Option Investor
Market Wrap

The Moment of Truth

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      02-05-2004           High     Low     Volume Advance/Decline
DJIA    10495.55 + 24.80 10522.52 10453.55 1.96 bln   1703/1513
NASDAQ   2019.56 +  5.40  2031.39  2012.79 1.94 bln   1777/1423
S&P 100   559.61 +  0.74   560.81   557.41   Totals   3480/2936
S&P 500  1128.59 +  2.07  1131.17  1124.44 
W5000   10974.04 + 24.50 10998.18 10935.34
RUS 2000  569.54 +  5.51   570.90   564.03 
DJ TRANS 2833.59 + 11.50  2843.81  2821.76   
VIX        17.71 -  0.16    17.99    17.60
VXO (VIX-O)17.75 +  0.17    18.39    17.66
VXN        26.17 -  0.48    26.81    25.96 
Total Volume 4,230M
Total UpVol  2,365M
Total DnVol  1,809M
Total Adv  3900
Total Dcl  3376
52wk Highs  279
52wk Lows    18
TRIN       0.82
NAZTRIN    1.02
PUT/CALL   0.76

Friday morning at 8:30 AM is the moment of truth for the markets. At least that is what the talking heads were telling traders all day. It is important but like all things economic the outcome may have already been baked into the cake.

Dow Chart - Daily

Dow Chart - 30 min

Nasdaq Chart - Daily

Economics for Thursday put a little more fear into those who were worried about the Nonfarm Payroll report when the Jobless Claims jumped +17,000 to 356,000. This was the first time in four weeks that the number was over 350K. Last weeks claims were revised down -3,000 and analysts theorize weather was the depressing factor. Those snowbound in the prior week finally got out to make claims last week. Ironically the unadjusted claims decreased in 51 states and territories but the total number of weekly claims rose.

There are numerous conflicting employment components for the various monthly reports. Some show minor job growth, some show minor job declines. NONE show any significant improvement in job creation. Is this like the emperor's clothes? Nobody can see any jobs but everyone assures us they are there?

One analysis suggested that during the two survey weeks for the nonfarm payrolls continuing Jobless Claims fell by 116,000. The payroll survey is done around the 12th of the month. They were suggesting that this would translate into an increase in jobs of +125,000 tomorrow. Dow Jones is expecting +160,000, the street is looking for +175,000 and one analyst on CNBC was expecting +225,000. With estimates all over the map but up significantly from just a couple days ago we are poised again for a potential disappointment.

Last month the estimates were also in the same ranges and the number was barely positive at +1,000. Various Fed heads almost promised that those missing jobs would be found in tomorrow's number. This has setup the markets for another failure in confidence. At this point I am not really concerned due to the market action this week. I think cautious traders have already positioned themselves for the worst and are now hoping it is just not as bad as they expect. I think they would be relieved to just have a positive number again. Don't forget the Challenger Layoff report from Monday showed a +26% jump in announced layoffs for the month over the December levels.

With the Fed on hold due to the light GDP a blowout number could actually turn up the heat again. Any light number will just be seen as more slow growth and not a real problem. Should the number come in negative I would not only be very surprised but I would expect the market to react negatively.

The Productivity report for the 4Q rose by +2.7% according to Thursday's release. Maybe I should say dropped to only +2.7% growth since this was the slowest growth since 2002. The 1Q increased +3.1%, 2Q +6.1% and the 3Q soared +9.5%. The drop back to a realistic number simply showed that the rapid unsustainable pace of growth was just returning to normal. Hours worked rose while unit labor costs fell and this suggests manufacturing will not let price prevent any new hiring.

After several days of weakness the major averages managed to close in the green but it was not a stunning performance. The Dow closed under 10500 once again and the Nasdaq closed exactly on its 50 dma at 2019. Traders felt the Wednesday drop was significantly overdone but they were not confident enough to buy stocks before the Jobs report. WMT, HON, KO, IP and BA were the biggest gainers on the Dow and helped overcome losses by IBM. MSFT and INTC were down fractionally and MSFT suffered one additional embarrassment. PFE passed MSFT in terms of market cap pushing MSFT to 3rd place behind GE and PFE.

