Option Investor
Market Wrap


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     09-24-2003            High     Low     Volume Advance/Decline
DJIA     9425.23 -150.81  9592.67  9423.54 1.86 bln    890/1951
NASDAQ   1843.70 - 58.02  1904.13  1843.43 2.17 bln    933/2176
S&P 100   505.46 - 10.66   516.67   505.23   Totals   1823/4127
S&P 500  1009.38 - 19.65  1029.83  1008.93
RUS 2000  507.86 - 11.50   519.85   507.86
DJ TRANS 2745.93 - 54.45  2802.74  2745.63
VIX        21.22 +  1.75    21.26    19.44
VXN        29.36 +  2.38    29.36    27.21
Total Volume 4,367M
Total UpVol    752M
Total DnVol  3,567M
52wk Highs     586
52wk Lows       15
TRIN          0.84
PUT/CALL      0.88

By Jonathan Levinson

Traders decided to do some selling today, and sell they did, with the major stock averages printing bearish engulfing days as bonds and precious metals advanced. The volatility indices all rose, with the "new" VIX (based on the S&P 500) breaking 20 for the first time since its inception days ago.

Volume exceeded that of the past several days, with the Nasdaq trading 2.17B shares and the NYSE 1.73B. The TRIN.NQ closed at 2.04, the highest level I've seen in what seems like a very long time, months on closing basis, and the TRIN 2.32. The 58 point drop on the COMPX to 1843.69 was verging on a sellathon, the INDU -150 to 9425.

For all that, the technical damage on the daily chart was not major, but the bearish engulfing to close at the day lows bodes ill for tomorrow's open. As can be seen on the 1 year daily chart of the COMPX below, any further selling from here could touch off a bear wedge breakdown, projecting potentially to the March lows.

1 year daily COMPX

On both the Nasdaq and the Dow, the daily chart oscillators are lined up to the downside, and appear to be completing what could prove to be a major top for the markets.

6 month daily INDU

On the Dow, the bear wedge projects again to the March lows on a maximum fulfilment, in this case at 7400.

20 day 30 minute COMPX

Notwithstanding the immensely bearish finish, bulls were sent home with a measure of hope in the form of a bullish descending wedge. The Nasdaq blew right through it on either a formation failure or a throwunder, while the Dow managed to hold within it. If the bottomy 30 minute chart oscillators combine with this pattern tomorrow morning, we could see a bounce potentially to the day highs. I don't think we will, but this is the message on the 30 minute charts.

20 day 30 minute INDU

Today is an opportune day to briefly review sentiment and some of the fundamentals beneath the economy and the markets:

Chart of Yale Crash Confidence Index

The Yale School of Management has been compiling the above data for the past 14 years, which measures the percentage of both individual and institutional investors who believe that there is no immediate risk of a stock market crash. The higher the reading, the higher the confidence in the health of the stock market. Note how confidence has risen since September 11, 2001.

On further reflection, one might conclude that the above chart depicts the growth of confidence in the Fed since September 11, 2001, as a precipitous market plunge was dramatically reversed by short term liquidity operations during the weeks and months that followed the tragic day. Note also that confidence has been rising with the markets during 2003. Despite the fact that markets which are overpriced tend to crash more readily than those which are underpriced, this sentiment gauge reveals confidence rising alongside price.

Viewed another way, here's a four year chart of the VIX, commonly referred to by option traders as the "fear" index. Once again, we see evidence of a bear market in fear:

4 year weekly chart of the VIX

Is this confidence in the Fed and the health of the markets justified? Let's look "under the hood" at some of the broader trends during this period. First, we have the money supply (MZM), depicting the inflationary effects of the Fed's work since 1990.

Chart of MZM

During the same period, the Fed Funds rate, which, though not captured in this more recent time series, is at a 45 year low.

Federal funds rate

The Fed has been aggressively lowering interest rates and increasing the supply of dollars. The proliferation of this new "hot" money has resulted in an impressive rise in consumer credit. I believe that current levels represent alltime highs.

Consumer credit

It appears, further, that US consumers have used this money to import goods and services from abroad, encouraging foreign economies but not their own.

