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Market Wrap

Old bear was a bull's best friend

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        WE 10-24        WE 10-17        WE 10-10        WE 10-03
DOW     9582.46 -139.33 9721.79 + 47.11 9674.68 +102.37 +259.23
Nasdaq  1865.59 - 46.77 1912.36 -  2.95 1915.31 + 34.74 + 88.50
S&P-100  511.25 -  6.87  518.12 +  0.07  518.05 +  2.88 + 15.56
S&P-500 1028.91 - 10.41 1039.32 +  1.26 1038.06 +  8.21 + 33.00
W5000   9983.50 -114.8810098.38 + 13.06 10085.3 + 95.02 +343.82
RUT      506.43 - 13.93  520.36 +  1.30  519.06 +  6.78 + 27.00
TRAN    2827.25 - 20.03 2847.28 + 23.73 2823.55 + 38.70 +121.02
VIX       17.71 +  0.09   17.62 -  0.83   18.45 -  1.05 -  2.73
VXO       18.93 -  0.26   19.19 -  0.05   19.24         
VXN       25.45 +  0.12   25.33 -  2.29   27.62 -  1.58 -  1.68 
TRIN       1.44            1.59            1.24                  
Put/Call   0.91            0.64            0.93                  
WE= Week Ending

Old bear was a bull's best friend
By Jeff Bailey
Click here to email Jeff

A late session rally, which I feel may have been largely attributed to short covering, had the major indices recouping the bulk of their session's losses, but still finishing lower as investors pondered stock valuations and another session largely driven my corporate earnings.

The negative tone to Friday's trade was put in place Thursday evening when Microsoft (NASDAQ:MSFT) $26.61 -7.95% told analysts that it wasn't going to be the 20% annual revenue grower it used to be, and for some technology bulls those revelations may have been too much to swallow.

It has been awhile since I've written a market wrap, so I was reading Jim Brown's wrap from last Sunday. Imagine the mental state of bulls this morning after reading that wrap, where Jim reminded us all about the crash of 1987.

While Jim noted that the "Crash of 87" began on Monday October 9, 1987, the party for the bears didn't reach full swing until the 28th and 29th when the Dow Industrials fell 23.9% in two days.

As I sat at my trading desk today, I had set some program trading buy/sell premium alerts on my QCharts trading software. This isn't something I do on a regular basis, but for those subscriber that read the Index Trader Wrap at OptionInvestor.com, you will know that the major indices were flirting with some weekly pivot matrix support levels, where in recent months, it has been an observation that the major indices would normally find some pretty good support, especially after having traded a 52-week high in a prior week or two.

Today, the buy/sell program premium alerts, which we report in every morning's 09:00 AM EDT Update, were being triggered at the sell side as fast as I could reset them. When I looked at an intra-day chart of these alerts on 5-minute intervals, I counted 19 sell program alerts and just 2 buy program premium alerts, where the alerts are created when there is an arbitrage discrepancy seen between the futures and the cash market.

I want to take note of this in today's trade, as it may come in handy in the days or weeks to follow.

I was thinking to myself... "gosh, with all these sell program premium alerts being triggered, how the heck are these markets hanging in here like they are." Now some traders may not think the markets were hanging in there during the bulk of today's trade, but I think there was one heck of a lot of short covering taking place today, as short interest continued to build through the middle of October, as the major indices were still setting new 52-week highs.

Intra-day SPY and Premium of S&P Futures - 5-min

There were plenty of sell programs in today's session, and with so many sell programs taking place, its my feeling that some old bears were using today's weakness to cover some positions after seeing new 52-week highs again last week.

Should the S&P Depository Receipts (AMEX:SPY) $103.58 +0.22% come back into the better part of today's range of $103.24-$102.18, and move QUICKLY or sharply through this range, then my thoughts that today's buying was largely short covering related may be correct. This could be an important observation in coming weeks as it takes BULLISH buying to keep stocks trending higher.

Yesterday I profiled a bullish trade in the above SPY at $103.40, with a stop loss at $103.20 and was stopped out almost right at the bottom of today's trade. While frustrating, I'll also take note of this and in coming sessions, if the SPY were to move quickly through today's range and further below these lows, I'm going to sense that today's stability was largely attributed to BEARISH buying, not bullish buying.

Here's a quick look at short interest on the S&P Depository Receipts (AMEX:SPY). Last month's data, tallied on the 15th of each month, show short interest fell for the first time since the March lows, but showed an increase in the latest month.

If you're a trader, you've probably shorted or bought a put on some security since the March lows, and may have lost money on the trade. There's probably some old bears out there from April, May, June, July, or even August that may have been doing some buying. One way to try determine who is doing the bulk of the buying, which will hold stocks steady or drive prices higher is to monitor areas of irregular or heavy institutional activity, like I think we saw today with a rather large number of program trading alerts, make a note of the area or range of that activity, and if the range is traded, try and observe the pace or how quickly or slowly price moves when the range is retested.

