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Did You Blink?

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      10-28-2003           High     Low     Volume Advance/Decline
DJIA     9748.31 +140.20  9749.94  9609.72 2.07 bln   2182/1026
NASDAQ   1932.26 + 49.40  1932.26  1892.43 2.08 bln   2236/ 964
S&P 100   518.64 +  7.87   518.64   510.77   Totals   4416/1990
S&P 500  1046.79 + 15.66  1046.79  1031.13 
W5000   10181.20 +154.00 10181.26 10027.22
RUS 2000  525.85 + 10.50   525.86   515.35 
DJ TRANS 2883.27 + 41.90  2885.06  2841.48   
VIX        16.82 -  1.23    17.89    16.77
VXO (VIX-O)17.84 -  1.26    19.17    17.71
VXN        25.00 -  1.12    26.22    24.78 
Total Volume 4,480M
Total UpVol  3,304M
Total DnVol  1,116M
52wk Highs  670
52wk Lows    30
TRIN       0.76
NAZTRIN    1.03
PUT/CALL   0.75

Did You Blink?
By Jim Brown
Click here to email Jim

If you blinked you missed it. Last Tuesday the VXO closed at 17.82 after hitting 17.50 intraday. The Dow dropped -250 points to trade under 9500 three days later. If you blinked you missed it and the Dow closed today within four points of last Tuesday's close at 9749. Unfortunately the VXO closed at 17.84 again today. Does that mean we are headed down?

Dow Chart

Nasdaq Chart

S&P Chart

Before we tackle the VXO question again we need to wade through the economic reports. Chain store sales fell again and by a larger margin than the prior two weeks. Sales posted a -0.9% drop and prompted the Bank of Tokyo to lower estimates for October yet again to +2.5% to +3.0%. They had been as high as +5% just three weeks ago. The lack of tax checks, tax holidays and mortgage refinancing is impacting sales. Despite reportedly strong Halloween sales the retailers are still seeing overall weakness. October sales are on track to be less than half the September levels.

The advance Durable Goods report came in less than expected at +0.8% when estimates were for +1.0%. This was the third monthly gain in four months but it was also another month in a down trend from the June highs. The jump in June was +2.5% followed by +1.6%, -0.1% and September's +0.8%. The gains were mostly in the private sector with defense orders falling -26.7%. Inventories fell again for 31 of the last 32 months and back orders rose for the seventh time in eight months. There are positive internals and the falling inventory number will eventually spark a demand rally. They have been saying that for much of the last 32 months but eventually it has to come true. The rising back orders indicate that production is not keeping up with the pace of new orders and that is a very positive sign.

Also positive was the +4.1 jump in Consumer Confidence to 81.1 after a -4.7 dip last month. The present situation component rose to 66.8 from 59.7 a much bigger gain than the + 2 point jump in the expectations component to 90.7. Those planning to buy an auto jumped to 6.7 from 5.4 last month. Analysts attribute that to the new model year and another round of heavy advertising of new incentives. The recovery in the headline number instead of a continued downtrend was met with a long sigh of relief and a short term spike in the markets. The spike did not last and we retreated to neutral territory to wait for the FOMC announcement at 2:15.

That FOMC announcement came as expected and only slightly changed from the prior months statement. They did say that spending is firming and the labor market appears to be stabilizing. The bad news was that business pricing power and increases in core consumer prices remains muted. They continued the statement about the risks of sustainable growth remain roughly equal but the unwelcome fall of inflation was the greatest concern for the near future. No change there. The comment the bond market was keying on was the no policy change for a "considerable period." This is Greenspeak for we are not going to raise rates for several more months. The bond market soared on the news and the analyst chatter is predicting no increase until the end of the first quarter. According to the Fed Funds Futures they are not expecting a 25-point rate increase until May-2004. After today's Fed announcement the fourth quarter is open for clear sailing in the bond and equity markets according to the analysts. The next meeting is Dec-9th but the Fed rarely changes policy in December to prevent a holiday spending backlash. In reality the Fed may try to keep rates at this level through next summer to continue to pump the markets and ease the deficit in front of the election. Nothing like a wave of stock profits to fill the income tax coffers.

The major stock news today was Sony's announcement they were going to lay off 20,000 workers or 13% of their work force. This had been rumored with statements over the last couple weeks about a 50% excess in capacity in their factories.

The fire in California is depressing insurance companies despite claims that they have plenty of reserves to deal with the expected $1 billion in claims. Allstate is the largest insurer at risk with 14% of the homeowners insurance in California. It will be months before the total of the damage is known.

Helping boost the markets today was new estimates that the chip sector would grow by +14% in 2003 and +15-20% in 2004. The SOX rocketed +29 points to 490.40 and a new 52-week high. This pushed the Nasdaq to a +49 point gain. TSM delivered the good news that plants were running at almost full production to keep up with demand. TSM also said they were going to raise capex spending to between 25% and 30% of next years revenue. That could be as much as $2.2 billion up from $1.2 billion in 2003. TSM net income soared +380% over last years levels. They saw wafer shipments increase +12% in the 3Q. This is what the market needed. Good news to back up the Intel profits three weeks ago. The news from the smaller chip makers has been spotty with guidance changes both up and down. TSM is the world's largest chip foundry and that is the one you want to hear brag.

