Option Investor
Market Wrap

Two Out of Three

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       WE 01-23        WE 01-16        WE 01-09        WE 01-02 
DOW    10568.29 - 32.22 10600.5 +141.62 10458.9 + 49.04 + 85.18 
Nasdaq  2123.87 - 16.59 2140.46 + 53.54 2086.92 + 80.24 + 33.54 
S&P-100  565.41 +  0.69  564.72 +  8.17  556.55 +  6.56 +  7.21 
S&P-500 1141.55 +  1.72 1139.83 + 17.97 1121.86 + 13.38 + 12.21 
W5000  11156.78 + 40.74 11116.0 +187.04 10929.0 +151.14 +115.48 
RUT      596.14 +  5.73  590.41 + 15.21  575.20 + 14.35 +  5.75 
TRAN    3072.94 + 36.66 3036.28 + 47.34 2988.94 - 19.22 +  8.49 
VIX       14.84 -  0.16   15.00 -  1.75   16.75 -  1.47 +  0.83 
VXO       14.87 -  0.40   15.27 -  0.67   15.94 -  2.00 +  1.36 
VXN       21.27 +  1.03   20.24 -  2.77   23.01 -  1.50 +  0.56 
TRIN       1.15            0.47            1.63            1.01   
Put/Call   0.77            0.51            0.65            0.76   

Two of the top three indexes broke their long running winning streaks. Two of the three busiest weeks in the earnings cycle are now over. While these milestones are noted in passing they have no real impact on our market direction next week. If anything it takes the pressure off the Dow to keep the streak going and gives dip buyers an entry point.

Dow Chart - 120 min

Nasdaq Chart - 60 min

The only economic report on Friday, the ECRI Weekly Leading Index, saw the projected six month growth rate rise to +9.6% after two weeks of declines. Almost all of the index components rose but the +12% gain in mortgage applications had the biggest impact. The strength of the internals suggest that the last two months of sluggishness in the index may be coming to an end. A problem for next week was the huge spike in the ten year note yields on Friday to 4.06% from Friday's low of 3.91%. That may not seem like much but the morning low was a four-month low. The bounce was due to some option expiration worries and news that the G7, meeting Monday, could warn the ECB to reel in the soaring Euro. The prospect of intervention in the currency sent bonds into a spin and helped take stocks with them.

In stock news the merger mania is alive and well. Regions Financial (NYSE:RF) and Union Planters (NYSE:UPC) agreed to merge in a nearly $6 billion transaction and create one of the largest banks in the Southeast. It was said this was an offensive strategy to better compete with STI, BBT and WFC in the region. It could also be a defensive strategy to make them less desirable of a target for a big bank to acquire. There was no premium on the deal for UPC which was the acquired entity. UPC was started in 1869 during Civil War reconstruction. They must have seen the bank Yankees from New York coming over the hill to surrender to RF without any recruitment fee. Analysts liked the deal as both stocks rose strongly on the day.

The Dow positive string was broken after eight weeks and the Nasdaq string was stopped at six. The S&P is still alive and celebrated its ninth straight week of gains. The gains are being fueled by massive amounts of cash flowing into mutual funds. The S&P is greatly supported by contributions to index funds which do not try to time the market but just invest the cash when it arrives. TrimTabs said $11.5 billion flowed into funds in the first eleven days of January. This was the second highest rate on record with $16 billion in early February 2000 the existing record. AMG Data said $5.6 billion flowed into funds for the week ended Wednesday. This flood of cash always trails market performance. We had a great earnings run that pushed the Dow back over 10,000 and the flashing alert light went on in homes across the country. That triggered the continued flood of cash and until that cash shrinks to a trickle the rally will continue. There is no shortage of cash on the sidelines. Some analysts now estimate that there is as much as 10% cash reserves now in many funds. They are waiting to see what will happen when the winning streak ends before putting all of the inflows to work. With seven trillion dollars in equity funds that is a lot of money regardless of how little you think they are hoarding.

Friday's market action did not play out as expected. The tech stocks traded down overseas but our futures rallied before the open and gave us a gap open instead of the gap dawn they were indicating late Thursday night. No problem, we will always take a gap up rather than a gap down. Unfortunately it did not last long and after taking one more shot at 10650 the Dow rolled over and led the broader markets down all day. The Nasdaq tried valiantly to reach for the sky on the better than expected semi earnings but could only make it to 2138 before following the Dow into the depths. The Nasdaq managed to close in positive territory thanks to a strong rebound off 2110 in the last 20 minutes.