The CSCO depression continued in the big cap techs with CSCO falling to mid-December lows. INTC closed under its 100 dma and under $30. It was the lowest close since Oct-9th. Dell closed at 32.11 and the lowest close since August. Dell is well under its 200 dma at 33.34. With all the majors so severely under water it is amazing the Nasdaq is holding at the 50 dma. We have had two significantly down days on the 28th and again on the 4th. Other than those we have been trading sideways in a consolidation pattern. Treading water for all practical purposes. We still have strong emotional support at 2000 and we are at the uptrend average support that has held since March. The techs have pulled back to their strong support level on decent profit taking to await the jobs report. No big surprise there. Earnings have been good and there is nothing to prevent us from moving higher. Each bounce is sold but each dip is bought and this is the area where consolidation was expected. Just look at the Nasdaq chart above if you have any doubts about support.

The SOX has pulled back to its 100 dma at 495 and has held there for two days despite some continued slippage by several chip stocks. This is the key for the Nasdaq. The SOX has not touched the 100 dma since April 2003. This is a major sell off in semiconductors and this is the critical support level. We could see one more dip to horizontal support at 480 but that would be a major break that should be bought.

SOX Chart - Daily

The Russell-2000 also pulled back to its 50 dma at 564 and rebounded slightly. The Russell has tested the 50 dma six times since March and rebounded each time. This level needs to hold. If we suddenly get a break of the 50dma on the Russell and the 100dma on the SOX then it could be serious. Until that happens I am still in buy the dip mode.

Russell Chart - Daily

The Dow is consolidating nicely above the 10450 level and has been in the same range for six days. It is still above 10400 support and the 50 dma near 10300. We could easily move up from here or move down slightly with no real damage. The 50-day average has not been tested since Thanksgiving and any real dip could easily retest that 10300 level. The blue chips are holding up the techs and the small caps. This is exactly the reverse from the last two months where the small cap techs lead the charge.

We appear to be seeing a rotation from prior high risk leaders and into the defensive blue chips like drugs. Cyclicals like AA, IP, CAT, MMM and DE are being sold on worries that the recovery is slowing. Drugs like MRK, LLY, SGP and PFE are seeing a flood of money as defensive value stocks. They suffered during the recent rally in favor of the techs. Traders are simply rotating funds back into the defensive issues. SGP is at a six month high and PFE hit a new twenty-one month high today.

The good news is that this is normal for a new year but just a couple weeks later than usual. The last week of selling has been on significantly lower volume and it appears to be just a normal consolidation period. The next hurdle is the Jobs report on Friday. Regardless of the outcome there will be volatility. Those still wising to sell will probably use any good news to dump stocks. The odds of a sell the news event on are very good despite the results. Personally I think the odds of new job growth over 100,000 are very slim but what I think does not matter. The market will react to the number and how it impacts the recovery scenario and the chances of a Fed rate hike. Friday is immaterial to the larger scheme of things. Monday is the key day for me. How the market responds on Monday to any Friday event will tell us if the rally has any legs left.

If traders were focused entirely on earnings there would be no doubt of direction. Over 70% of the S&P have now announced and 67% have beaten estimates. 19% announced inline and only 14% have disappointed. This is very good! Overall earnings are now expected to be in the +27% range or better for the 4Q. This is the second highest in recent history with only 3Q-1993 higher at +30% growth. That quarter's results sent the Dow on a vertical ramp in the 4Q to nearly 4000 in January-1994. Once the 4Q earnings fell short of the miraculous 3Q results the Dow crashed -12% beginning in the last week of January to nearly 3500 by the end of March. It traded sideways for the entire year and did not reach 4000 again until February-1995.

If we could use this historical trend as a model it would suggest that the 1Q should ramp to the heavens as traders buy the chance for an even stronger 1Q-2004. Since the comparisons are harder for Q1 than Q4 the odds of a repeat are tougher. The majority of guidance for Q1 has been coming in higher and I suspect that has kept the market from falling under its own weight more than anything else. In about two weeks we will start to get the mid-quarter updates and the beginning of any earnings run for April. That makes the next two weeks very critical. If we can get past the Jobs report the economic calendar next week is fairly light. There is a flurry of reports but none are really important milestones.

The bottom line is don't let any negative Jobs commentary on Friday or any negative market reaction bother you. Wait for Monday and let's see how the market responds. If we drop on Monday then be worried. There is a lot of money on the sidelines looking for an entry point and Friday's market action could lure them into the game. The odds are good the Jobs outcome has already been baked into the cake and Monday is the real moment of truth.

Enter Passively, Exit Aggressively.

Jim Brown


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