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Market Wrap

Are We There Yet?

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07-10-2002                High      Low      Volume Advance/Dec
DJIA     8813.50 -282.59  9143.23  8811.70 2073 mln    760/2369
NASDAQ   1346.01 - 35.11  1396.95  1345.22 1635 mln   1082/2296
S&P 100   458.69 - 16.55   477.49   458.40   totals   1842/4665
S&P 500   920.47 - 32.36   956.34   920.29
RUS 2000  419.78 -  9.47   430.62   418.97
DJ TRANS 2547.84 - 28.73  2605.38  2545.17
VIX        39.02 +  3.85    39.36    34.73
VIXN       65.22 +  2.07    65.46    62.53
Put/Call Ratio      0.83

Are We There Yet?

Strangely, the market action today reminded me of a scene from a classic 80's movie. No, it wasn't a slasher-horror movie like any of the Nightmare(s) on Elmstreet, any of the Halloweens or Jason's Friday the 13th rip-a-thons. Although given the painful declines in today's indices I'm sure there are plenty of investors who felt like they (or at least their trading accounts) felt like the unnamed teenager left alone in the bunk house during a thunderstorm. The scene I remember is from "Back to the Future". Christopher Lloyd plays Doc Brown and Michael J. Fox plays Marty Mcfly. After realizing that they know when the clock tower will be struck by lightning, Doc Brown, with his mad scientist white hair flying, looks at the camera and says "We're sending you back to the future!"

Unfortunately for us, the "future" for Wall Street appears to be the late 90's. A huge number of stocks and indices are already trading at 1998 to 1999 levels but some market analysts believe we could have a few more years to erase. Many are speculating that the greed and excess of the late 90's bubble has to be completely wiped out with fear, loathing and apathy to finally reach a capitulation event worthy of a bottom. Let's hope we reach these levels soon. Marty Mcfly may have wanted to get back to 1985 but I doubt many investors want to see stocks trading any closer to 1997 than they already are.

Starting the morning off right, Merrill Lynch hinted at a favorite late 90's pastime with a bullish upgrade for an overvalued tech stock. Their pick today was none other than networking behemoth Cisco Systems (Nasdaq:CSCO). MER upgraded the stock from a "buy" to a "strong buy" and shares of the tech giant were trading higher in pre-market. The analyst at MER felt that the macro indicators are pointing to a recovery for the communications equipment sector in the second half of 2002. CSCO's valuation at 23x 2003's earnings estimates for 58 cents made this an opportune entry point for bullish investors looking ahead 12 months. Also joining the pre-morning optimism was Morgan Stanley with an upgrade for another telecom equipment maker, Brocade Communications (Nasdaq:BRCD). Is this some sort of follow through effect after Warren Buffet's move to invest in lagging telecom services provider Level 3 (LVLT)? I doubt it, but the timing is somewhat curious. If there are any left, optimists for the markets can applaud the bravery of these analysts but what are they seeing that no one else is? So far the idea of a second half recovery has largely been shot down, especially for tech. If there is a recovery waiting for us in Q3 and Q4 of this year it's hiding pretty well. Both stocks managed to close in the green today but were significantly off their highs for the session.

Any bullishness these upgrades for two previous tech high-flyers failed to show up after the markets opened. Within about 30 minutes of the opening bell, news that Qwest Communications (NYSE:Q) had confirmed the U.S. Attorney's office was conducting a criminal probe, a rumor that was denied last week, acted as a starter's gun for what was a truly ugly day on Wall Street.

The Dow Jones Industrial Average fell 282 points or 3.1% to close at 8813, only two points from the lows of the day. This is below the recent lows for the last two weeks and confirmation that the bearish channel has not been broken. A retest of the 8500 level looks like a good bet and those whispers that the Dow would have to retest its September 2001 lows are getting louder.

Chart of the DJIA

The Nasdaq Composite fell 35 points or 2.5% to close at 1346. The bearish channel is still very much in effect for the Naz and this is yet another close below the September 01 low of 1387. History fans will note that today's close is actually below the Long-Term Capital & Asian Flu inspired October 1998 lows of 1357. Even more depressing is the call by some market watchers that the Nasdaq composite may need to retest the 1000 mark. Lows not seen since the summer of 1996. Coincidentally, the Nasdaq-100 index or NDX has already traded below the 1000 mark and closed at 959 today with a 3.14% loss.

Chart of the NASDAQ Composite

The worst performing index of the big three today was the S&P 500. The index lost 3.39% closing down 32 points to 920. A lot of investors and analysts are asking, "can it go much lower?" Hopefully, they're voicing there opinions with a little fear in their voice to satisfy the bottom cravers but with constant talk of bottom fishing or value buying a bottom may not be too close yet (I'll contradict this thought in a moment). Closing at the lows for the day is not a good sign for tomorrow morning's open. The SPX is already below its September 2001 lows of 944 and it has already surpassed the October 1998 lows of 923. Care to guess where the next significant low is without looking at a weekly chart? That would be the October 1997 low of 855. A couple of weeks ago I remember Jim joking that the S&P 500 would not only be the name of the index but the value of the index too. Suddenly I don't find it quite so funny. Jeff Bailey was speculating that the next significant support level for the SPX was the 817 area. I've noted that a few other analysts are also eyeing the 800 level. If Jeff and the other analysts are right then we can anticipate another 10 to 13 percent drop in the markets.

