Don't say I didn't warn you. We are only eleven days into the historical spring crash period and all the major indexes have done just that, crashed! Positive economic reports and lingering earnings announcements could not entice traders back into the market. Fears of a double economic dip are rising despite the GDP news and even Bush got into the act by warning that the current bounce may not continue. Trend lines, moving averages and technical support levels all failed on Friday when a short covering rally failed to appear at the close.
So much news, so little space. The GDP numbers led the economic hit parade on Friday with a huge 5.8% growth rate for the first quarter. What recession? This was the fastest rate of growth since 4Q-1999 but the fly in the ointment was inventory liquidation. Everyone has been pointing to the rapid draw down of inventory and the spurt of orders related to replenishing those levels. Those orders spiked the 1Q GDP but they are not expected to continue. Also, those inventory levels suddenly spiked upward which would indicate the rate of sales had slowed. Traders were hit with a double whammy. The super strong GDP could pressure the FED to raise rates preemptively and much sooner than expected. Secondly, the slowing consumption numbers caused concern that the economy could quickly dip back into recession during the summer. Granted, both of those scenarios would not happen at the same time but either one would have a negative impact to the markets.
Consumers continued to drive the GDP numbers with retail purchases and new home buying. Businesses continued to cut spending but the pace of the decline is slowing. Defense was the strongest sector with a +19.6% increase. There is a catch 22 here which should be obvious to everyone. If businesses are continuing to cut spending, layoff workers and delay expansion plans then unemployment will continue to rise and raises will be hard to come by. This will put the consumers on a budget before summer is over and without the consumer to provide support the house of cards will collapse. Consumer sentiment numbers, which fell from 95.7 in March to 93 in April may already be the leading indicator for this problem. The expectation component fell to 89.1 but could have been influenced by the stock market. New home sales have now fallen for two months in a row which could also indicate a slowing of consumer demand.
The markets continued to be pressured by more weak earnings and accounting problems. AOL posted a record loss of $54 billion although it was funny money not cash. Still traders are bombarded with these huge headline numbers on a daily basis. Stalwarts like General Mills, GE and Merrill Lynch are being killed on negative news. Adding to those headliners are the me too companies like Tyco, JDSU, VRSN, Dynegy, which were crushed by news, warnings and SEC investigations. Apologies by company executives don't cut it when the legal enforcement agencies come calling. The apology was only the first step as the Merrill Lynch CEO found out on Friday. That just laid the groundwork for civil lawsuits and a possible $2 billion fine/reimbursement for recommending stocks to the public that they were trashing internally. Dynegy was hit with another -4.81 loss on accounting concerns. Does this brain damage ever end?
Debt ratings are dropping faster than hail in Kansas with TYC, DYN, GIS and MER getting the call on Friday. This is just the tip of the iceberg and as Moodys, Fitch and S&P catch up on their backlog it will clearly result in another downgrade wave. Companies with huge debt are seeing their shares drop with every passing day. After the Enron, Global Crossing, Tyco and ADLAC problems, stocks with high debt are being seen as possible targets of wrong doing. With the debt game more closely resembling a shell game nobody wants to be the last one holding stock in a heavily leveraged company.
What is a trader to do? Focus on the trend and don't fight the tape. I got several emails today asking if XYZ stock was a good buy as these depressed levels. First, I cannot give individuals specific stock advise because I am not a broker. Second, I don't know your time horizon. If you want to hold GE for the next 10-20 years then $31.50 may be a good price. If you only want to hold it for two weeks then $31.50 may not be a good price. Why everybody wants to buy stocks on the way down is beyond me. Just because GE looks cheap at $31.50 does not mean it can't get cheaper. Remember CSCO at $45, $30, $25, $20, $15? It looked cheap at every price point but Friday's close at $13.93 was a new six month low. Is it cheap enough yet? Who knows, it depends on your time horizon. Two months, you can bet it will be lower. 20 years, you can almost guarantee it will be higher. Remember Lucent at $13? AOL at $27? Let's try not to catch the proverbial falling knife and simply follow the trend instead.