Monthly Short Interest on the SPY

Sometimes it is helpful to see the market as a football game. One team is the bulls and the other team is the bears. Then look at the markets from both sides (bullish and bearish) to determine who has been winning. Then, put yourself on the winning team, which we will show has been the BULLS, but identify a point where you might want to switch teams and changes of allegiance.

Let's take today's range of the SPY and observations made of active buy/sell program premium alerts, and see if that observation may have any significance in the future, but just as important, see if it might make any historical sense with the above short interest data.

Just for grins, imagine your short 100,000 shares of SPY, and established that short position on August 15th. If you were a baseball manager, or football coach, aren't you always trying to figure out what the other team is thinking and what there next move will be?

S&P Depository Receipts (AMEX:SPY) - Daily Interval

Boom! Had I been paying more attention to the June 17 and 18 relative highs when I set up the bullish trade in the SPY on Thursday, with a stop at $102.20, I might have set the stop lower to $102.10 or just under $102.00. In horizontal red lines, I've just extended to the left, Friday's active program trading range. There is definitely some technical significance at, or just above the $102.00 level isn't there?

You've heard of "counting cards" haven't you? If you are caught counting cards in Vegas, the casino will ask you to leave.

However, counting short interest in the stock market, and trying to figure out what a bear is doing, especially the SMART ones, is not illegal, and in trading and investing, all is fair in love and war.

Starting at the recent 52-week high on October 15, and comparing that high to the Sept. 18 relative high of $104.70, we get a rough idea that there is just over 3.2 million shares of short interest that is profitable. That's not a lot of profitable bears at this point when we see from the short interest that bears have been shorting all the way up the scale since March. Please note that there is a difference between a SMART bear and a normal everyday run-of-the-mill bear.

True you are! At some point, a bear, just like a bull, will be proven correct. Going into next weeks trade, I will say that some bears (those from $104.70-$105.89) will begin to look SMART if the SPY breaks below $102.00, which would be a break of trend, but also give those BEARS that were short the SPY dating clear back to mid-June a chance to cover on further weakness to the $100.00 level.

If I'm a bull, and I was in the SPY until I got stopped out at $102.20, I could put myself in the paws of a bear that has been short the SPY since mid-June, even at the then 52-week high of $102.17 and perhaps get the sense that on Friday, he/she didn't care what the heck Microsoft (NASDAQ:MSFT) said about future earnings has they had the chance to get squared up after seeing a new 52-week high. Maybe, MSFT's news will have a negative impact on the other 499 stocks in the S&P 500 (SPX.X) 1,028.91 -0.47%, but what if it doesn't?

OK, so we've determined that it may be best to be bullish above $102.00, but CAUTIOUSLY more bearish below $102.00.

Below SPY=$102.00 (this is roughly equivalent to SPX 1,020) I've marked two prior relative lows of $99.25-$98.83. In actuality, this marks a zone of support, which oddly enough is just below July 15 and August 15 closing values. Couldn't we say the REASON the SPY found both of those relative lows was because SMART bears, especially those still short on the pullback to $99.25 that had now seen a new 52-week high thought... "gosh darn it! I didn't think the SPY would trade a new high when I shorted it at $102.17 in June, so I'd better cover some of that position around $100.00, just in case the SPY trades another new high."

Do you sense the point I'm trying to get across? Until a bear or even a bull sees a LOWER HIGH and a LOWER LOW, he/she is just as uncertain about a MARKET'S valuation as any bull is at this point. A bearish trader has seen just as many higher and higher lows as a bullish trader has. Haven't they?

If simply thinking about the MARKET in this respect, the first sign of any near-term trouble is a break below $102.00, which most likely finds support at $98.83-$99.25, and as I learned today, those levels may be off by a couple of pennies.

It's always nice to sell short a rally than the breakdown, but where does a bear that does know for fact that the market is overvalued, look to short at? Most bears at this point are tired of guessing, but my best guess would be to look for a bounce back near, or just above the $104.70 level (SPX = 1,047) and a reversal back lower, where a mandatory stop of $106.50 might be placed. Then and only then, a good trade would be sensed on a decline back below $102, with a bearish cover target of $100.00.

Below the SPY $98.83 level, I've followed with a red arrow, to depict increasing weakness. This would depict a MARKET now seeing its first relative low after a 52-week high and a DIVERGENCE of pattern since the March lows.

Since I'm combining tonight's Market Wrap with this weekend's Ask the analyst column, this would a level where a portfolio of stocks should be hedged at currently.

I received several questions from subscribers this week that felt the markets were getting a little top heavy, and were ready for a reversal, and wondered at what level would a meaningful breakdown occur. My best thought would be the equivalent of SPY $96.00, or S&P 500 (SPX) 960.

In percentage terms, a 10% pullback in a major index is considered a healthy correction. If I were to assume the top is in at $105.89 on the SPY, a 10% pullback would be equivalent to $95.30 on the SPY, or 953 SPX.

For the tax-sensitive bull, that is hesitant to sell current holding for capital gains reasons (tax consequences is an important part of an investors overall plan, but should NEVER be the ultimate decision making tool for not selling and profiting from the risk taken), the use of a put option with January expiration, may be your best strategy. By purchasing a January expiration, tax consequences may be pushed into the 2004 tax year. So, if you do NOT want to take some profits off the table today, or a break below SPX 1,020 and option would be to hedge part of the portfolio with a January put option.

