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Traders Return Stocks Purchased in November

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       WE 12-27        WE 12-20        WE 12-15        WE 12-06 
DOW     8303.78 -208.22 8512.01 + 78.16 8433.85 -211.92 -250.32 
Nasdaq  1348.46 - 14.59 1363.05 +  0.63 1362.42 - 60.02 - 56.30 
S&P-100  443.06 - 12.40  455.46 +  3.65  451.81 - 12.61 - 14.43 
S&P-500  875.42 - 20.34  895.76 +  6.28  889.48 - 22.75 - 24.08 
W5000   8305.63 -169.60 8475.23 + 48.97 8426.26 -202.90 -217.52 
RUT      384.16 -  2.72  386.88 -  1.10  387.98 -  8.74 -  9.64 
TRAN    2291.66 - 32.56 2324.22 +  5.75 2318.47 - 70.34 + 28.19 
VIX       34.15 +  2.68   31.47 -  0.65   32.12 -  0.56 +  1.60 
VXN       46.71 -  1.80   48.51 -  2.41   50.92 -  1.36 +  2.80 
TRIN       3.60            0.66            1.34            1.11  
Put/Call   0.94            0.88            0.87            0.91  

Traders Return Stocks Purchased in November
By Jim Brown

Traders may have returned stocks Friday for cash but the bargain hunting was confined to the malls. Market volume was very low at only 1.8 billion across all markets but 1.5 billion of that was down volume. Considering the holiday period is normally bullish there is a definite trend change in progress.

Dow Chart - Daily

Nasdaq Chart - Daily

Friday began with another surprising economic announcement. New home sales soared to a record annual rate of 1,069,000 and well over consensus estimates. This +5.7% bounce caught everyone off guard considering mortgage applications were down significantly on Thursday. On a deeper look the internals showed that most of the gains came from the Midwest with a sharp -26% decline in the Northeast and a -4% decline in the West. Sales rose +41% in the Midwest and only +2.4% in the South. Inventories fell to a 3.8 month supply due to a flurry of price cutting. Median home prices fell -6.5% as builders competed to sell excess inventory before mortgage rates begin to rise. The median home price fell from $191,900 in June to $167,300 in November. With pricing power falling the stocks of the major homebuilders also were knocked for a loss. The additional sales obviously came as the result of strong incentives and is not something we should expect to continue.

The Conference Board help Wanted Index remained at 40 in November for the second consecutive month. This is the low for the year, very close to a historic 40 year low, and indicates there has not been any surge in help wanted ads that would indicate a recovery in progress. If there is a recovery in progress it is obviously a jobless one and many analysts think this could continue until the 2H of 2003. Several high profile analysts are now expecting unemployment to go as high as 6.5% before the economy recovers. The nonfarm payroll report for December will be delayed by the holiday to Jan-10th.

The positive home sales report only managed to hold up the market for a very few minutes. Other factors quickly came into play and the descent began. North Korea ordered the IAEA inspectors to leave the country as they prepared to begin nuclear work. They are currently thought to be moving 1000 plutonium fuel rods back to the reactor complex every day. Scientists thought North Korea was only a couple months away from making a bomb when the last treaty was brokered. Since North Korea recently admitted they never quit their bomb making efforts like they had agreed eight years ago the risk is now that they have the capability and only need to extract the plutonium to complete the weapons. This means within 60 to 90 days they can have those weapons in their arsenal. This overt "in your face" threat to go nuclear is a wildcard the markets are not prepared to deal with.

Add to this problem the news of the attack in Grozny, which could have killed as many as 200, when suicide bombers drove truck bombs into a government building. This is not a problem for the world as it is more of a civil war but it was just one more negative news event.

Oil prices spiked to $32.72 and will be much more of an impact to the markets than the Russian civil war. Most investors think the Iraq war will impact prices but they are wrong. Iraq is only pumping 400,000 barrels a day, which is down from millions a day. The US has not used any Iraq oil for over a year. The real problem is Venezuela and there does not appear to be any resolution in sight. The US imports 14% of its oil from Venezuela and that pipeline has been shut off. This is the same amount as we import from Saudi Arabia. There will be additional purchases from other countries but the price of oil is going up. For every $1 increase it represents a monthly $7 billion undeclared tax on US consumers. Every recession since 1970 has been preceded by a large spike in oil prices. This is the kind of news that makes investor nightmares.

The lack of retail sales continues to make headlines with the official estimates falling to only +1.5% sales gains for the season. This is the lowest sales growth since 1970 and means the profit forecast for retailers is grim. There is still hope by some that the returns and post holiday discounts will help lift the numbers but reports from the malls are very discouraging.

Adding to bearish investor sentiment was the call up of another 25,000 troops to go to Iraq. This makes over 150,000 officially called up but there was as many as 60,000 in the area before the build up "officially" started. 4,000 marines were put on alert and told to prepare to leave. Orders were issued to put four or more carrier battle groups in the oceans around Iraq by Jan-27th. Orders were given to begin moving aircraft from US locations to attack launch points in the area. The intent is clear. The pressure is building on Saddam to come clean or face the consequences with a Jan-27th deadline. This is the date the inspectors have to formally report to the UN on the status of the search. The most recent news from their spokesman was Iraq had failed to comply with the resolution. They have not claimed to have found any weapons and the weapons they already knew about have disappeared. Considering Saddam had years to move/hide them I am not surprised. 250,000 troops are expected to be in theater before Feb-1st so investors know there is more bad news coming. The US does not have near the consensus of opinion this time and there are going to be dissenters at the UN. The current indications are that the US will attack regardless of the opposition and that could cause grave global repercussions. Investors flight to gold and bonds is increasing with gold hitting $349 on Friday and a five year high. The dollar fell again on the world markets as Asian and European investors shifted their positions.