The S&P broke 1150 and it's nearly two year high once again and struggled to hold near that level but the diving Dow finally sunk it. This is a very tough level for the S&P with 1152 a 50% rebound from the October-2002 lows. 1161 is a 50% retracement from the Jan-2000 to Oct-02 drop and 1173 is the 2002 resistance highs. Very tough territory for the S&P.

The strongest index was still the Russell-2000 which closed up +4.41 at 595 thanks to a really strong end of day bounce. The low was 589.92 but the key was the close. It was only .77 below the high for the day. Very strong performance and proof that the retail investor is alive, well and buying the dips with a vengeance despite the very extended indexes. 600 is still very strong resistance and 606 was the all time closing high. Both could be tough levels to break.

Russell-2000 Chart - 120 min

Microsoft recovered from the bad-mouthing drop Thursday night to spike to a two month high and ended the day up +.47 cents. Volume was 127 million shares. Intel, which should have benefited from Microsoft's prediction of double digit PC growth for the first six months closed only fractionally positive but off its lows. KLAC had great results but got knocked for -2.21 loss. This helped accelerate the $SOX drop which began Wednesday morning. The SOX closed at 526 and well off the high for the week at 558. That is nearly a -6% drop in three days for a sector that has been giving positive guidance and had a book-to-bill number last Monday of 1.20, the highest level since July-2002. This is proof that profit taking sometimes occurs despite good news.

Next week is going to be tricky. Monday is a very light day economically but we have the FOMC meeting on Tue/Wed and a strong economic calendar the rest of the week. We have already seen 1/3 of the Dow stocks report and we get another 1/3 next week. Another 143 S&P companies also report earnings. This is a very busy week but the two key points are the Fed announcement on Wed and the GDP on Friday. As I said on Thursday the Fed may take the opportunity of low bond rates and a high stock market to adjust their bias statement and traders could be very cautious into that announcement. The threat of an ECB rate cut could actually be a wild card that could cause a 1/4 point rate hike to show cooperation. While almost nobody expects that the news report on Friday put the possibility in traders minds. The bond market imploded on the potential sending yields soaring. Everyone expects this meeting to be a non event but the rumors are flying. Greenspan will speak in London on Monday and there is always risk when he speaks to an international crowd. With Howard Dean suggesting he be fired there is always the risk Greenspan uses his oratory skills to reinforce his current clout.

The other fear is the GDP. I say fear because the GDP expectations are getting out of line. With the ECRI Index showing a growth spurt to +9.6% Friday it just provided more fuel for the GDP whisper number. This could be a big disappointment. On Thursday I suggested a hot number would prompt Fed action and disappoint the markets. The current official estimate is +4.5% and the whisper number +6.5%. The best case would probably be something in the +5.1% range that would be neutral to everyone.

The roadmap is clear but the road may be rocky for the next five days. The market conditions are still strong with advancers BEATING decliners 3916 to 3414 despite the Dow and S&P turning in negative performances. Volume was almost perfectly split between up (2.23B) and down (2.31B) and it was still strong although about -10% from the prior levels this week. This suggests that the Dow drop is just a normal pullback on profit taking.

If the markets remain bullish the Dow now has breathing room of nearly -100 points from the weeks highs. This will allow some room to consolidate and give dip buyers an entry opportunity if desired. Resistance remains 10650 and support at 10500 then 10400. This is a no risk range for the Dow in front of a rocky week. Plenty of room to wander without having to take out any critical levels. The Nasdaq is in the same shape with resistance at 2150 and support at 2085. That 65-point range will take some of the stress out of trading techs.

The key levels are still 1150-1160 on the S&P and 600 on the Russell. Those indexes are still close enough to test those resistance levels and if broken the other indexes would be quick to catch up. My market view for next week would be flat to down Mon/Tue with Wednesday's close dependent on the Fed meeting. Beginning Thursday I am expecting a cautious uptick in anticipation of a positive Jobs report the following Friday. I say cautious because of the GDP time bomb. It could be very bullish, very bearish or a dud. Once that report is over we will review the outlook for the following week. This could be the busiest earnings week for this cycle and there will be no shortage of stock news. The better earnings tend to be reported earlier in the cycle so there is a potential for a few more disappointments. I do not think it will matter. Investors already have their minds made up and they are not going to learn anything new. We are in a momentum market and according to the internals there is no slowdown in sight. That could change abruptly the first time a big dip fails to rebound. Keep those parachutes handy.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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