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Market Wrap

Calm After The Storm

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        WE 9-19         WE 9-12         WE 9-05         WE 8-29 
DOW     9644.82 +173.27 9471.55 - 31.79 9503.34 + 87.52 + 66.95 
Nasdaq  1905.70 + 50.67 1855.03 -  3.21 1858.24 + 47.79 + 45.13 
S&P-100  520.62 +  8.32  512.30 -  0.19  512.49 +  9.13 +  5.94 
S&P-500 1036.30 + 17.67 1018.63 -  2.76 1021.39 + 13.38 + 14.95 
W5000  10054.07 +176.76 9877.31 - 29.38 9906.69 +136.23 +158.03 
RUT      520.20 + 11.14  509.06 +  0.19  508.87 + 11.45 + 11.91 
TRAN    2794.71 + 59.11 2735.60 - 11.69 2747.29 + 64.05 + 41.68 
VIX       19.07 -  1.18   20.25 +  0.88   19.37 -  0.12 -  0.78 
VXN       29.74 -  2.94   32.68 + 11.98   30.70 +  1.18 +  0.05 
TRIN       1.35            1.11            1.04            0.78 
Put/Call   0.68            0.90            0.72            1.29 

Calm After The Storm
By Jim Brown
Click here to email Jim

While the cleanup begins on the hurricane battered east coast the cleanup in the markets also began. The excesses from the big gains on Thursday eased and the NYSE board began its search for a new chairman and started the long task to rebuild its image. The quadruple witching Friday ended calmly after traders apparently cleared their books on Thursday

Dow Chart

Nasdaq Chart

The only economic report on Friday was the Weekly Leading Index and it came in at 129.5 which was +1.0 over last weeks reading. This is a sleeper report and is not really a market mover as most of the components have been announced earlier in the week. Components of this index include Jobless Claims, Ten year yields, NYSE Composite, money supply, etc. This is an index created from all the other data for the week. Next week is devoid of material economic reports until Thursday when we will be overrun with numbers beginning with Durable Goods, Jobless Claims, Help Wanted Index, New Home Sales, Monthly Mass Layoffs and Existing Home Sales. Friday has GDP and Michigan Sentiment.

While we will not get consumer sentiment numbers again until next week the sentiment numbers that matter were announced by AMG Data on Friday. U.S. stock mutual funds had inflows of $2.2 billion in the week ended Sept 17th. This was the 17th consecutive week that these funds have generated positive flows. International funds saw inflows of $987 million and small-cap funds received $615 million. The headline number was up +$94 million from the prior week. With positive fund flows continuing to feed the markets it is no wonder we are still seeing some upward pressure.

The profit taking from Thursday's strong gains to new highs was weak and on low volume. The Dow only gave back -10% of its gains and the Nasdaq only slightly more. Considering the current levels this should be considered very bullish. My opinion is still the same concerning the huge spike and I think it was option related short covering. We will not know for sure until Tuesday. Impacting the markets on Friday other than the options expiration was a rebalancing of the S&P indexes and the FTSE Global Index. These were not major movers as they were simply an adjustment of percentages of stock held. As companies add or remove stock from the market the index fund managers must add and subtract stock from their portfolios to maintain an equal balance with the index. For instance MSFT has increased its weighting in the S&P-500 by 0.72%. Funds must add 0.72% to their current positions. If your fund position was 25 mil shares then you had to buy an additional 180,000 at the close on Friday to bring your position into parity. PFE saw its weighting drop -1.39% so index funds needed to reduce their holdings by that amount. Multiply this by several hundred stocks and you can see why there was some serious volume at the close. HPQ announced that is was going to buy back an additional $1 billion in stock. This means the next quarterly rebalancing will reflect the change in HPQ once they actually buys that stock back.

I am not going to bore you today with repetitious stock news from Friday because there was hardly any. It was a quiet news day with most stories focusing on the Isabel damage and clean up, the Grasso exit or the California recall election. This was not a day where the news moved the markets. There were no real economics and other than a couple of small cap earnings warnings it was quiet. Boring and quiet. The calm before the storm. I know, you have heard it before, but here it is again. Is that thunder in the distance?

