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Market Wrap

Diplomacy is Dead

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03-17-2003                   High    Low     Volume Advance/Decl
DJIA     8141.92 +  282.21  8145.84 7779.73   2003 mln  1852/143
NASDAQ   1392.27 +  51.94  1392.41  1326.28   1834 mln  1665/151
S&P 100   438.64 +  14.57   438.64  420.12    totals    3517/294
S&P 500   862.79 +  29.52   862.79  827.17
RUS 2000  365.40 +  11.01   365.40  352.38
DJ TRANS 2094.06 +  66.97   2096.84 2008.03
VIX        36.46 +   0.13    37.75   36.39
VIXN       46.67 +   0.87    48.65   46.63
Put/Call Ratio 0.70

Diplomacy is Dead
By Steve Price

Finally a decision. That's what the markets seemed to be saying today as the U.S., Great Britain and Spain announced they would bypass a vote on a new U.N. resolution and deal with disarming Iraq themselves. The announcement came from those countries' ambassadors this morning, which cited France's stated intention to veto as the reason for not calling a vote. Just asking, did France give the U.S. exactly what it needed - a reason not to count votes and a reason not to blame Russia? President Bush will be addressing the nation tonight and according to Colin Powell, will be issuing a final ultimatum to Saddam Hussein. The U.S. has already suggested that UN weapons inspectors leave the country and that the time for inspections is over. Short of Saddam lining up his mobile weapons factories and handing them over to the U.S., it seems unlikely that the current situation will end in anything but an invasion. The U.N. is pulling its personnel out of Iraq and the Israeli army has instructed its citizens to attain the insulation and other materials they may need for sealed spaces in advance of a possible attack by Iraq. We also got news late in the day that Turkey would now allow U.S. troops. Apparently they decided to take the money that was offered since there was going to be an invasion either way. The trick for traders is deciding just how the markets will react.

There has been talk of a possible war rally, as an invasion would finally start the clock ticking toward an end to the uncertainty surrounding war. The futures certainly did not indicate that would be the case overnight. They started out down severely, following similar action in Europe, after last night's announcement that the U.S. was giving the UN until today to get on board. However, once the UN Ambassadors stepped to the mike and said there would be no vote due to France's stated intention to veto, the markets caught fire, reversing from morning lows and rallying strongly. The Dow saw a turnaround of 300+ points intraday following the announcement. Think we're just a little sensitive to each war-related announcement? Overall the market seems to be pricing in a short war. It just took someone to roll the dice and start the game to get the clock ticking.

The theory on the recent weakness in the stock market has been traced back to spending by businesses and their reluctance to make any plans ahead of a possible war. Even Alan Greenspan said it was difficult to tell just what type of economy we were looking at until after geo-political concerns had worked themselves out. Businesses are supposedly holding off on spending and hiring until after there is some resolution, either through war or otherwise. The high cost of fuel has not helped either. However, with the start of war apparently imminent, since Saddam Hussein's only response so far has been to threaten worldwide terrorism, we should think about what we are seeing in the economy, since that's all that we will be left with after the invasion.

Granted, all of the negativity can be traced back to a reluctance to spend and bulls are hoping for a quick loosening of the purse strings after the uncertainty ends. However, I would be hesitant to assume that all of our economic problems are based on fuel costs or war hesitations. The economy was already starting to crack, heading into recession last year, before things in Iraq started to heat up. The drop in technology spending fueled a stock sell-off that experienced some bounces along the way, but in reality was largely dependent on disappointing earnings and low future outlooks given by both techs and traditional companies. The world economy continues to suffer along with the U.S. and it will take more than the completion of a war in Iraq to turn things around. Will a drop in fuel costs after a war help things? Most definitely. But will it help things to the point of a complete economic turnaround? That seems less likely.

