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Market Wrap

On Hold

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08-12-2002               High    Low     Volume Advance/Decl
DJIA     8688.89 -56.56 8742.06  8582.01 1223 mln  1410/1674
NASDAQ   1306.84 + 0.72  1311.43 1286.91 1053 mln  1562/1710
S&P 100   407.88 -15.22   426.21  405.47   totals  2972/3384
S&P 500   903.80 - 4.84   908.64  892.38
RUS 2000  388.56 + 0.11   389.51  383.56
DJ TRANS 2308.67 -42.98  2350.58 2277.32
VIX        40.46 + 1.10    42.90  39.98
VIXN       56.29 - 2.41    59.13  56.09 
Put/Call Ratio 0.74

On Hold

It certainly looks as though we are in a holding pattern ahead of tomorrow's Fed Funds rate announcement. Volume on the NYSE was a paltry 1.2 billion shares, while the Nasdaq traded only 1 billion. The speculation regarding tomorrow's FOMC meeting led to huge gains and large trading ranges the last several days. This morning saw a triple digit drop, however after a 700 point increase over the last 4 days, this give back was not terribly bearish as the market has held on to most of its gains. The rebound to a finish of 8688.89, down only 56.56 on the day, looks almost bullish. What does look bearish is the double top formation of the last couple weeks. This is not a textbook double top, as the second peak is actually slightly higher than the first, however there was a definite turn back, around the same point as July 29 - August 1. There is also lower volume on the second peak, which is bearish. The high water marks for the first top were 8762.14 intraday on July 30, and a close of 8736.59 on July 31. The second top was last Friday with an intraday high of 8796.68 and close of 8745.45. Bulls may see this as an indication of higher highs. While that may be technically true, I see it as more of a sign the sellers were not quite as committed ahead of the Fed meeting, as they were the last time we reached this area. However, the buyers ran out of steam and I think we will see an even tighter trading range tomorrow, prior to the rate announcement. The bond market reflected renewed skepticism about a rate cut, as traders unwound positions that would be favorable for such a move. The 10-year note reached levels not seen in over 30 years.

Chart of Dow Jones Formation

There is one interesting pattern that highlights the effect the FOMC meeting had on today's action. While volatility does tend to increase on market drops, today's initial drop found support and then traded within a very tight range, compared to the wide trading ranges of the last few days. A comparison to the patterns of the last few days shows a trading band today of about half what it has been on a daily basis during the recent rebound. This would normally be reflected in a lower Market Volatility Index (VIX.X) reading.

Chart of Trading Ranges

In spite of this lack of activity today the Market Volatility Index was actually higher. This is in anticipation of a big move tomorrow. Option holders will generally not want to pay high premiums (over 40 is considered very high) for options that could decay at a fast rate without market movement. On a day when the market is range bound, volatility almost always drops. This was not true today. Expect a big move tomorrow after the 2:15 e.s.t. announcement, as the VIX is telling us to expect big things. Because volatility increases to the downside, today's increase may be foreshadowing a drop tomorrow, or at least the fear of one. Does this mean the Fed will not lower the Fed Funds Rate tomorrow? Not necessarily. It may simply mean that the market is expecting a drop, regardless of whether the rate is lowered. It is worth noting however, that on a day when the Nasdaq finished up fractionally with a gain of 0.72, the Nasdaq Volatility Index (VXN.X) was down 2.41 to 56.29

Chart of the Market Volatility Index (VIX.X)

One of the developments that sent us lower this morning was sell recommendations, in this weekend's Barron's, of a number of tech stocks, including heavy weight Intel. Other companies in the group were Nokia (NOK), Texas Instruments (TXN), Qualcomm (QCOM), EMC Corp (EMC), Sun Microsystems (SUNW) and Applied Materials (AMAT), which also saw its price target dropped from $27 to $21 by Prudential. This helped lead the semiconductor sector lower. The Semiconductor Index (SOX.X) reversed some of its recent gains, losing 3.80 to close at 312.09. A look at the daily chart shows that last week the index actually rebounded to the top of its descending channel, begun in early May, and was turned back the last two days. With no new positive news coming out of the sector, I expect to see a drop back toward the middle of this channel. A trade below 282.75, the previous low, could be very bearish, as it would not only place the sector in the middle of this channel, with room to fall, but also establish a new 52-week low.

