What a difference a week makes! The prior two weeks capped a five week winning streak for the Dow that left it within a handful of points from 10600 at each Friday's close. This week started well with Monday and Tuesday seeing the Dow trade well over 10650 both days as investors expected the Fed to leave rates unchanged and say positive things bout the economic recovery. All of that happened as expected but was quickly followed by more cautionary comments, and fears of an aggressive Fed in the near future. Those fears subsided quickly when they were replaced with even greater fears of a new recession in our future and a flurry of earnings warnings.
So many topics and so little space! Leading the big news we will start with the controversy over GE. As the largest company in the Dow it has a major impact in Dow direction. Unfortunately that direction was down after several negative news stories. After trading at a high of $40.55 the stock dropped to a five week low under $37 on Wednesday. Bill Gross, bond fund manager at PIMCO, said he was concerned about their disclosure practices and their heavy debt load. GE sold $11 billion last week and said they could go out for another $50 billion earlier this week. This caused a run on the stock which only slowed after GE announced on Friday that they were reaffirming their 2002 full year earnings and were going to reduce their short term debt going forward. Unfortunately investors did not race back into the stock after the GE comments. The volume was only 30 million shares compared to 56 million on Thursday. The problem it appears is nobody wants it even at $37. If this trend continues then the Dow will have one more anchor to drag.
Adding to the Dow's problems was an earnings warning from McDonalds. The company warned on Friday that sales around the world were under pressure for many different reasons including weak economies and mad cow disease. The company said it would miss estimates for the quarter and the year. They were forced to close many restaurants which were under performing. The stock dropped -1.05 for the day and could be under pressure going forward.
Another Dow component took a hit and dragged several others with it. An internal memo from HWP said that revenue and profits in the services division was well below plan. The memo said that orders for technology services were "very soft" and called it a "cause for concern." The services division accounted for 17% of the $45 billion in revenue last year. A dramatic drop in this high profit performer could cause HWP to miss estimates substantially. HWP dropped to a low of $17.50 on the news but rebounded to close down only -.35 cents but at a five month low. However, the worry about weak services orders knocked -1.18 off of IBM and will continue to pressure the stock next week. IBM gets more than 20% of its revenue from its services division. Microsoft also suffered from the backlash as weak service orders could equate to weak software sales as well. INTC dropped nearly $1 on the same concerns. The birds of a feather concept works great when the news is good but bad news ripples downward even faster.
The Dow problems above paled in significance to the ramifications from the Philadelphia Fed Survey on Thursday. The index headline number was 11.4 and much less than the expected 16. This was the first drop since November and the new orders component was the weakest since December. This brought an immediate wave of warnings that the economic rebound everyone had been bragging about was just the inventory correction process and real demand was simply absent. The double dip scenario crowd took center stage and the markets felt the impact. Historians pointed to the past when almost every prior recession was met with a second dip after the oversold phase was seen.
Adding to the worry about another dip was warnings from several companies that they would miss earnings and they saw no recovery in their future. If you think about it this is nothing new. Everybody except maybe the chip makers has been saying "still no visibility" all month but the bulls simply ignored it. Even GE said they saw no recovery in their future when they reaffirmed earnings the first time. Solectron for instance announced earnings inline with already lowered estimates but warned that the next quarter will be lower. The biggest comment was that much of their $4 billion in outstanding orders may get pushed into the end of NEXT YEAR. The contract electronics sector, where chips meet boards and become actual equipment, is still very weak. Reading between the lines would indicate that there are no orders for completed equipment if production is being delayed as much as 18 months. Does this mean the inventory correction orders are already over and companies are expecting another dip before things get better. It would appear so to investors. As I mentioned above the only tech sector still expressing optimism is the chip sector. AMAT announced a 2:1 split on Thursday night and said they still "expect" orders to rise 10-15% in the next quarter. There is no rush to buy chip equipment but with the new .09 micron process for new chips those companies who want to be competitive must step up to the table.
Even the oil services sector, which had been on a roll, came up dry on Friday. BHI warned that declining rig counts would impact their earnings and the stock dropped -2.55. Quick on the trigger Salomon Smith Barney downgraded BHI, RDC, NBR, SLB and TDW. The analyst said weak Latin American economies and slowing consumption due to higher oil prices made the sector overpriced by as much as 20%.
Where did all the bullishness go? Reality of a possible double dip enhanced price concerns that were already present. Many analysts have been preaching the overpriced market mantra for several weeks and it only intensified after the +1000 point Dow gain in the last five weeks. This is a constant babble and I do not want to place too much emphasis on its credibility. Still, when traders start looking for excuses in times of trouble that is the first one they find. Anyone looking closer than the talking heads on stock TV knows that other factors are more important.
First there is that +1000 point gain. Did anyone expect there to be no profit taking? Of course not! Only the hobby traders get caught flat footed after those types of gains. Also, historically speaking, the last five trading days of March have also been rough the last several years. This is a normal cyclical thing, which should be expected. Add in all the warnings and double dip talk and it just becomes more likely.
For next week the Dow still looks like it could be under pressure. There was an intraday bottom at 10400 on Friday but it could just be a resting place instead of a bottom. The S&P has the same thing at about 1145 but you would be stressed to call it support. 1850 is performing the same function on the Nasdaq. I would like to stress that these are not support levels but simply areas where some buyers stepped in to snag a few shares at a discount.
