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Market Wrap

Special K, Special Day

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      12-05-2001          High     Low     Volume Advance/Decline
DJIA    10114.29 +220.45 10142.32  9891.35 1.75 bln   2063/1098
NASDAQ   2046.84 + 83.74  2056.81  1980.30 2.72 bln   2420/1272
S&P 100   597.70 + 12.07   599.38   585.63   Totals   4483/2370
S&P 500  1170.35 + 25.55  1173.62  1143.77             
RUS 2000  479.42 + 11.58   480.43   467.84
DJ TRANS 2612.49 + 77.64  2618.47  2531.40
VIX        24.79 -  0.54    24.79    23.62 
VXN        47.44 -  0.60    48.90    46.57
TRIN        0.34 
Put/Call    0.44

Special K, Special Day

The Dow Jones Industrial Average (INDU) closed above the 10K mark for the first time since September 5. Meanwhile, the tech-laden Nasdaq Composite (COMPX) closed above the 2K mark for the first time since August 7. WHOA, what a day!

The Catalysts:

There was a confluence of catalysts that emerged Wednesday morning, which would carry stocks higher throughout the day. Salomon Smith Barney raised its earnings per share estimates for the S&P 500. Salmon upped its earnings estimates for this year and next.

The National Association of Purchasing Managers (NAPM) reported its non-manufacturing index of business activity rose to 51.3 percent during the month of November, which was a big jump over October's reading of 40.6 percent. Economists had predicted the November NAPM number to rise to 42.2. In other words, the actual number was a big upside surprise. A reading above 50 percent in the NAPM index suggests growth.

Late Tuesday, Larry Ellison of Oracle (NASDAQ:ORCL) said his company's businesses were stabilizing. Ellison upped margin estimates and reaffirmed revenue opportunities in the company's new application server product. Shares of Oracle finished over eleven percent higher Wednesday. The stock's gain added fuel to the momentum in the Software Sector Index (GSO), which finished 6 percent higher. Other notable advancers in the GSO included Rational (NASDAQ:RATL), PeopleSoft (NASDAQ:PSFT), Siebel (NASDAQ:SEBL) -- an OI put play no more -- Check Point (NASDAQ:CHKP), and Veritas (NASDAQ:VRTS). I of course have to mention Microsoft (NASDAQ:MSFT) when writing about the GSO; the stock finished $2.10 higher.

Micron (NYSE:MU) boosted the chip sector. Talk spread of consolidation within the DRAM market. The aim of consolidation is to clear the excess inventory among DRAM manufacturers in an attempt to firm up prices. Shares of Micron added $2.57 on the news. The Semiconductor Sector Index (SOX) finished over seven percent higher Tuesday.

The Short Covering Impact:

The two positive developments in the technology sector caught the bears off guard in a big way. Traders shorted into last week's rally and again during Tuesday's rally. I highlighted that fact in Tuesday's Market Sentiment piece, noting the excessive number of puts traded in the QQQs -- the tracking stock of the Nasdaq-100 (NDX) -- which is a barometer for big cap technology stocks. I wrote that "I [didn't] expect another 4.25 percent day in the NDX [Wednesday]," which was obviously wrong. But the revelation of continued short selling into the rally Tuesday proved to be a costly mistake for the bears. Without the necessary supply to cover their shorts, the bears were forced to chase stocks higher Wednesday, especially technology stocks.

Big Breakouts:

Big Blue (NYSE:IBM) and Intel (NASDAQ:INTC) broke out to the upside Wednesday. In addition to only a few others, the two stocks are the most important in technology. Fortunately, both IBM and Intel are current call plays on Option Investor.

In IBM, we've been writing about entering near support at $112. The stock dipped down to that level last Thursday and provided yet another entry opportunity near support, where risk could've easily been managed. Five days and nine points later, you're a genius if you entered on the weakness. The breakout in Big Blue bodes well for the health of the technology sector.

And then there's Intel. Our play on Intel was written in a simple fashion: enter on a breakout above $33. Amazingly, the stock opened Wednesday morning at $33.04, which was a rare gift from the market makers. More than $1.50 later, you're a genius if you entered on the breakout. Intel's advance above $33 is a positive development for the SOX.

