Option Investor
Market Wrap

Bullish Sentiment Fading?

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        WE 8-16          WE 8-09          WE 8-02          WE 7-26 
DOW     8778.06 + 32.61  8745.45 +432.32  8313.13 + 48.74  +245.13 
Nasdaq  1361.01 + 54.89  1306.12 + 58.20  1247.92 - 14.20  - 57.03 
S&P-100  468.44 +  9.62   458.82 + 24.77   434.05 +  7.12  +  3.83 
S&P-500  928.77 + 20.13   908.64 + 44.40   864.24 + 11.40  +  5.09
W5000   8770.28 +198.41  8571.87 +385.31  8186.56 + 94.93  +  8.63 
RUT      395.97 +  7.52   388.45 + 12.00   376.45 -  5.81  -  3.94 
TRAN    2339.40 +  7.52  2351.65 +149.62  2202.03 - 52.76  - 77.39 
VIX       32.82 -  6.54    39.36 -  6.03    45.39 +  4.95  -  3.01 
VXN       50.65 -  8.05    58.70 -  6.74    65.44 -  3.58  +  7.85 
TRIN       1.52             0.90             1.47             1.21 
Put/Call   0.51             0.69             0.93             0.70 

The bullish spike on Wednesday energized traders but they were unable to follow through on the sentiment as the week drew to a close. The Dow did end the day still above 8750 support but even farther below its next resistance at 8850. It appears the 10-week moving average at 8800 may be keeping a lid on it as well. The Nasdaq did manage to finish on a positive note as techs got a boost from the positive Dell earnings. Still all is not well in the broader markets.

Chart of the Dow

Chart of the Nasdaq

The day started off bad with economic reports giving mixed messages. Housing starts slowed for the second consecutive month as the stock market drop continued to weigh on buyers as well as builders. This is not really a negative as it represents a stabilization of the booming market and a return to more sustainable levels. The pace of new building is continuing at a strong pace and is driven by the very low mortgage rates.

The Consumer Price Index came in slightly lower than expected at +0.1% with drops in apparel prices offsetting higher prices in medical, communication and education costs. This continues to show that inflation on a yearly basis is a very mild 1.5% rate. No Fed worries here! With a slowing demand picture prices should continue to fall and provide no inflation barrier to future rate cuts.

The University of Michigan Consumer Sentiment report showed that the drop in sentiment had slowed significantly over the last two weeks. The number fell to 87.9 from 88.1, hardly a perceptible drop. This was influenced in part by the market bounce over the last two weeks and would indicate a wait and see attitude. It is still at the lowest level since November. The key here is not if sentiment has stopped falling but will consumers continue buying or are they running out of money.

One of the keys for me to the question about consumers and their sentiment is the mutual fund outflows. TrimTabs.com reported that investors withdrew $3.5 billion from stock funds in the prior week, the week of the initial bounce, and those withdrawals accelerated this week to $5.4 billion. If consumers were feeling that the crash was over then why were they taking even more money out this week? If they are using this money to fund their purchases then the well will eventually run dry. Also, once spent for clothes, food, housing, education, toys, etc, it is not available in the future for investing in stocks again. That money is lost to the market and while it is powering the economy in the short term is also a limited resource. Just my opinion.

There is also a growing fear that the market drop along with the numerous bankruptcies has sunk public pension funds to the point of failure. According to one report on Friday 51% of public pension funds are now under funded and have insufficient assets to satisfy future cash flows as retirement ranks swell. Estimates are that this will grow to 75% by next year. This is a huge problem and not one that will be cured easily. It will take a return to bubble highs to provide the needed liquidity again and we know that is not going to happen anytime soon. We are looking at a growing crisis that is still unknown to most consumers.

