Option Investor
Market Wrap

Reality Check? Don't Flinch, Stay Long!

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       10-25-2001           High     Low     Volume Advance/Decline
DJIA     9462.90 +117.30  9462.90  9177.90  1.3 bln   1902/1189
NASDAQ   1775.47 + 43.93  1775.51  1683.61  2.3 bln   2155/1403
S&P 100   565.62 +  6.93   565.62   548.02   Totals   4057/2592
S&P 500  1100.09 + 14.89  1100.09  1065.64
RUS 2000  435.96 +  8.31   435.97   422.20
DJ TRANS 2239.99 + 18.98  2241.35  2175.10
VIX        31.36 -  1.51    35.08    31.18
VXN        56.93 -  4.98    64.20    56.93
TRIN        0.82
Put/Call Ratio       .93

The economic news this morning bombed the markets back into the current reality of the business climate. The jobless claims came in at 504,000 or +8,000 more than expected but the worst jobless data was the continuing claims. At 3.65 million that number has now reached an 18 year high. More workers are losing jobs every day and fewer are able to find new jobs quickly. This would normally be very negative considering the continued drag on consumer sentiment that this creates.

Other news included Durable Goods Orders that fell -8.5%. Capital goods orders fell -10% indicating the continued deterioration of the business climate. Communications fell the most at -40% and that news depressed LU, CSCO, NT and AT&T at the open. Semiconductors posted a gain for the second month in a row which would indicate the beginnings of a possible recovery in manufacturing underway even though computer equipment orders fell -6.2%. Semi stocks were the first stocks to rebound off their lows as the day progressed.

Existing Home Sales fell by a dramatic -11.7% to an annualized pace of 4.89 million homes. This however must be taken into context with the record numbers from August of 5.54 million units. The drop in sales, even in a time of very low interest rates, shows the impact of the nearly four million workers on unemployment and the continuing layoff announcements. The slowdown in sales impacted the average selling price which fell -3.6% and showed the competitiveness of the resale market. Comments from the Dallas Fed head on Wednesday indicated that future rate cuts, at least one more, were on tap. Analysts are now speculating that this cut could be for 50 basis points again. Once rates start back up the sales numbers will slow even more if the job market does not pick up. The next Fed meeting is Nov-6th.

The Employment Cost Index showed labor costs rising +1.0% but overall job cost inflation is almost nonexistent. The biggest gain was in benefit costs which rose +1.6% which was pushed by medical insurance. Employers are offering more benefits for workers that escaped the layoffs to ease the fears of future job losses. Wage growth is still decelerating compared with the +5.0% average from last year. That growth has fallen to only +3.7% in the last quarter. Help wanted ads continued to fall as well with the help wanted index falling to a decade low of 52 indicating that there is zero pickup in hiring and wages are likely to continue falling.

Dell also helped pull the Nasdaq back from the cliff after Michael Dell said consumer demand was better than expected and was powering their recovery in the 4Q. They had already affirmed their earnings for the quarter and claim to be gaining market share from every competitor. The stock has had problems crossing the $25 barrier since hitting it on Oct-11th but that level fell today. While talking at the Windows-XP launch Dell was flanked by eight other CEOs including those from CPQ and GTW. When asked about XP boosting computer sales he took a jab at those around him and said "I speak only for those companies that are actually increasing their sales." Zing!

The drop at the open was simply a knee jerk reaction to the economic news and each report added to the impact of the one before it. The -160 Dow drop took out stop losses from those traders who profited from the Monday rally and those stops accelerated the selling after the open.

Did anybody really expect the economic news to be good? Of course not but this shows the amount of fear still felt by traders as October draws to a close. There was also a flood of downgrades at the open across multiple sectors. This is of course normal as summer earnings show the true strength of each company in each sector. For instance JNPR and HLIT were downgraded but CSCO was upgraded. The weak earnings report from FDRY cause analysts to rethink that sector and take profits in those that had recently seen strong gains.

By 1:PM the markets had recovered their losses and the Dow was well on its way to its +117 point gain. Remarkable considering the continued bioterror news but proof that we need to be more concerned about being long instead of contracting anthrax. The continuing rebound in the semiconductor orders is our strongest clue that things will get better over the next couple quarters.

The fear of tax loss selling by funds with October year ends has all but disappeared. There was some concern that funds with significant losses would sell winners during October to offset those losses. This is not likely since funds have an eight year carry forward and cutting the flowers to let the weeds grow, as Peter Lynch is fond of saying, would not be a wise decision. There is no rush to mitigate the losses as there would be to offset any taxes from gains as in a normal year. If funds were going to sell, the drop this morning should have triggered those sales. Instead buyers appeared almost immediately and the -160 point drop proved to be another buying opportunity.

There was strong volume on the Nasdaq as the rebound took hold and the Dow closed at a post 9/11 high. The range on the Dow was nearly 300 points and almost 100 on the Nasdaq. The volatility indicators VIX/VXN both closed at levels not seen since September 11th. Both are making new lows as traders fear missing a rally more than they fear a new bottom. Puts are falling out of favor and long calls are climbing. CSCO has traded near 100,000 calls twice this week already and today broke out of the post 9/11 $17.50 top.

Speaking of breakouts there were quite a few today. Besides CSCO and Dell, AMAT and most of the chips stocks, Microsoft broke over the $61.50 barrier and closed at a new two month high. With many of the Nasdaq leaders hitting new relative highs the index is poised to test the next level of resistance which is 1915. The Dow closed at a new post 9/11 high and that alone should cause another wave of short covering. With a close over the 9450 level the investors who were still capitulating this week may rethink their decision. TrimTabs.com reported that over $7 billion flowed out of equity funds in the week ended on Wednesday. Those investors were probably patting themselves on the back at the open today and tonight they are kicking themselves instead.

I still think the market is behaving remarkably well especially in light of the over $20 billion in new high grade corporate bonds that were priced this week. If the $4 bln in GMAC bonds are priced tomorrow that will be a whopping $25 billion in cash leaving the sidelines for safety in one week alone. Granted, some of the money would have never ended up in stocks, but that is still a huge drain for investable cash.

Friday could easily see another bounce instead of the normal dip at the open as investors go flat before the weekend. The bounce is based purely on the rebound today and the urge to not miss any future gains. THE BAD NEWS IS PRICED IN! After the economic news today AND the continued anthrax updates, investors understand this is a new environment and they have decided it will not get any worse. The almost +300 point recovery on Thursday will be very convincing to anybody still on the sidelines. My advice is still "stay long and prosper"!

Sell too soon!

Jim Brown

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