Know Your Debt:

Away from stocks, Treasuries were whacked Wednesday. But that made sense, right? If bonds were sold heavily, wouldn't it make sense for the proceeds of those sales to move into stocks? Especially if bond market participants think the economy is going to recover next year, right? Wouldn't you rather own a stock during an expansion than a bond?

The positive reading in the non-manufacturing NAPM number added credence to the argument that the Fed is nearing the end of its easing cycle. The Fed Funds predicted about an 85 percent chance of an easing next week, but no more cuts thereafter. If the economy rebounds and the Fed is near its easing cycle, which way do interest rates move next? Chances are higher, which is what was reflected in the sell-off in Treasuries Wednesday. (Remember that bond prices move inverse to yields. Lower prices equate to selling equates to higher yields.)

The recent action in the 5-year Note (FVX) was the one thorn in the side of stocks. The 5-year Note saw buying recently as indicated by its falling yield. But that all changed Wednesday in the wake of the NAPM report. The yield of the 5-year sharply reversed as bond market participants discounted a stronger economy. The yield finished 6.87 percent higher, which was a massive, massive move.

From a technical standpoint, the 5-year yield recently turned lower at the 44.65 (4.46%) level. The advance Wednesday carried the yield to as high as 43.06 (4.30%), just above a key retracement level at 42.80 (4.28%). Readers can monitor the progress of the yield through the levels of the retracement bracket. (I've anchored the bracket at May's high and September's low.)

The Business Cycle:

The recent economic reports and action in stocks and bonds discounted a recovery next year. How do you play the recovery? There are many, many ways to play an economic recovery, but one you might not have thought of is through cyclicals -- the companies closely tied to the business cycle. There are several sub-sectors within the cyclical group, one of which is chemicals.

The S&P Chemical Index (CEX) hit a peak in late 1999 up around the 550 level and traded all the way down to 315 in September of this year. The rising price of energy during that time pressured the group and so did the economic slowdown.

But those two trends have recently reversed. Despite Russia's agreement to cut production Wednesday, the price of crude oil remains relatively low around the $20 per barrel mark. Energy is a chief cost of the chemical companies. In addition, a recovery in the economy will spur economic activity and a greater demand for chemical products. As long as the price of energy remains relatively low, the CEX could be a good place to look for ideas for playing an economic recovery.

Among the more attractive CEX components include: FMC (NYSE:FMC), Praxair (NYSE:PX), International Flavors & Fragrances (NYSE:IFF), Dow Chemical (NYSE:DOW), and Engelhard (NYSE:EC). Although not a component of the CEX, Neogen (NASDAQ:NEOG) might be another stock worth a look. No, the chemicals aren't sexy. But they're something different and worth a try at this point in the cycle. Don't you get tired of reading only about tech?

What To Do Next:

The last two days have been most bullish. But I've received a lot of e-mails from readers who've experienced a great deal of frustration because they missed the move. I've been told by my mentors: opportunities are easier to make up than losses. Write that down! If you missed this move, don't worry about. There will be more. The only thing a trader can do is stick to his/her strategy, discipline, and methodology. If the recent rally didn't offer a suitable entry point for YOU, then wait until it does.

For those who captured this move, now may be a good time to consider taking defensive steps in order to preserve gains. That could include setting trailing stops, selling covered calls, or scaling out of partial positions on further strength. Just have a plan in place and stick with it.

Cisco Systems (NASDAQ:CSCO) is reporting to analysts this evening and Intel will do the same after the bell Thursday. Remember that the market is a forward-looking mechanism, so bullish guidance by either of the aforementioned tech bellwethers may actually be met with selling, in a typical "buy the rumor, sell on the news" event. Now, I'm not suggesting that either stock will go lower. Rather, the good news may have been discounted in the last two days.

The jobless claims Thursday morning and non-farm payrolls number Friday morning are two big forthcoming economic reports. Each could influence the Fed's decision on interest rates next week and consequently impact trading in the bond market.

The Dow and S&P 500 (SPX) kissed their 200-dmas Wednesday, while the Nasdaq measures closed well above their 200-dmas. That was a significant development in tech, which may prompt institutional buyers to step in again Thursday. The Nasdaq-100, for example, hasn't traded above its 200-dma in more than a year. Yep, it sure feels like a new bull market.

Eric Utley
Option Investor

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