Option Investor
Market Wrap

A Banner Week!

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        WE 10-26         WE 10-19         WE 10-12         WE 10-7
DOW      9545.17 +341.06  9204.11 -140.05  9344.16 +224.39 +272.56
Nasdaq   1768.96 + 97.65  1671.31 - 32.09  1703.40 + 98.10 +106.50
S&P-100   567.98 + 14.18   553.80 -  6.98   560.78 + 11.40 + 16.28
S&P-500  1104.61 + 31.13  1073.48 - 18.17  1091.65 + 20.27 + 30.44
W5000   10185.53 +290.64  9894.89 -154.23 10049.12 +212.01 +274.18
RUT       438.65 + 12.95   425.70 -  2.89   428.59 + 13.62 + 10.10
TRAN     2247.58 + 73.30  2174.28 - 60.45  2234.73 + 25.31 + 15.43
VIX        30.53 -  5.31    35.84 -   .61    36.45 +  1.79 -   .53
VXN        56.91 - 12.37    69.28 +  3.30    65.98 +  2.63 -  1.84
TRIN        0.87             1.19             1.08            1.14
TICK        +828             +342             +283            +290
Put/Call     .53              .80              .76             .96

The Dow managed to tack on +341 points while the Nasdaq squeezed out a respectable +97. While these numbers may not be as large as investors would like we need to realize that there have already been some great moves in the last few weeks. The Dow has posted a +18% gain since the Sept-21st low of 8062 and the Nasdaq is now up +27.5% since the low of 1387. These moves are larger than most entire years and they occurred in the last four weeks. Don't complain that the Nasdaq lost -6 points on Friday. It was just profit taking after a very nice run!

After the great run described above we are now on our own and at the mercy of the markets. Confused? Earnings are over for all practical purposes. There will continue to be a trickle all the way into late November but the lions share of the S&P companies have all reported. There are some who feel that these earnings gave us a boost out of the depths. The reasoning is that the bar was set so low it would be hard for any company to miss the estimates. Sorry folks, some managed to do it anyway. Those who beat the lowered bar were not rewarded in general. There were some but they were the exceptions. Regardless of your feelings about the impact to the markets by this earning season, the impact is over.

We are now watching carefully as next week looms ahead of us. The few companies that will announce are not expected to move the markets. Instead traders will start looking at economic news much more carefully as we get closer to the Nov-6th Fed meeting. Will they or won't they? Zero, +25 or +50 basis points? Reports that will impact that decision include the Consumer Confidence on Tuesday and 3Q GDP on Wednesday. The week is loaded with economic news and analysts are fairly confident that the Fed will drop rates by another 25 points. The common idea is that the supply of bullets is running low and they need to ration those that are left. You can make more small cuts than large ones and even if they are not making a difference on the surface the continued press is positive. The Fed will probably try to choose their shots carefully and we can expect the public appearances and statements to increase as they try to talk the economy back into growth mode.

The wild card on our side is now the mutual fund community. Historically the last five days of October are used for end of year window dressing. There is a flurry of activity and most selling is already out of the way. This coming week is reserved for buying winners as a sales tool for fund shoppers. Many funds have October as a year end and this provides the incentive. Also historically the best six months of the investing year begins Nov-1st and many investors have made fortunes by using the strategy of buying in Nov and selling in late spring.

While you may not subscribe to this theory it does exist. However the January effect was once a valid investment tool as well. That strategy has gone the way of all prior repeatable trends. Once they are commonly known traders try to beat the trend by buying earlier and selling sooner and the trend disappears. The January effect moved into late December then early December and then into the Thanksgiving week. Recently it has faded from view as buying and selling became more spread out. The end of October trend could be the next sacrificial offering. As traders buy earlier and earlier to capitalize there is nobody left to buy during the last week. Funds are not stupid, at least most of them. They plot these trends and attempt to profit from them. Those that wanted to profit from the last week of October would have bought over the last two weeks and they would sell into any window dressing next week. If the window dressing does not appear then funds who had speculated on it would still be forced to sell rather than hold stocks they had no long term desire to own.

For traders the markets have been very exciting to watch. Lower openings with acceleration into the close. Poetry in motion! Volume on Friday was even decent with the NYSE trading over 1.2 billion shares and the Nasdaq nearing 2 billion. Decent, not strong. Advancers beat decliners even on the Nasdaq which lost ground on profit taking on a couple big caps. The comment was heard several times last week that happy hour had been moved up to 3:PM in the markets as the last hour has produced some strong moves. From a technical and sentiment standpoint the markets have been performing extremely well. Investors are counting on fiscal stimulus, tax cuts and increased government spending to bolster the economy and keep it from crashing. The GDP is estimated to be reported next week at -0.8% but nobody appears to care that the recession will be confirmed. They are looking 6-12 months into the future and counting on the rate cuts to provide long term growth again. Historically once in a recession the markets tend to do very well over the next 24 months and investors are taking that bet. It is the decline into a recession that crashes markets and we have already seen that chapter of this movie.

Investors are so positive that earnings will improve shortly that they have ignored the continuing anthrax news and weak economic data. It is tough to fight the tape when it powers through all the bad news we have had over the last several weeks. This bullishness has a catch. The VIX closed at another post attack low of 30.53 and lost over five points for the week. The VXN is now at pre-attack levels and could break under 50 next week. Granted the monstrous volatility we have had over the last several weeks has created havoc with bid/ask spreads and increased premium prices, the threat of it collapsing is also real. When everyone lines up on the buyers side in the markets there is nobody left to buy. Once the current buyers are fully invested they need new buyers to push the prices up to the next level. If there are no buyers ready to pay higher prices then the rally will fail. Falling volatility means that nobody is buying puts to protect their positions because they do not expect the prices to fall. Great if it happens but Murphy is still alive and well.

Several problems facing the markets next week are simply a factor of cycles. The biotechs have been storming to higher levels for several weeks. Many of them are approaching levels of resistance dating back many months. The BTK.X is only 23 points away from serious resistance at 600 and is up +38% since 9/11. Any reasonable trader would tell you that a pause for a rest was imminent. The SOX.X is nearing resistance at 500 (19 points away) and has rallied substantially since 9/11. The Nasdaq has reaped the benefits of the Biotechs and Semis in its +27% rally. Take out those two sectors and the Nasdaq is devoid of any other leadership groups. Retail (RLX.X) has run into trouble in the 825 range and will be no help. Software has been strong but is also ready for profit taking.

My advice is simply this. We have had a great run and "historically" next week is a bullish week. We hope history repeats itself and the Dow duplicates this week with another +341 point gain. The Nasdaq basically held its ground despite profit taking in techs on Friday and is only 150 points away from serious resistance at 1920. I will take it! Give us a +150 point week and then take a well deserved rest before heading for 2000 again! The problem as I see it is the already over extended markets. We are due for profit taking next week. The farther up we go the more likely and more severe it could be. I have been telling you to go long and I am not changing that instruction. As traders we need to set some stop losses on those plays and be prepared to move to the sidelines for a day or two. Any pullback will be another buying opportunity and we should be looking forward to getting into our next series of positions cheaper. For those of you in cash the prospect of another pullback is exciting. For those currently long it is an opportunity to take profits and reload again. Either way the long term outlook is still positive and the prospect of having a new bull market ahead of us will do wonders for consumer sentiment. An October without a crash? It is almost a reality!

Sell Too Soon!

Jim Brown
Editor

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