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Market Wrap

Careful What You Wish For

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01-13-2003                  High    Low     Volume Advance/Decl
DJIA     8785.98 +  1.09   8869.29 8746.97   1657 mln  838/801
NASDAQ   1446.04 -  1.68   1467.35 1436.98   1565 mln  618/919
S&P 100   470.83 +  0.42   475.06  468.45   totals    1456/1720
S&P 500   926.26 -  1.31   935.05  922.17
RUS 2000  396.18 -  0.26   399.55  393.48
DJ TRANS 2387.44  - 6.23  2405.74 2377.65
VIX        27.52 +   0.39    27.83   26.31
VIXN       41.74 -   0.54    44.64   41.29

Careful What You Wish For
By Steve Price

The last couple of weeks have been a struggle between the bears and bulls, without either faction being right for more than a few days. That old saying about being careful what you wish for kept popping through my mind all day. The bulls finally got the confirmation rally, with point and figure buy signals and breakthroughs of recent highs across the board in the major indices. The only problem was that none of those gains lasted very long.

We have been discussing the possibility of a bearish head and shoulders formation after the recent rally took us up to about the same level (possibly a left shoulder) as the November highs in the Dow, SPX and OEX. The head of the formation would be based on the post-Thanksgiving, December 2 high. However, the last time we predicted doom and gloom based on this formation, we were dead wrong and what we thought was the head at Dow 8800 turned out to be what we are now looking at as a possible left shoulder. Does that mean we'll find ourselves using that 9043 trade in December as our possible left shoulder several months from now?

The head and shoulders pattern we looked at between July and September actually turned out to be right on, with a measuring objective just below Dow 7200. We had a left shoulder at 8762, head at 9077 and right shoulder at 8726. That objective was fulfilled back in October, and became the launch point for the rally to the November/December highs.

This pattern has been a little harder to decipher on a short term basis. If a trader steps back and looks at the pattern without trying to figure out how to trade it tomorrow, we haven't really seen anything to tell us that the pattern has broken down. But that's certainly not the way it looked this morning and the rally we saw to start the day cannot be discounted. We started with a rally that for all intents and purposes looked as though the head and shoulders pattern was dead. The right shoulder, which does not have to come at the same level as the left shoulder, appeared as though it was on its way to a breakout and a re-test of the December highs. However, as quickly as it registered the new buy signals in the Dow and SPX on the point and figure charts, the rally faded. Those buy signals were the second in the current rally. The first signals came at Dow 8500, SPX 905 and OEX 460. We then got a pullback into a column of "O" and then a rally to this morning's buy signals, just above the previous rally tops at Dow 8850, SPX 935 and OEX 472.50. The OEX buy signal came last week, and even though it reached a new high, it was not a new signal. It did, however, add another box to the current column of "X."

This action brings back shades of November and December, when the second buy signals in those rallies were short lived. In fact, the SPX gave what appeared to be a buy signal at 925 on its second leg of the October-November rally (topping out on November 6), hit a high of 925.66, then rolled over and headed to a low of 872. The index then rebounded during December and on the second leg of its November-December rally, also gave a buy signal at 940, before topping out at 954 and rolling over to a low of 869. We are now on the second leg of a January rally which has given a buy signal at 935. The Oct/Nov buy signal was good for a gain of 0%, then a loss of 5.7%. The Nov/Dec buy signal was good for a gain of 1.4%, then a loss of 7.5%. Once again, these results are for the second leg of the rally, much as we are seeing now.

The Dow showed similar action to the SPX. The second leg of the October-November rally produced a buy signal at 8750. It was good for another 50 points before rolling over and hitting a low of 8298. The second leg of the December rally produced a buy signal at 8900, which was good for 143 points, before rolling over to a low of 8242. The Oct/Nov buy signal was good for a 0.5% gain and then a 5% loss. The Nov/Dec buy signal was good for 1.6% gain, followed by a 7.3% loss.

