Option Investor
Market Wrap

Shock and Awe

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        WE 3-21         WE 3-14        WE 03-07        WE 02-28 
DOW     8521.62 +661.91 7859.71 +119.68 7740.03 -151.05 -127.03  
Nasdaq  1421.17 + 80.84 1340.33 + 35.04 1305.29 - 32.25 - 11.48 
S&P-100  456.37 + 32.30  424.07 +  3.95  420.12 -  5.24 -  4.51 
S&P-500  895.89 + 62.62  833.27 +  4.38  828.89 - 12.26 -  7.02 
W5000   8463.32 +566.83 7896.49 + 39.17 7857.32 -115.30 - 63.35 
RUT      376.23 + 21.84  354.39 +   .21  354.18 -  6.34 -  3.84 
TRAN    2263.49 +236.40 2027.09 - 15.39 2042.48 -  6.57 - 47.36 
VIX       33.62 -  2.71   36.33 +  0.68   35.65 +  1.50 +  0.01 
VXN       45.78 -  0.02   45.80 -  0.59   46.39 +  0.74 -  0.45 
TRIN       0.59            1.11            1.29            0.84   
Put/Call   0.63            0.70            0.75            0.59   


Shock and Awe
By Jim Brown

Yes, I am shocked and awed but by the moves in the market not the bombs in Iraq. Without showing extreme vertical spurts of buying and even with intraday drops and periods of inactivity the Dow has managed to produce more shock than the war in Iraq. Numerous record book entries were created and support and resistance points rewritten.

Economic reports on Friday were bland with the CPI rising slightly due mostly to high oil prices. Real inflation remains tame despite gas prices being up +43% over last year. That high priced energy component is about to change with the June contract for oil dropping to $26 a barrel and well below the $39.99 price paid a month ago. This should add +1.25% to the GDP for the 2Q. This is the removal of the -1.25% impact that will be felt in the 1Q GDP when finalized. The lowered energy prices are very bullish for the stock market as lower costs are passed through in manufactured items. It is good for the market because the consumer feels better paying less for gas and will be spending that money on other things to benefit the economy.

The Weekly Leading Indicators fell slightly on the basis of jobless claims, a falling money supply and selling in bonds. The leading indicators and the economy appear to be in a wait and see mode as the war progresses.

Mutual Funds saw the first inflow of funds in eight weeks as the war appeared to be going well and the prospect of a new bull market looms. The +$900 million of inflows for the week ended Thursday was but a trickle compared to the -$4.9 billion that flowed out the week before. Remember the 90% downside volume day last week? Evidently that was a capitulation day and the flood of money out of funds was the evidence of capitulation by many investors.

What a week! I am still spinning in disbelief. The Dow turned in its best week since 1982, a 21 year record. It is now positive for the year and has gained over +1100 points since the low for last week at 7400. Yes, +1100 points in eight days. This is the biggest gain since Dec-1998. It is an amazing feat, especially when you consider the major resistance levels that were passed with barely a pause. 7900, 8050, 8150 and 8350 are just blips on a chart now but they were major battle lines in the past. The Dow is above all averages now except the 200 day EMA. This average has stopped the last two major rallies in their tracks but I am not sure anything can stop this train.

Dow Chart - Daily

The Nasdaq performed admirably but significantly less convincingly than the Dow. The Nasdaq closed over 1400 but only managed +19 points compared to the +235 for the Dow. Problems for the Nasdaq included CSCO, which was weak on the rumor that JNPR would warn next week. The same 200 EMA that stopped the Dow and the Nasdaq in the past was 1416 at Friday's close with the Nasdaq at 1421. This technical break was encouraging for the bulls but there was little real difference.

Nasdaq Chart - Daily

The S&P, a broader indicator of market strength than the Dow, has not reached the same levels of bullishness as the Dow or the Nasdaq. The S&P is below the 200 EMA at 912 and horizontal resistance at 950 and down trend resistance at 900 and 923. I am not claiming that any of these levels will stop the advance but the picture for the S&P is clearly more challenging than that for the Dow.

For an even broader look at the markets we can look at the Wilshire 5000. This broader look takes out the confusion of the Dow 30 where one or two major stocks can influence the entire average and indirectly the market reaction to the the Dow gains. We can't ignore the Dow but for real market breath the Wilshire is a better indicator. Notice on the chart below the confluence of resistance at 8675 and the 200 EMA at 8613. This will be a serious problem for the broader market to overcome.

Wilshire-5000 Chart - Daily

I definitely do not want to claim a sell off is imminent. I have been expecting it for several days based on the unsupported spike and terrible economic conditions but obviously the market has a mind of its own. The war and the perception of the war is controlling our destiny. We have rallied on hopes that the war was going to be delayed, on hopes it would be sooner, on expectations that it would be quick and we even rallied on statements from Bush that it would be longer and more difficult than previously thought. We have alternately rallied on bombs falling and sold off on bombs falling. We rallied when Saddam was killed and rallied again when it appeared he wasn't.

The bottom line is we rallied. Good news or bad news from the war, good news and bad news from the economy. We rallied because everybody thought we should rally. Traders had been condition to expect a war rally just like they were conditioned to sell on uncertainty before the war. Nearly $5 billion in cash left equity funds last week on fear of the war. The Dow has rallied +15% from last weeks low when that cash was flowing out of the market.

