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Market Wrap

Better Than Expected

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10-23-2002                  High    Low     Volume Advance/Decl
DJIA     8494.27 +  44.11  8494.76 8294.38   1815 mln  1175/621
NASDAQ   1320.23 +  27.43  1320.25 1279.46   1587 mln  1279/289
S&P 100   454.73 +   2.14   454.74  443.36    totals   2454/910
S&P 500   896.14 +   5.98   896.14  873.82
RUS 2000  368.95 +   6.29   368.97  359.79
DJ TRANS 2341.55 +  29.12  2342.08 2281.47
VIX        39.38 +   0.04    41.99   38.87
VIXN       52.37 -   1.24    55.41   51.76
Put/Call Ratio 0.73

Better Than Expected
by Steven Price

Just as the Dow looked to be gaining steam with a series of higher lows, the usual suspects, in the form of Citigroup and J.P. Morgan jumped out of hiding, along with some help from healthcare and telecoms, pushing the index lower by 155 points, before a late day rally pushed us up 44 points on the day. However, even though we hit a lower low than yesterday, we got a better look at the 50-dma and previous head and shoulder support, which could be our new support levels in the Dow. What was even more impressive was the fact that we rallied shortly after the release of the Fed's Beige Book report, which contained mostly bad news.

The Beige Book showed a slowdown in consumer spending, evidenced by weak retail sales in September and October. It also showed a slowdown in the furious pace of auto sales that had resulted from the zero-percent financing deals offered by major manufacturers. Manufacturing activity declined and was described as tough, stagnant, or sluggish in many districts. There were also declines in commercial lending, commercial real estate and construction activity, as well as labor markets and energy exploration. The increases were in homebuilding and residential real estate, which went hand in hand with increased activity in consumer lending. The song remains the same - low interest rates are leading to a strong housing market, but everything else is suffering. However, one important note on housing is that the report showed some softening in the higher end of the market.

The speculation is now that the numbers in the Beige Book will give the Fed the excuse they need to lower rates. After a lackluster report, that would seem to be the reason for the afternoon rally following its release. However, there were a few other developments before the report was released that indicated investors were ignoring the bad news and buying the dips.

This reminds me a little of the 90s, when missing earnings by just a little was just another buying opportunity. I am looking at the semiconductor stocks once again and seeing amazing resilience to bad news. Whether the rally is simply lemmings heading toward the cliff's edge, or institutions that were expecting even worse numbers, I'm not sure of; but one thing is certain - the bears are in hibernation for the moment. Leading the "Huh?" rally is Cymer. Last night, Cymer (CYMI), which makes lasers used in chip production, released earnings, along with comments that "The semiconductor industry has apparently entered the second decline of a double-dip downturn, which will have a negative impact on our fourth quarter operating results." The company predicted a 20-25% decline in fourth quarter revenue. After trading $2 lower after hours yesterday, it not only made up the loss, but actually traded up $1.65 on the day. KLA-Tencor (KLAC), another chip equipment maker which released after the bell on Tuesday, guided revenue lower for the fourth quarter, from $381 million to $330 million, a 13% drop in expectations. KLAC also lost about $2 in after market trading, but made up the loss, plus another $2.13 on the day. Storage Tech (STK) also said it doesn't expect the IT spending environment to be any better next year than it is this year and is assuming IT spending will be flat based on its conversations with customers. The stock was, of course, upgraded after those comments and gained 24% on the day. If the chance of a rate cut were really behind the rally, it would seem that there would be plenty of better places for investors to go long, other than three stocks which are seeing declining revenues. This morning also brought a downgrade from Thomas Weisel of eight chip equipment makers, including KLAC, Applied Materials (AMAT) and Novellus (NVLS). The firm said it believes that the industry is entering a period of bifurcation as the prolonged downturn has created a chasm between companies that are profitable, with strong balance sheets and little debt, and companies that are burning cash and are highly leveraged. Wiesel said it expects this trend to continue. All eight stocks it downgraded finished the day significantly positive, with only one up less than 5%. The Semiconductor Index (SOX.X) tested the 50-dma in August, and failed it after a massive rally, much like the one we are seeing now. However, that rally did so within the descending channel that had contained the movement since March. It also did so at a time when the index had been rebounding off the bottom of the channel. I have noted in recent wraps that the bounce pattern has changed, with the SOX finding support on recent bounces from the center of the channel. These observations do not change the fact that revenues are still DECLINING, but apparently institutions must have been looking for numbers that were even worse than were reported. The SOX has now broken out of its descending channel, taken out its 50-dma, pulled back and then surged above that level once more on bad news. I'm still not going to put my money on a sector with declining revenues and no real plan for when that will turn around, not to mention a declining book-to-bill ratio, but I'm not going to stand in the way of a rally. The only positive news I can see for the sector is today's report from IDC (the same group that predicted a slide to 200 in the SOX) that the growth rate for PCs is expected to pickup next year in China. Some of largest PC sellers in China include IBM and Dell.