There was good news this week and that was the lack of a major certification event. It was a classic good news, bad news joke. The good news was there was no bad news. The bad news was there was no positive reaction to the good news. Confused? Traders have been worried for two months that the end of the stock world as we know it would come to pass on August 14th. The date came and went and the markets failed to melt. In fact they failed to do anything on Thursday and Friday but move sideways. You would have thought the lack of disaster would have energized investors to go shopping for bargains. Instead total market volume has been half of the 5-6 billion share days from the last two weeks of July. With only 3.2 billion on Friday the numbers of 52 week lows still beat new 52 week highs 3:1. The NYSE is running 2:1 lows to highs but the Nasdaq, despite a good week, is running 4:1 lows to highs. The rally we have been seeing has not been as broad as everyone thought.

I have two observations today. The first was a perception gained during the pick meeting on Friday afternoon. We had a very hard time finding put plays. We looked a several hundred more charts than usual and very few looked like put candidates in the normal view. This would normally mean that there were hundreds of great call candidates. This also was not true. The problem is resistance. Almost every chart we looked at, somewhere close to 1000, was at resistance. Every one looked ready to breakout OR breakdown but there was no visible directional indication. Normally you have a nice pattern of higher lows edging ever higher and culminating in an eventual breakout. What we were seeing was a sprint to resistance and then a flat line on Thursday/Friday. There simply appeared to be no buying OR selling interest. This could have been simply an expiration week syndrome but is very reminiscent of failed rallies in the past.

In March the Dow sprinted to resistance of 10350 in a week after posting an apparent double bottom at 9800. In May the Dow spent 12 days at resistance of 10600 after sprinting from an apparent double bottom at 9600. In both of those instances resistance held and a severe drop followed. After twelve trading days in August we are still within 50 points of the July 31st close. The +1200 point V bottom rebound in July came to a screeching halt exactly at the same resistance we are facing today. Obviously a break over it would be highly positive but we are in historically the worst quarter of the year for stock performance. Add to this the weakening economy and hibernating consumer and expectations for the market to buck the trend, even after 28 months of a bear market, are slim. October is known as the bear market killer as it has the reputation for seeing the end of more bear markets than any other month. Unfortunately that is still two months away.

The second observation today is the speed at which the build up for an Iraq war is occurring. There were several news articles today referring to huge troop movements to the middle east and a reader in Qatar confirmed that the military buildup over the last couple of months has been tremendous. The climate in Iraq would make a ground assault very tough until January at the earliest but there was a wave of rumors again on Friday that Saddam already has as many as 40 nuclear bombs of which 30 are in the dirty bomb class but 10 are true warheads. The problem it appears was a reported military meeting last week where he discussed striking a pre-emptive attack on Israel, Jordan and possibly some US port cities with these bombs. He knows he cannot win a war and has decided to cause as much damage as possible before that final cruise missile lands in his lap. Another reader in Germany said they were just called up and have spent a week doing fly-in casualty drills with their unit running 24 hrs a day. They have been told they were shipping out on Saturday to an undisclosed location, they are guessing Turkey. The rumor again is that Saddam is planning a huge pre-emptive strike. They said military equipment was pouring through Germany at a frantic pace with 2hr touch and go refueling on the ground.

Sentiment is running very strong against an attack both in Europe and the middle east. If Bush were to get real proof of the nuclear rumors above he would no doubt decide to strike on his own and risk getting into a serious oil fight with OPEC. Don't think they would not use that as a weapon against us and anyone else who joins the party. Also, Russia announced signing a $40 billion deal with Iraq today. They are one of the largest suppliers of military equipment to Iraq. Obviously they will not be on our side in any conflict. The challenge I see in all of this is back to the problem of consumer sentiment. Consumers are not stupid. As events ratchet up as we get closer to the event they will withdraw even further and hoard gas and money again. As countries start choosing sides hedge funds and institutions will start shorting heavily again. This is just an opinion but with only four months before the invasion window opens there is going to be a lot of maneuvering as the buildup races to its climax.

There seems to be a unanimous agreement that the bottom is behind us. That scares me. If the bottom is really behind us then why are investors continuing to pull money out? Obviously the glib answer is they are always wrong on both extremes, selling at the bottom and buying at the top. Do you think maybe the market is not going up because quite a few traders still think there is another period of weakness ahead? I do. They can be just as wrong as anyone else but they just might have the right idea. I look at the chart of the Dow and I want to believe it is going to breakout any day. My wanting it will not make it happen. I keep seeing the conflicting internals and lack of movement and wonder if we are not setting ourselves up for another fall.