Chart of the SPX

Broken was one word I heard today in reference to the markets, or was that investors' spirits? I'm not sure. It could have been both. Volume was strong but not capitulation strength. The NYSE ended up with 2.0 billion shares and the Nasdaq turned over 1.6 billion. Down volume punished up volume 1,778M to 284M on the NYSE and 1,192M to 424M on the Nasdaq. Declining issues outnumbered advancing equities 23 to 7 on the NYSE and 22 to 10 on the Naz.

There was plenty of news today but a lot of it was the repercussions of the S&P 500 index reshuffling seven non-U.S. based companies out of the index and replacing them with more locally owned businesses. Europe was hit hard by the news and the pan-European FTSE Eurotop 100 fell by more than three percent to 2284. The London FTSE 100 fell 2.7% and is approaching five year lows on its own. Leading the European rout were (the soon to be expelled from the SPX) Unilever (UN) and Royal Dutch (RD) who's ADRs fell 6.3% and 9.2% respectively. The implosion in the drug sector continued to hit the Europe continent as well with AstraZenca and GlaxoSmithKline both falling more than 5% each.

Analysts estimate there is between $830 billion to $1 trillion indexed to the S&P 500. The timing for this large reshuffling was ripe for rumors. Furthermore, the last time the SPX swapped seven stocks was back in 1983 when S&P added seven baby bells. One analyst also noted that the seven stocks leaving the index have a combined market cap of $30 billion more than the seven stocks entering the index. They went on to surmise that index funds would have about $3 billion left over to be reinvested in the other 493 companies. Theories began to spring up that the markets were being manipulated and the July 19th swap date, which happens to be options expiration next Friday, would only increase market volatility.

While I'm not one for conspiracy theories, aside from Dick Clark's longevity (I hope I look that good at 73), volatility is something that bears addressing - no pun intended. The volatility index or the VIX has been steadily gaining ground the last six weeks. Monday's and Tuesday's market declines this week had the VIX springing higher from the 30 level, when it had appeared like it might make a break lower. Today's massive decline and three-day losing streak for the markets has pushed the VIX up to the 39 level. This is great news for those waiting on the sidelines hoping for that big capitulation event in the sky. As a sentiment indicator it means fear is increasing. Looking at a weekly chart of the VIX one can see that it is somewhat rare to see the VIX traded above 40. After the 9/11 attacks, the VIX spiked up to 57. Back in Oct. 1998 the VIX hit a high of 60. Now we don't have to get that high for a bottom to form but some analysts would love to see a close above the 40 level. Unfortunately, given the extreme oversold conditions of the broader markets I'm actually looking for a bounce soon. This would have the VIX trading lower but a move over 40 could be in our short-term future and thus if you believe in VIX signals then a potential bottoming event may be just around the corner.

Now for the really bad news... and it's not some technical indicator but the reality of second quarter earnings season is here. Internet giant YHOO may have beat earnings estimates after the bell this evening but the markets are expecting results similar to what VeriSign (VRSN) told Wall Street today. The company didn't announce. They are not due to report earnings until July 25th but they did warn that Q2 revenues would be lower and they would miss estimates. The negative expectations for earnings are running pretty high and the key will be the conference calls and any guidance the management can provide going forward. Lack of guidance will be the same as negative guidance and investors will continue to seek safety in bonds as we saw today. The big earnings report this week will be General Electric (NYSE:GE) before the market on Friday. However overshadowing GE's earnings will be the retail sales report.

The official retail sales report will come out on Friday before the bell. Unfortunately, American Eagle Outfitters (Nasdaq:AEOS) may have let the cat out of the bag. The company announced this afternoon that its same-store sales were lower by 3.9% due to disappointing June numbers. AEOS went on to lower their Q2 guidance and I'm sure downgrades will be sure to follow. More importantly is what could be the start of a trend. It was yesterday that Tiffany & Co (NYSE:TIF) warned that their Q2 numbers would be lower. If this trend shows up in the retail sales report on Friday it could be "the last straw" or the trigger event to spark that big blood-in-the-street capitulation that everyone keeps talking about. Why is this so important? Because the U.S. consumer has been the backbone of the economy for so long that if the lone standing pillar begins to crack everyone will be running for the exits to avoid the crash.

I know I'm painting a pretty gloomy picture here. No, I won't post a link to any 20th century expressionist painters but you get the idea. Wall Street, CNBC, and probably anyone else you'd like to refer to has been talking about and looking for a "capitulation" to call an end to the bear market for over 12 months. The death of the bear has been called so many times that no one's listening. The only thing we have going for us this time is the combination of the spiking VIX, the weakening dollar, and the expectation for a terrible earnings season. A weak retail sales report might be the missing ingredient for a bear-killing cocktail but the cure may be worse than the disease. A pull back by the U.S. consumer might lead to the double-dip recession everyone is so afraid of. The death of the bear may be near but it's going to go down fighting and there may not be anyone left standing after it's gone.

Hmmm... after looking over the last couple of paragraphs let me clear up a few things. Am I calling a bottom? No. Do I think we'll get an extremely painful spike down with a negative retail sales report? Yes. Will it be the capitulation event everyone's looking for? Ask me next week.

James

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