -  0.48  2842.22  2812.12 
VIX        28.96 +  0.30    30.50    28.58 
Put/Call Ratio      0.75

April Lows Bring Retest Woes

There's been a lot of hype circulating through the financial media recently concerning the "need" for the major market averages to retest their respective April lows. Call it a self-fulfilling prophecy, but the major market averages slid ever-closer towards their yearly lows Wednesday. Of course the afternoon rebound helped to ease the fears of capitulation, but earlier weakness allowed the bears to print increasingly larger amounts of profits.

The Nasdaq-100 (NDX.X), a market cap weighted index of the largest 100 Nasdaq-listed issues, fell as low as 1371 Wednesday - a mere 23 points from its April low of 1348. The tech and biotech heavy index is oversold according to Stochastics and Bullish Percent readings. And although oversold markets can grow more oversold, a short-term bounce is possible as buyers step in around the April lows. Of course the duration of any future bounce is the variable as we enter third-quarter warnings season. Furthermore, attempting to trade from the long side should be done only with the strictest of risk management.

When searching for bullish trades in an attempt to game any forthcoming bounce in the NDX, it makes sense to focus on the strongest sectors within the Nasdaq. And the two strongest sectors currently are the Semiconductor (SOX.X) and Biotech (BTK.X) sectors. A simple, rudimentary glance of where the two sectors are in relation to their April lows reveals their respective relative strength.

Intel (NASDAQ:INTC) will hold its mid-quarter update Thursday, after the bell. And rumor has it that the company will reaffirm its guidance, which may induce some short covering in chip-related issues. So there's one potential catalyst.

The potential driving force behind the Biotech sector is the possibility for earnings out performance in the third- and fourth-quarters of this year. Biotechs are relatively immune from the economy, so we won't be hearing a lot about slumping demand and excessive inventories from the likes of Biogen (NASDAQ:BGEN) nor Amgen (NASDAQ:AMGN). Furthermore, there's the potential for about six new drugs to receive approval from the FDA in the coming months - a friendly FDA has the propensity to boost biotech issues.

Conversely, when searching for bearish trades in the Nasdaq, I think that it makes sense to focus on the weakest links. In no particular order, the weakest links in the Nasdaq are Software (GSO.X), Networking (NWX.X), Internet (INX.X), Hardware (GHA.X), and Telecom (XTC.X), (YLS.X). A quick glance over the charts of these sectors reveals a predominant theme: Fresh 52-week lows.

The Compaq (NYSE:CPQ) - Hewlett-Packard (NYSE:HWP) merger revealed how dismal things are in hardware. And the Merrill downgrade of Motorola (NYSE:MOT) proved once again that anything related to telecom is buried in a mire, or worse.

In terms of points and percentage, the S&P 500 (SPX.X) didn't come as close to its April low as the NDX did. But the broad market index appears technically pathetic nonetheless. I'd been monitoring the 1125 level as support for the SPX, but the index easily violated that level early Wednesday. However, it did manage to close back above 1125, which is about the only constructive attribute that I can think of concerning its price action Wednesday. And like the NDX, the SPX's Stochastics are in oversold territory. But, unlike the NDX, Stochastics have already crossed over, which reinforces the slight relative strength of the S&P over the NDX, in my mind at least.

The finance space - the largest component of the S&P 500 - traded rather poorly Wednesday. Traders can monitor this complex with the Brokers (XBD.X), Insurers (IUX.X), and the Banks (BKX.X). All three broke down below key support levels Wednesday, and the idea of the Fed nearing the end of its benign policy could continue to pressure the group so long as credit quality concerns float around.

UBS Warbug attempted to boost the Brokers Wednesday morning with an upgrade, but the failed rallies in shares of Goldman (NYSE:GS), Lehman (NYSE:LEH), and Morgan (NYSE:MWD) proved to be no more than a solid entry point for the bears.

The strongest complex among S&P-related issues is the drug space. Both the Health Care (HCX.X) and the Drug (DRG.X) sectors finished higher, which may have been a product of defensive positioning. The trouble with these two sectors, along with the Biotech sector, is that each are at or very near significant resistance. Barring a breakout in any of the health care-related sectors, it's hard to argue a bullish case as they approach resistance.

With the broad market averages and narrow-based sector indexes sliding ever-lower, pessimism is growing among market participants. But it's not to a capitulatory level yet. The Market Volatility Index (VIX.X), Nasdaq-100 Volatility Index (VXN.X), and QQQ Implied Volatility Index (QQV.X) have all gone near-parabolic over the last five trading days. But they don't smell of real fear as they did back in April. Indeed, the recent advance in the aforementioned fear gauges supports the idea of a short-term bounce across the broader market averages, but by no means indicate that a bottom is being traced. A bottom, I'm reminded, is a function of time not price. And in this trader's very humble opinion, there's a lot of time between now and The bottom.

Another event that supports a bullish short-term view was the sell-off in bonds Tuesday. Now, I appreciate that a lot of our subscribers don't like reading about bonds. But bonds foreshadowed the massive rally from April's lows, so I think it's worth writing about the debt market. With that said, the sell-off in bonds Tuesday was one of the largest in recent history, and had nothing to do with inflationary fears. The capital that was raised from selling bonds Tuesday has to be put to work somewhere, and I'm willing to bet that some of that money makes its way into stocks if it hasn't already. I think that traders looking for a bounce in stocks would do well to monitor the yield of the 10-Year Treasury Note (TNX.X) over the coming days. Let's keep this simple: If the TNX advances in the coming sessions, there's a better chance for stocks to advance. Look for an advance above 50.00.

There are several signs pointing towards a short-term bounce, including the oversold conditions of the SPX and NDX, the bullish readings of the ARMS Index, the spike in volatility, and the increasingly negative nature of the crowd. While the market could very well roll higher from current levels, it's my belief that trading from the long side should be approached lightly. And in the spirit of adaptability, and for what it's worth, my sense is that the NDX will ultimately take out its April lows, and then some. The SPX may fare a bit better, however.

It's not my role to tell readers what to do nor how to trade. But I think it's worth realizing that there's been a lot of money made in this market trading the downside. And until bearish traders are proven wrong through losing money, they'll continue leaning on fundamentally and technically weak stocks and shorting rallies.

Eric Utley
Option Investor

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