Option Investor
Market Wrap

One Down, Two To Go

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       WE 01-16        WE 01-09        WE 01-02        WE 12-26  
DOW    10600.51 +141.62 10458.9 + 49.04 10409.8 + 85.18 + 46.45  
Nasdaq  2140.46 + 53.54 2086.92 + 80.24 2006.68 + 33.54 + 22.12  
S&P-100  564.72 +  8.17  556.55 +  6.56  549.99 +  7.21 +  2.52 
S&P-500 1139.83 + 17.97 1121.86 + 13.38 1108.48 + 12.21 +  7.61 
W5000  11116.04 +187.04 10929.0 +151.14 10777.9 +115.48 + 82.96 
RUT      590.41 + 15.21  575.20 + 14.35  560.85 +  5.75 +  8.22 
TRAN    3036.28 + 47.34 2988.94 - 19.22 3008.16 +  8.49 + 12.24 
VIX       15.00 -  1.75   16.75 -  1.47   18.22 +  0.83 +  0.97 
VXO       15.27 -  0.67   15.94 -  2.00   17.94 +  1.36 +  0.53 
VXN       20.24 -  2.77   23.01 -  1.50   24.51 +  0.56 -  0.94 
TRIN       0.47            1.63            1.01            0.79  
Put/Call   0.51            0.65            0.76            0.86  

With January half over we have one significant earnings week behind us and two monster weeks ahead. The majority of 4Q earnings from U.S. companies will be released over the next two weeks. Over 800 major companies and 75% of the S&P will confess their sins, brag about their successes and try to artfully craft a bullish outlook while avoiding blatant lies. I love earnings season!

Consumers cheered the coming of January it appears with the Michigan Consumer Sentiment coming in at a whopping 103.2 compared to the paltry 92.6 in December. Looks like the holiday cheer is still flowing in many areas. The expectations component rose from 89.8 to 99.5 and the present conditions component soared to 108.9 from 97. Must have been a lot of gift cards under the tree to generate that kind of euphoria. The bounce completely erases memory of the December decline and according to analysts was due to the rising stock market, availability of bargains for holiday shopping and no holiday terror event. Life is good in America. If this number continues to rise we would expect consumers to part with more money at the register and start looking at new homes again. The perception is for positive jobs market despite the lack of any proof.

Business Inventories rose +0.3% in November, which was inline with consensus estimates. Because it was a November number it was considered old news. The best part of the equation was the inventory to sales ratio at 1.35 and the second month at a record low. This continues to suggest there is an inventory building period in our near future.

Industrial Production rose at a much slower rate in December then expected. It rose +0.1% when consensus was for a +0.4% gain. Many of the components actually declined with only construction materials and supplies showing gains. If you remember November showed a huge spike of +1.0% in productivity and way out of context with the average gains of +0.4%. This spike has now been negated and the steady progress continues. Capacity Utilization remained low at 75.8 for the second month. This lack of utilization should continue to prevent any inflationary pressures for the near future.

The picture is clear for the 2004 economy. Despite various weak components in the majority of the different economic reports the overall trend is still an improving recovery. The market continues to rise in anticipation of even stronger gains ahead and interest rates are slowly falling again. The job market is seeing very small signs of improvement but at least it is heading in the right direction. There are estimates starting to appear for a +7.0% GDP for the 4Q-2003. The initial GDP release is Jan-30th. Based on the guidance from the companies already public there is an outside chance the 1Q could be as high as +6%. This chain of successes is nearly unheard of in modern times. This suggests the economy is not only recovering but is about to explode. The stock market is reacting to this news with great enthusiasm. The outlook is not for a cooling off period as expected after the +8.2% tax rebate spike in the 3Q but for continued expansion all the way into late 2005. I personally think extending the forecast past the election is asking for trouble but I am willing to let others take the lead.

The big name on the earnings front on Friday was GE which reported 45 cents per share and inline with estimates. GE can do no wrong in the eyes of investors. They failed to reach their stated goal and post double digit gains for the second consecutive year. No problem for investors for GE promised to hit that goal and do +10% in 2005. Hurray! GE rose +1.35 on the news. Actually I am poking fun at them and I do like them as a company. The reason GE was up had more to do with stemming losses in a couple of its divisions and some very positive guidance. Chairman Jeff Immelt said industrial orders were at their strongest level since 2000. This is a dramatic turnaround from somebody that did not see a recovery in progress just three months ago.

