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Market Wrap

After Two Strikes, Bears Throw A Ball

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        05-22-2002        High      Low     Volume Advance/Decline
DJIA    10157.90 + 52.20 10157.90 10063.50 1149 mln   1606/1530
NASDAQ   1673.50 +  9.30  1676.64  1643.96 1735 mln   1524/1950
S&P 100   541.92 +  3.64   541.92   536.06   totals   3130/3480
S&P 500  1086.02 +  6.14  1086.02  1075.64
RUS 2000  493.91 -  1.55   497.14   490.23
DJ TRANS 2716.20 + 13.42  2721.17  2700.93
VIX        21.59 -  1.18    23.19    21.52
VXN        44.70 -  0.38    45.24    44.29
Put/Call Ratio      0.86

After Two Strikes, Bears Throw A Ball

With two negative days already under out belt this week it appeared that Goldman Sachs was pitching for a third day in the red with a massive downgrade of the software sector before the bell this morning. This move came on the heels of Tuesday's downgrade of several software issues by Solomon Smith Barney. While Solomon threw darts at SEBL, PSFT, ARBA and EPNY yesterday, Goldman unloaded a barrage of cuts for 26 software companies before Wednesday's bell.

The source for Goldman's bearish outlook was a May survey that showed IT budgets would likely remain flat throughout 2002. This put a pretty big rip in the bulls' security blanket that a second half recovery for the tech sector might still materialize (well at least the software sector). You'll recognize most of the names on Goldman's list. Here are some of the tech bull favorites: PSFT, RATL, CHKP, VRSN, SYMC, BOBJ, ARBA, SAP, SEBL, VIGN, ISSX, QSFT, ITWO, and MANU. But wait, there's more. You'll love this. In spite of Solomon's and Goldman's downgrades, CS First Boston came out with a "buy" upgrade from "hold" for PSFT. Granted their reasons were that the stock was trading at a discount from its peers and appeared to be at a level of lower downside risk, we don't believe them. PSFT still looks like it's heading for its September lows, which is at least another 12.5% below current levels. However, that is a stock specific bias and a new relative low under $19 might be the key trigger point. Let's look at what happened in the markets today.

Weak overseas markets did little to inspire investors this morning with most major indices following the U.S. markets lead from Monday-Tuesday. The London FTSE 100 closed down 0.87% to 5152. The German DAX slipped 1.3% to 4919 and the French CAC-40 lost 1.7% to 4326. With no apparent leadership, the Dow Jones traded sideways early morning while investors tried to decipher the Bank of Japan's decision to sell the Yen and weaken their currency against the falling dollar. There has been a lot of focus on the dollar and how it relates to gold recently but more on that later.

It wasn't too long before a rally developed from what appeared to be a buy program but the market's strength withered under another round of terrorists warnings. All the major indices were soon trading at their lows for the day as news that a package had been found on the Brooklyn Bridge and New York authorities closed the bridge for an hour before bomb squads revealed no threat. The uneasiness felt by this false alarm left a shadow across the markets that lasted the better part of the day. Government officials had been warning U.S. citizens that possible attacks against New York landmarks in conjunction with the up coming Memorial Day holiday could be a threat.

Fortunately, turnabout is fair play. The same way negative terrorist rumors had stolen investor enthusiasm for the markets the bulls erupted from their dugouts in the last hour of trading on rumors that Osama Bin Laden had been captured by the U.S. Army. The effect was immediate, as bears, realizing the indices were still near significant support, were quick to cover positions into the close. The Dow rallied about 90 points from the 10063 area to close up 52 points at 10157. The S&P 500 jumped from its lows near 1075 to end up 6 points on the day at 1086. Likewise the Nasdaq Composite rallied about 30 points from its 1644 lows to end the day with a gain of 9 points at 1673. Unfortunately, the internals of the market, while improving in the last hour, still did not reflect a true turnaround. Advancers beat decliners on the NYSE but the reverse was true on the Nasdaq. Across the U.S. markets, new highs squeaked past new lows 53 to 49. The Army denied those rumors later in the day but it was enough to end a two-day losing streak for all three major indices.

