Option Investor
Market Wrap

The Buyer's Dilemma

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        9-26-2001          High      Low     Volume Advance/Decline
DJIA     8567.39 - 92.58  8718.16  8527.05 1.53 bln   1493/1648	
NASDAQ   1464.04 - 37.60  1516.12  1458.34 1.73 bln   1380/2243
S&P 100   516.29 -  1.63   522.45   513.29   Totals   2873/3891
S&P 500  1007.04 -  5.23  1020.29  1002.62             
RUS 2000  389.79 -  6.39   397.66   389.11
DJ TRANS 2076.79 - 16.01  2118.36  2072.70
VIX        39.26 +  0.39    39.71    37.95 
VXN        65.94 -  1.63    68.67    65.65
TRIN        1.63 
Put/Call    0.74

The Buyer's Dilemma

With tensions escalating in the Middle East, earnings disappointments increasing in frequency and magnitude, and Yom Kippur around the corner, there weren't many reasons to buy stocks Wednesday. The decrease in day-over-day volume reflected the market's apathetic and reluctant nature.

It's difficult to discern whether or not the anti-American demonstrations in Kabul, Afghanistan, played a role in Wednesday's pullback. But, the images of the abandoned U.S. Embassy set a light may have caused some uneasiness among already shaken bulls. If not, then the tensions in Afghanistan contributed to the rumor mongers' causes Wednesday. Talk of large blocks of stock for sale ran rampant following that big margin call in Disney (NYSE:DIS) stock last week. It's unfortunate, but times of uncertainty such as these allow stock manipulators greater freedom, so to speak. However, those spreading rumors in an attempt to knock down stocks and profit from their manipulations will eventually face justice in the form of a massive short squeeze.

On the topic of short covering, Monday and Tuesday's advance across the broader markets is shaping up to be another failed bear market rally in light of the lack of follow-through Wednesday. Then again, Wednesday's price action could've been a precursor to a basing period. Some might argue that the light volume pullback was constructive, while others might argue that we've witnessed the pattern of failed rallies for the last 18 months. Only price and time will tell.

Both the S&P 500 (SPX.X) and the Nasdaq-100 (NDX.X) have worked off some of their oversold condition judging by daily Stochastics readings. Of course Stochastics is only one measure of overbought versus oversold, so it must be taken in context with other indicators such as Bullish Percent. Both the S&P and NDX remain grossly oversold by way of Bullish Percent.

On a shorter time period, such as the 30-minute charts below, it's easy to see that the SPX is holding up much better than the NDX. The SPX has managed to stay above the psychologically significant 1000 level during Wednesday's pullback, while the NDX settled below the psychological 1150 level.

The SPX's out performance can be attributed to several sectors, most notably the financial sector. Both the Insurance Sector (IUX.X) and the Bank Sector (BKX.X) finished in positive territory - the former tacked on almost 2 percent. The Insurance sector has been an inspiring source of strength over the last three days. Its bids are most likely stemming from bargain hunters who were reassured by the industry's comments that it would be able to handle the more than $30 billion in claims from the terrorist attacks. Also, industry representatives were meeting with government officials Wednesday to propose government backing for insurance claims in any future attacks. In the wake of the talks on Capitol Hill, industry leaders such as AIG, CB, JHF, AFL, PGR, and ALL worked higher.

The bid in banks Wednesday may have stemmed from the Fed's upcoming meeting. The FOMC meets next Tuesday and is expected to cut rates again. The consensus is currently calling for another 50 basis points which, if the Fed actually cuts by that much, will take Fed Funds down to 2.50 percent - the current target rate is 3.00 percent.

While the financial sector has helped prop up the SPX, it hasn't been able to do the same for the NDX. That's because the NDX does not include any financial components. But the NDX does contain a whole lot of technology.

The three worst performing sectors within technology Wednesday were Semiconductors (SOX.X), Internets (INX.X), and Softwares (GSO.X). The semiconductor and software sectors are the heart and soul of the NDX, and neither the SOX nor GSO look very technically strong at current levels.

Micron's (NYSE:MU) disappointing results Tuesday night resulted in a slew of lowered earnings estimates and downgrades across the chip spectrum. For the day, the SOX shed nearly 8 percent and shares of Micron lost almost 19 percent.

On top of the downgrades in the chip sector, three prominent brokerages cut their third-quarter and full year 2001 estimates on several software companies. Merrill, Prudential, and U.S. Banc Piper Jaffray reduced ratings on the likes of BEA Systems (NASDAQ:BEAS), i2 (NASDAQ:ITWO), and Ariba (NASDAQ:ARBA). The GSO finished lower by 4.46 percent.

There are a total of 37 semiconductor and software companies in the Nasdaq-100, which goes to show just how influential the SOX and GSO are on the broader tech sector. The downgrades across both sectors Wednesday in addition to Micron's earnings report Tuesday might be a precursor to third-quarter earnings season. As Jim alluded to Tuesday, the third-quarter is typically back-end loaded, which means a lot of business is done in the final two weeks of the quarter. Since this week is the last in the quarter, companies may be scrambling to make sales in order to meet their quarters, which may also be the reason that we haven't heard many warnings this week.

Because many buyers are taking a 'wait and see' approach to the third-quarter, especially in technology, some of the defensive sectors caught a bid as capital flowed to quality. Both the Healthcare Index (HCX.X) and Drug Index (DRG.X) performed quite well Tuesday, with roughly 2.3 percent gains in each. Indeed, the flight to quality in the bond market Wednesday seemed to reflect defensive positioning. Part of the flight to defensive issues Wednesday may have stemmed from Yom Kippur, which also explained the rather light volume. Whether or not the defensive positioning continues this week will probably depend on news on the earnings and military fronts. There may be a trade looming in the HCX and DRG to the upside this week, but one would think that some end of quarter window dressing would unfold Thursday. If the mutual fund buyers show up, targets of window dressing may include some of the defense industry stocks that have done extremely well in the wake of the terrorist attacks.

Aside from the window dressing that may or may not occur in the next two days, there are not a lot of reasons to be buying stocks in the current economic and political environment. Of course contrary opinion suggest to buck conventional wisdom and swim against the tide. But, with so much uncertainty in the market, it's hard to get a hold on what exactly conventional wisdom is currently.

Eric Utley
Option Investor

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