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Market Wrap

Not So Calm Before the Storm

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03-19-2003                   High    Low     Volume Advance/Decl
DJIA     8265.45 + 71.22  8277.64  8141.50   1706 mln  1086/585
NASDAQ   1397.07 -  3.48   1401.24 1378.57   1679 mln  712/924
S&P 100   444.84 +  4.46    445.48  437.72   totals   1798/1509
S&P 500   874.02 +  7.57    874.99  861.21
RUS 2000  368.51 +  0.51    368.56  365.10
DJ TRANS 2149.15 +  20.13   2151.01 2121.02
VIX        36.18 +  0.40     36.39   34.87
VIXN       48.20 +  0.18     49.51   47.62
Put/Call Ratio 0.74

Not So Calm Before the Storm
By Steve Price

With just hours to go before the deadline set by the U.S. for Saddam Hussein to leave Iraq, or face military action, the markets showed plenty of indecision early on. The techs found sellers following Oracle's cautious guidance, while the Dow headed higher, building on gains of the previous five sessions. However, it wasn't long before war jitters took some shine off the recent gains and bulls took some profits.

There have been may theories offered for the recent rise in the markets. I've heard that shorts began covering last week at the conclusion of head and shoulders objectives and then institutional money flowed in this week when war became imminent. I've heard there was selling into the rallies overseas in case a war does not go as quickly as some are predicting. I've heard plenty of explanations, but it is interesting that with all the reasons offered for movement, the recent movement continues to find pivotal technical levels as support and resistance.

Granted, his morning's rally was fighting an uphill battle after disappointing guidance accompanying Oracle's earnings release on Tuesday night, but we did head into the green, stopping only at levels that have continued to play a big part in the movement over the past several months. We can conclude that the Dow, OEX and SPX did form classic bearish head and shoulders formations from October through January, resulting in a breakdown that fulfilled their objectives last week. Our big bounce came when the OEX and SPX hit their bearish objectives almost to the point. Now that we have bounced much higher, we have run right into bearish resistance on the point and figure charts. Those charts show bearish resistance in the Dow at 8300, SPX at 870 and OEX at 442.50 (on the 2.5 point box), while the OEX traditional chart registers that resistance at 448. Today's highs came in at Dow 8277, SPX 874.99 and OEX 445.48. We broke above that resistance on a closing basis in the SPX and OEX and fully through it in the OEX on the 2.5 point chart, although we are right up against it on the traditional chart. The SPX top at 874.99 came within 0.01 of a breakthrough. The next box level is required for a complete breakthrough, as can be seen on the chart below.

Daily Chart of the Dow

Point and Figure Chart of the SPX

The Nasdaq struggled to hold the achievement of the 1400 level it made on Tuesday pretty much from the open. After Oracle said demand had softened near the end of the third quarter (fiscal) due to anxiety over a war in Iraq, calling it a "wild card" for customer demand, the reminder that the economy is still in neutral weighed across most of the techs sectors. What was also a concern was that some of the profits that the company posted were due to some outside issues, such as unusual cost of service savings and currency translation to U.S. dollars and even the estimate beat for the past quarter suddenly looks less convincing. In the afternoon rally that took the Dow, SPX and OEX all to new highs, the COMP was still unable to hold its late day test of 1400, eventually falling to 1397 on the close.

Chart of the COMP

In the area of conundrum, we got some results from Bear Stearns that further muddy the equity waters. Financial stocks are a good place to start any rally - or any market drop. BCS actually seems to have found the best of both worlds. It released earnings that beat expectations, citing record profits from its bond trading operations. Those operations turned into a big winner as investors fled the stock market and shifted back into fixed income instruments. So if financial stocks are turning profits on a market decline, will they lead us higher? Keep n eye on the BKX, BIX and XBD as we get earnings tomorrow morning from Goldman Sachs, Lehman and Morgan Stanley. Those indices have all bounced over the past week along with the broader markets, but are within points of their 50-dmas, which coincide with resistance from early and mid-February.

Speaking of bonds, it appears that much of last week's rally was fueled by asset allocations between treasuries and stocks. Watching yields, which are a good indicator for where stocks are headed as they trade inversely to bonds (as bond prices rise, the yields from the purchase of those bonds drops and vice versa), also gave us a good indication of a possible market bottom last week. In fact, while the equities were testing July lows, and the bond market was rallying with the cash flow out of equities and into treasuries, yields had already dropped below July levels. The yields also took out their December and November lows and headed toward October levels. It was when the yield hit the October low that the broad markets all bounced. A look at the weekly chart of the ten-year note index shows big reversal off that level. Now that we are on the upside, we are also seeing some key levels tested by the yield. The five and ten year yields both broke above their 50-dmas on Tuesday and then gapped higher to start the day on Wednesday. The early indications from those 50-dma breaks are bullish. However, we are also entering some heavy resistance on both yield charts that could be tough to break. That could indicate a reallocation back in the other direction and should put bulls on alert.