Chart of the SOX

Looking back at the Dow again, today's bounce point looks as though the average is now finding support again right around 8300. This level also provided temporary support on the way down, as a head and shoulders formation evolved between July and September. It now correlates with the current 50-dma of 8257.15, as well, and with a descending trendline from the May highs through the August peak. That 50-day moving average is declining, due to activity in the last couple of months, but is starting to level out. The fact that we are bouncing in this area on the way up looks bullish and it may be difficult for bears to get through to the downside with so many converging factors. Additionally, a look at the bullish percentages shows that the NYSE bullish percentage has rebounded from a low of 26% and reversed up right around the time the Dow broke through the 8000 level. This is the third straight rebound from this level. The reading is now 32% on the three-box reversal and appears as though it has room to run. The last two rebounds have taken the percentage up to 64% and 46%.

Chart of the Dow

Chart of Dow Consolidation Levels

Point and Figure Chart of NYSE Bullish Percentage

The S&P 500 (SPX.X) shows a slightly different story. The index has been unable to crack 900 on a closing basis, and was rejected from an intraday high of 900.69 two days ago. One of the reasons the S&P may be more important than the action in the Dow is the fact that the rally of the last two weeks actually started when the SPX finally broke its July 24 intraday low. This is an indication that institutional trading may be playing a much bigger role in this rally than the individual investor, since it's programs are based on the S&P 500. It may also indicate a sell program in place at 900.

Chart of the S&P 500

The original drop today came after Sanford Weill, chairman of Citigroup, said he would testify to the New York attorney general's office in their probe into research activities at Salomon Smith Barney. The fact that Citigroup's CEO may be the target of the investigation scared investors who initially sold off the stock, before the end of day rally brought it back to near even (-0.11 on the day).

Johnson and Johnson (JNJ) was also downgraded, contributing to the drop in the Dow, even after the FDA gave approval for the company's drug coated stent, used in clearing blocked arteries. CIBC World markets cut their rating on the stock, stating that the earnings boost from the stents was already figured into the price and there was limited upside in the stock from this level. Eli Lilly (LLY) helped send the drug sector lower, as well, after it lowered its fourth quarter outlook, due to the need to put more money into its drug pipeline. It also cited marketing costs and slower sales of some of its products.

AOL hit its earnings target, but announced that it would restate revenue by $190 million. This was somewhat expected after it announced an internal review several weeks ago. However, the restatement was apparently not as bad as expected, as the stock rose $1 from its closing price in after hours trading.

Amgen also reported earnings, which showed a loss. However, that loss reflected the effect of a one-time $3 billion write-off related to its purchase of Immunex. The company said third quarter revenue was up almost 50% and raised its sales forecast for chemotherapy drugs. The stock traded up $1.20 from its close of $50.00.

So now what? Things look bullish, in spite of warnings on a seemingly daily basis. While I can't imagine buying shares of a stock that is showing revenue declines, apparently someone else has no problem with it. Or make that a lot of someone else's. The trend looks like it is still heading north, and an S&P 500 break of 900 would certainly add to that sentiment. If we do break 900 in the S&P, then the next challenge in the Dow looks like 8750, and playing long on a break over 8500 to that level seems logical. The Market Volatility Index (VIX), remains close to 40, indicating there is still plenty of fear of the downside out there, as premium sellers, who normally come out en masse during market rallies, have not done so with any real conviction. Right now, I would be playing only 1/2 positions to the long side, until I see some good news that isn't simply "better than expected."

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