Chart of the SOX

Another development contributing to this morning's decline is renewed fear that the airlines could be facing more closures. The nation's seventh largest airline, U.S. Airways, filed for Chapter 11 bankruptcy protection on Sunday. The stock traded $0.65, down $1.80 from Friday's close of $2.45. Dow Jones removed U.S. Airways from the Dow Jones Transportation Index and added Continental in its place. This follows the recent grounding of Vanguard Airlines and could foreshadow continuing closures in the industry. United Airlines(UAL), the world's second largest carrier, is currently losing $1 million per day. United has $2 billion in reserves, however, is facing a debt payment of over $900 million by the end of the year. United is hoping for a $1.8 billion bailout loan from the U.S. government, however this is far from a sure thing. United is currently negotiating deals with its mechanics, flight attendants and ticket agents, with little progress on wage concessions. It would seem that this employee-owned airline should be able to strike a deal to keep its "owners" employed.

The retailers also took a hit, as big shot Wal-Mart was downgraded, bringing Target (TGT), Kohl's (KSS) and Sears (S) down along with it. K-Mart (KM) is under investigation after revelations that two of its former executives, Chairman Charles Conaway and President Mark Schwartz, bargained for more money to support lavish lifestyles while the company was heading into bankruptcy. Sounds like they'll be shopping at K-Mart soon, along with Dennis Kozlowski and the Rigas family. Speaking of K- Mart, Martha Stewart has been given until a week from Tuesday to provide a senate committee with telephone and email documentation regarding her sale of ImClone shares ahead of their dive.

Crude oil futures rallied today as reports surfaced that Iraq once again denied U.S. requests for weapons inspections. There was also a report of U.S. helicopters moving into the Persian Gulf. Iraq exports about 1.8 million barrels a day, under United Nations supervision. A U.S. invasion is beginning to be priced back into oil after the possibility had previously been discounted.

Heading into tomorrow morning, we can expect a market on hold. Unless there is specific news, it should be relatively quiet as the market awaits the FOMC's announcement. There are several different scenarios that can take place tomorrow afternoon, depending on what the Fed does. If the Fed were to lower rates by 25 basis points, I would expect an initial rally, followed by a pullback, as the buyers who have been expecting a cut have mostly bought into the market in the last week. If we see a 50- basis point cut, there may be a continued rally throughout the week. If, as I believe, the Fed leaves rates at the current level, but announces an easing bias, we will most likely see a sell-off. I think this is the most prudent action the Fed can take, as the September 11 anniversary is around the corner and I believe the Fed should save its rate cut for after this date, in case there are any anniversary attacks which send the market tumbling. I believe that even if there is a cut, we will see a sell-off at the beginning of September as investors don't want to be holding long positions heading into that date. There is usually some extreme gapping immediately following a rate announcement that has uncertainty surrounding it. Be patient, as the market will then pick its direction within a few minutes. Don't get caught jumping on a gap, as it can turn by the time you have placed your order.

It seems that the August 14 reporting period for CEOs to certify their companies' financial reports has been all but forgotten in the wake of the interest rate debate. Expect a slew of reports the next few days regarding which companies have certified and which have not. The August 14 date is not the deadline for all companies. The schedule for each company can be accessed through the Securities and Exchange Commission Website using this link. http://www.sec.gov/rules/extra/ceocfo.htm

Betting on the Fed can be a dangerous proposition, so respect your stops, don't get caught in the gaps, and remember to let the market pick its direction before jumping on for the ride.

Steven Price
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