Option Investor
Market Wrap

Surprise, surprise, surprise!

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       10-2-2001           High     Low     Volume Advance/Decline
DJIA     8950.60 +113.80  8950.60  8798.40  1.3 bln   2072/1055
NASDAQ   1492.33 + 11.87  1504.24  1473.13  1.7 bln   1973/1578
S&P 100   539.57 +  6.17   539.57   530.02   Totals   4045/2633
S&P 500  1051.33 + 12.78  1051.33  1034.47
RUS 2000  401.79 +  4.19   402.12   397.53
DJ TRANS 2170.44 + 28.28  2179.34  2142.79
VIX        34.07 -   .71    35.77    33.93
VXN        63.84 -  1.10    64.71    63.20
TRIN        0.90
Put/Call Ratio       .72

Surprise, surprise, surprise!

Shorts have got to be reconsidering their strategy at this point! The Fed announcement is normally an excuse to sell regardless of the direction of the rate change. The selling came right on cue but buyers bought the dip and surprised the bears with a strong end of day rally. While it was probably not the rate cut that stimulated the rally it certainly did not hurt the case for the bulls.

The market hit the high of the day on news that British Prime Minister, Tony Blair, made some strong statements about the Taliban and their need to produce Osama quickly or else. The markets then pulled back again to await the Fed decision. Just about the time the selling was heating up after the Fed cut rates there was another rumor that the Taliban had offered to turnover Bin Laden. Buyers jumped in on the incorrect idea that the war was going to be over before it started. This caused shorts, who had seen the morning bounce on positive news, to run for cover yet again.

The buying may have looked pretty on the Dow chart but the markets had clearly already priced in a 50 point cut and the volume for the rally was almost nil. The total NYSE volume for the day was only 1.2 billion shares, barely half the volume for almost any of the selling days last week. There is still no conviction in the markets although it is clear that there are some bottom fishing buyers.

There is so much indecision in market direction that a survey of hedge funds, notorious shorters of stock, showed that they were sitting with almost 60% of their assets in cash. A remarkable figure considering the volatile markets. Other reports have mutual funds buying on every dip and that the negative cash flow from the last eight weeks has reversed. We will have to wait until Thursday night to verify that with the TrimTabs.com but typically the cash does come back in time to buy the October lows.

The Fed did cut rates for the ninth consecutive time in nine months and lowered the target rate by 50 points to 2.5%. This is the lowest level since 1972 and they indicated they could cut even further. The language of the announcement said that the terrorist attack increased the pressure on the already weak economy and the outlook for the future was still weakness. "Business and household spending as a consequence of the attack are being further damped", but the Fed concluded that the long term prospects for growth remained favorable. This will continue to help cushion the recession but the government focus is now toward a new stimulus package. Typically the day after a Fed meeting is a down day in the markets and this 50 point cut was already factored into the current market levels. It will be interesting to see if there are enough buyers to prevent the typical post announcement sell off. The Fed also cut the discount rate to 2%. With two more meetings this year there is a very good possibility that the Fed funds rate could hit 2% as well. Time to refinance?

After the bell today Nortel warned again that it was going to cut up to another 19,000 jobs and that the inventory backlog was still a problem. They are going to take a -$3.6 billion loss for 3Q as it continues to restructure operations. Since Nortel has been warning, sometimes twice a quarter, for over a year this came as no real surprise. What did amaze analysts was the severity of the continuing business drop for Nortel. Nortel said that although the magnitude of market adjustment from previous levels of spending has been challenging they believe that they are beginning to see some early signs of sustainable capital spending at current levels. Far from predicting a rebound, they feel that a bottom my be forming. They hope that the final cuts, to less than half of their original workforce of 94,000, will enable them to break even on an ongoing basis. Not that this is encouraging for NT shareholders, at least the stock should stabilize at the current $5 level.

The latest airline to close its doors as a result of the attack was Swissair. The cash strapped airline was forced to stop flying after some planes were impounded for nonpayment of gate fees and British Petroleum refused to sell them any more fuel. Heathrow airport blocked two planes and prevented them from taking off until fees were paid. Midway Airlines had already closed its doors rather than go deeper in the red with the expense of the new regulations. Taiwanese carrier EVA Airways cut 17 flights to the US and Asia as of Tuesday while Austrian Airlines abandoned its flights to Miami.

Not all the news was bad however. Wal-Mart said it was comfortable with estimates even though sales had suffered as a result of the attack. They also said they would add over 50 new Sam's Club stores and as many as 185 new Super Center Wal-Mart stores. The plan represents 46 million square feet, the largest increase in Wal-Mart's history, and will boost its capacity by 9% over the 2002 total.

The best thing I saw in the market today was the lack of real selling. Even the shorts were only half hearted shadows of their recent activity. Even the discouraging news that auto sales had fallen substantially and would likely fall further did not crash the markets. American corporations are adapting to the new economic conditions. Car dealers are reporting some success with the zero interest promotions. Airlines are luring travelers back with half price sales and buy one, get one deals. Resort hotels are starting to advertise 50% off deals or better. I am traveling to Dallas on Wednesday for a funeral and the car rental deals were great. I had no problem with airline reservations and got a next day flight for six people for 25% of the "listed price".

With another $100 billion financial stimulus package in the wings the floor under the market is gaining strength every day. While there was no volume on Tuesday and the rally was mostly blue chips and not tech stocks, it was still encouraging. The key of course is staying power. As I write this the Dow futures are up +110 while the S&P & Nasdaq futures are down. There is still indecision in ranks but rumors abound that institutions are nibbling on every dip. If I had to pick an entry point on the Nasdaq I would call it 1550. We have traded over 1500 several times since the attack but failed to hold it. Should we trade and hold over 1550 I would be a buyer. That same level on the Dow would be 9050. This is going to be a stock pickers market until the warnings are over and they are far from over. Without volume any gains will be suspect as shorts may be simply waiting for the bottom fishers to satisfy their appetites and for the next stronger than expected profit warning. Make no mistake, we are only two days into October and nobody can make any forecasts based on only two days. Has oversold translated into undervalued? Only time will tell. Be patient!

Definitely, enter passively, exit aggressively!

Jim Brown

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