Option Investor
Market Wrap

Let The Bargain Hunting Begin?

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        WE 9-21          WE 9-14           WE 9-7          WE 8-31
DOW     8235.81 -1369.7  9605.51 -   .34  9605.85 -343.90  -473.42
Nasdaq  1423.19 -272.18  1695.37 +  7.67  1687.70 -117.73  -111.37
S&P-100  491.70 - 66.88   558.58 +  4.69   553.89 - 23.51  - 29.31
S&P-500  965.80 -126.74  1092.54 +  6.76  1085.78 - 47.80  - 51.35
W5000   8900.45 -1203.9 10104.44 + 37.95 10066.49 -448.60  -433.32
RUT      378.89 - 61.84   440.73 -  4.46   445.19 - 23.37  - 12.25
TRAN    2054.84 -621.65  2676.49 - 36.65  2713.14 -100.27  - 40.98
VIX       48.27 + 13.67    34.60 +   .24    34.36 +  6.51  +  5.56
VXN       77.73 + 13.89    63.84 -  1.61    65.45 + 12.59  +  5.16
TRIN        .60              .68             1.25              .71
TICK        +21             +100             -113              -74
Put/Call   1.27 

Let The Bargain Hunting Begin?

That is the feeling expressed by every trader I know but nobody appears to acting on it. The consumer confidence board said over half of everyone they surveyed this week think it will get worse before it gets better. That is the glass half empty crowd and what we can read into this negative headline is that the other half thought it would get better first. It is how you read the headlines that matter and today "dire" headlines are selling more newsletters and attracting more TV viewers. The slanting of news is contributing to the fear factor and it is hard to find any positive investment news. I will try to change that today just don't kill the messenger if you disagree!

The best news of the week came from General Electric on Friday. GE CEO, Jeffrey Immelt, said he had only been the CEO for two days when an airplane with engines they lease hit a building that they insured while their network reported on the tragedy. This created huge losses on multiple fronts. But the punch line was that GE would still provide double digit growth because of their wide diversification. They affirmed their recent estimates and the news rallied the Dow back to positive territory for a brief moment. GE closed up nearly $1 at $31.50 but nearly $3 off their intraday low of $28.50. They said because of the decline in the markets they would use excess cash to buyback stock and make acquisitions while companies were cheap. He did say they did not expect an economic rebound this year and maybe not until late in 2002. Still I think the power of GE is evident and it is a stock that every investor should own. (See editors plays today)

The SEC extended the "get your buyback free" deadline for another week to allow corporations time to shuffle money and take advantage of the cheap prices. Several new companies indicated they were going to institute new buybacks. This is a good sign that the government is really interested in the markets putting in a bottom. I may be stretching here but that should also mean they will be putting pressure on Greenspan to cut rates again on Oct-2nd. Over 100 companies have announced new buyback programs in excess of $110 billion.

While companies are jumping on the buy stock bandwagon individuals are not yet convinced. AMG Data released a report that said $66 billion, a record amount, went into money market funds between Sept-6th and Sept-19th. They also said equity fund outflows only amounted to 5.9 billion for the week ended 9/19. The AMG data and the TrimTabs.com data is always different due to the methods used to collect it. TrimTabs said $9 billion left stock funds in the week ended on Wednesday. The bottom line is that there is money still available and in record amounts. That $66 billion in new money market cash joined an estimated $2.5 trillion that is waiting safely and patiently on the sidelines. This brings back visions of those old westerns with hundreds of homesteaders lined up and waiting for the cannon to signal a new land rush. The stock buyers are lining up but are currently in no hurry for that starters gun.

Technically the markets are extremely oversold and ready to rebound. The spring has been compressed so far that it will be very hard to sell off any further without at least a short relief rally to relieve the pressure. The Dow is now down for eight days in a row, a string not seen since May-1989. The Dow drop from an intraday high of 10440 on August 27th to an intraday low of 8062 on Friday was -2358 points or -22.6%. The drop this week alone of -1369 points was over -14%. These numbers are almost unheard of in recent times. There have been big percentage drops but all were accompanied by almost immediate rebounds. This week on the Dow represented the fifth worst percentage decline ever and the closest event to us was back in 1940. The four largest prior weeks were in 1914 -24.4%, 1933 -16.7%, 1940 -15.5% and 1932 -15.1%. The current oversold conditions on the NYSE have only been exceeded twice before and that was in 1940 with the fall of France and during the 1987 crash.