Is this rational buying? Not in any market I have ever seen. We have these big spikes but they very seldom stick. They are reactions to extremes in the market. We were extremely oversold last week. We are extremely overbought this week. There has to be an equalization of pressures where reality comes back into the market. Maybe Monday, maybe next week, maybe in a couple weeks but it will eventually correct.

Remember this was a quadruple option expiration Friday in a month/quarter where there were extreme market moves. Art Cashin said on Friday night that the type of orders appeared to be option related not buying from Ma and Pa Investor. Volume across all markets was 4.3 billion shares and very strong but only 2:1 advancers to decliners. The 2.1 billion on the NYSE came in two buying spurts with 500 million in the first 45 min and another 500 million in the last 90 min. The rest of the day was quiet and trending lower except for a 45 min buy program at 11:50 that triggered some short covering.

I went back and looked at some similar rebound streaks over the last couple years. There were more than I expected but all had the same result. They streaked into the stratosphere only to pause and retrace much of their gains before moving up again. The biggest problems with streaks like this is not the massive individual streak itself but the dozens of less spectacular rebounds that only lasted 3, 4 or even five days before rolling over. Those dozens of bounce and roll rebounds are quickly forgotten as traders chase stock prices to either catch the speeding train to add to long positions or by shorts just waiting for it to slow so they can jump off. Those who remember the 3-4 day bounces have been waiting patiently for the retracement for a week to no avail.

Combo Chart - Dow

What should investors do? Investors are faced with a tough choice. Wait for a pull back that may never come or jump on the speeding train. There are plenty of reasons to buy including the potential for the war to be over next week. The massive 20,000 vehicle US advance is moving at high speed toward Baghdad but when they get there the war could be over. With the surrender of the 51st Iraqi division on Friday the incentive for other commanders to follow suit is growing. With massive destruction of everything related to Saddam in Baghdad it will quickly be obvious that clinging to past hopes is a losing battle. IF the war is over next week the market could add another 1000 points on happy thoughts alone. This would be especially true if the troops were greeted in Baghdad as liberators as they have been in the towns already passed. This continued rally would be emotional only and could push the indexes to even more unsupported heights.

Should the war turn into a street fight where high tech cruise missiles and laser guided bombs are useless then the TV sound bites could turn into Mogadishu type pictures of US wounded and dead civilians. The administrations hopes are built on the war being over before the street fight begins. They are almost begging everyone to surrender to prevent having to fight in Baghdad. A street fight could turn this rally into a rout very quickly.

As traders we need to remain focused and trade what we see. I have not been successful in that recently. My remembrance of the dozens of bounce and rolls is much more vivid than the half dozen 7-8 day spikes over the last several years. I know many traders are not saddled with this affliction and I am envious. I have bought so many breakouts over the years that turned out to be tops that I have an instinctive fear of unsupported rallies.

I understand that markets sometimes make major moves on nothing and that appears what is underway now. The earnings picture is terrible with almost every guidance announcement negative. Traders have decided momentum is more important than fundamentals and until that momentum fades the earnings and the economy will be a footnote. On the positive side a quick war with minimum casualties will do wonders for consumer sentiment. Once families of servicemen hear the fighting has stopped and they are no longer in immediate danger several million relatives will rejoice. With nearly 500,000 military personnel in theater counting the shipboard crews that will be one big sigh of relief.

If the collective sigh of relief carries over to consumers and the wallets are opened then a recovery can begin. This does not mean it will be instant. The summer months are normally a drag on the economy and the market. Offsetting this drag could be the successful passage of the $700 billion stimulus package. The house passed it on Friday but the Senate has put off the vote until next Wednesday. There could also be a rush of government spending to replace equipment used in the war and buy new equipment with enhancements from lessons learned in the war.

Still we are faced with a tough decision. Do we jump on the speeding train knowing there is a bridge out up ahead just not how far ahead? Or do we wait for the pull back and for fundamentals to catch up with the market. It is a tough call. If the current rebound continues like the October rebound then it could be a month or more before weakness appears. If it is like the July rebound then weakness could hit next week. If you are an agile trader then jumping on the train is not risky as long as you keep your eye on the exit. It is the market timing thing that becomes risky. Is this the drop or a pause? Is this the next wave up or just a spike. Get in, out, in, out, etc.

With any positive news over the weekend the rally should continue as any remaining shorts bite the bullet and exit. Investors who took $5 billion out of the market last week may also decide to put it back in +15% higher. Investors on the sidelines may read the paper this weekend and see a 21 year record for the Dow and start looking for the mattress money to put back in the market. In short until the fog of war clears and the heightened uncertainty of market direction fades we are likely to see continued unexpected moves.

Next week we should see an increase in earnings warnings but they will likely be overshadowed by events in Iraq. They are important and whether the market pays attention next week or not they will come back to haunt us in April.

With the quadruple expiration Friday behind us we will have one more day of nervous trading as exercised options are settled on Monday. Another factor will begin to take control soon and that is end of quarter window dressing. Especially after the big rally equity funds will be hard pressed to go into the quarter end with cash on the books. With investors getting statements after such a big market event they will be looking for signs that their fund owns the winners. Ironically, those, which are currently heavy in cash will be trying to doctor those statements to show they participated in the rebound even if it means buying at the current inflated prices.

Next week should be a key week for the markets. If they can retain the momentum through the end of March then we could see some significant gains from train chasers. If this momentum fades next week then we could see three weeks of consolidation until April earnings give us our next direction. Either way next week should not be dull. Just don't let your bias get in your way.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
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