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Market Wrap

Tricks And Treats

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      10-31-2001          High     Low     Volume Advance/Decline
DJIA     9075.14 - 46.84  9223.07  9064.41 1.32 bln   1929/1172
NASDAQ   1690.20 + 22.79  1721.69  1677.71 1.87 bln   2220/1367
S&P 100   544.43 -  0.63   552.84   543.55   Totals   4149/2539
S&P 500  1059.48 -  0.01  1074.79  1057.55             
RUS 2000  428.17 +  5.34   429.48   422.83
DJ TRANS 2195.84 +  0.58  2221.20  2194.82
VIX        35.28 +  0.13    35.55    33.67 
VXN        62.42 -  0.99    64.27    60.66
TRIN        1.51 
Put/Call    0.50

Tricks And Treats

The U.S. Treasury Department played a trick on bond market participants Wednesday. The Commerce Department delivered a treat, and a worse case scenario morphed into a better case situation.

The Commerce Department reported Wednesday morning that the U.S. economy shrank by a 0.4 percent annual rate during the third-quarter. The drop in Gross Domestic Product (GDP) - the broadest measure of economic activity - marked the sharpest decline since early 1991 - the last recessionary period. Going into Wednesday morning, the consensus among economists was for a 1.1 percent annual rate of contraction in GDP, so the upside surprise was welcome by the bulls, who carried stocks higher earlier in the day.

Whether or not GDP declines sequentially in the fourth-quarter is up for debate. Some economists expect the U.S. economy to contract by as much as 4 to 5 percent annually during the current quarter. While others are more upbeat, pointing to the government's fiscal stimulus package, suggesting that the economy could actually grow during the fourth-quarter. Such is the dismal science.

Treasury Secretary O'Neill opined that the economy could grow during the fourth-quarter on the heels of the fiscal stimulus package, but his opinion of the economy's prospects wasn't the exciting news from the Treasury Department Wednesday.

Rising Fear, Falling Yields...

When I wrote about the bond market in the Market Sentiment Tuesday night, I had it all wrong. The recent rally in bonds has been fear-induced, but not the fear of future terrorist attacks.

The government announced it would stop new issuance of 30-year Bonds (TYX.X). The news caused a historic plunge in yield as buyers scrambled to lock-up existing bonds.

The Treasury said that it no longer needed the 30-year Bond to finance the government's operations, adding that it's more expensive to issue because of the longer maturity. The Treasury's stance is that the U.S. government will run at a surplus once the current economic setback passes, possibly as soon as '03. Apparently, the government is confident that the economy will rebound soon. It would make sense for the government to lock in the currently low rates, so the Treasury's decision to cease issuing 30-year debt was a bold move. In essence, the government wants to cutback on debt payments by eliminating the most expensive aspect of its debt structure: The 30-year.

More On The IUX.X

What Jeff Bailey and I are trying to figure out is if the Treasury's decision is going to adversely impact the Insurance Sector (IUX.X). I wrote about a set-up in the IUX over the weekend, and both Jeff and I have been covering the sector this week. Enough readers are following the IUX's set-up that I think it warrants an update, especially in light of Wednesday's development in the sector.

There's debate over whether or not organizations, such as insurance companies, will be able to find an equivalent to the 30-year Bond for hedging and investment purposes. Mine and Bailey's work is preliminary on this idea, so I'd rather have some more research in place before elaborating, so stay tuned.

In the meantime, the dynamic in the IUX.X dramatically changed from Tuesday to Wednesday. I wrote about a worse case scenario Tuesday afternoon in that the IUX had given its sell signal at the 700 level earlier in the day, completing the bearish triangle, but had rebounded and gained strength later in the day. Fast forward to Wednesday and that scenario reversed. So much so that the IUX lost a significant amount of strength relative to the market Wednesday.

Now below the 700 level, from where I sit, the IUX has some support between the 680 and 685 area. That's the area where the IUX has paused in recent past descending trends. I think there's the potential for a rebound in the IUX Thursday, but I'm not convinced of that. For that reason, we're trying another put play in the Insurance Sector with St. Paul (NYSE:SPC). We've had a lot of success with our put play on American Int'l Group (NYSE:AIG) in conjunction with the IUX set-up, and I've always been told that great traders add to their winners. The key level for the IUX currently is 680; a breakdown below that level could confirm further measurable downside.

IUX.X 60-minute

I was pretty excited about this IUX set-up last weekend and it's my sincere hope that many of our readers have been able to share in my excitement, if you know what I mean. If you haven't been sold on the benefits of point & figure charting, I hope the recent IUX trade has created some conviction in the tool.

Major Market Averages

The 9050 to 9100 area provided support during the Dow Jones Industrial Average's ($INDU) most recent pullback a few weeks ago. The same area has propped the average up so far this week. A breakdown below the 9050 area should cause the Dow to test 9000 in short order. The real question is whether or not 9000 holds. There's some significant historical support at that level and I'd be willing to bet that buyers try to defend that level if the Dow tests it.

However, a breakdown below 8950 over the short-term would cause some significant technical damage in the Dow. While I subscribe to Jim's notion of buying a rebound back above 9000, I would also caution that there exists downside potential on a breakdown below 8950, potentially to the 8800 level. Then again, a rebound from current levels is certainly possible, but that will depend upon the upcoming economic data.

Dow - 60-minute

Like the Dow, the S&P 500 (SPX.X) is nearing a key support level at 1050. And like the Dow, the S&P could see some downside upon a breakdown below support. Also evident on the S&P's 60-minute interval chart is the curling of the 200-period moving average. That moving average has provided support for the two averages in the last several sessions, and could carry them both higher. Keep an eye on bounces from the 200-period moving average, especially if the continue tracing at higher relative lows.

S&P - 60-minute

Big-cap tech was a bastion of strength again Wednesday. The Nasdaq-100 (NDX.X) gapped higher and tested the 1400 level twice during the day, but was unable to breakout. A breakout above 1400 could be used as an entry point into big cap tech, but I'd be cautious about the 1410 level.

Head-And-Shoulders Top?

Not only is 1410 a key retracement level, but it could potentially be the right shoulder of a head-and-shoulders top in the NDX on the 60-minute chart. I'd be especially suspicious of a rollover around 1410 because that would complete the pattern. Of course a breakout above 1410 would negate the pattern, and probably lead to a short covering rally back up to relative highs. But, I'd suggest watching for the potential of a head-and-shoulders top here in the NDX, you know I will.

To the downside, the NDX has been catching bids around 1335. A breakdown below there could pressure the NDX down to 1300, which is the key short-term support level in my mind.

Nasdaq-100 - 60-minute

There are two more big economic reports due Thursday and Friday. The NAPM number is due out Thursday morning, followed by the big one in the employment report Friday. Good economic news should now translate into good new for the market, seeing that the Fed is nearing the end of its easing cycle. Although, an exceptionally weak NAPM and/or jobs number could lead the market to believe that Greenspan is bringing rates down by another 50 basis points in November. The Fed's lost credibility this year, though, so that prospect may be a moot point.

Eric Utley
Option Investor

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