Certainly traders who had simply stayed long from the corresponding buy signals I referred to back in November (actually the second leg of the rally) would be just about where they entered, but would have taken an awful lot of pain in the meantime. Those entering on the second leg of the December rally would still be looking to break even.

Point and Figure Chart of the SPX

There are a couple of other complicating factors to playing the current rally from the long or short side. First we have the 200 day moving averages, which are descending from the levels they were at on the last rally attempts. They have now moved below the December highs and if we are going to make a run at those December resistance levels, we will have an additional obstacle this time around. Back in December the 200-dmas sat in the OEX at 493, SPX at 982 and Dow at 9177. They now sit at OEX 476.72, SPX 949.49 and Dow 8927. If they continue to descend, traders can look at the graph below to see approximately where they may lead to resistance heading out into time. Another possibility is that this morning's rally was a blow-off top before a reversal, similar to what we saw on the PnF buy signals in November and December.

Chart of the Dow

The sticking point from the short side is simply the fact that we are still climbing higher, have not rolled over and even if the rally cannot seem to catch any sustained momentum from this level, it has not rolled over and shown weakness. In fact each pullback has found buyers, establishing a series of higher highs and higher lows. This morning's sell-off after the big rally found a higher level of support than recent pullbacks and the rally took us to a mew relative intraday high. The close below 8800 in the Dow is significant in that it means we once again failed to hold a rally above that resistance mark, lending credence to the possibility of a right shoulder.

One of the catalysts for today's rally was OPEC, which met over the weekend to cement an increase in oil production. The group raised its quota by 6.5%, or 1.5 million barrels a day, in an attempt to offset shortages and higher prices resulting from the Venezuelan strike. Venezuela has gone from producing about 3 million barrels per day to about 500,000. The quota increase will not take place until February, which means a lag in the replenishment of diminishing reserves, but the price of Crude Oil Futures still took an immediate drop, falling to just over $31 per barrel, then bouncing to close near unchanged on the day.

AOL Time Warner (AOL) also got a boost to start the day, as Steve Case stepped down as chairman. AOL founder Case led the disastrous merger which brought along with it many additional "surprises" about past accounting at AOL and saw shares drop 70% since the companies joined. Case said his presence at the annual meeting would have been a distraction and made the move that has been the subject of speculation for months. There is now talk that the company may spin off the AOL unit. That would be a pretty strong statement that they would like a do-over and an admission that one of the business world's biggest mergers was an abject failure.

Dell was downgraded by J.P. Morgan, which cited risks to the PC market heading into a traditionally slow season. Morgan said to expect more aggressive pricing and lower margins and also mentioned the stock's current placement in the upper end of its trading range. The stock had once again been approaching resistance near $30, which was the high end of its range for the year, before the end of last week when rumors began circulating that the company would issue a secondary offering. The stock began to sell-off last Thursday after hitting an intraday high of $29 and traded as low as $25.43 before rebounding to finish the day at $25.98. DELL also broke decisively below its 200-dma of $26.61, which had served as support throughout the December market swoon. The downgrade spilled over to the chip stocks, with the Semiconductor Index losing six points and heading back down to support above 330. The SOX closed at 333 and we should get a better idea whether the groups will be re-testing resistance in the 365 area, or breaking down below 330 and testing support at 300, when Intel releases earnings Tuesday after the bell.

The Nasdaq Composite also gave up some ground after moving through its 200-dma. The last couple attempts at that barrier have either failed the same day or held only briefly, resulting in massive sell-offs after the failure. So far we've held above that level, but bulls beware if we break down below it.

Chart of the NASDAQ Composite

The market close with the Dow up only a point, OEX up only 0.42 and the SPX and COMP both in the red, actually looks bearish. We once again got a close beneath 8800 in the Dow after what may turn out to be a blow-off reversal top. That being said, we still got those PnF buy signals and no collapse on the intraday sell-off. We are seeing some very conflicting signals right now and keeping an eye on history is probably the best approach to managing risk. Traders who are looking for an upside breakout may be forced to wait for a re-test of the August/December highs, while those looking for a breakdown should look for a re-test of last week's lows.

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