Option Investor
Market Wrap

Conviction Test

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      02-19-2004           High     Low     Volume Advance/Decline
DJIA    10664.73 -  7.30 10753.63 10656.59 1.96 bln   1189/2040
NASDAQ   2045.96 - 30.50  2094.92  2045.96 2.07 bln   1128/2036
S&P 100   566.06 -  2.27   571.62   565.83   Totals   2317/4076
S&P 500  1147.06 -  4.76  1158.57  1146.83 
W5000   11176.92 - 60.40 11302.82 11174.80
RUS 2000  582.59 -  8.89   596.00   582.38 
DJ TRANS 2892.80 -  8.30  2933.37  2892.67   
VIX        15.80 +  0.21    15.97    15.20
VXO (VIX-O)16.90 +  1.16    16.90    15.46
VXN        24.24 +  0.51    24.55    23.16 
Total Volume 4,386M
Total UpVol  1,116M
Total DnVol  3,170M
Total Adv  2672
Total Dcl  4591
52wk Highs  507
52wk Lows    10
TRIN       0.88
NAZTRIN    2.25
PUT/CALL   0.72

Good earnings news breaking out all over but economics are not following the plan. The combination of these factors in an option expiration week turned into new highs and a strong drop from those highs. This created a test of conviction for those already long and a buying opportunity for those who still want to be long.

Dow Chart - Daily

Nasdaq Chart - daily

The fly in the ointment for investors was the Philly Fed Survey which dropped to 31.4 from 38.8 last month. This was the 8th consecutive month in positive territory but a major drop from last months high. The internal components were not exciting with New Orders falling to 27.8 from 36.5. Shipments fell to only 19.3 from 33.1. Back orders fell into the low single digits at 4.4 from 10.7 and was the second month of declines. Employment fell to only 12.5 from 17.5 and was also the second monthly decline. Prices paid rose to 43.7 from 35.3 and prices received jumped from 9.4 to 18.9. The picture was very clear. Orders, production and employment fell while prices showed a significant inflationary jump. The only really positive component was the jump in the average workweek to 23.6 from 12.9. This suggests companies are trying to make do with existing workers and at some point they will have to hire if hours worked continues to rise. Inventories also rose for the first time in five months. Could that have been on purpose or because sales suddenly shrank? The prices paid component reached a nine-year high and it was the seventh monthly increase. This trend was also seen in the NY Empire Survey earlier this week.

Jobless Claims fell more than expected to 344,000 and back under the 350K level again. However, claims for last week were revised upward by +5,000 to 368K. The four-week average rose to 352,000 and the highest level since December. The bad news here was a significant jump in continuing claims to 3.186 million from 3.08 million. Most analysts suggested the jump was weather related but I miss the connection. This report was a neutral for the market despite the minor relief bounce in the futures when it was released.

Leading Indicators rose by +0.5% and inline with expectations. Considering this number is composed of already released data from other reports including jobless claims, stock market and bond data is should be called the lagging indicators. Only five of the ten components showed any gains but this was the biggest jump since October. It is mostly ignored since the data is already old.

The biggest news of the day was old news and that was the AMAT/BRCM boost to the chip sector. The earnings news for the day was less than exciting. Wal-Mart said an excellent January pulled the 4Q out of mediocre territory and turned it into a double digit quarter. Wal-Mart said the holiday period was challenging and it had to result to deep discounts to move apparel. WMT posted 63 cents and inline with estimates and said strength in international sales and a resurgence at Sam's Club helped WMT meet expectations. CEO Lee Scott said 2003 was not a great year and he was much more optimistic about 2004. Sales for the quarter hit $74.49B. The bad news for other retailers was a new commitment to be the low price leader in 2004 and he reiterated they were not going to raise prices to increase profits.

Competitor Target beat the street by four cents and posted a 91 cent profit. Sales were only a fraction of Wal-Mart's at $15.57B but were inline with estimates. The better results were do to higher gross margins and improved product mix. Credit card operations added +$641 million in profits to the total. Considering how stores like Sears have been fleeing the credit card business this is remarkable.

After the bell today HPQ formally announced their earnings of 35 cents which they preannounced without warning last week. The market was less than impressed with the inline guidance. The number of companies reporting has slowed to a trickle but most are still beating estimates. These companies beat tonight, UVN +1, JWN +8, BEAS +1, OCLR +1, PTEK +1, SRNA +1. Unfortunately most guided inline with estimates or slightly down. The quality of companies this late in the cycle precludes much in the way of blowout guidance.