Chart of the Ten Year Yield

One of the other indicators that I often use is the Market Volatility Index (VIX). The VIX has been a reliable indicator of market bounces and pullbacks at its extremes. Readings of 40% have indicated it is time for an equity bounce and readings of 34-35% have indicated it is time for a market pullback. The last decisive breakthrough of these levels came in January, when the VIX was finding resistance at 35%, rather than support and eventually took out that resistance on the head and shoulders neckline break between Dow 8200 and 8300, depending on how you draw the neckline (I have it at 8220). We have now rallied all the way back into that territory and once again the VIX is testing 35%. If we do manage to breakthrough the recent bottom, it will likely coincide with a move back above Dow 8300. The first close below 8300 was the domino that signaled a trip much lower and a close back above it may signal a true reversal higher. However, note that a trade of 8350 will be required to break through the bearish resistance line noted above on the point and figure chart. What is interesting here is the divergence in the VIX from the action in the equities. Although we saw a VIX decline early in the day, it was higher once again by the close, in spite of late day gains in the equities. Usually we see the opposite and it was the second time this week we've seen this divergence. Obviously, there are plenty of institutions holding up premium levels in the OEX that are still concerned about the downside possibilities that a messy war could bring, or the possibility that the rally is not for real. While the VIX is at the low end of the recent range, it is still historically high and if the big boys really thought we were headed higher, I would expect them to take advantage of the high levels of premium by shorting them.

Chart of the VIX

The crude oil futures, which have also been a reliable indicator of equity action, with a consistent inverse relationship, continued to drop further again today. Certainly if the oil fields in Iraq began flaming, we could see a reversal in that market, where the per barrel price has fallen 21% since March 12. I heard an analyst yesterday commenting that a drop in the price of oil from $31 per barrel to $24 could amount to a 1% increase in GDP from the fuel cost savings to Americans and U.S. businesses. That would seem to support the consistency we have seen in the inverse relationship between the equities and oil prices.

Let's see, what have I left out? Oh, yes, the bullish percents. The bullish percents - the number of stocks giving point and figure buy signals in a particular index - have all been in free fall mode since the middle of January. That is until the past couple of days. Each prior rebound attempt was not quite enough to turn these indicators higher and they remained in oversold territory in the Dow, SPX and OEX, with the NDX just making it to the oversold line at 30%. In the past couple of sessions we have finally seen a rebound that was strong enough to reverse some of the indicators. The Dow bounced from a reading of 10% all the way up to a reading of 20%. The NDX bounced from 30% to 44% and the SPX which tends to lag because of the amount of stocks in the index, has now bounced from 28% to 34%. Those bounces should be a warning sign to bears and may indicate the beginning of a move higher, rather than an exhaustion of a bear market rally. While I am not ready to declare the bear market over, since these also reversed up on other bear market rallies, I am conscious of the fact that this bear market rally may still have some legs left in it. The rebounds from July and October took these percents up to 60% and 72% in the Dow; 50% and 82% in the NDX; and 58% and 68% in the SPX. So there is plenty of upside to this indicator if we are able to continue the breakout. Once all of these reached oversold territory, the risks began to shift out of the bears favor and now that they are on their way up, they are no where close to overbought at 70%.

Bullish Percent of the Dow

So we now have a number of technical indicators all converging at the current levels. The VIX, the bond market, the bearish resistance lines, the head and shoulders breakdown levels - all testing just how much strength the bulls have left after a gain of almost 900 Dow points in 6 sessions. Combine that with the possible start of a war in the next day or two and it appears that the spring is wound awfully tight right now. We saw bulls in charge in the major indices, but the techs unable to overcome the Oracle news. If the U.S. launches an attack tonight after the 8 p.m. deadline passes we should have a clearer picture of just whether the pre-war rally will stick. So far, it appears we will get a quick war - that is if today's unsolicited surrender of 17 Iraqi soldiers is any indication. There were also reports that the U.S. had already conducted air strikes on Iraq artillery that boosted the market late in the day. If the rally does stick, then traders who have been on the sidelines may want to go long if we complete those bearish resistance breakthroughs and a move above resistance in the yields I highlighted above. If we fade, then a higher level of support that doesn't reverse the bullish percents back down may also be a long entry point. However, defining a pullback will be tough and we have to remember that we have yet to see an economic recovery. After six straight up days in the Dow there is bound to be a pullback at some point, but wait for that pullback to show some support before jumping in long. If the rally isn't for real, traders may find themselves picking one bottom after another, all the way back to last week's levels Trade what you see, and keep your risk level comfortable.

Steve Price


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