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Market Wrap

Outstanding - Don't Pinch Me!

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        WE 7-26          WE 7-19          WE 7-12          WE 7-05
DOW     8264.39 +245.13  8019.26 -665.27  8684.53 -694.97  +136.24
Nasdaq  1262.12 - 57.03  1319.15 - 54.35  1373.50 - 74.86  - 16.58
S&P-100  426.93 +  3.83   423.10 - 35.81   458.91 - 33.75  +  2.54
S&P-500  852.84 +  5.09   847.75 - 73.64   921.39 - 67.64  -   .79
W5000   8091.63 +  8.63  8083.00 -628.50  8711.50 -601.90  - 70.63
RUT      382.26 -  3.94   386.20 - 27.08   413.28 - 27.64  - 21.74
TRAN    2254.79 - 77.39  2332.18 -147.96  2480.14 -172.50  - 77.68
VIX       40.44 -  3.01    43.45 +  5.12    38.33 +  8.12  +  1.08
VXN       69.02 +  7.85    61.17 -  4.83    66.00 +  9.72  -  1.67
TRIN       1.21             1.44             0.89             0.28
Put/Call   0.70             1.14             0.64              .77

If I am dreaming don't pinch me! I do not want to wake up from a dream where the Dow closed up +245 points on the week and stands a good chance of carrying that gain over into next week. The Dow rebounded from its Wednesday lows of 7532 to close +732 points higher on Friday at 8264. Considering the -1191 point drop in since July-17th this is remarkable. Even more remarkable was the fact that it did not give back any of those gains and finished near the highs of the day. Even the Nasdaq, which had a rough Thursday, finished positive +22 points.

Dow chart

Nasdaq Chart

Friday started out with CEO checkers as Tyco announced they had recruited Motorola President Edward Breen as their new CEO. Motorola quickly said they named Mike Zafirovski as president and CEO saying he had turned around their mobile phone business. TYC gained +3.78 or +45% on the news and MOT dropped -1.28 or -10%. Breen is well thought of and is walking into a win-win deal. If he pulls Tyco out of its problems he will be a hero. If he can't do it then everyone will say it was too far gone anyway but he made a heroic effort. No mention of compensation was made.

Goldman, trying to be on the bleeding edge again, upgraded the chip stocks this morning after TSM warned of weaker conditions ahead on Thursday. While Goldman grabbed the headlines with the call you need to read this carefully. Goldman said it was increasing its rating on chip equipment makers to market overweight from market weight saying that "investors have finally accepted that orders have turned down and things are getting worse." "While fundamentals are not likely to improve in the near-term AND the stocks could go lower still, investment from funds and seasonality may drive a meaningful move in the stocks." On CNBC the analyst agreed fundamentals would get worse before they got better and this was for traders with a long time horizon. While I may poke fun at them for their call I do think it is a good one. Most chip makers have fallen -50% or more and should represent value soon. With AMAT at $14 how much more risk can there be? We are not likely to quit using chips anytime soon.

IBM was the big drag on the Dow on Friday with a -2.95 loss on worries they have some hidden accounting problems. Barrons is rumored to be doing a hatchet job on them in this weekends edition. At the close IBM issued a statement that their CEO would sign the accounting certifications in the normal course of business when the time came. They said they were very comfortable with their accounting. Depending on the Barrons article IBM could bounce off the 52-week low set on Friday.

The good new/bad news story. TrimTabs.com reported on Friday that -$18.5 billion dollars flowed out of equity funds in the week ended on Wednesday. Very ugly! More than twice the average rate for the prior four weeks. Investors are capitulating at twice the prior rate. The good news? They also said there was a net inflow of cash on Thursday after that huge rebound on Wednesday. So, investors are not dead or ignorant of the market. They are just not willing to sit and watch their accounts shrink on a daily basis. I did not catch the inflow amount but you can bet it was nowhere near the prior outflows.

The Consumer Sentiment numbers were actually better than expected which makes me wonder who they actually asked about their feelings. The 88.1 final number was better than the 86.5 preliminary number but still well below the 92.4 from last month. The main issues impacting the final numbers included the markets, corporate accountability and employment. Nothing new here! The problem remains that spending is rumored to be slowing and that will be the kiss of death to the fragile recovery.