That statement from Immelt is the story in a nutshell for this earnings season. Almost every major company that has reported has said they were seeing a pickup in economic activity, industrial orders and IT spending. This expectation is what investors have been buying for the last three months. The JNPR guidance upgrade Thursday night was like a chain reaction through the tech sector. Gains in chip, telecom and computer stocks pushed the Nasdaq to new 30 month highs. Investors were delirious despite CNBC running an interview with the JNPR CEO expressing negative comments. He said there was not a broad based recovery underway and the JNPR gains were company specific. He said they were at the right place at the right time with the right product mix. Nobody seemed to care.

The JNPR earnings and guidance added tens of billions in market cap to Nasdaq stocks despite a definite disconnect. JNPR only had profits of $14 million for the quarter. This is not a big deal. Their closest competitor Cisco, will report earnings of more than $1 billion for the same period. CSCO has a PE of 47 on a trailing twelve month basis and JNPR has a TTM PE of 236. It drops to 115 using estimated 2005 earnings if you are into forecasting the future. Obviously the roughly +$50 billion in market cap the Nasdaq gained on Friday as a result of JNPR earnings is a complete disconnect from reality. It is a result of investors hearing what they wanted to hear to justify their bullish view. Is that wrong?

If the economy is really growing as fast as the earnings guidance from everyone including JNPR has indicated then the gains are ok. My only question is what changed from the Intel, YHOO, QLGC, AAPL, SUNW earnings earlier this week? They said business was good, but not great. Guidance was positive just not overly optimistic. Those companies with the exception of QLGC are bigger than JNPR with a broader customer base. Why did their guidance not matter and Juniper's is so critical. It is simple. Investors were looking for a white knight to carry their flag forward. JNPR was the hero of the day and was rewarded with a +$7.00 jump in the stock price on volume of 76 million shares. The Nasdaq traded 2.6 billion shares with the average share gain of +0.81%.

In the rest of the world WCOM announced it was cutting another -1700 jobs on top of the -22,000 they have already cut. Home Depot restated its 2003 guidance to suggest the 4Q was a drag and that same store sales would be lower than expected. They raised earnings estimates slightly based on cost cuts and technology upgrades. They warned that growth in 2004 would be slower than previously expected and HD was going to cut its pace of new store openings.

Abbot Labs (NYSE:ABT) posted solid profits for the 4Q but warned that profits for 2004 would fall below estimates. JNJ dropped on Friday after several brokers issued reports predicting a dramatic drop in revenue. QCOM was downgraded by Morgan Stanley on fears the most optimistic of conditions were already priced into the stock. There were plenty of those Friday. Downgrades and warnings got very little air time with all press going to GE, we will grow in a couple years, and JNPR, no broad based recovery in sight, leading the charge upward. Cynical? No, but I find it strange how the market chooses what it wants to focus on based on the bias of the herd.

That herd trampled resistance on all but the Dow. The Dow managed to close .51 over 10600 and it did it after the close as final orders were settled. The Dow has now stretched its string of winning weeks to eight and a feat not seen since the rebound out of the October dip in 2002. The S&P also stretched its string to eight weeks and a streak not seen since 1998. The Nasdaq only completed six positive weeks but set a new 30 month high. The volume was very strong across the board with up volume 4:1 over down. Over 1000 stocks set new 52-week highs.

Was all this bullishness related to JNPR and GE? Not entirely. Friday was options expiration for January and much of the volume, like in December, was option related. Like I speculated on Thursday night it appeared that many option sellers who were trapped in December either rolled those positions over into January or reinstated new ones to recover December losses. The lack of the expected January dip buried those seller once again and the race was on to cover those shorts. After the initial opening dip on Friday there was a bid under the market all day and volume was very strong. Market on close orders were very large. The one thing I was watching was the lack of real movement. We watched the heavy volume flow through during the day but there was not any real price movement until after 2:PM. I have mentioned this before but it sure looked like there were a lot of sellers feeding stock to those that were short. I keep thinking we are seeing distribution on every bounce near the 10600 level.

