Trade, Don't Invest
Notice anything funny about the box score numbers posted on the indexes above? Before you read on, glance up and take a look at those numbers. The Dow, NASDAQ, S&P, Wilshire, Russell, and Dow Tranports have traded in a tight range for the last three weeks. This is not environment in which we want to invest. With turning or rising long-term oscillator patterns, we would expect the candles to be leading the charge up the charts. They have not, as we'll see in a minute, and the charts are turning weak. Getting long-term points from this market is like getting blood from turnips. And based on Friday's methodical selling, might I suggest the turnip is getting blood from long-term investors? This is a market made for trading.
Not to be a pessimist here and drone on about old news, but accounting issues born of casual contact with "Enronitis" sufferers are infecting the brains of the investment community. Call it headline risk. What were once considered to be safe investments (and especially speculative ones) now have investors on edge in anticipation of a sudden price implosion. One can't protect against that (except to buy protective puts, which cost money), so the logical course of action is to protect capital, sit out, and let the dust settle. Trouble is the dust may not settle too quickly. Where you find one accounting cockroach, you usually find many - each one kicking up a new dust cloud as it scurries across the trading floor and front page news. They are virulent little buggers
This is not going to end anytime soon as the companies engaged in opaque accounting techniques usually cloaked as "pro forma" income now face the choice to come clean and take a stock price hit, or be found out and take a bigger hit - caught between the devil and the deep blue sea. We can see the resultant hesitancy of investors' commitment in the lack of volume on the NYSE and the NASDAQ. If the rally that began in October represented a true anticipation of an economic bottom, volume should have been much stronger over the past few months. This is not the stuff of which sustained bull markets are made. The volume says that many would- be participants are not participating. By default, conviction is not there.
But back to the immediate Enronitis problem -- many news bits popped up last week that left investors feeling a bit anxious. For instance, SEC documents revealed that Warren Buffet's Berkshire Hathaway (BRK.A) sold most of its Citigroup (C) holdings, which put pressure on the financials upon the news release. Think Warren and Charlie have high hopes for an accounting recovery or economic recovery in which banks are SUPPOSED to lead the way? Don't bet on it. That sale was as much a vote for economic non-recovery as it was to decrease exposure to bad loans and accounting cockroaches.
Well, let them eat steak! And so they shall as BRK.A also filed notice that they had acquired at least a 5% stake in Outback Steakhouse (OSI). In my read between the lines, there's a vote that the economy isn't going into depression either as Berkshire believes that particular brand of dining will continue to grow without major economic recovery.
Recovery or not, the Telecom-related companies are going to burn a bigger hole in planet Earth and perhaps vaporize their bankers in the process (unless they are wearing asbestos bunny suits). Rumors - OK, forget rumors - facts of Qwest Communications (Q) accounting practices surfaced too, which revealed Q had drawn on its bank lines of credit because they could not refinance their commercial paper. It suggests investors' lack of faith in Q's ability to repay loans and gives the banks major heartburn as their contingent liability get converted to a real one. Look for banks to begin writing down telecom failures in bigger numbers. Neither sector should see any recovery until more pain is inflicted. If you thought things were tough on JPM who had exposure to K-mart, Enron, and Global Crossing, stay tuned as the dominos continue to fall in banking and telecom. WCOM ought to be on our "ball of flames" lists too.
IBM also took a big hit on accounting reports in the New York Times that it failed to book a subsidiary sale to JDSU as a one- time gain, and instead, used the sale as regular income. To boot, they are said to have applied it to the reduction of expense thereby manufacturing falsely inflated earnings when they last reported. IBM was single-handedly responsible for roughly 25 points loss in the Dow as it traded down $5 to $102.89 on nearly three times its average daily volume (ADV). The company reports no SEC investigation (as though investors should have confidence in that factoid). Hard to buy into that as a virtue though as the SEC also didn't investigate ENE and GX until after it was too late.
Just as a matter of note, rumors - only rumors - permeated some trading circles that Intel's (INTC) sales were off thanks to lower selling prices of the P4 chips. While that would not surprise me, INTC declined comment until their mid-quarter update scheduled in early March. I would be cautious on this stock for any continued upside action as INTC, along with CSCO and MSFT, have a long history of "managing" earnings. I don't worry as much about MSFT because they still make money and have $36 bln cash - soon to be more I presume.
On the economic front, output fell in January though the decline was the smallest in the last eight months. More disconcerting was the downward revision of December's figures to -0.3% from -0.1%. (OK, so the government makes them up as they go along too. They ought to call them "pro forma" economic figures. Take them with a grain of salt.) However, industrial capacity utilization also fell to its lowest level since 1983. The number itself (74.2%) isn't important, but it does go to show that huge capacity is meeting with little demand. There is no pricing power, thus no inflation, and many think the Fed ought to be lowering rates still. Flat to declining prices rule, which will make profits tough to grow organically. That said, stock prices would have a hard time advancing in the long run if they remain at parody (oops, "parity") with earnings.