The Nasdaq has not escaped damage either. This was the second worst percentage week with April-2000 being the worst. The Nasdaq lost -16% last week. The Nasdaq VXN reached a record high at the open on Friday of 91.79 and then fell to close at the low of the day at 77.73. The VIX also hit 57.31 at the open which neared the high of 60.63 set in October 1998. This is the second highest reading in the last four years. The TRIN also hit an astronomical high of 12.24 at the open which was the second highest reading in the last four years. The put/call ratio on Thursday at 1.27 was the highest reading on record. I said I was going to be positive today and these facts are leading me to only one conclusion. There is not much downside left.

The selling on Friday was easily discernable. The morning drop was dramatically influenced by margin calls and investor washout. We were estimating in the office that the drop over the last 30 days and the, (and I am going to use the C word), capitulation event on Friday morning had washed out nearly one million investors out of the market. There were 66 million active brokerage accounts two years ago and by some estimates only around 40 million today. Of those 40 million it is easy to speculate that 2-3% were either liquidated or suffered serious margin calls in the last week. That dip at the open was not only retail selling but selling by institutions as well. As I have said before, being big does not make you right and heavy institutional selling along with retail selling paints a vivid picture of capitulation. The volume on the NYSE was 2.3 billion shares of which 1.5 billion was down volume. Declines beat advancers 3:1 at the close and that was much improved over the numbers earlier in the day. The Nasdaq volume was 2.5 billion with only a 2:1 D/A ratio. This is positive, bear with me.

Life must go on. The brain numbing impact of the attack is wearing off. Businesses are picking up the pieces. Airlines are getting billions in aid but life is changing as we know it. At the GE analyst meeting Friday morning, which is normally attended by everyone possible, they had 75 unclaimed name tags from analysts and reporters who decided the trip risk was not worth it. Still the meeting went on as scheduled and the market benefit was the same. The coming Dell analyst meeting has been changed to a conference call because traveling to Round Rock Texas was not high on the risk/return/reward profile of many analysts. Still the call will go on and information will flow. Life as we know it has changed but business will continue to be conducted.

Warnings continued and analysts continued to predict a dire future. Ashok Kumar said we are in the perfect economic storm and he did not see things turning around anytime soon. However he also said that valuations were becoming very attractive. Semiconductors attractive? Other analysts were also starting to go out on a limb about different sectors or the markets in general. I am not talking about the highly visible lightning rod analysts but those who just keep their head down and work hard at analyzing events. Even Art Cashin, who never makes a real market call for fear of being wrong on TV, said he expected a market bottom by Tuesday. That pretty well isolates the possibilities.

What, other than severely oversold, will cause this bottom? First, the big event is over. The shock of the tragedy and the constant replay of the collapsing towers is over. We are either still numb or have made a conscious effort to get back to our daily routines. The market reaction to major news events is usually in the several days afterwards and is almost always overdone. This is way overdone. Yes, we are in a recession. Yes, it will be worse because of the tragedy and yes, it may be longer than previously expected. However the market had already priced in a recession before the attack. We were approaching the September warnings season and now that season is almost over with a surprisingly small number of warnings. Microsoft did warn on Friday but only that their XBox would be delayed a week due to parts shortages from shipping delays. No big deal!

Second the quarter is almost over. Stock funds have one more chance to dress up portfolios before the quarter end. This will involve more selling but I think most of it is over. Those with airline, insurance and hotel stocks will be dumping their positions and buying defense, software, energy and maybe even some financial stocks. Tech stocks are likely to find fund buyers as well. What is the risk reward ratio on SUNW at $8, Nokia at $16, GE at $31? Very slim! Should SUNW go to $5 that is hardly a big loss but let it go to $25 as the country adds backup computing power and more disaster recovery sites and that is a big win. Expect the big caps to see bargain hunting next week. Also, there is a strong rumor that more pension funds are going to take profits in bonds and move into stocks because of the very low stock prices coupled with an interest rate that is not likely to drop much more. Already several funds have swapped well over $100 million each in the last two days to position themselves for the eventual rebound.

Third, the insurance companies that needed to raise cash by selling stock should be done. Fourth, the "speech" is over. Bush did an excellent job of delivering the speech and it was met with almost universal acceptance and goodwill. The allies are lining up on the side of the coalition and even though it will be a long fight the nation appears ready. Even better it appears it will be a low intensity campaign with no major battles, no major opportunity for loss of coalition lives and will be fought against an enemy with no planes or serious ground to air missile capability. Simply stated the risk is mostly on the side of the terrorists. Security has been increased to almost insane levels in the U.S. and the fear of a quick repeat of the WTC disaster is dwindling.