The Dell earnings were decent and energized the tech sector again even though it is really a company specific story and not an industry win. Dell is gaining market share and reducing costs while running on only four days of inventory. Nobody else has the same business model yet Dell can only manage +5% revenue growth for next quarter. The majority of that growth is expected to be from gaining market share not an improving business climate. Still the Nasdaq gained +16 points and actually closed six points over resistance. Obviously six points can evaporate in an instant if sentiment changes.

All of the broader indexes are showing a possible breakout or down. The Wilshire-5000 closed -65 points off its high, which is also its strong resistance, at 8825. The bullish view is that it is poised to breakout. The bearish view is that resistance has held and it is poised to fall and retest the lows. My view is that there is a floor under the market. It may not be ready to breakout yet but as long as there is a floor under the market the pullbacks will be buying opportunities. The key here is "as long as there is a floor" and that floor can disappear at any moment. Currently that floor is around 8475 on the Dow and rising. This means we have about -300 points of risk before we know if the floor has vanished.

The Fed confused traders this week by saying the odds of a weaker economy were better than a stronger economy. Stocks dropped on the news but rallied back on media assurances that with a bias to easing the Fed could cut rates at any time. You know my thoughts on that so I won't bore you again on that topic. The S&P, OEX and Dow have posted four weeks of gains, a feat not seen in a year on the S&P. Since we know nothing goes up in a straight line the possibility of a negative week is strong. With stocks struggling to make new relative highs the bond market was beaten like a rented mule as Art Cashin would say. However, Art confessed to being puzzled by the lack of gains in the market compared to the amount of selling in the bonds. He said the Dow move should have been +800 to +1000 points based on his experience. He said they raised the cash but did not spend it. This poses an interesting question, what are they waiting for? Could it be they just felt that bonds had gone up as high as they could go and just wanted to take profits? I think the answer is yes. With yields at 40 yr lows the time to sell was right. However, it just may not be the right time to buy stocks and that is why they are sitting on the cash.

Another factor could be that buying distressed corporate bonds today makes far better sense than buying stock or government paper. Corporate bonds have literally fallen through the floor. Worries over corporate governance and the certification factor drove corporate bonds to new lows as investors were afraid they would be caught holding the next WCOM on August 14th. Once that initial deadline had passed without a disaster the coast was clear to take profits on government bonds and move those funds into corporate paper. Warren Buffet led the way last week when he went public with several high dollar investments in beaten down companies. If this is the case then the billions of dollars that came out of the bond market is not waiting on the sidelines for the stock market. Did you just have an Ah-ha moment? Did you just realize why the markets were running on only half the volume this week?

Yes, there is a floor under the market. It is low volume bargain hunting by pension funds, retail investors and probably some nibbling by mutuals as well. These bids can disappear in an instant if the sentiment direction changes. The bottom line, buy a breakout over Dow 8850 and buy any bounce from a dip to the 8500 range but don't buy in the middle. If 8500 fails then it is an entirely new ballgame. Use those same levels as stop losses on any long positions you may enter. Consider the risks outlined above because you can bet the big money is thinking about it. There are also strong rumors the Fed juiced the market on Wednesday to avoid a total meltdown if there was a rash of certification failures. If they did then the buying was artificial and was successful because of the very thin market. Now that that hurdle has passed we are on our own again. That is a scary thought with September and October still ahead of us.

In the Guess the Dow contest we had a tie this week. The Dow closed at 8778.06 and two readers guessed an identical 8777.77. We decided instead of awarding the 2-monitor card to the earliest entry we would give each a one monitor card. (grin) Just kidding. We are going to give each of them the dual monitor card. Congratulations guys!

bbgold2001@h...... 8777.77 entered at 9:57:16 pm on 8/11.
scott.deb@gt.... 8777.77 entered at 11:52:55 pm on 8/11.

Send me an email with your addresses and we will get those in the mail to you.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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