The conviction of those long was tested today after the Dow set a new 52-week high at 10753 and the Nasdaq came very close to 2100 at 2094. The worst performer was the Russell at -1.50% with the Nasdaq close behind at -1.46%. The Nasdaq closed down over -30 points after being up +17 at the open. The range of movement was nearly 50 points but the majority of it was down. After the gap open there was never a serious attempt to move higher for the Nasdaq but the Dow hit its highs as late as 2:PM.

The Dow gapped up to 10725 and after a brief pullback rallied to 10750 twice about two hours apart beginning shortly after noon. The Dow showed amazing strength until the crash but the Nasdaq and Russell bled points from the start. At 3:20 all the markets imploded with the Dow dropping nearly -80 points in just under 30 min. The Russell fell -8 points from 2:30 into the close. The initial selling in the small caps and techs with the Dow remaining so strong appeared to be rotation into the blue chips. I remarked in the monitor at the time that it appeared to be a rotation in progress and we could have a significant dip ahead.

The conviction part comes tomorrow. The Nasdaq has nearly completed another test of its 50dma currently at 2040 and that retest has come on the heels of a lower high. This is a bad sign and could suggest the retest may not hold on the initial try. There is still strong support at 2000 and the 100dma is rapidly rising to meet the price at that 2000 level. Currently the 100dma is 1980. Buyers with probably have their conviction tested again on Friday as those levels are targeted. Make no mistake this is a serious support test for the Nasdaq. A failure at 2000 could be very dangerous.

There are two wild cards in play here. The first is Option Expiration on Friday. This massive swing from new highs to retesting support on Thursday could have been the result of option positions being squared. The last two months we have had strong opex rallies and traders could have overshot for February and produced a negative bias to the settlements. This could continue through Friday.

The second wild card is the Dow. The Dow has not tested its 50dma since November. It is way over due despite the current bullish sentiment. Fear of a Dow correction could keep buyers on the sidelines until some stability appears. Fortunately for the Dow to retest the 50dma at 10439 it will have to break several levels of strong support at 10650, 10600 and 10550. This is not likely to happen in one day and may not happen at all.

The spark for the entire morning rally was AMAT and BRCM. Both opened much higher and then closed negative for the day. AMAT hit 23.86 at the open and closed at 22.14 and the low for the day. BRCM hit a high of $44 and closed at $41.56. The SOX hit a high for the month at 535 and then closed -20 points lower at 515. This was a huge reversal in the semiconductor stocks and it is no wonder the Nasdaq and Russell followed suit. The SOX closed right on its 50dma but that has not been real support. The SOX has performed better in recent weeks from the 100dma now at 501.

Semiconductor Sector (SOX) Chart - Daily

Russell 2000 - Chart

Late tonight the Semiconductor Book-to-Bill was released for January and it came in at 1.18 and a drop from the 1.23 final for December. This was the sixth monthly rise for semiconductor orders and the ratio would have been higher but shipments rose +8.2% compared to only a rise of +3.7% for orders. This is very good news for the sector but the late release of the numbers tends to be overlooked by most investors. This could slow any chip selling on Friday if it makes the headlines.

The bottom line to all this mumbo jumbo is that we are likely to see the Nasdaq/SOX take another dip down on Friday and that dip could continue into next week due to a lack of further catalysts for February. This is the buying opportunity that all tech bulls should be excited about. At least those with conviction for their position. If the afternoon downdraft was options related then the dip should be brief. However, the Nasdaq was the laggard all week and we need to see how it performs on Monday before making any judgment calls.

The only material economic report on Friday is the CPI and that is before the market opens. As a trader tonight I would suggest not opening any new long positions until Monday. Option expiration Friday's are usually wild and crazy at the open followed by total boredom. With the potential for more selling and the ever present weekend event risk I would wait for Monday to go bargain shopping. Even then it could be risky because next week is filled with economic reports that could mimic the Philly Fed today. This is a risky period for February but any weakness should simply be more consolidation in the current range. You are going to get tired of hearing that but until the range breaks it is still true. The range on the Nasdaq is still 2000-2100 and 10450-10700 on the Dow. Take Friday off and make it a three-day weekend. Come back next week ready to pick up some bargains at a discount.

Enter Passively, Exit Aggressively.

Jim Brown


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