Last Wednesday I noted the almost 500 point gain in the Dow was quite impressive, however I also noted that the Dow had given up 1800 points in three weeks, and that a 50% retracement in a bear market rally would add another 400 points. Lo and behold, here we are three trading sessions later and the Dow has almost another 500 points to show for itself, 447.49 of which came on today's impressive rally. The gains are well spread out, on a percentage basis, with only Dow component SBC Communications in the red (by -0.04). So is this a retracement, or have we found a bottom? This week, I'm going to look a little further back, to the Dow's most recent high, before it started rolling downhill. Going back to March 19, the Dow closed at 10,635.25. It then began its slide to an intraday low of 7532.66 last Wednesday morning, before beginning a rise of 1179.22 points over 4 trading sessions, including Wednesday. We are now just shy of the 38.2% Fibonacci retracement level, as you can see on the graph below.
Chart of the Dow Jones Retracement Levels
This level may be significant, as we could see resistance here. Of course, with 30 stocks in the index, it is not easy for a bear looking to short the market to control all 30 stocks at once. What is also significant, however, is what could happen if we break this level. We are just six points away from 8717, so a higher open tomorrow could take us through that level in the first minute of trading. Looking at the next retracement level of 50%, we would need the index to trade over 9000.00 to attain it.
A look back at the last time the Dow traded down to the 7500s shows us just how much of a springboard this level can be. The first time it traded down to this level was between October 1997 and January 1998. It did so again in August of 1998. Each of these times, the current 50% retracement level is exactly where it eventually ended up - above 9000.
Monthly Chart of the Dow Jones
This pattern shows up once again in a look at the Market Volatility Index (VIX.X). Each of these times, in late 1997 and again in August of 1998, the VIX traded over 50, only to decrease as the market rallied to 9000 points. The only other times the VIX has been over 50 were last September, after which it rallied over 10,000 and this month. A rally above 9000 would repeat this scenario once again, as the VIX has now receded to close at 33.73. This is not a coincidence. The VIX measures the reaction to market moves, as option prices increase when fear of a market crash is present. While large moves to the upside are possible, moves to the downside are usually quicker, which is why the VIX spikes tremendously when there is negative uncertainty in the market.
Chart of the VIX
A Dow trade over 8718, breaking through the 38.2% retracement bracket could certainly suggest a trip up 9000. Of course with the 400-point days we've had recently, 9000 could be seen before noon.
The S&P 500 ($SPX.X) has also rebounded to a significant level. The index closed on its high of 898.96. It was up 46.12 on the day, a gain of more than 5%. The rally into the close suggests confidence, but it stopped just short of 900. Had the market stayed open an extra ten minutes, there is no way to know if we would have seen selling at the 900 level, or a takeoff as the bulls pushed resistance aside.
So who led us higher? Well the goats of just a week ago are looking much prettier today. J.P. Morgan was up almost 13%, adding $2.85 to close at $25.10, while Citigroup added more than 8%, gaining $2.57 to close at $33.31. American Express was also sharply higher adding $3.32 to close at $33.49. Citigroup and J.P. Morgan provided the Senate with sworn affidavits as to the nature of offshore entities that were involved with Enron. These affidavits were requested last week by Sen. Carl Levin, who is chairing the subcommittee that is looking into the Enron scandal. The Senate wanted these responses by today, and their presentation no doubt removed some questions investors may have had about what the institutions might be hiding.
On a day when there were lots of winners, WorldCom got news that it would be delisted by the Nasdaq. The No. 2 long-distance provider, who recently filed for bankruptcy, will most likely join the bulletin-board world of penny stocks.
The retailers had a banner day. The Retail Index ($RLX.X), had had been in a free fall. It was stuck below the 280 level, having been turned back on three separate occasions last week, but finally got through, and closed near its high of the day, knocking on 290's door. The day started with Wal Mart announcing that last week's sales were lower than expected, however, the industry leader finished up $1.35 at $49.53. It carried along with it Circuit City, Target, Home Depot, Best Buy and a host of others.
Microsoft (MSFT) continued its rise after announcing expansion of its workforce and R&D budget last week. It was up $2.90 to $48.25, after setting a new 52-week low of $41.41 just last Wednesday morning. Microsoft led the tech sector higher, as the Nasdaq composite (COMPX) closed up 73.13 to 1335.25, up over 5% for the day. The index looks to have put in a solid bottom at the 1200 mark, but has a lot of congestion on the chart around 1400 that could serve as resistance. This would also coincide with the top of a descending channel from the beginning of April.
Chart of the Nasdaq Composite
While a few individual issues were left behind, such as Motorola (MOT), which received a downgrade, the only area seeing red were the treasuries. As money flowed out of bonds and into equities, all equity sectors were in the green today. The dollar (DX00Y) rallied 1.41 to 106.71, and is continuing its gains with a reading of 107.06 as I write. Even the gold sector ($XAU.X), which has suffered greatly in the last few weeks, got a reprieve, rebounding almost 7%, in spite of gold dropping 0.90.
On the NYSE, advancers outnumbered decliners 2,581 to 614, while the Nasdaq posted similar numbers with a margin of 2,522 to 870. Volume was heavy, once again trading over 2 billion shares. The CBOE Put/Call ratio also continues to decline, at .69, reflecting fewer puts being traded as compared to calls. The bulls are certainly out in force, and continuing strength is impressive. However we still have not recovered even 40% of the losses in the Dow since the end of March. This could still be considered a bear market rally. That being said, there is still plenty of room to the upside within which to trade. Shorting the rally could be dangerous. Remember the adage that a trend is in effect until evidence presents itself otherwise. Right now the short-term trend is up. However, we have just experienced an 1100-point rally in four days. A market pullback is very possible, and a 50% retracement of the rally would bring us back down 500 points to the 8230 range. A pullback with support, and then another move up, would be more convincing to the conservative trader. A more advanced trader, with plenty of time to track the intraday movements of the market, could play the range between Fibonacci levels if we break out to the upside. This pace cannot maintain itself forever (otherwise the Dow 30,00 advocates would have been right a couple of years ago) and we are bound to experience pullbacks, even in a strong uptrend. Remember to ride it, not defy it, and keep your stops in line with your account.