The markets received even more bullish news from Charles Biderman at TrimTabs.com. He said that fund inflows were running at a record rate for October and could reach $30 billion. This is just barely behind the record for any month which stands at $35 billion from Feb-2000. He said the merger activity was strong and new offerings were light which increases both sentiment and cash. The thought of investors pouring billions into the market in hopes of an October dip was too much for the bears to handle.

The indexes opened up on the semiconductor news and rallied into the FOMC announcement. For 30 min after the Fed news the buyers and sellers fought for control across a very narrow range but once the Dow crossed above 9675 it was all over for the bears. With the bulls pressing the averages higher the shorts began to cover and it was a race to the close. The Dow closed at 9745 and only 100 points from the Oct-15th high. The Nasdaq closed at 1931 and only 35 points from its October high of 1966. This is a major event for the market but it came at a price.

The VXO (old VIX) closed at 17.84 and in danger territory. The S&P closed at 1046 and only 4 points from very strong resistance. While neither of these events are earth shaking they are important. The markets break resistance all the time and we all know how many levels of significant resistance the S&P has had to break since October of last year at 768. While it has broken through countless resistance levels, some several times, the VXO has only traded in the 17s once before today. This is an indicator of extreme bullish sentiment. Is that always bad?

Normally it is bad. However, these are not normal conditions and bullish sentiment can get even higher. In July of 1998, the last time we had levels this high the VXO traded at 18 or below for two weeks while the market made new highs. The break finally came when the VXO traded intraday at 16.73. Prior to the advent of Internet trading in Dec-96 the VXO spent months at a time below 18. The lack of volatility came from a Dow that had stocks like Bethlehem Steel and Sears and all trades have to be screened by a broker over the phone. There were less than 20 million brokerage accounts and everyone was an investor not a trader. An investor made a dozen trades a year maybe and a trader 4-5 a week. This brings us back to the future. We are not in the pre Internet days and we have Nasdaq stocks in the Dow and Internet stocks in the Nasdaq. Volatility is a fact of life that we have to live with.

That sets up a serious unknown for tomorrow and for the rest of the week. The futures sold off after the close but after a +140 point day you would expect that. Looking at the internals for today and they were extreme. Extremely bullish! The volume was high with over 2 billion shares traded on the NYSE and the Nasdaq. Advancers beat decliners by better than 2:1. Advancing volume across all exchanges was better than 3.3 billion with declining volume only 1.1 billion. This 3:1 ratio was strong, not as strong as traders would really like to see for a confirmation day but this was not a normal day. There was a FOMC meeting right in the middle. Traders took half the day off waiting for the announcement and still traded over 4 billion shares. This was very bullish in my opinion.

We now have a directional problem. It appears on the surface and on the internals that we could test resistance at S&P 1050 and Dow 9850 as early as tomorrow. This would drive the VXO even lower. A break of that resistance could ignite a new 4Q rally. All thoughts of an October dip and end of fund year portfolio rebalancing would be forgotten. Actually I think part of the rally today was investors who had been expecting a bigger pull back than 9500 now chasing the indexes. If funds really have $30 billion or more inflows in October then they are awash with cash. Many had been hoarding cash to either buy the dip or cover withdrawals and neither has occurred.

This leaves us with a potentially explosive scenario. We could see funds/investors throw cash at the market the rest of the week and continue to chase it higher. I could easily see new highs in place before Friday. I could also see a VXO induced sell off but I have far less confidence in it today than I did last Tuesday when I would have taken all bets. What I would be worried about is Monday. Next week is the economic reports from hell week with both ISM reports and the Nonfarm Payrolls leading the list. It is also the first week in the new year for mutual funds. There is a train of thought that they did not sell stocks in October because they wanted to go out at the top with a full portfolio to show massive gains on fund statements and be fully invested. Many of those stocks are very extended and could easily be targets for dumping once the statement date has passed. This is just speculation but one scenario that needs to be considered.

If buyers continue to chase prices then the VXO could continue to plummet. The lower it goes the higher the risk. While there may not be an event on Wednesday it will only be a matter of time before we see another bout of profit taking. Hopefully it will be from much higher levels. I personally think the economic numbers, while weak, are slowly improving and while much of it is already priced in there is still room to grow. Every extended bull market continues to rally over the groans of the analysts claiming stocks to be over valued. Instead of climbing the wall of worry about economics and earnings the wall becomes disbelief that the market is running away from them. They begin to capitulate and chase prices driving the markets into one final feeding frenzy. That frenzy normally culminates in an extremely low VXO and a new high in the market. In this case that target for me is still Dow 10,000. I would be very surprised if we made it over on the first attempt but I would not be surprised to see that attempt this week. Just keep looking over your shoulder if we move higher because Friday's goblins may be after more than candy.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
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