Volume on the exchanges was evenly split between advancers and decliners and despite the negative headline numbers the new 52-week highs rose to 824 and a two week high. The quarterly quadruple witch appeared to be over after the open based on the lack of volatility for the balance of the day. The VIX closed at 19.07 and only .17 off the 52-week closing low of 18.90. The investor sentiment levels rose to 56.1% and bearish sentiment dropped to 19.4%. The Dow bullish percent rose to 83.33, OEX 87.0, SPX 82.8, Compx 77.41. In the OEX Bullish percent chart below you will notice that the index is running off the top of the chart while the RSI and MACD are showing clear bearish divergence. How much higher can it go?

A reading over 80, much less 87.00, is very rare. This is the highest reading since 1996 and the oldest date I could chart. It has only been over 80 three times in six years and it has been over 80 since mid June. Think about it. Not only is it very rare but this length of time over 80 is unheard of.

The VIX close at 19.07 is at a level only seen four times since Jan-1999. This is very bearish but it is not a trigger indicator. That means it can stay there for some period of time before the reaction takes place.

I have shown this chart before but it bears repeating. Each time since 1998 that the VIX moved under 19 the results were the same. I don't make this up, I just report it. Everybody says quit harping on the VIX. In my opinion anybody that does not watch the VIX is asking for trouble. It is up to you to decide to react to it or ignore it.

VIX/Dow 5-year chart

Let's recap the facts and the result:

Bullish investor sentiment at 56% (bearish)
Bearish investor sentiment at 17% (bearish)
Bullish percent on the OEX at 87.0 (very bearish)
VIX at 19 for the 4th time in 5 yrs. (bearish)
Bearish divergence on indicators
on the OEX bullish percent chart (bearish)
Monday begins the worst four weeks (bearish)
Markets at new highs after 7 mo run (bearish)

It is statistics like those that are driving the bears crazy. The market refuses to go down and extreme bullish indicators are growing even more bullish on a daily basis. The off the scale bullishness is feeding on itself and providing the urge for investors to chase stocks even higher.

Next week is going to be a major test for the indexes. I have been reporting for weeks that we were about to enter the worst six weeks of the year from mid September to the end of October. Well boys and girls we are now moving into the worst four weeks of the year. This is the period after September options expiration and before the October expiration. Why?

Mutual funds have an October 31st fiscal year-end. This means funds wanting to lock in profits and/or off set losses have to sell over the next four weeks. They could wait longer but the normal plan is to wait for the Sept option expiration period to pass before dumping stocks. They try to get all the portfolio rebalancing, including buying new stocks, done before the October option expiration. This compresses the time frame for all these events to occur into the next 3-4 weeks. In a year where many stocks have more than doubled in value since March the odds are good that many funds are going to lock in profits to dress up statements. After three years of a bear market the urge to show a nice profit is going to be strong. Don't get me wrong. The funds are not stupid. If the market opens up on Monday and they feel the momentum is still there they will try to stretch their gains just like everyone else. Once the momentum appears to fade it may trigger the end of that stretch attempt. The next three weeks are the three most important weeks of the year for funds. This is where all the planning and pain pays off and bonuses are earned. Until those profits are translated into cash they can disappear in an instant with any negative event. However, not all funds sell and they do not sell all stocks. If they think there is more upside in a stock and they do not have anything better to replace it with then just taking profits to take profits is a self defeating process. Confused? The bottom line is that some will and some won't and until it happens nobody has a clue.

I feel like Chicken Little. I have been reporting on the "normal" market trends since late July and none of them have come to pass. The fix was in and the retail traders are convinced the worst is over and recovery is ahead. This belief has produced a positive inflow of cash to funds for the last 17 weeks. The Fed is going out of its way to promise no rate hikes until well into the recovery cycle. We are poised for a huge explosion in earnings if the recovery comes to pass. At this point that is more of "when" instead of "if" but it has not happened yet. We are seeing a slow increase in the economy but maybe not enough to justify the strong rally from March.

This brings us to next week. "Normally" this would be the beginning of the lock in profits volatility period. However, with the funds still pouring in and the investing public counting dollars instead of sheep at night it remains to be seen what will happen. The Dow and Nasdaq are in nosebleed territory not seen in over a year and by many indicators very overbought. This could produce a spectacular dip back to the August lows or just another dip to be bought by the bulls. Until it happens it is just speculation and nobody has a clue. The market has embarrassed quite a few analysts over the last couple months and has proved one thing more often than not. The market will always do exactly the opposite of what analysts expect at critical points. Hopefully by doing my Chicken Little imitation again today if the sky does fall you will be ready for it. If it doesn't then no harm done. While Friday could have been the calm after the storm there is a much better chance it was the calm before the storm. Or should I say calm before the next buying opportunity?

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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