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Market Wrap

Post Attack Pullback

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      10-08-2001          High     Low     Volume Advance/Decline
DJIA     9067.94 - 51.83  9144.81  9012.30  976 mln   1717/1894	
NASDAQ   1605.95 +  0.65  1621.11  1574.65 1.40 bln   1511/1975
S&P 100   544.88 -  4.50   549.38   541.53   Totals   3228/3869
S&P 500  1062.44 -  8.94  1071.37  1056.88             
RUS 2000  412.18 -  2.79   415.13   410.25
DJ TRANS 2183.24 - 26.18  2212.78  2148.31
VIX        25.91 +  1.25    37.55    35.88 
VXN        66.13 +  2.78    66.76    62.93
TRIN        1.09 
Put/Call    0.62

Post Attack Pullback

The major market averages ended Monday's session mixed in the wake of U.S.-led strikes against Afghanistan. But once again, the Nasdaq out performed to the upside.

Last week, I wrote about how the Nasdaq-100 (NDX.X) had the potential to out perform to the upside. I suggested that the Nasdaq was less overbought than two other major market averages: Dow Jones Industrial Average ($INDU) and S&P 500 (SPX.X). For that reason, I felt that the Nasdaq had some catching up to do to the upside. And we've seen that happen over the last few sessions. As a result, the INDU and SPX have given up some ground. But, that's not necessarily a bad thing.

The rally off the bottom two weeks ago was sharp, fast, and furious by any measure. Anytime a market moves that quickly, naturally there's going to be some backing and filling. It's my sense that the INDU and SPX are entering that phase now. If the INDU and SPX are entering a consolidation phase, there's obviously going to be the variables of how long it lasts and just how low the markets pullback.

But, we can use some shorter term retracement brackets to get a better handle on just how much, if at all, the INDU and SPX will pullback. I've set up some 60 minute charts of the INDU and SPX that I think give a good view of the last few weeks worth of trading. We can see from where the INDU and SPX have come, and hopefully where they're going. (Readers might wonder if they can continue using retracement brackets on a daily timeframe for the INDU and SPX. And I say absolutely! But, the one problem with retracements on the INDU and SPX on a daily timeframe is that the two are trading in the lower end of their ranges, so traders are left with only one retracement level that is quite a distance from the current levels in each index. So, by the using the 60 minute interval, I'm simply retracing smaller moves in the INDU and SPX, but moves worth measuring nonetheless.)

The SPX traded as high as roughly 1085 last week, which should be a point of resistance going forward. At the same time, though, the SPX has held its 19.1 percent retracement level around the 1055 to 1060 area. (The 19.1 and 80.9 percent retracement levels are simply half of the ranges between 0 and 38.2 percent and 61.8 and 100 percent, respectively. 38.2 divided in half is 19.1.)

The longer the SPX holds that level, the more likely it is to resume advancing after near-term supply is absorbed. But, if the SPX does lose the 1055 to 1060 area, it will most likely make its way down to the range between 1015, plus or minus 15 points. That's a wide range, I know, but it should help to get a better handle on potential downside.

The INDU is trading similar to the SPX over the 60 minute interval, perhaps marginally stronger. The INDU, like the SPX, rebounded from its 19.1 level last week right around the 9000 level. In this case, 9000 acts as both psychological and technical support. Below there, 8760 and 8625 are possible support levels, while the relative high at 9190 can be used as a resistance reference.

The SPX and INDU are beginning to work off their overbought nature judging by Stochastics on the DAILY timeframe. That's the bigger picture view of overbought versus oversold as opposed to monitoring Stochastics over a 60 minute interval, where whipsaws and false signals are frequent. The best case scenario for dip-buying-bulls is for the INDU and SPX Stochastics to move into oversold territory, while the two find support at their respective retracement levels. That way, risk is shifted away from the downside to the upside. But, for the time being, risk is still weighted to the downside in the INDU and SPX in my opinion.

Part of the reason I think the INDU and SPX are suspect to further downside is due to their still relatively overbought conditions. Another reason is the recent weakness in the KBW Bank Sector Index (BKX.X). The BKX is a good gauge for the health of the broader economy because banks are so closely tied to economic activity.

The BKX has taken a nose dive in the last three sessions. I think part of the weakness stemmed from last week's employment figures, the warning from U.S. Bancorp last Friday, and possibly the military action over the weekend may explain Monday's weakness. Whatever the reason(s), the BKX has gone from overbought to quickly approaching oversold in the space of three days.

The BKX led the rally to the upside once the markets found bottom a few weeks back, so I'm wondering if the BKX is foreshadowing the path that the INDU and SPX are going to take over the short-term? What's more, it's going to be interesting to see if the BKX traces a higher relative low when it finally reverses, or if it traces a double-bottom, or takes out its relative lows. Again, I think the price action in the BKX could be telling of the future short-term direction of the SPX and INDU.

What the short-term future holds for the NDX is a little harder to discern, at least for me. The NDX finished higher again Monday, outperforming both the INDU and SPX, as well as its brother the Nasdaq Composite (COMPX). The COMPX only tacked on 0.04 percent Monday while the NDX added 0.62 percent. I know we're dealing with fractions of a percent, but the NDX's out performance Monday once again revealed that big cap tech traded stronger than most other stocks.

But, the NDX is now growing more overbought on the daily timeframe and its turn to rollover in similar fashion to the INDU and SPX may be around the corner. Here's where it gets interesting. Keep in mind that the NDX didn't really advance until about a week after the SPX and INDU found bottom on September 21. In fact, the NDX's out performance is only a week old -- it began last Tuesday, one day before Cisco's (NASDAQ:CSCO) comments. It would be too easy if the NDX's out performance ended after one week, but based on technicals alone, I expect that the NDX will pullback in the next few days.

While the technicals of the market give us a better handle on risk versus reward, in the end, stocks are moved by earnings. This week kicks off third-quarter earnings season. And the usual early-announcing-suspects are on deck, including Motorola (NYSE:MOT) and Yahoo (NASDAQ:YHOO), among others. I would think that this third-quarter is going to be an ugly one, especially for tech. But we won't know for sure until we hear the reports.

There were a few smaller reports and warnings after the bell. First Data (NYSE:FDC) reported a good quarter on the surface, with the stock climbing more than $1.50 in the after hours. Meanwhile, Commerce One (NASDAQ:CMRC) lowered the bar.

While earnings are the primary foundation for stock prices, emotions tend to have an impact, too. But, the one variable that is the most difficult to quantify is psychology. With ongoing military action, out breaks of anthrax, and the potential for further terrorist attacks, the markets are likely to remain on edge. Monday's tepid response to the weekend military action is hard to read into because the bond market was closed for Columbus Day. We'll know more about how the market feels about the U.S. strikes against Afghanistan tomorrow. But, I'm not going to try to guess how the market will respond, I don't know.

In the meantime, we're faced with an overbought market that is due for a pullback. But, that's not to say that the INDU, SPX, and/or NDX won't continue advancing. Catalysts can emerge when least expected as Cisco and Dell proved last week. However, neither stocks nor markets move in a straight, so a routine pullback would be natural over the next few days.

Eric Utley
Option Investor

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