I went through the prior paragraph to set the stage for our discussion of the markets this weekend. You might cover the eyes of any small children reading this with you. It is not a pretty picture and while there is no mention of blood and guts there is still plenty of red ink. The Dow closed at 9910, a level not seen since Feb-22nd and well below the critical 10,000 benchmark. It even closed below its 200 DMA of 9956. There is no joy in Mudville tonight. The problem only compounds as we move into the broader markets. The Nasdaq has broken through anything resembling a moving average long ago but the last ditch support levels have finally collapsed as well. Once below 1700 the index picked up speed and appears earthbound at meteoric speed. There is support at 1650 but without some good news soon that level will be road kill as well. The S&P-500 resembles the Nasdaq in its rate of descent. Support at 1100 is history, support at 1080 is toast and the index is clinging by its fingernails to Feb lows at 1075. Should 1075 fail we could only be a day away from October support levels at 1050. Do we dare imagine a triple digit S&P?
I got a good laugh all week as TV commentators kept revising their "critical support levels." Every day a critical support level was given for whatever index was being discussed. As each day passed those "critical" levels were broken along with their premise. Each day there was no mention of the prior days critical level as though by not mentioning it the viewers would forget that it was different. These TV experts, who are supposed to report the news not make it, seem fixated at trying to pick the bottom. I know the feeling well since the majority of email we get does not ask "how far are we going to drop" but "when should I buy." The answer would be the same but the context of the questions prove that most investors are just that, investors, and not traders. Those TV commentators are selling to the vast majority of their audience, buyers not sellers. When the market feeds them day after day of losses the temptation is too great to try and be a hero by calling the bottom with a forecasted "support" level.
Fortunately OIN readers appear to be learning that money can be made both ways. I just wish I could convince you to ONLY buy calls when the market is going up and puts when it is going down. There is that contingent that still believes a recommended call can be play any day just because it is recommended. But that is another lesson. Those who have been playing puts over the last week have done very well. We currently have more than an $8 gain in MXIM, $4 in MU, $6 in NVDA and $3 each in EBAY and ADI. Also, remember the VRSN put from last week at $25? We dropped it before earnings to avoid a surprise but it closed Friday under $10. I am not posting this to claim perfect results since everyone knows we have been stopped out of several lately. I only post this to emphasize that profits can be made both ways. Why? Because I think the downside chances are still better than upside as we go forward. You do not have to sit on the sidelines because the market is down.
With that prelude let's get into the forecast. Up, down, flat and all of the above. Seriously! While Friday's close was very bearish there is a good chance there is a bounce in our future. The VIX rocketed to over 24 and very close to the levels seen just before the February bounce. Still a far cry from the 40 level seen in last April's sell off but still it is moving in the right direction. The put/call ratio rose to .87 and closer to a bullish reading. These represent fear coming back into the market and a necessary component to any future rally. The TRIN or Arms Index closed at 1.99 indicating a very oversold condition. Those indicators taken along with indexes nearing "critical support levels" (grin) are a recipe for a bounce.
The Nasdaq should find support in the 1645-1650 area, which is only 15 points or so away. The S&P could find buyers in the 1060 level only 16 points away. The Dow should get a transfusion around 9750-9850. The Dow could also see a lift on Monday from an article in Barrons this weekend. They are profiling Boeing as lean, mean and oversold. A $2 takeoff by Boeing won't help however if Microsoft continues to accelerate to the downside. Speaking of downside another Dow component, Intel, is only 36 cents away from breaking the to a new six month low. This happened even after Intel made bullish statements last week. Apparently investors were not impressed with their continued cautious outlook. On a side note, the SOX closed below its 200 DMA and under support despite a large increase in the book-to-bill numbers this week. If semiconductors can't find support on good news then........ Traders will be watching the 500 level for a tradable bounce but will short a break under that level aggressively.
While the oversold conditions may be pointing to a bounce soon it may not have legs and could only be a bear trap rally. I would look at any bounce as a new opportunity to buy puts cheap and not the beginning of a new bull market. My entry points for going long are so far out of range that they are not relative to this discussion. It is far too early to revise them downward since a short covering rally could occur very quickly and then die just as quickly. My entry points for going short were 10000/1725/1100 all of which have been penetrated substantially. This means you should already be short stocks or long puts. I would use those same levels as exit points. Should an oversold bounce occur then exit those shorts at 10000/1725/1100 OR BEFORE! Keep those seatbelts fastened and trade in the direction of the skid!
Enter Very Passively, Exit Aggressively!
Editors Note: We are having a spring cleaning sale at OIN. We have rounded up the last remaining videos sets of the last seminar consisting of 10 four hour VHS cassettes and workbooks. I think we have eleven of them. click here
Also we have a couple dozen of the year end special CD/Workbooks available. Watch the website this week for our special offers. Act fast because there are no more. When they are gone they are GONE! click here