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Market Wrap

We've Fallen and Can't Get Up

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07-22-2002               High    Low     Volume Advance/Decl
DJIA     7784.58 -234.68 8103.86 7717.29 2517 mln   617/2553
NASDAQ   1282.65 -36.50  1332.10 1272.46 1737 mln  1067/2351
S&P 100   407.88 -15.22   426.21  405.47   totals  1684/4902
S&P 500   819.85 -27.90   854.13  813.26
RUS 2000  379.65 - 6.55   389.11  374.69
DJ TRANS 2241.50 -90.68  2357.78 2215.89
VIX        48.23 + 4.78    49.67  42.81
VIXN       62.58 + 1.41    63.61  62.58 
Put/Call Ratio 0.87

We've Fallen and Can't Get Up

If you were as bad with the yo-yo as I was, you remember what it's like to see it hanging at the bottom of the string, spinning around, defying your attempts to get it to wind upward. I usually got it to go down and up a few times, but always ended in this manner. The market had a day much like my yo-yo experience.

As we ended last week, the Dow had rebounded to close over 8000. The proverbial line in the sand seemed in place. This morning we started off hovering around the even mark, before dropping 300 points. Friday's break through last September's lows was in the rear view mirror and getting farther away. The Dow bottomed at 7717.29 before roaring all the way back into positive territory. The bulls had their rally and looked to start a market turnaround. It didn't last long, however, as the market lost its grip and fell back over 200 points. It closed down 234.68 at 7784.44, and its next support level looks to be around 7400.

Monthly Chart of the Dow Jones

As for the S&P 500, it was just last week we were talking about support at 900. It appears now that we may be testing the 800 level very soon. The S&P 500 closed just above its intraday low of 813.26, to settle at 819.83. This, however, wasn't a bounce off of support. The index closed heading downward, after rallying back up to 842, only to be slapped down by some very aggressive bears. Looking at a long-term chart, dating back to March of 2000, we see a trendline pointing to approximately the 700 level for the S&P, which would coincide with support levels from early 1997. Now that we've approached support at the 800 level within a week of breaking 900, 700 seems reasonable before our next consolidation.

Monthly Chart of the S&P 500

Does this mean we are headed straight down? Not necessarily. We have seen almost 1600 points shaved off the Dow in the last 11 trading sessions. We could see quite a bounce, before giving into pressure, or until the bulls run out of steam. With no major economic releases between now and Thursday, when new and existing home sales, as well durable goods and 2nd quarter employment cost index are released, we could see a rebound over the next couple of days.

Some news that weighed on today's market undermined investor trust once again. Congressional investigators are looking at the roles of Enron's bankers in hiding massive losses. The Washington Post reported that Enron raised more than $5 billion in cash from Citigroup, J.P. Morgan, and other banks, which was labeled as energy trades. They used a complex transaction, known as prepays, which helped hide some of Enron's debt. In exchange, the banks collected interest and fees. Enron collected advance payments from the banks, for future supplies of natural gas and other commodities. It then used the money to improve cash flow, rather than listing it as debt. These arrangements will be reviewed during a Senate hearing tomorrow.

Citigroup's Salomon Smith Barney also came under fire today from the NASD, which is investigating high profile analyst Jack Grubman, who kept a buy rating on Winstar Communications, even as the company was headed for bankruptcy. At issue is the possible conflict of interest in an analyst keeping up his rating on a company, in exchange for profitable investment banking business. This type of arrangement was thrust into the spotlight with Merrill Lynch's $100 million settlement with the New York Attorney General's office. This news weighed heavily on the sector with the Securities Broker Dealer Index ($XBD.X) losing over 3% on the day.

Another Grubman darling, WorldCom, finally made it official. The company filed the largest ever bankruptcy petition at $107 billion, almost doubling Enron's total. This, along with BellSouth's reduction in estimates for the year, weighed heavily on the telecom sector, with North American Telecom Index losing almost 6%, taking down companies such as Verizon (VZ) $28.65 (-3.85), and SBC Communications (SBC) $23.96 (-2.72).

As further evidence of investors "run for the hills" mentality, almost $40 billion dollars flowed out of equity mutual funds last month, the third largest outflow on record, while bond funds attracted $18 billion in new investments.

After hours earnings releases left the market pretty much where it ended the day. In the latest guidance warning, Computer Associates beat 1st quarter estimates, however lowered its full year revenue forecast and stated what most market watchers figured out a while ago, that "it appears that an economic recovery will take longer than originally anticipated."

Novellus reported that profits fell more than 80% from last year's second quarter. Shares were down over $2 from a close of $29.55 to $27.50. CEO Richard Hill said that customers were concerned about the economy and cautious about their ability to spend in this environment. 2nd quarter profit fell to $12 million from year ago profits of $59.2 million. These numbers were in line with expectations.

Texas Instruments (TXN), the number one maker of semiconductors for cellular phones, released earnings, which were also in line with expectations. However, its shares traded up slightly after more than doubling profit from a year ago. TXN's second quarter revenues also increased by $335 million over the first quarter. The company said this increase was due to gains in all of its business segments.

The Market Volatility Index ($VIX.X) has reached new relative highs once again. The index closed today at 48.23, gaining 11% on the day. Higher levels in the VIX are usually bullish, as they forecast market bottoms. However, the last couple of times the VIX was this high, it kept going. Last September it reached 57.31, before settling back down as the market bounced back from its September lows. In October 1998, during the "Asian Flu" and Long-Term Capital's problems, the VIX hit 60 before coming back to earth. In October 1997, we saw a high of 51. The pattern heading into the fall has been for the market volatility to spike in September and October. This is something to note as we get closer to the fall.

Chart of the Market Volatility Index

If the markets do bounce, don't expect the VIX to come falling down right away. Traders will look for continuing reassurance that the market has found a bottom before they are willing to sell options at lower levels, knowing how much a short option position can cost in a highly volatile market. The put/call ratio of .87 is still relatively high, although off its highs over 1 last week. This represents the number of puts traded per call. In low volatility markets, there are many more calls traded than puts. At the beginning of the week, there is also less impetus for the VIX to come down. There are several trading days left for the market to move before the weekend, giving long option holders lots of trading opportunity before the weekend, which brings 3 days of time decay.

In another bearish development, the bullish percent of the Nasdaq 100 ($BPNDX), which had been on an upward tear since the beginning of July, finally relented. This index has historically led the overall market. Since the beginning of July, the index had soared from a low of 8%, which represents the number of companies in the index which are currently giving buy signals, to a high of 35%. This bullish indication had provided some hope that the rest of the market may follow, as it had done in the past. Now the NDX bullish percent has fallen back to 28% after dropping to 31% last Friday.

Be aware of the potential for a bounce back, but also view this as a possible shorting opportunity. With no lack of bad news and warnings, any bounce could simply be a pause before the fall.

Steven Price
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