Other than a slightly down Preliminary Michigan Consumer Sentiment (from 93.0 to 90.9) mostly born of expectations rather than current conditions, Ken Lay taking the 5th, and Sharon Watkins Enron testimony helping Lay look like a Fastow/Skilling dupe, not much else to talk about. And I'll bet you are glad about that!
Summary: Finance and techs are weak. Strength not likely to return soon.
So much for fundamentals and news. Let's turn to technicals. The battle cry in the previous week was to short every rally. That turned into choppy but slightly up in the first four trading days of the past options expiration week. What to expect this coming week? Shall we take a peak at the charts?
[Note: U.S markets will be closed Monday in observation of a President's Day]
Dow Industrials weekly/daily (INDU):
Starting with the weekly Dow on the left, notice the tight candle range between roughly 9700-9900 with stray days of volatility displayed by the wicks. The 5-period stochastic did manage to turn up, but not from oversold territory, indicating the move is suspiciously weak. As noted earlier, low volume suggests the same. The 10-period stochastic is still pointed down.
The daily chart however, appears to have reached the top of its game last week and is having a difficult time holding over 10,000. Points of resistance are plenty, which make bullish trading a bit dicey. The first inflection point was 9712, which fell, became resistance for a short period of time, and now looks like it could act as support again. Then there is the 50-dma (magenta line), currently 9925, which failed to hold as support. Look for it to act as the first point of resistance. After that, the upper Bollinger band (tagged and reversed by price action Thursday) at 10,031 and the 200-dma (gray line) at 10,070 will be really tough to break without any volume to back it up. If accounting and volume remain issues (bet on it), a break is extremely unlikely.
Couple that with daily stochastic oscillators that now have entered overbought, and the next sustained move appears to be down, especially given the non-committal condition of the weekly chart. Nothing says the Dow is going bullish this week.
However, there has been a great deal more strength in the cyclical index. Take a look.
Cyclical Index weekly/daily (CYC.X):
Weekly oscillators are a bit stronger for the CYC than the Dow. However, note that it has nearly reached its declining top trendline, which could spell trouble for bulls at the 550-552 level.
The daily is a bit mixed as oscillators, including the upper Bollinger band, suggest these have topped out and are ready for a roll down. Friday's final candle - that golf club looking thing - doesn't help the bullish cause. Since the charts don't generally lie, there may be some downside action here too.
However, my optimism is based on the candles giving very little back and continuing to find support for the last two days at the 542 level. Individual stocks like IP, DD, and X bucked the trend and made impressive gains on Friday despite the Dow's loss.
More optimism is based on the point and figure chart that reversed from a column of O's to a column of X's that has now exceeded the column of O's. It already went green with one double-top breakout. Risk/reward measures could take cyclicals bullishly to 550 and perhaps another breakout at 555, while the downside support looks to be 535. Thank Stockcharts.com for this one and see below:
PF chart on Cyclicals (CYC):
Some good strength here and pullbacks to 535 on the index makes individual hard resource issues - chemicals, steel, paper - look buyable. Follow Eric and Jeff's comments in the Market Monitor next week, as I'll bet these show up bullish on many radar screens.
NASDAQ composite (COMPX) weekly/daily chart:
NASDAQ bulls. . .TOAST! Declining trend line, rolling or already diving long-term stochastics, bullish divergence on the daily chart. 'Nuff said. Bulls became steers long ago on the COMPX. Attractive short candidates will likely be had on any strength in the tech market, particularly among the walking dead telecom related companies. Whirling knife blades - watch fingers!
S&P 500 (SPX) weekly/daily chart:
Sadly for bulls, wither the SPX too. With so many financials and tech stocks included in the broad market, the bearish side looks to be more profitable in the coming week. Evening star reversal on Thursday at the declining trend line with bearish divergence and rolling overbought stochastics on the daily chart favor bears. Weekly chart is already pointed down stochastically with 1100 about to be mashed into the S&P cowcatcher and 1080 the next major support. This along with the OEX make for great put opportunities on any strength.
But watch the upper trend line to see if it holds at 1120. A breakout while highly unlikely would send all above indicators the way of the Dodo and T-Rex - extinct.
Any clue from indicators of volatility, the VIX and VXN? Not much. The VIX is at 24.09 and possibly climbing based on oversold stochastic reversal. The VXN is in the same boat. Oscillators suggest they will climb, which would show investor favoritism toward puts and away from calls. While it corroborates the coming bearishness in the air, it is no guarantee.
So for the coming week, all appearances are for bulls to buckle their seatbelts and bears to get honey pots at the ready. Though it could always turn out different that's the way I see it in the charts this weekend.
Fear not, be happy! For this is the making of a profitable albeit short week, as long as we adhere to our charts, which objectively favor the bears. Remember, no U.S. markets will be open Monday. Be well this President's Day extended weekend. See you at the Tuesday morning bell!