Balance of Payments

The Fed's efforts appeared to be having a stimulative effect on employment until 2001, at which point unemployment began to rise steeply. The pullback in unemployment that pundits have been cheering during the past months is better contextualized by the time series below.

Lastly, evidence that the current levels of services enjoyed by the citizenry are becoming increasingly unsustainable, with the level of overall government deficit in a breakout.

Government defit

The net picture is one in which the Federal Reserve has been aggressively increasing the supply of dollars and lowering the carrying cost of those dollars, ostensibly to stimulate the US economy. What has resulted is a bubble in consumer credit, accompanied by bubbles in stocks (Nasdaq 5000), real estate prices (ongoing), consumer credit (ongoing) and imports (ongoing). The rise in unemployment and the record government deficit levels, as well as the record personal bankruptcy levels (not shown) are a compelling rebuttal of the Fed's thinking to date. Unfortunately, the Fed's response appears to have been an acceleration of the process- witness Governor Bernanke's no- holds-barred "printing press" comments.

In view of the foregoing, while stock market crashes are indeed low-probability events, I see little reason for an increase of confidence in the unlikelihood of one's occurring. On the other hand, while the Fed appears to be unable to cure the problems it claims to address, the aggressive increase in liquidity could well reinforce the price of the markets even as their underlying value drops.

In economic news today, the Mortgage Bankers Association (MBA) announced this morning that seasonally-adjusted demand for mortgage refinancings, the MBA refi index, dropped 0.4%% for the past week, despite the decline in mortgage rates from 5.91% to 5.85 for a thirty fixed. Demand for loans with which to buy homes, the Purchase index, fell 7% to 402.1 from the previous week's 432.4. The Application index fell 3.7% for the week to 699.6.

Early in the session, it was reported that OPEC had agreed to restrict output by 900,000 barrels per day to 24.5M barrels per day. Marketwatch reported that the move "comes as a complete surprise to the oil markets," as the cartel was expected to keep levels unchanged. John Person, head financial analyst at Infinity Brokerage Services, was reported to have called it a "shocking and yet disturbing decision."

Being unfamiliar with John Person and "Infinity Brokerage Services", I can only guess why he or his firm would find it shocking or disturbing, given that oil prices have fallen during recent months. Note further that Bernanke, Snow and others have been preaching a further devaluation of the dollar, and the charts I've attached above bear this out. With a greater supply of dollars and recent lower prices for oil, it is absolutely beyond me how any person or bucket shop in intellectual good faith could possibly find it "shocking" or "disturbing" or "a complete surprise" that oil producers are unwilling or unable to sell as much oil at those lower prices in less valuable dollars. Go figure.

In other news, the Energy Department reported that crude inventories rose by 1.5M barrels in the week ended Sept. 19. Gasoline inventories rose by 1.5 million barrels as well, and distillate supplies fell by 100,000 barrels. The American Petroleum Institute confirmed an 800,000 barrel rise in crude inventories to total 282.9 million barrels.

It was an otherwise quiet day news-wise, with DELL announcing a $500M army contract and FLEX getting smoked for 5.18% on news of a $934M jury award against it. We have the following economic data due tomorrow:

               Report                   Briefing  Market    Prior
                                        Expects   Expects
Sep 25 8:30 AM Durable Orders Aug -       1.5%    0.5%      1.0%
Sep 25 8:30 AM Initial Claims 09/20 -     410K    400K      399K
Sep 25 10:00 AM Existing Home Sales Aug - 5.95M   6.05M     6.12M
Sep 25 10:00 AM Help-Wanted Index Aug -   39      39        38
Sep 25 10:00 AM New Home Sales Aug -      1120K   1120K     1165K
Given today's strong selloff, traders are left in a precarious position. Bears need to keep stops close above, while bulls are either getting stopped out or are close. The 30 minute formations and oscillators portend a possible bounce within the confines of the early stages of a long-awaited daily cycle downphase. The bounce should not carry very high, if it comes at all. While the oscillators do not tend to trend or get pinned in oversold territory, the close at the day lows on higher volume sets up conditions more conducive for such to occur. The tide could well be turning against the bulls, and if so, there should be plenty of downside left. Plan your trades and wait for your entries.


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