All That Glitters

Gold bugs must be in heaven right now as you can hardly miss the media's recent fixation on the rising price of both gold futures and the gold-specific indices. Jeff Bailey discussed gold today in a couple of his intraday updates so I won't go into a lot of detail but as usual he looks to be right on with his observations. To recap, Jeff discussed the Bank of Japan's move against the Yen had more assets flowing into gold in a potential hedge against the dollar. Plus, given a backdrop of two significant down days in the markets and a U.S. that's on high-alert for terrorism, investors were shifting their focus to traditional safe havens like gold and bonds. Obviously, some investors are buying gold as a hedge against a dropping stock market and as an anti-inflationary investment. Still others are merely trying to cover their shorts when gold futures crossed the $300 and then $310 marks on their beliefs the metal was overbought. Jeff also went into detail on how different gold companies who hedge have under performed those companies that do not hedge. I'm going to focus briefly on the short-term observations I see in the gold futures and gold indices.

Gold, like the U.S. bond market, can be seen as a global safe haven. When money managers and hedge funds decide to move into gold, we're not just talking about U.S. investors but investors around the world. It is the global political and military insecurities that has been a big factor in the strength of gold and right now the spotlight is focused on the India-Pakistan showdown. These two fledgling nuclear powers are on the brink of their third war over the battle-torn Kashmir region. Remarks made by India's Prime Minister today, directed at his troops, to be prepared for a "decisive" encounter have many global spectators expecting the area to heat up quickly.

A quick look at the price of gold futures (gc02m, June futures) will identify the $320 level as current overhead resistance. This will be meaningless if India and Pakistan open fire on each other (for real this time). However, in the meantime, we agree with UBS Warburg who feels that the $315 level is likely to be short-term support for the futures. I think we could even see a pull back to the $310 level and the bullish trend will still be very much intact. Meanwhile, it is the XAU.X Gold and Silver index that looks like it's way overdue for a bit of profit taking. It could easily see a consolidation back to the $80 area without losing its bullish trend. The question is whether investors will use that pull back as a chance to cover and drive the sector higher once again. A glance at the weekly chart of the XAU will show that there is potential overhead resistance in the 90 to 92 range but that's still a good distance away.

chart of the XAU

Even In Sideways Markets

Like everyday in the markets, there are a hundred little company-specific stories that could influence your trading in their respective sectors. To sum up some of the leading news we'll touch on the bigger headlines for Wednesday.

If you've got a gamer in the family they'll be interested to see what's coming out of this year's E3 or Electronic Entertainment Expo - the annual video game industry trade show. The biggest news in this industry has been the continuing saga of MSFT's willingness to do battle with industry leader SNE for the game console market. Recent reports have revealed that MSFT is staking a huge claim in this market with a $2 billion (with a "B") investment to oust reigning champ Sony's PlayStation 2 from the top gaming console slot. You've probably already heard about the price cuts, initiated by Sony in what could be a console war that lasts for years to come. Everyone knows that MSFT loses money on each console they sell with plans to make it up on the game purchases. Sony's move to slash their game box by $100, one that was matched by MSFT, is going to make MSFT's move into this industry that much more painful. MSFT's strategy on this is geared to more than just games but games will be the first battleground. And why not? With a $20 billion gaming industry that is expected to grow for several years to come, there is a huge slice of the pie at stake. Industry forecasters don't have to look far in a post-9/11 world to see an American public with a potentially growing subconscious desire to stay home and be entertained.

One of the interesting observations that tech investors might see is the strength shown by the software companies that make the games for SNE and MSFT. Compare the charts of ERTS, THQI, ATVI and even AKLM and you'll see how they have all out performed a sinking GSO.X software index. They may not qualify as bullish plays at the moment but they'll definitely be on my watch list when the tech sector does turn around.

Speaking of watch list, I've been watching shares of GSB rocket higher the last few sessions on rising volume. Suddenly, Citigroup (NYSE:C) announces that they will buy Golden State Bancorp for $5.8 Billion in cash and stock. Gosh, you don't think someone knew about the announcement before it came out do you? GSB was up 7.78% to close at $39.34 while C was down 26 cents to $45.00. What makes this even more interesting is rumors that WFC might make a counter offer for the California-based GSB.

Another story stock today was Johnson and Johnson (JNJ). The company announced positive results for their U.S. trials of its drug-coated stents. These stents are already on the market in Europe so it's not a big surprise but JNJ did help lead the Dow Jones higher.

Shares of the Gap (NYSE:GPS) reflected news today that CEO Millard Drexler, a 19-year veteran of the company, would effectively step down once a replacement could be found. Shares of GPS fell 15% to $13.55 on the news and MER was quick to downgrade the stock.

