Option Investor
Market Wrap

Al Qaeda Expiration

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      03-18-2004           High     Low     Volume   Adv/Dcl
DJIA    10295.78 -  4.50 10328.82 10214.15 1.57 bln 1389/1724
NASDAQ   1962.44 - 14.30  1972.31  1947.31 1.66 bln 1431/1787
S&P 100   550.69 -  0.79   552.44   546.32   Totals 2820/3511
S&P 500  1122.31 -  1.44  1125.50  1113.25 
W5000   10960.56 - 20.30 10990.90 10875.18
SOX       480.66 -  6.40   578.57   569.23
RUS 2000  574.55 -  4.02   578.57   569.23 
DJ TRANS 2830.92 - 16.70  2850.50  2813.10   
VIX        18.53 +  0.42    19.23    18.35
VXO (VIX-O)18.62 +  0.48    19.65    18.18
VXN        24.58 -  0.17    25.36    24.32 
Total Volume 3,569M
Total UpVol  1,222M
Total DnVol  2,277M
Total Adv  2928
Total Dcl  4004
52wk Highs  255
52wk Lows    33
NasTRIN    1.72
TRIN       1.15
PUT/CALL   0.80

News that the number two man in the Al Qaeda organization may expire along with March options lifted the markets off their lows and back to the highs for the week. The rumors were flying fast and the market makers earned their money today keeping the SPX under 1125 and guaranteeing the most SPX options would expire worthless.

Dow Chart - 45 min

Nasdaq Chart - Daily

SPX Chart - Daily

Pakistan announced they were in a major battle with Al Qaeda and the tribesmen supporting them and they thought they had a high value target surrounded. The rumors were flying as to what high value target it might be and the latest word was Ayman al-Zawahiri, the number two leader was trapped. The fight was centered around a very heavily fortified area that the military said had been built to withstand a military attack. The military said over 200 heavily armed defenders were surrounded and they were going to bring in air power at dawn Friday to finish them off. It may be some time before we really know who is under the rubble.

Fortunately the news came just in time to prevent a market melt down as the indexes were accelerating into a decline just after 12:00. The economic news had been less than encouraging with the exception of Jobless Claims. New claims for last week fell to 336,000 and the lowest level in three years. Also encouraging is the week of the month this report represents. Last week was the survey week for the monthly Jobs Report and that suggests we could have an improved jobs number for March.

The PPI for January, yes we finally got it, showed prices jumped twice the amount expected at +0.6% but the majority of the increase was in energy. Gasoline prices were up +14% in January. This was old news and traders breathed a sigh of relief that the long awaited report, delayed due to a new method of accounting, was not substantially worse. Prices rose on capital equipment, vehicles, construction equipment and aircraft due to higher demand. Nobody is going to complain about that. The only category with lower prices was foodstuffs brought on by the Mad Cow panic in January.

The Conference Board Leading Indicators was unchanged for February and less than expected. The lower than expected number was caused by a drop in sentiment. This information is produced from previously announced components so the market tends to ignore it.

The biggest negative for the day was the Philly Fed Survey which dropped to 24.2 for March from 32.4 in February. This was not exciting news. While it still shows an increasing level of manufacturing there was a substantial drop in several areas. New Orders fell to 21.9 from 27.8 and suggests a slowing in the buying process. Inventories fell back into negative territory at -12.8 from +0.8 last month. Unfilled orders rose to 8.8 from 4.4 and delivery times rose to 19.0 from 7.2. This is confusing as you would think a drop off in business would speed up the delivery process. Because of a shortage of inventories in the entire system it could suggest a shortage of new components and raw materials. Adding to this theory was a drop in the average workweek to 17.9 from 23.6 and a minor drop in employees. Prices paid jumped +10 points which also suggests higher demand for raw materials. The biggest component drop was in the six-month outlook which fell to 36.7 from 51.4. That is a -14 point drop! This report was a shock for traders but it was still a positive report. Only the inventory component was negative. The still positive headline number means manufacturing activity is still increasing but only at a slower pace.

The last report was the FOMC minutes for the January meeting. The minutes were fairly calm except for fears of a potential deflationary enemy. The minutes said "In the view of many, some modest further disinflation appeared to be the most likely prospect." That feeling still persists in the recent meeting announcement where they still gave the nod to a potential deflationary scenario as having the highest risk although the risks were "roughly equal". They were still expecting "faster growth in employment" but so far that has been an elusive goal. There was some concern about the potential health of the economy in the second half of 2004 once the tax cut stimulus (refunds) ran their course. The concern was a slowing of demand and potential problems in the consumer area. I do not see any rate hikes any time in the near future based on their valid concerns for lack of robust and continued growth.