We are at a critical point in this process. The Nasdaq has blown through the roof and is dragging the Wilshire with it. Both are over all critical resistance with plenty of room to run. The Russell is rocking and at 590 is only 24 points away from its all time high at 614. The retail investor is alive and well and they are buying small caps and techs like there is no tomorrow.

Nasdaq Chart- Daily

Russell 2000 Daily

Wilshire 5000 Weekly

That was the good news. The bad news comes from the Dow, S&P and SOX. Just like the little train that thought it could the Dow inched up to close .51 over 10600 after struggling since Jan-8th to move over 10590. By settling over 10600 after the close the Dow managed to avoid any sell programs trigging on that level and set up a potential gap open on Tuesday. Regardless of the open or any programs that appear the Dow is finally entering the critical resistance band from 10600-10650. This is the highs for 2002. The Nasdaq finally broke that same level at 2100 this week and is forging higher. Can the Dow equal this feat? That remains to be seen but investors have been eagerly buying every minor dip.

Dow Weekly Chart

The more critical index is the S&P because it is the favorite target of program traders. The S&P is rapidly approaching its 2001-2002 resistance highs at 1175. The S&P failed in the 1170-1175 range four separate times in 2001-2002. This is very strong support and it is looming in our path. Adding to this resistance is the 50% retracement level at 1161. Together this is going to be very tough to break. Timing is also going to be key. At an average of +7 points a day the S&P could hit 1161 in three days, 1175 in five. With the Nasdaq in breakout mode the techs in the S&P are helping this process. The wildcard is the Dow at 10600. Can it plow through those next 50 points of resistance with the S&P moving up even faster? Either way both should reach what I am going to call terminal resistance sometime near the end of next week if the trend continues. Earnings will be half done with most of the large companies already reported. The breakout over this resistance will have to come on the earnings from next week.

S&P Weekly Chart

The SOX is nearing the spot where it could become the Nasdaq anchor. It is nearing the highs from last week at 560 but still below the 2002 resistance from 618-642. The chip sector is up +166% from the 209 SOX low in Oct-2002, +116% from the Feb-2003 lows. Using any investing metric this is a very strong run. Analysts are increasing their caution about too much good news already priced into this sector. This is especially critical with news that Intel is going to spend less on CapEx in 2004 than previously expected. If this trend is system wide then chips could be in for a slowdown. Intel also said flash memory sales were flat. All cracks in the SOX foundation supporting an ever growing high. I am not saying it is going to crash but just suggesting the 600+ level could be tough to crack.

SOX Weekly Chart

So where do we go from here? Monday is a holiday and provides a shortened week where more than 35% of the S&P will post earnings. There is no way to list the hundreds of companies but the most notable for Tuesday are MMM, AMD, ACS, C, MOT and a dozen chip and networkers. Wednesday has EBAY, QCOM, SYMC and nearly 200 others. Thursday AMGN, ADP, EMC, TLAB, MSFT, T, EK, F, FER, NOK, PFE and over 200 more. Needless to say it will be a busy week. Will they tell us anything we do not already know? Probably not. The economic schedule is light with many filler reports but nothing earth shaking. That leaves us to trade on sentiment and stock news.

If the end of week rally was really option related again then Tuesday could be crazy as those expired option trades are settled. Traders waking up Tuesday with stock in their accounts that they did not expect or missing some they did not think would be called away will be scrambling to make adjustments. This is both a positive and negative impact to the markets and could provide heavy volume and heavy volatility without much actual movement by the close. We will also get to see if there are any program trades as a result of the Dow moving over 10600. The eight consecutive weeks of Dow gains will eventually end. The only question is when. For nine months the 50 dma has provided strong support as each streak came to an end and I suspect it will again.

Dow Chart - Daily

The keys to watch are the 10600-10650 level on the Dow and the 1160-1175 level on the S&P. Until those levels are broken any upside on non tech stocks could be limited. The bulls are in control and there are plenty of buyers waiting in the wings. Worry over the January-27th Fed meeting should not begin until late in the week and bonds are showing no fear. Enjoy the holiday because the rest of the week could be very hectic.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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