Option Investor
Market Wrap


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      06-04-2003           High     Low     Volume Advance/Decline
DJIA     9038.98 +116.03  9057.40  8909.01 2.05 bln   2561/ 771
NASDAQ   1634.65 + 31.09  1638.57  1603.17 2.50 bln   2230/1009
S&P 100   465.20 +  1.62   465.58   461.07   Totals   4791/1780
S&P 500   986.24 + 14.68   987.85   970.72 
RUS 2000  451.23 +  7.36   451.58   443.87 
DJ TRANS 2556.40 + 44.37  2557.47  2503.53 
VIX        22.48 +  0.03    23.80    22.37 
VXN        33.01 -  0.50    34.63    32.70 
TRIN       0.53
PUT/CALL   0.76

By Jonathan Levinson
Click here to email Jonathan

The GDP revision seemed to sober the markets, and then the ISM report kickstarted the party again, blasting past resistance and then holding for the afternoon, at the end of which a fresh push took the indices to new year highs on very strong volume.

Daily Chart of the INDU

The speed and ferocity of the buying had a blowoff feel to it, as the Bollinger band violation indicates, but there was simply nothing bearish about today's session, with the indices closing near their session highs and printing a bullish hammers on the candlecharts.

Daily Chart of the COMPX

All of the longer-period oscillators I follow are on buy signals from lofty levels. Just as bulls got shredded to pieces trying to pick the bottom last July, bears have been unsuccessfully trying to nail the top for weeks. If this lesson has any lessons, and there are many, it would be that "the trend is your friend" and to trade what you see.

The 1st quarter GDP revision was released at 8:30, showing an increase in overall productivity of 1.9% instead of the 1.6% originally reported. Buried below the headline number was the Factory Productivity number, which was revised down to a 1.9% gain from the 2.1% first reported, which was below analyst expectations of a 2% gain. Labour costs grew by 2.6% instead of the 2.7% first reported. The futures went from slightly positive to slightly negative following the revision, and the yield curve steepened. I'd guess that bulls expected either a better revision number or felt that the mediocre corporate results for Q1 on the heels of a better GDP number bodes ill for Q2, as the pace of layoffs has remained high. This data was soon forgotten as the ISM number was released.

The Institute for Supply Management's non-manufacturing survey was released at 10AM, indicating that the U.S. service-sector expanded in May. The index rose to 54.5 in May from 50.7 in April, exceeding expecations for 52. Readings above 50 indicate economic expansion. The market liked it.

In between the two reports, the Mortgage index was released, setting new record highs for the week ended May 30, with the Market Index (demand for home loans) +13.6%, the Purchase Index +16.4%, and the Refi Index +12.9%. We're watching the spike in mortgage activity and home prices caused by the collapse in treasury yields, with the thirty year at its lowest levels since the Mortgage Bankers Association of America began its weekly survey in 1990, rates at their lowest levels since 1958, and the resulting surge in liquidity it is causing. This is bad news for bears, in that the rally on "bad news" has seen a surge in buying across all asset classes, from equities to treasuries to commodities. With new debt being an important source of liquidity for the financial markets, we see mortgage activity increasing even as treasuries and equities near important relative highs at the current stage of their respective rallies. The blowout numbers reported this morning by the MBA portends higher prices to come, if the theory is correct.

I discussed this when the data was released this morning in the Market Monitor, and a reader replied: "Remember the S&L crisis in the 80's. Congress relaxed restrictions on the industry the floodgates opened and economy improved. When the loans collapsed the economy slowed. When you build economic improvements on borrowed money you had better hope earnings will appear to service the debt. If they don't the consequences of an overleveraged economy are dramatic. The fed's action thus far is very speculative. If it doesn't work we will be paying for this for years."

Indeed, the fed has been noteworthy during the past months in its overt concerns about the prospect of "dis-inflation". Bernanke's comments about printing money showed complete disregard for the threat of inflation, mentioned by Jim in his Market Wrap last night. I believe that the current rallies in different asset classes are the result of the fed's intensive inflation of money supply in an effort to spur productivity. The long term risks of such policy decisions are beyond the scope of this discussion, but it should give us option investors an inkling of the magnitude of the forces at work in the current rally. As timing is everything for leveraged investors, we must be patient and follow, not fight, the prevailing market trend. It appears inevitable that money will have to begin to appreciate in value at some point, but that point shows little evidence of appearing just yet:

Weekly chart of the Ten Year Treasury Yield

The ten year yield closed at 3.291% today.

The Energy Department reported rises in gasoline, crude oil and distillate inventories for the week ended May 30. This data helped lower prices across the related commodities, despite the fact that inventories of the various petroleum products are down significantly against their comparable years from this time last year.

In corporate news, the New York Post reported that C is expected to lay off up to 50 investment bankers and MWD up to 1000. The Post said that the cuts will be spread across a broad array of industry groups and will be mainly senior level bankers and directors. Citigroup said, "We continue a process of targeted reductions throughout our organization that reflects current market realities and an ongoing review of our businesses," while Morgan Stanley refused to comment. Despite this, the Amex Broker Dealers Index, the XBD, was up strongly through the session, and a number of its component stocks posted new 52 week highs.

AOL shares were higher today as well, despite a report in the Washington Post report to the effect that it has lost more than 1 million of its dial-up subscribers to low-cost competitors.

Without going into more detail than necessary, Martha Stewart and broker Peter Bacanovic were indicted in the ImClone scandal on securities violations, conspiracy and obstruction charges. The coverage was extensive all day, verging on saturation. Stewart and Bacanovic pleaded "not guilty" to the charges.

Today was another shock and awe session for bulls and bears alike, as the indices posted huge gains from technically significant levels. Despite the breakouts, however, the put to call ratio remained stubbornly high, rising throughout the session. Whether it was market makers buying in their short put positions or speculators trying to catch the top, we cannot know. However, the persistence of the put to call ratio has been one of the characteristics of this rally. Unlike last year, when call volumes exceeded put volumes by a wide margin on all but the sharpest declines, this rally shows every dip, no matter how shallow, being met with a spike in put volumes and a relatively high put to call ratio. This looks like bad news for bears, because the willingness of traders to assume a bearish stance on every pullback means that the dips will be bought not just by optimistic bulls, but also by shorts covering their positions. I believe that it was just this phenomenon, among others, that led to the rangebound chop during the Nikkei's bear market of the 1990's. I saw a chart of the 1992-1993 Nikkei which looked remarkably similar to our current indices. There was an extended rally in the spring of 1993, followed by sideways chop into October of that year, which only then saw a sharp plunge.

As option investors, we must be sensitive to the risk of extended moves, be they up, sideways or down. If the market chops its way sideways for six months from here, long contracts will bleed premium. If it continues to rise, puts will get killed. If it plunges, so will calls. Know yourself and know your open positions. In the meantime, we must trade what we see and follow the trend. Trading without stops is very dangerous at any time, but particularly in the current environment. See you at the bell!


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