I am not claiming that the market is going to rocket on Monday morning. That is not my point. I do think we will see a rebound but there will still be some margin selling on Monday if not Tuesday. What I think we will see to begin with is some selective buying, bargain hunting in a select few stocks. There will be some short covering, assuming there is not some news event over the weekend that changes the picture, and then there will be another attempt to drive the markets down by the shorts. In my opinion the Dow drop to 8062 on very heavy volume at the open on Friday was the "capitulation" event traders always look for. Had this not been on a Friday before a war I suspect we would have seen a better close.

I think this is going to be a stock pickers market until after we get past the October earnings and tax selling. It is hard for me to expect any serious tax selling since winners are almost nonexistent but there could still be some. Also, if funds have not already sold their losers by now they need a new fund manager. We are trying to focus on stocks on our play list with real stories behind them because that is what will power investor interest. Today for instance we added Symantec because of the increased potential for a quality network virus solution. If you doubt this need try this link: http://www.zdnet.com/anchordesk/stories/story/0,10738,2813473,00.html

Another new play for instance is Raytheon, a defense contractor. RTN gapped up almost 50% on Monday as a prime candidate for billions of dollars in consumable defense spending. Things that need to be replaced constantly in a prolonged conflict. It refilled half of that gap since Monday and is threatening to make a new high.

Unfortunately not all plays in the new war economy will be bullish. Stilwell Financial (SV) is a diversified global financial company which owns 82.5% of Janus Capital Corp. As we all know there are literally millions of investors who are either not stock/fund investors any more or will not be after they get their next fund statement. Back to the money markets and CDs and a drop in fees for funds. With over one million new layoffs expected from the new economy and employment expected to reach as high as 6% by year end, there is not likely to be a wave of workers rushing out to buy new big screen TV sets or computers. Best Buy (BBY) is going to find sales and margins tougher to come by as we enter the holiday season. EBAY has struggled to maintain its share price as the Internet sector got crushed. True, it has actual earnings which is something most other Internet stocks cannot claim, but with a PE of 150 compared with the sector PE of 26 and the S&P PE of 24, it is having a tough time. The PE compression for all the major tech/internet stocks has leveled the playing field in general and EBAY is one of the last stocks to succumb.

While I would like to call the bottom and suggest a bullish stance for next week I can't. Nobody can. We can only look at the indicators and the data we are given and try to trade the current trend. We try to predict the changes by watching the indicators and individual stocks. If you only looked at the Nasdaq big caps after the close on Friday you would see nothing to cheer about. CSCO, DELL, ORCL, INTC, MSFT, SUNW, JDSU, QCOM, YHOO, EBAY, the pillars of the Nasdaq, all were off their lows of the day but still trending down. It would appear the selling is not yet over. The Dow 30 did not look any better with only eight of the thirty stocks closing in positive territory. I suggest you read carefully the market sentiment section this weekend, it is very informative.

If I had to place a bet on the market direction on Monday it would involve margin selling again but less as the week wore on. If pensions funds continue to move to equities and mutual funds start buying for the end of the quarter then shorts might get scared. With the Fed meeting on Oct-2nd and likely to cut rates again the shorts could decide that 2000 Dow points are enough and move to the long side for a pre Fed bounce. It is just my opinion but there is a relief rally here somewhere and as you have seen the last two days the Dow can move very fast when motivated. I try to keep things simple and to me the risk of buying stocks this coming week for long term is very low. The Nasdaq is at lows not seen since 1997 and others should see this as well. For us as option investors the opportunity has never been better! The only caveat is time.

This is not the time to be going long with short term positions. If you are going to attempt to pick a bottom here, PLEASE use longer term options, at least Dec/Jan or longer. This may not be the bottom but we are very close and longer term options will hold their value better through any further dips and then accelerate in value quicker once the market recovers. Let me qualify this one more time. I am not recommending you go long on Monday morning. We need to trade in the direction of the trend or not trade at all. What I am suggesting is that the current trend could change very quickly one day next week and those prepared for that change will profit handsomely. Be prepared!

Definitely, enter passively, exit aggressively!

Jim Brown

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