What is the worst thing that happens for a capital gains sensitive bull that buys a protective put to hedge a portfolio of stocks? The market moves higher and your current holding most likely increases in value by January 2004 expiration. You sell your PUT for a loss and you take that loss against capital gains, and reduce your capital gains tax amount.

Russell-2000 Index (RUT.X) - Daily Interval Chart

Note the upward trend on the RUT.X looking striking similar to that of the upward trend on the S&P Depository Receipts (AMEX:SPY) we just looked at. I carried over Jim's 515 initial support level from last Sunday's wrap, but added a little twist to the above chart.

It is this kind of retracement that lead me to the "fitted retracement technique. Why in the world would the RUT.X see a double top at 534.25? Who picked that level as a selling point. If I anchored a retracement from the August 7 low and "fit" the 61.8% retracement near the September 29 low, which was 482.13, then I can perhaps make some sense out of the recent 52-week high. It is also notable how nicely the 38.2% retracement came into play PRIOR to the 52-week high, when the RUT.X pulled into support.

Conclusion: The RUT.X should find support near 502.05, if it doesn't, the RUT.X vulnerable to 61.8% retracement and match the recent relative low. Should the RUT.X break much below the 500 level this week, then break of trend that has held since August 7 (the attachment point for trend and retracement), is an alert to a change in trend. If RUT.X were to fall to 480-482 level, then look for resistance right back higher at 518.

Anytime a stock or index breaks an upward trend, be cognizant that the potential bounce back higher finds that broken support trend coming into play as resistance.

Dow Industrials ($INDU) Chart - 50-point box

Today's trade in the Dow saw an additional 2-box decline with MSFT -7.95%, HPQ -2.52% offsetting gains in T +3.91% and SBC +2.68%. While 9,500 may be psychological support, more formidable support found at 9,400.

Gains in AT&T (NYSE:T) $19.91 +3.91% were found after the Wall Street Journal reported that it and Bell South (NYSE:BLS) $25.83 -0.34% had recently renewed talks of a merger and that a merger between the two makes strategic sense in the very highly competitive telecom services industry, where price competition is high. AT&T continues to see revenues decline and has cut costs to the bone. A merger with price talk of mid-$20 per share may be best for T shareholders, and allow further cost reductions to be seen when combined with another bell. Bell South is said to have a very strong balance sheet, and can afford to take on debt to further gain market share and T's coveted long distance business. Some say the talk were revived as it looks like WorldComm will come out of bankruptcy. The talks between T and BLS stopped when it was questioned whether WorldComm was going to survive, if not allowed by the bankruptcy courts.

NASDAQ-Composite (COMPX) Chart - Daily Intervals

The broader NASDAQ found support at its rising 50-day SMA and PINK trend from the March lows, which I've attached to the August 7 lows. This PINK trend would be considered significant as it looks to have provide support for a rebound to new highs on the late September pullback. First sign of weakness would be a move below 1,835 which would then have 1,775 in play as support.

The RED regression channel was a channel I had placed on the COMPX months ago, that seemed to represent the aggressive bullish nature of the broader NASDAQ and other major indices. Only today do I see that the base of this old trend may have come into play as resistance at the recent 52-week highs.

This may make some sense in the scope of an early economic recovery when the markets anticipate and accurately reflect a growing economy. However, there is always some "finite second" when the markets realize a point of perfect price, that fully reflects true price perfection, then awaits further information to try and figure out if their is further upside fundamentals, which are always depicted by the charts.

The markets have been inundated with fundamental data from corporate earnings this week, and I get the sense from the NASDAQ chart that it is digesting the plethora of information it has been given and ready to make a decision. The trend is higher from what I can see, but the suspicious 52-week high that found the base of regression may hint it is time for a rest.

This week, the only economic report (other than a lot of corporate earnings) was weekly jobless claims, which were in line with forecast at 386,000. With all the earnings being released, the jobless claims data really had little impact, but still showed some sign of an improving labor market.

While last week was rather void of economic data, next week will heat up with Monday's report for September existing home sales forecasted at a 6.3 million unit annual rate and new home sales forecasted at 1,113K annual rate. The MARKET seems to be looking for good numbers from the new homes data as the Dow Jones Home Construction Index (DJUSHB) 537.39 traded an all-time high on Thursday.

Then on Tuesday, September durable goods data, October consumer confidence and the FOMC meeting will intrigue investors.

Most Fed watchers do not expect the Fed to raise rates, and with Gold still below $400.00, Steve Forbes would agree.

For some thoughts on why the Fed should not raise interest rates because gold is trading under $400/oz. I wrote an Ask the Analyst column on Steve Forbes' thoughts, and we back tested these thoughts as to what the Fed had been doing over the years, where gold was trading, and wanted to see what the stock market's reaction was to the Fed's decisions. Here is the link to that article.

Have a great weekend!

Jeff Bailey



 
 



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