The uncertain and contradictory economics along with option expiration produced a day that opened with a negative bias after two days of strong gains. Traders started out taking profits and the negative Philly Fed report accelerated that trend. The Dow had fallen to 10214 from yesterday's 10305 close when the rumors hit the wire. Within 30 min the Dow was back to the high of the day at 10328. Most of that was in three candles as traders rushed to cover their shorts. Once the burst of news was over and it was determined that Bin Laden was probably not in the area the excitement begin to fade with the indexes pulling back to support to await a Pakistani update. When the 3:PM bell rang and there was no further drops and no further news those still short began pondering their fate if a surprise announcement hit the wires overnight. Shorts began to cover once again and the Dow jumped +60 points into the close.

The Nasdaq followed the same pattern as the Dow only it never returned to yesterday's levels. 1970 remained the current resistance level. This was frustrating to traders because Merrill upgraded the semiconductor sector before the open to overweight. The SOX made it to positive territory but could not hold it and ended down -6 for the day.

The real challenge for the day was not the news, economics or al Qaeda. It was option expiration week. Those who bought the bottom on Tuesday took profits and closed those option positions at the open and then paused to determine direction. With the Nasdaq hovering right in the middle of its range for the last six days it was tough to decide what direction we were headed and everybody waited on the sidelines.

This was complicated by the max pain points being at the high end of our ranges. The SPX max pain point was 1125 and we have stopped dead on that level for two consecutive days. When the al Qaeda spike hit at 1:15 the S&P futures ran to exactly 1124.80 and stopped dead on huge volume. The short covering rally at the end of the day also stopped at 1124.80 on large volume. Market makers had a serious desire to keep the SPX pinned under 1125 and despite the monster news spike they managed it beautifully. Now they have to hold their breath overnight and hope there is not any news before tomorrows open to upset their plans.

Despite the market weakness today, regardless of the cause, there was not any serious problem with stocks. Microsoft was knocked for a minor loss at $24.89 after they announced settlement talks with the EU had broken down. The EU is set to hit MSFT with a fine in the hundreds of millions of dollars after Microsoft refused to make certain changes to Windows. Microsoft said it planned to appeal any ruling in court. A court case could take years to even come to trial and an EU order could force the Microsoft make changes in a matter of months. The EU is demanding that Microsoft sell a discounted version of Windows that does not contain Media Player so that rivals like RealNetworks and Apple have a chance to sell their products. They are also likely to require Microsoft to make their code available so other companies like SUNW can integrate their software into Windows. Microsoft only lost -24 cents on the news but it did close at a new multi month low.

We are actually seeing some bullish things shaping up for the current quarter. We are continuing to see companies post good earnings. Adobe earnings tonight were a prime example. They posted earnings of 50 cents when analysts were only expecting 40 cents. They earned a record $423 million and a +43% increase over the same quarter last year. Shares were up +$2 in after hours.

This continued trend of better than expected earnings and better than expected guidance, except for Intel, continues to raise the expectations for the first quarter. We are right in the middle of the regular warning cycle and to date we have not had any major confessions and very few minor ones. The quarter is shaping up to be outstanding. The low interest rates should continue, possibly for the rest of the year. All we need is for the economy to catch fire.

Countering the bullish thoughts above there is a growing crowd of analysts that are worried about the 3.7% yield on the ten-year note. They claim this is a number that could be telegraphing economic problems ahead that may include another recession. Some people would complain if you hung them with a new rope. There is also the news making the rounds again today that Japan may quit buying bonds to weaken the Yen. They budgeted $100 Billion for that in the first quarter and they have already spent $45B and have twice this week floated the trial balloon that they were rethinking their policy. This could impact rates, the dollar and the equity market. While everyone agrees the economy really needs to be growing faster they also agree it is growing and eventually it will heat up. We still have not seen the impact of the massive flood of income tax refunds that should be hitting mailboxes soon. Large refunds, low interest and spring weather should provide a boost to the economy for the second quarter.

The challenge over the next several weeks is to rebuild the bullish sentiment in the market. We suffered a huge sentiment blow over the last two weeks. While the drop to date was only a garden variety profit taking dip any further drops from here could be serious. This coming week is going to be pivotal. We will either move higher and begin battling to recover lost ground or we are going to head for the next lower support level. The odds are very good we are NOT going to just continue trading sideways. We are clearly going to have some volatility at the open as the index options settle and probably some news event movement as well. The rest of the day may expire peacefully.

Moving into next week we will not have the options weight hanging over our head and will be free to move without restrictions. One thing is clear, even with the news event spike today the volume was terrible. Only 3.5B shares traded across all markets. This is almost holiday volume and the second consecutive day under 4B. We need a catalyst to get things going again and I do not see anything on the horizon. There are no material economic reports until next Wednesday so we will be left to focus purely on stocks. Friday may not be a stellar day to jump into a position due to all the conflicting forces. Finding somebody important in the Pakistan rubble could provide the stimulus for a short term breakout but there is also the possibility that after today much of the news has been baked into the cake.

Enter Passively, Exit Aggressively.

Jim Brown
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