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Market Wrap

Merger Monday

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        10-29-2001        High      Low     Volume Advance/Decline
DJIA     9269.50 -275.70  9543.40  9269.50 1.11 bln   1026/2067	
NASDAQ   1699.50 - 69.40  1767.97  1699.40 1.65 bln   1246/2364
S&P 100   553.34 - 14.64   567.98   553.34   totals   2272/4431
S&P 500  1078.30 - 26.31  1104.61  1078.30           
RUS 2000  429.41 -  9.84   438.88   429.38
DJ TRANS 2218.96 - 28.62  2264.28  2218.72
VIX        32.39 +  1.86    32.70    30.95
Put/Call Ratio      0.61

Merger Monday

As the markets opened slightly weaker this morning, it looked like the big news of the day would be the final resolution of sale of GM's Hughes Electronics division (NYSE:GMH). What has been called one of the strangest mergers in recent memory was finally resolved over the weekend, as GM decided to sell the division to Echostar (NASDAQ:DISH), much to the chagrin of Rupert Murdoch of NewsCorp. (NYSE:NWS) fame. The $26 billion deal creates the second largest television company in the United States and creates a formidable competitor to the Cable TV industry. While the details of the deal filled the CNBC airwaves early in the day, that quickly gave way to chatter about the worsening decline in the broad market averages.

Within the first 30 minutes the DJIA had accrued a triple-digit loss and it only worsened as the day wore on. By the time the closing bell rang, the Industrials had dropped more than 275 points from Friday's closing level, putting a damper on the attempted breakout over the 9500 level. Volume topped 1.1 billion shares, and advancers languished behind decliners by a 2:1 ratio. With Stochastics rolling lower, confirming the bearish divergence in the making, we have to look at the 20-dma for support at 9250 and then down at 9100, which has been holding as support since the breakout on October 10th.

The NASDAQ didn't fare much better, as it continued to pull back from its attempt to break through the 1800 level. Not only did today's 70 point decline endanger the breakout through 1750 from last week, but the rollover in the daily Stochastics confirmed the emerging bearish divergence there as well. Barring a bullish reversal it looks like the 1640 support level is in jeopardy, with a test of 1600 soon thereafter. Internals were decidedly negative here as well, with decliners outpacing advancers by almost 2:1, although volume was only moderate at 1.65 billion shares.

The Technology rally over the past month has been led by the Biotechnology index (BTK.X), Semiconductors (SOX.X), Networkers (NWX.X) and Internets (INX.X). It is no coincidence that these were among the loss-leaders today, as investors moved to lock in profits and protect themselves from giving back their gains. The SOX led the losers, giving up nearly 7%, while the INX and NWX weren't far behind with 5.80% and 4.74% declines respectively. Even the BTK shed nearly 4% (actually 3.84%), dropping back to the 555 breakout level. What we have here is a solid rally that is right on the cusp of reversing into a bearish trend, and we'll need to see some serious bullish support tomorrow to rescue these sectors before they roll over even further.

Delving a little deeper into the movement in the Internet sector, it is clear that the catalyst for this sector's decline came from the annual Ebay (NASDAQ:EBAY) analyst meeting. While the stock was showing some mild weakness throughout most of the day, the bottom fell out in the final hour. Despite an upbeat presentation, investors weren't wild about the forward guidance provided by the company, as the stock fell from north of $56 to $51.25 in less than 30 minutes before firming up somewhat ahead of the closing bell. For the record, EBAY guided analysts to expect earnings in the range of 70 to 73 cents per share vs. consensus estimates of 73 cents. We've recently featured put plays on EBAY on both the short-term play list, as well as in the LEAPS column due to valuation concerns, and it appears we were in the right place at the right time.

I think it is instructive to look at the INX index as a way to measure the current situation in the broader Technology sector. As you can see from the chart above, the INX reversed from the $120 resistance level and by the closing bell had fallen right to the $108 support level, also the site of the converged 20-dma and 50-dma. The bullish trendline that has been in place since early October has been solidly broken, and we'll need to see some concerted buying near current levels if the Technology rally is going to continue. While the support levels and moving averages are different, similar patterns can be seen in the daily charts of the NWX, SOX, GSTI Software index (GSO.X) and GSTI Hardware index (GHA.X). In a nutshell, the rally is in trouble, and barring a solid bullish reversal tomorrow, it looks like the odds will favor more downside this week -- namely puts.

In terms of sentiment, we're starting to see a bit more fear creep into the broad market, as the VIX moved higher for the first time in the past 8 sessions, ending the day at 32.39. Daily Stochastics are just starting to poke out of oversold territory, indicating that we could see more fear prompt a significant market retracement over the next several sessions.

With earnings season winding down, investors are once again focusing on the economic reporting calendar, and there isn't likely to be much positive news available from that quarter until the Fed delivers their next decision on interest rates on November 6th. For this week, we have Consumer Confidence tomorrow morning at 10am ET, followed by the 3Q GDP numbers on Wednesday. Anyone think those numbers are likely to provide a boost to the markets? Me neither! Without a tangible bullish catalyst, I'll be leaning towards puts, but cautiously due to the underlying bullish sentiment caused by traders afraid of missing the end of year rally.

Remember to trade what you see, not what you believe.

Mark Phillips
Research Analyst

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