I can certainly point out numerous reasons to short the current rally. The most apparent is the fact that once we have the war behind us, we will be faced with the same negativity that ended the January rally. Specifically, the 2003 outlooks by companies such as IBM and Microsoft that included the possibility of geo- political problems eventually ending and still saw a disappointing year. Once the beginning of the year fund contributions were out of the way, that's exactly what we got - bottom line earnings reports and disappointing future guidance.

However, any casual market observer will note the massive reversal we have seen over the past few days and certainly can argue that we have seen a reversal in trend off the bottom. We achieved head and shoulders bearish objectives in the Dow, SPX and OEX and have been moving higher ever since. Bears that have mad an attempt at shorting the rallies have had no success and although we can point out plenty of reasons to go short, so far we have not seen signs of weakness. Trade what you see, right? It is certainly hard to do in the current environment and we are steaming ahead right into serious resistance levels. The Dow has now bounced almost 700 points in less than a week. That certainly seems unsustainable and we are likely due for a pullback at some point. But if this constitutes a trend reversal, then should we be looking to buy the pullback? In an uncertain economic environment, there are undoubtedly plenty of bears looking to short any sign of weakness and today's stall as we got into a previous level of resistance from late January and late February would seems to indicate we have run into a significant barrier. Especially considering the rally came on a news event. Unfortunately, we really don't know how much of the recent decline came on geo-political concerns and how much was based on the poor outlooks from individual companies. Therefore, it is difficult to predict just how far we may bounce when the pressure of uncertainty is released.

For those traders who are looking for a similar recent pattern in the charts, look no further back than October. At that time, the bullish percents were similarly extended to the downside. The Dow bullish percent was down at 8%, similar to the current reading of 10% heading into today's trading. This reflects the percentage of stocks in the index giving point and figure buy signals. The big rally, with today's extension certainly looks like a similar pop. In October, we gained 15% in the first four days of the reversal off the bottom, which is certainly greater than the 9% gain over the past four sessions, but nevertheless was a significant pop and signaled a coming reversal. While we did get a pullback, it was only for a day, before we headed significantly higher, eventually reaching a top of Dow 8800 before a more significant pullback. Today's rally took out significant resistance at Dow 8000, but eventually stopped dead at the 8150-8160 level that capped the January bounces repeatedly after the Dow broke its head and shoulders neckline earlier that month. The high on the day was 8145, but of course that was after a rally of 284 points, so we must take that failure in context.

Daily Chart of the Dow

We also broke the 50 day moving average in the broader indices. Rallies in the Dow, OEX and SPX all failed at that level this morning, but cruised past those numbers in the afternoon. The Dow 50-dma of 8097; the SPX 50-dma of 857.76; and the OEX 50-dma of 434.57 all fell in afternoon trading.

The point and figure charts show a reversal that has been strong enough to create buy signals in the Dow, OEX and SPX. The signal in the SPX amounts to a triple-top buy signal at 855, which is a very bullish indication. The triple-top also carries with it the possibility of a bull trap, which is a sudden reversal down and would require a trade of 860 to break. We got that trade of 860, when we topped out at 862.68. Unfortunately for bulls, the bearish resistance lines in those averages also lie just above at 870 in SPX (which coincides with resistance from the end of January in the 865-868 range), 8300 in the Dow (which was previously strong horizontal support before the January breakdown, and 442.50 in the OEX (which coincides with strong resistance at 440 from January).

Point and Figure Chart of the SPX

The COMP, following a 50 point rally to 1392.25, is also approaching its next level of resistance at 1400, powered partially by the chip stocks. The SOX gained 5.6% to close at 322.25 and has crossed its 200-dma to the upside for the first time since May 2002. The next level of resistance in the SOX is likely to be 230, where there is heavy horizontal resistance.

The dollar jumped through recent resistance and bonds sold off decisively, lending credence to the idea that now that we have some certainty, the bears are getting out of the way and money is coming back into stocks.