The bounce this week was remarkable but not likely to continue much longer. The problem is stock valuations. With the Nasdaq PE at 44 and the S&P at 19 we could be approaching historical value levels if the economy was in strong growth mode. Unfortunately we continue to hear about reduced expectations, slower sales, shrinking margins and increased competition. Add to that the move to trash the current multiple accounting standards and increased scrutiny and the earnings will fall. With this likely to be the last quarter of cookie jar accounting the earnings we get next quarter may be significantly different than the ones we have been seeing. There could be a lot more downward revisions from more conservative accounting methods as well as from the downturn in the economy. The stock market is very good at factoring in problems and discounting future results but it needs a base to start from. We do not currently have a clue what real earnings for the 3Q will look like and that makes the markets very nervous. With the certifications beginning August 14th, only 13 trading days away, the odds are good that there are some surprises in our future.

Next week there is a technology conference in Boston presented by Soundview and that could give tech stocks some visibility. Increased visibility did not help AOL this week. S&P cut their outlook for AOL to negative saying the cash drain from AOL would put a strain on other Time Warner divisions. AOL has clearly become the ugly duckling and will be kicked out of their flock as soon as they can arrange it.

Bullish markets, what a change. The action today may not have been outstanding compared to the triple digit finishes as of late but at least it was positive. Bullish points during the day included the lack of a serious drop on the new Israeli killings and vow by Israel to get tough. There was no drop when the news reported that four American servicemen had been captured and seven killed in Afghanistan. The story was later denied by the U.S. There was no major sell off of the gains made on Wednesday. There was no major sell off when Citigroup was rumored to have said, "somebody said it was ok so we thought it was ok." Duh! The markets even rallied late in the afternoon in front of the weekend. Considering Mondays have not been kind recently this is remarkable.

The Dow stopped right at significant resistance where two different retracement brackets converge. If you draw a retracement bracket from the July-17th high to the Wednesday low you get a 61.8% fib level at 8268. If you draw one from the July-8th high you get a 38.2% level at 8249. The Dow closed right between them at 8259.

Dow 60 min retracement

Dow 90 min retracement

A strong open on Monday could propel the Dow over these levels and hopefully the next resistance at 8300 as well. Once clear of 8300 the Dow could easily run to near 8600 before sellers appear in volume. I emphasize the word "could". Personally I am surprised at the strength of the rally and probably agree with one trader in his analysis. "The shorts have been squeezed out so many times in the last two months only to have the markets roll over again, that there are quite a few trying to tough it out." They are likely going to sweat over the weekend and a big open on Monday could break their pain threshold and burst the dam. While everyone certainly hopes he is correct there is no guarantee.

Next week the earnings will slow to a crawl but economic reports will flourish. We get the Consumer Confidence, different from Consumer Sentiment but the same concept, on Tuesday. The Wednesday reports include the Q2 GDP, PMI and the Beige Book. Thursday is ISM, Construction Spending and Auto Sales. Friday closes the week with the Nonfarm payrolls, Personal Income and Spending and Factory Orders. As you can see the boat is loaded to the roof and balanced to perfection. Any one of those reports can tip the current bullish balance and swamp the boat and the markets. As an investor why should you buy in front of these economic time bombs unless you simply don't care where the economy is going. Stocks are cheap relatively speaking but they can still get cheaper!

I took some heat for suggesting we could get a strong relief rally soon in last Sunday's newsletter. I also pointed out that the VIX at 43 was definitely high but could easily hit the 57-60 levels seen on prior crashes. The high for the week for the VIX was 56.74 and the Dow rebounded over +700 points off the lows when that level was hit. The bottom line for next week. Protect any long positions on Monday and prepare to take profits if the rally runs out of steam. The two worst months of the year, August and October are still ahead of us. The question remains, why buy? As traders we will play the moves but without real buyers to power the market those coming moves may be to lower lows.

We need your help. We don't know where the Dow is going to close next Friday. We decided to offer a reward to anyone that can tell us. We are giving away a very high-end video card that supports two monitors on one PC to anyone who comes the closest to the correct closing number for the Dow next Friday. Go to this page and enter your guess! It is free and this is a great video card. 64MB DDR ram and two 350MHZ processors! It paints screens so fast you will not even see them blink! (grin) Go here: http://www.OptionInvestor.com to enter your guess.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
Editor

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