The name of the game appears to be "dips are for snacking" not buying. Funds are seeing cash come into accounts but they are not rushing out to buy something. According to TrimTabs.com $4.4 billion in new cash flowed into funds for the week ended on Wednesday compared to a whopping $7.6 billion the prior week. In comparison to the past couple months this is a huge inflow. This apparently means consumers saw the Dow about to breakout to a new post attack high and wanted to buy a ticket for the rally. This "headline" buying is part of the problem that is pushing the VIX to new lows. The herd buys the tops and sells the bottoms and considering the $12 billion inflow of cash over the last two weeks you would be hard pressed not to see the trend.
The VIX closed under 20 on Friday at 19.62 and the VXN closed near an all time low of 37.56. Does anyone else think it is strange that the volatility indexes fell on a day the markets dropped? This is contrary to the conventional trends. People are simply so sure that the markets are going up that they are not buying puts to protect themselves. This is dangerous complacency in its highest form.
What should investors do? I think the answer is clear. The closer we get to April earnings the more earnings warnings we will see. There is a stronger possibility that the markets will move sideways or down instead of up. We have failed so many times at 10635/1175 that traders now want to see if there is a bottom. Once the market is assured there is support nearby then traders will feel better about buying stocks and attempting the breakout again regardless of the possibility of a second economic dip ahead.
I revised my entry/exit points last Sunday to 10475/1850/1150 and all of those levels were breached on Thursday. Since the Nasdaq appears to be the index to watch next week I am going to revise my ENTRY point to 1875. If you are not long tech stocks then I would not open new positions until after the Nasdaq trades over Friday's high of 1873. The index closed at 1851 on Friday and could be headed lower. Many tech stocks that rallied on Thursday did so on short covering after the huge Wednesday drop. They rallied right to resistance and collapsed again. I am changing my Dow entry point to 10500 since it failed just below that on Thursday and Friday. We only want to be long the market if the market can take out the prior resistance. The number for the S&P is 1155.
Should the markets continue to show weakness I would short the S&P below 1140, the Nasdaq below 1825. (QQQ = 36) Real support for the Nasdaq is not until 1750. (QQQ = 33.50) Above all, regardless of the options you purchase, puts or calls, I would strongly advise buying more time than normal. With the volatility so low the option prices are also low and you can afford to buy that extra time insurance. When the volatility returns you will be richly rewarded as those option prices expand again.
The weak before Good Friday is typically flat to down. Fund managers window dress their portfolios the prior week in order to take a long holiday. The first two days after Easter are normally bullish as traders pickup bargains from the prior weeks drop. This would suggest buying the close next Thursday for a quick trading play could be higher odds than usual. I will update that outlook on Tuesday night. Volume next week could be even worse than the 1.2B NYSE, 1.3B Nasdaq on Friday. Any surprise news events could produce some serious market swings. Be prepared.
Unfortunately, the "Sell Too Soon" close has been put back on the shelf until later. Until then....
Enter Passively, Exit Aggressively!
Jim Brown Editor
It is with great pleasure that we announce the addition of Leigh Stevens as Chief Market Strategist at OptionInvestor.com
Leigh was working a Cantor Fitzgerald with an office on the 105th floor of the WTC when the attack occurred. Fortunately Leigh was out on leave finishing his new book called "Essential Technical Analysis" at the time and was spared. After that close call Leigh decided to move to Denver and join OptionInvestor. We are pleased and fortunate to have someone as knowledgeable and experienced as Leigh join our staff.
Look for his daily input in the Market Monitor and in the pages of Option Investor.
Check out his latest contribution here:
Leigh Stevens began advising a trading and investment clientele in 1982, at the advent of the long-term equities bull market, as a stockbroker at the Park Avenue office of Merrill Lynch in New York City. Leigh was later employed at Morgan Stanley Dean Witter where he continued to advise equities and stock index oriented customers until 1986, when he joined PaineWebber as the stock index and fixed-income derivatives strategist. He later became senior technical analyst at PaineWebber, taking over from Jack Schwager and was widely followed by the brokers there, especially by those with an active option and index trader clientele.
Leigh indicates that "it was my great good fortune to have been privately mentored by a hugely successful professional stock options and index trader, Mark Weinstein. Mark made brilliant use of technical analysis techniques and principles, which he trained me in. I later brought Mark to the attention of Schwager while we worked together at PaineWebber and Jack featured him in his first Market Wizards book, where I am also mentioned."
In 1993, Leigh was invited to join Dow Jones Telerate as senior manager for technical analysis and spearheaded the growth in the institutional trading room environment of Dow Jones TradeStation, the premier technical analysis/systems testing and development application. While at Dow Jones, he continued to write and train in the area of the technical analysis, using the Dow Jones Markets magazine and client seminars as his vehicle, as well as by overseeing the technical analysis and product training of 30 Dow Jones TradeStation support personnel.
In 1998, Cantor Fitzgerald, the largest third market equities and fixed income broker-dealer in the world, making markets for the major mutual funds, Wall Street firms like Merrill Lynch and Goldman Sachs and online brokers such as Charles Schwab, tapped him to revamp the Cantor Morning News web site, the most highly rated morning market summary going out to the major institutional stock trading community (1999 Reuters survey).
While at Cantor, Leigh also wrote the highly popular "Stevens on Technical Analysis" weekly columns for CNBC.com. His ability to make technical analysis understandable and useful to the average trader and investor, lead to his authoring, Essential Technical Analysis, due out in spring 2002 from John Wiley & Sons. While on leave writing this introductory book, Cantor Fitzgerald, which occupied the top floors of #1 World Trade Center, was devastated in the 9/11/01 terrorist attack.
While personally saddened by the loss of so many colleagues, Leigh was also then able to become more involved in web-based advisory services, joining OptionInvestor.com as chief market strategist. According to Leigh, "my first love is the market and advising individual traders and investors. My vehicle of choice for doing that is the Internet and OptionInvestor.com offers the premier service in this field."