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Market Wrap

Extreme Volatility

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        08-07-2002        High      Low     Volume Advance/Decline
DJIA     8456.15 + 182.02  8460.17  8214.62 1739 mln   1980/1128
NASDAQ   1280.90 +  21.35  1298.12  1243.49 1567 mln   1704/1530
S&P 100   441.46 +  10.29   442.39   429.15   totals   3684/2658
S&P 500   876.77 +  17.20   878.74   854.15
RUS 2000  383.47 +   2.68   385.21   376.56
DJ TRANS 2271.38 +  35.88  2277.96  2214.87
VIX        43.07 -   2.66    47.01    42.07
VIXN       68.84 +   4.66    69.26    63.91
Put/Call Ratio      0.76

Extreme Volatility

This morning's market reaction to Cisco's earnings release didn't last long. A 180-point gain in the Dow was erased and sent into negative territory. This seemed to make sense, given the recent economic news indicating a shrinking economy, and the German fund equity buy program having been placed in the rear-view mirror. But the end of the day found buyers again, rallying the Dow 230 points to finish up 182.06 on the day. There are several factors hanging over the market that may be contributing to the recent volatility. A look at the rally of the last couple of days can possibly be attributed to a simple retracement of the plunge of the previous three days. The close of 8456.15 (and high of 8460.17) is awfully close to the 61.8% retracement level of 8467. This is based on Wednesday's high of 8736.72, just before the 700-point drop to Monday's low of 8030.82.

Chart of Dow Retracement

Although the market is looking strong after this retracement, it still has not made up the recent loss. A look at the longer term shows two points that are more significant. Monday's low of 8030.82 presented what could be evidence, in hindsight, of a bottoming process. We won't know for some time if this is the case. However, if we were to break below 8000 again, it would be significant in the longer-term picture. A continued rally above the Wednesday high would also look bullish. The hold at 8000, combined with a trade above Wednesday's high would look more bullish with a series of higher highs and higher lows.

Chart of Dow Trend

As of right now, however, the long-term trend is still down. As we get closer to Tuesday's Fed meeting, we may see a continued rally in anticipation of a rate cut. This is the first time in quite a while that the action the Fed will take has been greatly debated. In the past, most changes have been widely anticipated, and although they have been either bearish or bullish for the market, the volatility has not been as high due to the fact that most investors felt that they knew what would happen. A look back at the Market Volatility Index (VIX.X) shows that during the 11 cuts the Fed made in 2001, the only time market volatility was over 35 was following the September 11 attacks. Leading up to six of these changes, market volatility was in the 20s. The VIX has traded over 40 intraday in 17 out of last 20 trading sessions. It closed today at 43.07.

Chart of the VIX

So the question on most readers' minds is undoubtedly "Where are we going next?" If the Fed aggressively cuts rates again by the end of the year, the effect on the economy may eventually be great. However, there is usually a time lag, and this will not necessarily help companies now. In addition, with the current rate at 1.75%, the Fed must be careful about how it uses its remaining bullets. As we approach the anniversary of 9/11, there is concern over an anniversary attack. For this reason, they may want to wait until the following meeting on September 24th before using up 25 basis points, or more.

Although the bond market has a more direct effect on mortgages, lower rates do trickle down and recent activity suggests that current low rates are having an effect. This morning, mortgage applications for both new homes and re-financing came in at record highs. This week showed an increase from 1055.5 to 1066.9. This is one area that pumps money directly into the economy and may lead to a more immediate economic impact. When homeowners have lower monthly payments, they have more disposable income to spend in all sectors. In addition, home equity loans used for home improvement could give both retailers and contractors a boost. The housing "bubble," therefore, may get a little more air pumped into it.

These mortgage numbers are in contrast to the Cambridge Consumer Credit Index, which showed that Americans are less willing to take on debt, because of the falling stock market. With less money in their portfolios, the prospect of paying off their credit cards seems more daunting. The index dropped from a reading of 63 in July to 56 for August, as 33 percent of consumers in August said they are willing to take on more debt, compared to 36 percent in July. This indication of reluctance to spend does not bode well for the economy. Total consumer credit, excluding mortgages, rose $8.4 billion in June to $1.173 trillion. This was slightly above expectations of $7.9 billion.

Vice President Dick Cheney took on the role of cheerleader today, in trumpeting the basic strength of the economy. Actually it sounded more like a veiled version of "it wasn't us." He said the economy was getting better, as a result of tax and interest-rate cuts that had taken place since Bush took office. He placed blame for the country's economic problems squarely at the Bill Clinton's door, saying that the Bush administration had inherited a country that had slid into a full-blown recession.

In the department of investor trust, there were three new developments today. First, insurance brokerage AON Corp. (AOC) released worse than expected earnings, with CEO Patrick Ryan claiming "Second quarter bottom line results were the worst in Aon's history due to certain unusual items, compressed operating margins, and lower investment income." That was only part of the story, however, as the company said it might have to restate earnings from both 1999 and 2000, after consulting with the SEC about its consulting practices. The stock was subsequently downgraded by Salomon Smith Barney and UBS Warburg, and lost $6.43, or 30.33% of its value.

Next in the mug shot line was Tyco, whose former chief Dennis Kozlowski apparently received $135 million in loans from the company, over a five-year period, which were either interest free or completely forgiven. This included a $19 million gift to help him purchase a 15,000 square foot estate in Boca Raton, Florida. As a former Tyco stockholder, I'm still waiting for my housewarming invitation. Apparently, one of the items deemed necessary for the health of the company was a $6,000.00 shower curtain for Kozlowski's New York residence.

Last in today's line was Sam Waksal, former CEO of ImClone Systems, who was indicted today on charges of securities fraud, bank fraud, and obstruction of justice. Waksal is accused of tipping off relatives that ImClone's application to market the anti-cancer drug Erbitux would not be approved by the FDA. The rejection sent the stock plummeting, from a high of more than $70, to an eventual low under $7. In related news, apparently there are more conflicting stories about Waksal acquaintance Martha Stewart's own dumping of the stock. The House Energy and Commerce Committee is apparently widening its probe into Stewart's activities in an attempt to clear up conflicts between the stories of Stewart, her broker, and his assistant. Of course, prison decorations and hot-plate recipes could be an untapped area of expansion for the home economics queen.

Citigroup has announced they will join the ranks of companies that will expense employee stock options. While they have continuing exposure to the Enron probe, this should give investors something positive to look at. While some companies, such as Cisco, have refused to do so, this practice may eventually become the norm, as more large companies are stepping forward to volunteer the new accounting practice.

With only 7 days left until the August 14 deadline for CEOs to certify their companies' financial results, only 60 companies have done so. This leaves 887 more, or 94%, which have not yet certified. It is hard to imagine that all 887 of these companies will certify without any problems. This week should be interesting in this regard. The Fed meeting coincides with the last day before certifications are due, so a cut in rates could play tug-of-war with any bad news that may come out in the final days before CEOs have to commit.

We will probably continue to see increased volatility heading into next Tuesday. Keep an eye on key resistance levels in the big picture, and don't be surprised by any whipsaw in the market. There is much news to come in the next seven days, so don't be stubborn and respect your stops.

Steve Price

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