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Market Wrap

Veteran's Day Volatility

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        11-12-2001        High      Low     Volume Advance/Decline
DJIA     9554.47 - 53.63  9606.10  9408.60  991 mln   1496/1561	
NASDAQ   1840.10 + 11.70  1848.00  1782.48 1.57 bln   1777/1770
S&P 100   576.13 -  1.86   578.31   566.41   totals   3273/3331
S&P 500  1118.33 -  1.98  1121.71  1098.32           
RUS 2000  440.48 +  2.38   440.48   432.15
DJ TRANS 2272.60 - 48.09  2320.50  2241.79
VIX        31.26 +  2.50    33.06    30.92
Put/Call Ratio      0.61

Veteran's Day Volatility

With the Bond markets closed on Monday and significant progress in the war in Afghanistan over the weekend, I awoke this morning with the expectation of quiet trading day ahead, likely with a positive bias. Imagine my surprise to see the futures off sharply ahead of the market open when I turned on my trading screen. Actually, you don't have to imagine my surprise, as you likely saw exactly the same thing.

For those that missed the news this morning, shortly after 9am ET American Airlines flight 587 crashed near Rockaway, New York shortly after takeoff, prompting the closure of all New York City area airports as well as tunnels and bridges leading to the city. Despite the fact that there was no apparent connection to the terrorist act that destroyed the World Trade Center, nervous traders took some defensive action early on, sending the broad market averages plunging at the opening bell. So much for a quiet day in the markets!

But what's this? Rather than continuing to sell off on irrational fear, the major indices fell right to the solid support levels mentioned in the weekend Wrap, from which they staged a steady advance throughout the day. Internals on both exchanged were almost dead even with volume light, just as we would expect on a holiday. By the time the closing bell rang, most of the early damage had been erased from the DJIA and the NASDAQ actually managed a positive close.

The wedge on the DJIA continues to narrow, and a breakout or breakdown can't be far away. 9400 held as solid support this morning (actually 9408), and we're starting to see support build near 9550. The next big test to the upside will be the descending trendline at 9700. Of course, eager bulls will want to be on their guard with daily Stochastics pointing down again. If this cycle causes a break of the ascending trendline (9350), the rally will be in big trouble.

We've got a tenuous picture here as well. Strength in the overall NASDAQ has helped to push the Composite through the 38% retracement level and now the bulls are chipping away at the 50% retracement level at 1857. A successful move through that level will open the door for a run at the 62% level and possibly 2000 (dare we hope?).

As would be expected in the wake of such a tragedy, Airline stocks were the biggest loser on the day, with the XAL index giving up 5.75%. But there were pockets of incredible resilience in the broad market, with continued strength in Networkers and Semiconductors. One of the bright spots this morning that likely helped the two Tech groups listed above was the conference call from Ciena (NASDAQ:CIEN). The company updated its guidance for Q4 with the top and bottom lines slightly better than the consensus estimates. Not only that, CIEN stated that it expects to be among the first to break out of this tough environment. Trading was heavy in CIEN, with nearly 54 million shares trading hands (vs. the ADV of 20 mln), and by the closing bell, the stock had tacked on nearly 10%.

Morgan Stanley added to the bullish sentiment in its pre-market call on the Semiconductor Equipment sector, raising its price targets on a number of names in the sector such as AMAT ($40 to $50), NVLS ($40 to $50), KLAC ($45 to $60) and LRCX ($25 to 30). Well, one man's treasure is another's trash, and it didn't take long to hear the dissenting opinion as Needham and Co. proceeded to downgrade shares of AMAT and NVLS. The market is a voting machine, and apparently the bulls had the winning vote today, with all of the stocks listed above finishing the day with fractional gains and the Semiconductor index (SOX.X) added 2.4% to finish the day at $519, and just below the $525 resistance level. The Semiconductor sector was the best percentage gainer for the day, but the Networkers weren't far behind with the NWX moving up to close at $307, a new post-attack high, and just a smidge below the $310 resistance level.

Semiconductors getting close to major resistance at 540. Either we get a breakout, which will undoubtedly lead the NASDAQ through resistance, or a breakdown. Look for a bounce in the 475-480 level to provide entries into plays in this sector. A fall below that level of support could prove unpleasant to the bulls.

Remember last week when the NWX cleared the 290 level? The support/resistance levels here are the same as last week. Uncanny, isn't it? Target bullish positions in the Networking sector on a breakout over 310 or a renewed bounce from above 290.

One predictable side-effect of the early plunge was a sharp rise in volatility as measured by the VIX (for the S&P100) and VXN (for the NASDAQ-100). Both volatility indices spiked at the open and then spent the day drifting back towards Friday's closing levels as the major indices recovered their early losses and fear-of the-unknown abated. Volatility is still high, but getting close to falling back into its historical 20-30 range. Either that, or we are about to see it shoot higher along with another large market selloff. Either outcome is possible in the near-term, but with the significant progress in Afghanistan and the steady, measured market advance over the past several weeks, I think the former case is the more likely one, at least over the near term.

Since last Monday's Wrap, we got good news from CSCO, followed by another 50-points interest rate reduction from the Federal Reserve, and the markets took it all in stride, continuing their steady advance. Even the disaster this morning in New York was reasonably well received by the markets, which continued their advance despite other spots of less-than-stellar news. Contrarian indicators like the VIX continue to show a healthy amount of fear still in the markets, giving the bulls a wall of worry to climb.

My personal bias says that we have some weakness ahead, and I would expect the worst of it in the go-go sectors that have seen the sharpest advance over the past 6 weeks. But there are also some powerful factors at work that could propel the market higher in the near term, such as positive guidance from leading Technology companies and of course a quick end to the war in Afghanistan certainly wouldn't hurt. Continue to play the long side as long as it lasts, but protect your gains and don't get greedy. Keep a sharp eye on the leading sectors we've talked about here tonight. Breakouts in the NWX and SOX could breath some serious new life into the current rally, while a breakdown in either group will be hard for the bulls to digest.

As Jeff Bailey is fond of saying, trade what you see, not what you believe. You'll make more money that way!

Mark Phillips
Research Analyst

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