One of the factors behind today's rally that was also connected to the war news was a drop in the price of oil futures. While I mentioned above that a decrease in fuel costs might not lead to a complete economic turnaround, it certainly will give the economy some boost by reducing the operating costs of almost all companies, whether they are involved in manufacturing or simply pay shipping costs for their products. Crude Oil Futures dropped another 0.50 per barrel on news that the U.S. may tap its strategic petroleum reserves. While that possibility was not a new one, talk heated up about the possibility in the wake of today's developments. The fact that we have seen oil futures drop over the past few sessions continues the inverse relationship between fuel prices and the stock market. I began highlighting the longer term charts going back to last summer that charted the general trends between the two and so far, little has changed in that relationship. Of course, much of it is due to the fact that both reflect geo-political developments in opposite ways, but the action of the past few days is particularly interesting, since they have been reacting opposite to their traditional behaviors as war becomes more certain, but still maintain to inverse relationship to each other.

Chart of Crude Oil Futures and the Dow

Does it seem that all I want to talk about is war? Maybe it's because that was the driving force behind today's action. However, there were some developments that are worth noting and could draw some attention after the impact of today's events on the markets begins to fade. J.P. Morgan cut its estimates well below previous estimates for auto stocks and their suppliers. It said preliminary feedback regarding March sales and a slowing momentum of industry incentive spending led it to predict light vehicle sales would fall to 15 million or lower in March and 14.5 million or lower in April. It said it expects the drops to lead to production cuts that are more dramatic than those that have already been announced.

Oracle releases results on Tuesday after the bell. This morning we got cautious statements from Pacific Growth, which echoed statements from Lehman on March 5. Lehman cited concerns that ORCL's license revenues could be weak. PG cited similar concerns and said the company should match estimates due to currency and cost cuts, but that revenues and licenses should be lower than forecasts. A disappointing report from Oracle could certainly erase much of the gains from the past few days, but if the auto news didn't put an anchor on the rally then it is likely even results from Oracle will take a back seat to global developments.

We also got some indications on retail sales that were mixed. Wal-Mart and Federated both affirmed earlier predictions for March same store sales. Wal-Mart is expecting an increase in the low single digits, while Federated is expecting a drop of 3-4%. J.C. Penney, on the other hand, said its department stores might miss forecasts for little change or a slight decline.

One of the more curious developments today was the rise in the Market Volatility Index (VIX). The VIX, which reflects implied volatility levels of options in the OEX, generally rises on rallies and falls on market drops. Part of this is due to the fact that markets generally drop faster than they rise and the other reason is that covered writing (the purchase of stock and sale of out of the money calls) creates selling pressure on the way up. The VIX is usually moved by institutional order flow, since the OEX is a heavily traded product and small retail orders don't usually make much of a dent. Rather than drop on today's big rally, the VIX actually rose, diverging from its usual pattern and suggesting institutions may not believe we are out of the woods just yet.

Now we are left to decide where we are headed next. If we follow October's pattern, we could be headed much higher. However, what more can the President say tonight that would make war any more imminent than it seemingly became this morning, or any shorter than analysts are already expecting? Shouldn't the short-covering be over by now? Won't oil spike up initially? Isn't the risk to oil prices greater that Saddam sets the field on fire than that he doesn't? Certainly it is difficult to step in front of a speeding train and even those bears who would like to enter in front of that resistance at Dow 8150 should do so with only small positions. Overnight futures trading should give us an idea of the initial reaction to the President's speech. A move through Dow 8170 could certainly indicate a continued run and if we do break that level, I would suggest shorts step to the side and wait for a test of bearish resistance at SPX 870. If we make it above SPX 870 (actually a break of bearish resistance comes at 875), look out above. For now, we need to respect the extreme uncertainty surrounding the current environment and make sure our bets reflect that uncertainty. I'd like to tell readers just how we will react to the President's speech, which I can't; but if the action of the last few days is any indication, then we have seen a major trend reversal. However, I would feel more comfortable coming to that conclusion if our jittery markets weren't making unpredictable moves each time we get new information on the global front.

Steve Price


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