Our daily serving of corporate earnings came from NIVIDIA (Nasdaq:NVDA). NVDA is best known as the chipmaker for the graphics card in MSFT's X-box. Shares have not had a good year and have slid by more than 50% from their January highs as the company dealt with a SEC probe into their accounting practices. The company will be expected to restate a few previous quarters but it looks like the probe may be behind them. Meanwhile, shares sold off yesterday ahead of their Q1 earnings report. NVDA turned in 47 cents, a penny ahead of estimates, on revenue of $582.9 million. This was more than double the same period a year ago and $83 million more than the previous quarter. The company offered bullish comments for the Q2 numbers but I'd be on the alert for any sort of sell-the-news effect that has been so rampant lately. However, I think a close over the $40 level looks attractive for a short-term play. Bears may not be able to hold this one down since it's one of the few tech companies that is actually growing revenues.

ADC Telecom (ADCT) was another company to announce earnings today. Unfortunately for shareholders the company came in with a wider than expected loss. Of course the stock has been range bound in the single digits for weeks but there seems to be a renewed round of bearish developments for a Telecom sector that's been sent to the intensive care unit one too many times. One to watch for tomorrow is Qwest (Q). S&P cut their credit rating to junk status today, which makes borrowing costs higher for this mismanaged company. It will be interesting to see if shares of Q can maintain its grip on the $5.00 level where it has been hovering for the last few weeks. It was only a couple of weeks ago that WCOM had its credit rating slashed but today was a good day for WCOM shareholders. The new management has decided to retire the MCI tracking stock (MCIT). This is expected to save the company more than $280 million a year in dividend payouts for MCI shareholders.

I would keep an eye on the telecom group. QCOM made positive comments this week but the stock really hasn't reacted to them. NOK took a 10% stake in Redback Networks in an effort to diversify and investors yawned. As a matter of fact, NOK shares slid over 8% overseas while the U.S. ADR shares only fell 3.2%. A move below $14.50 and NOK looks like a short to its September lows.

Looking Ahead.

Last week I had outlined a potential pull back in the Dow Jones Industrials to the 10150 to 10100 with a possible short-term bottom at 10K. I didn't expect it to take a week to occur but the low today was 10063 before the afternoon rally brought us back into the green. While I'm not enthusiastic about the overall investor sentiment it would not be surprising to see a little more short covering tomorrow spark a potential move back to the 10350 level in the next few days.

Chart of the Dow

The S&P 500 index has painted a similar technical picture. Last Wednesday my target was for a pull back to the 1080 area and the low today was about 1075. The end of day rally could carry over into Thursday but it's not a rally I would take serious positions on. There is still resistance between 1100 and 1108 and the 50 and 200-dma's are going to be extra pressure on the index soon.

Chart of the S&P 500

I'm probably the most optimistic about the Nasdaq even though there isn't much but my short-term bullish bias to support it. The longer-term downtrend is still very much intact but the pullback to the 1650 level could be the consolidation we needed for the next move up. I outlined a "fill the gap" theory in my wrap last Wednesday and Leigh reaffirmed it in the market monitor today.

Chart of the Nasdaq

Don't misunderstand me. Broader market indices look like we're still due for more consolidation. The Wilshire 5000 (TMW.X) bounced at the 10200 level today but could easily drift to the 10K again before we see real buying step into the market. The Russell 2000 index (RUT.X) is also looking pretty weak with a new relative low before the afternoon bounce. Yet despite the Russell's weeklong decline I'd bet it's overdue for a relief rally. The 490 level is likely to be a crucial pivot point for this index and one a lot of traders may be watching.

Additional major sector indices that traders will want to watch is the SOX. If the chip sector can follow through on the bounce at the 500 level today then the Nasdaq might just be able to put together a few back to back gains. The lead weight on the tech rally could be the software sector. Traders may also want to keep their eyes and ears open for news from SUNW. Prudential put out some positive comments on the company today and Wall Street is expecting SUNW to provide a mid-quarter update tomorrow after the bell on Thursday.

Overall I'm quietly optimistic. We've suffered through a string of terrorist warnings, another bombing near Tel Aviv today, potential war in Kashmir, a terminal diagnosis for any software sector rebound later this year by Solomon and Goldman and still the markets held at support levels and even managed to stage a late day rebound. As Jeff said in one of his updates today, "trade what you see". Aggressive traders are probably looking at a potential short-term rebound but the rest of us may be better off taking a wait and see approach.

James

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