Volume on the NYSE was the second lightest day of the year with Thursday being the lightest. 83% of the volume across all the US markets was down volume. While there was no rush to the exits it was a steady procession. Just because it was an orderly exit does not mean investors should not panic. The Dow closed only 3 points above 8300 and the lowest close since Oct-17th. Make no mistake, this is a critical area for the markets. Serious technical damage has been done and there is only the bare minimum of support between us and disaster. By disaster I am speaking about a move to 8127 and the 50% retracement level or even lower to 8000 or below. A break below 8000 sets up a possible retest of the October lows at 7200.

The Dow is on track to post the worst December since 1931 and the Nasdaq will post its first three down years in a row ever. The Dow has lost -1717 points or -17% for the year. The Nasdaq is even worse with a -602 point loss and a -31% drop. Despite these numbers there are still some significant problems in our immediate future. There will be a flurry of earnings warnings over the next three weeks. Because of the holidays the January warnings period is normally compressed into the first two full weeks of the year instead of stretched out over 4-5 weeks. This means we could get a serious dose of bad news in a short period of time. As is normally the case the COT report is showing the retail traders lined up on the wrong side of the playing field. On the Nasdaq, commercial traders increased their net short positions by 600% and small traders just posted their most bullish position of the year at a 3:1 net long. Retail traders are clearly betting on the typical holiday tech bounce and commercial traders are happy to take those bets.

I see considerable risk over the next three weeks. I have been telling readers for three weeks I expected a drop after Christmas and it appears that drop is underway. There is a significant chance that we will see a bounce on Monday simply because of the oversold conditions. The TRIN closed on Friday at 3.60 which is extremely bullish. It is an indicator of very oversold conditions and is powered by advancing/declining volume. At this level the indicator typically predicts a very quick bounce to equalize pressure. With much of Friday's drop related to weekend event risk that bounce could be traders coming back into the market on Monday. However, the oversold conditions can be relieved very quickly with a very small spike so I would not look to it for salvation. I would look to short any real bounce over the next week. I believe the earnings warnings, the increasing buildup in Iraq and the increasing noise out of North Korea will weigh heavily on trading until companies begin announcing real earnings the week of Jan-13th. To put it bluntly, we are entering a period where negative news is likely to outweigh fundamentals and the path of least resistance is down.

I will leave you with the bright side. I would be very surprised if the current weakness will last much longer. Looking at the problems long term provides much more hope. The Iraq problem will go away once the shooting starts. There are considerable indications the Iraqi army will evaporate once the war begins. Privately the Iraq citizen would love to see Saddam depart. Want proof? The Iraq stock market has soared recently as the threat of a forced regime change gets nearer. Iraqi civilians cannot speak out about Saddam but they can vote with their money. The implications are not that the country will be obliterated by attacks but that the post Saddam regime will be pro-business and life will be better for all.

The Korean thing will not deteriorate into a war because their army is too strong and South Korea would suffer too much damage. It is likely to be only an attempt by North Korea to blackmail the world powers into yet another payoff to "stop" nuclear research. They have a history of this and eventually somebody will pay their bribe or blockade them into submission. They can't afford to feed their people much less risk a real war. In Venezuela, Chavez will eventually be toppled by either internal or external forces and oil will flow again.

On the home front the Y2K PC upgrade wave will eventually take place. Too many companies have already paid MSFT for licenses they are not using and rumors are surfacing about multiple bids being floated for 20,000 to 50,000 PC lots for delivery later in the year. One OIN reader emailed that his company was scheduled to replace 24,000 Intel PII laptops with 28,000 new P4s in 2003. I am pretty convinced that despite the serious problems in our immediate future there is a recovery about to take place. Flaws in that theory are the rising unemployment, lack of consumer spending and the possibility of a double dip recession before the recovery appears. With the 4Q GDP estimated to be only 1.5% any second dip recession will be in the 1Q. The Fed has gone into overdrive and is pumping large sums of money into the system. If another economic dip occurs it should be short and the rebound from a double dip could be strong. Once any real signs of a recovery appear the race to upgrade and the release of pent up spending could be violent.

Technically I think the current dip in the market is being artificially created. I think institutions want to invest in the market since bonds have peaked and money market rates are near zero. They are afraid to make heavy bets with all the uncertainty. My view is that they are trying to force a retest of the October lows. Many institutions missed the bounce in October because they were expecting a stronger dip later. They will not miss it this time. If they can force a retest by pulling bids and some strategic short selling then they will be ready to go long for the recovery when the retest is complete. That retest would have a tough time breaking below 7700 so that is where I think the real buyers will begin to appear. The next likely support point for the current market is Nasdaq 1320. This is the confluence of the 50% retracement and the 100 DMA and with the Nasdaq bullish sentiment at the high of the year I see that as a potential bounce point.

On the Rukeyser show on Friday he hosted his four best market forecasters for 2002. They were quizzed on their outlook for 2003. The average of their predictions were Dow high 9913, low 7505, close 9155. The Nasdaq high 1732, low 1186 and close 1525. What is your guess? On New Years Day we are going to activate our "Guess the Dow" contest and award a total of $2003 to the top three forecasters. Get out your charts and get ready to place a bet. We will be asking for the Dow high, low and close for 2003.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

"Don't gamble in the market; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it." - Will Rogers

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