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     07-09-2003           High     Low     Volume Advance/Decline
DJIA     9156.21 - 66.88  9229.11  9108.24 1.99 bln    974/ 988
NASDAQ   1747.46 +  1.00  1758.18  1735.30 2.17 bln   1385/ 742
S&P 100   503.63 -  2.71   508.25   501.73   Totals   1359/1730
S&P 500  1002.21 -  5.63  1010.43   998.17
RUS 2000  476.99 +  3.02   477.88   470.50
DJ TRANS 2562.41 -  2.71  2575.07  2552.50
VIX        21.03 -  0.37    22.22    20.88
VXN        33.22 -  0.27    34.06    32.60
Total Volume 4,415M
Total UpVol  2,436M
Total DnVol  1,902M
52wk Highs     872
52wk Lows       19
TRIN          0.88
PUT/CALL      0.72

By Jonathan Levinson
Click here to email Jonathan

The indices pulled back to their ascending trendlines today in a much anticipated and long-awaited correction. Although there was an "impulsive" feel to the selling, the bounces came on schedule at the lower ascending trendlines.

30 minute 20 day candle chart of the INDU

30 minute 20 day candle chart of the COMPX

The Commerce Department announced that US wholesale inventories dropped 0.3% in May, following a decline in the same amount in April. Wholesale sales dropped 0.5%. The inventory-to-sales ratio remained at 1.24, just above its record low of 1.21 posted in March. This negative economic news, a downside surprise against expectations of gains in both inventories and sales, sparked a selloff when it was released at 10AM, but within minutes it was bought on huge volume in the futures pits.

The American Petroleum Institute reported a 3.97 million barrel increase in crude inventories for the week just ended, while the Energy Department reported a mere 100,000 barrel gain. The API reported that gasoline inventories fell by 2.5 million barrels, while the Energy Department reported a gain of 500,000 barrels. Nothing like a disagreement on the facts. Crude and heating oil futures both finished higher, with the market apparently ignoring both, judging that in any event, the data was bullish for these commodities.

The Mortgage Bankers Association (MBA) announced that seasonally- adjusted demand for mortgage refinancings, the MBA refinancing index, dropped 21.3% for the week ended July 4. Demand for loans with which to buy homes, the Purchase index, dropped 5.5%. The MBA's market index, an overall measure of mortgage activity, dropped 17.7%. The average interest rate for a 30-year fixed rate mortgage rose to 5.37% from 5.23%. Reports cited rising interest rates and a shortened holiday week.

For the past several weeks, I have been discussing the impact of money supply on the prices of paper assets. This past week saw a slight downtick in the overall money supply as measured by the MZM money supply, coincident with the downtick in mortgage activity.

MZM chart

The previous week had seen a downtick in mortgage activity as well. We also saw lower prices in equities and treasury bonds. While these data are coincident, I do not believe that they are coincidences. My premise is that the overall levels of debt are directly correlated to overall levels of liquidity. Debt is liquidity - the more debt, the more liquidity and hence, higher asset prices. The reverse appears to be true as well, as we've seen in the downtick in mortgage activity, money supply, bond and stock prices. Note that the Fed, whose ostensible mission is to promote stability in the financial markets, has been fighting this downtick in liquidity by dramatically increasing its levels of open market operations over the past weeks (see chart below). We track the Fed's daily open market operations in the Market Monitor, and my very first article on this website (in Traders Corner) attempts to explain how open market ops function.

Chart of overnight and term repurchase agreements (repos)

We have seen that despite the dramatic inflation of the money supply by the Fed, the money (or rather, the debt) has managed to miss commercial and industrial borrowers, flowing into the hands of individual borrowers instead. The data shows that they have used this debt for the purchase of houses (mortgages), automobiles (auto loans and leases), and other consumer products (home equity loans, lines of credit and credit card debt).

Chart of Real Estate Loans

Chart of Total Consumer Credit

Unfortunately, as the ongoing record-breaking current account deficit has been telling us, the bulk of the economic stimulus from the Fed's operations has been in foreign countries, and this is confirmed by the rising unemployment rate at home in the US.

Chart of Unemployment Rate

Lastly, the selling in treasuries since the Fed's last quarter- point rate cut has caused a spike in yields. In light of the rising number of bankruptcies during the past year and the 45 year low federal funds rate, I believe that the single greatest current danger to the economy is higher interest rates. Given the Fed's strong words about its intention to keep rates down, I do not expect the selloff in treasuries to go much further.

5 year weekly chart of the ten year note yield

The President named his remaining top treasury officials today, adding Susan Schwab, former dean of U. of Maryland, as deputy Treasury secretary and Kenneth Leet, former Goldman Sachs executive, to replace outgoing domestic finance undersecretary Peter Fisher. Fisher is best known for having phased out the thirty year bond. The new appointees join John Snow as Treasury secretary, Stephen Friedman as White House economic advisor and Gregory Mankiw as chairman of the council of economic advisors.

In corporate news, it was announced that the SEC has launched a formal probe of THC, sending a subpoena requesting documents relating to Medicare payments and other disclosures going back to May 1997.

LOGI got clocked today after warning that fiscal Q4 operating income would be between $7 million and $8 million, far below its its goal of $14 million. It cited weak demand and intense competition for decrease.

Techs got a lift in the afternoon after it was reported that Gartner Group expects worldwide semiconductor capital spending to grow 7.9% in 2003 after dropping 38% percent in 2002.

After the bell, DNA beat estimates, reversing a loss from Q2 2002 and announcing pro forma earnings of $163.5 million, or 31 cents per share excluding special charges. Estimates were for 26 cents per share.

The much-anticipated YHOO earnings release was poorly received by the market, cratering QQQ afterhours to below 32 as of this writing and reversing a positive close by over one dollar for YHOO. The company reported that Q2 earnings were $50.8 million, or 8 cents per share, up from $16.48 million, or 3 cents per share, in Q2 2002. It missed its earnings projection of 9 cents per share by a penny.

For tomorrow, we have the following economic data due before the bell:

              Report                     Briefing  Market   Prior
                                         Expects   Expects
Jul 10 8:30 AM Export Prices ex-ag. Jun - NA       NA       -0.1%
Jul 10 8:30 AM Import Prices ex-oil Jun - NA       NA       -0.2%
Jul 10 8:30 AM Initial Claims 07/05 -     420K     420K      430K

For tomorrow, we can expect further tests of the bullish trendlines on the major indices. I am very far from caring about YHOO's financial well-being one way or the other, but the action following its earnings release is relevant for the broader market as we approach earnings season. Bulls have amassed fat profits this year, and the mighty Nasdaq is sitting near the top of a very steep ascending trendline as we head into earnings season at the start of the summer. We had a small correction today. A profit-taking event would have a distinctly deleterious effect on bull accounts, and for that reason, we should be attentive to the current support levels. Bulls should set appropriate stops and be alert. While the rally can certainly march higher, the risk- reward balance has become lopsided, and it appears to me to favor the downside.


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