Option Investor
Market Wrap

Fear Factor!

Printer friendly version
       WE 03-26        WE 03-19        WE 03-12        WE 03-05 
DOW    10212.97 + 26.37 10186.6 - 53.48 10240.1 -355.47 + 11.63 
Nasdaq  1960.02 + 19.55 1940.47 - 44.26 1984.73 - 62.90 + 17.81 
S&P-100  543.52 -  0.16  543.68 -  6.24  549.92 - 18.53 +  3.91 
S&P-500 1108.06 -  1.68 1109.74 - 10.83 1120.57 - 36.29 + 11.91 
W5000  10840.18 - 12.80 10852.9 -115.20 10968.2 -346.24 +141.50 
SOX      479.25 + 15.90  463.35 - 21.75  485.10 - 19.15 +  1.99 
RUT      572.92 +  2.18  570.74 - 12.10  582.84 - 16.70 + 13.98 
TRAN    2835.90 + 49.07 2786.83 - 76.26 2863.09 - 29.98 -  9.12 
VIX       17.33 -  1.82   19.15 +  0.85   18.30 +  3.82 -  0.09 
VXO       17.21 -  1.95   19.16 +  0.44   18.72 +  3.92 +  0.04 
VXN       23.04 -  2.95   25.99 +  0.69   25.30 +  3.22 -  0.79 
TRIN       0.89            1.93            0.44            1.40 
Put/Call   0.77            1.03            1.05            0.79  

Was it the end of the bounce or just fear of weekend event risk that sent the indexes plummeting at Friday's close? We will have to wait for Monday's open to tell if the highs set Friday afternoon will be surpassed. Considering the big gains from Thursday a simple positive close would have been bullish and it looked like a sure thing until 3:PM. Traders capped a very boring consolidation day with a dramatic plunge back to negative territory. Sounds bad but it wasn't despite what the talking heads said. The indexes ended down only single digits and the bulls will gladly take a single digit loss for every triple digit gain.

Dow Chart - 180 min

Nasdaq Chart - 180 min

For what it is worth the economic calendar on Friday was relatively light. The Personal Income for February rose by +0.4% compared to estimates for only +0.3% with upward revisions in several components for January. This report was generally positive although spending slowed to its lowest rate since October. Savings were up +1.9% and that is a product of weakening consumer sentiment in February.

The final Michigan Consumer Sentiment for March was also released and it jumped to 95.8 from 94.4 in February and recovered from a weaker initial number two weeks ago. This could be seen as a consumer rebound now that the economy appears to be getting over its February blahs. The initial campaign blasts are history and voters are beginning to glaze over with the claims and counter claims. Jobs still appear to be getting stronger and there was no follow on to the Madrid attacks. Americans have a very short memory when it comes to things happening outside the country and this jump in sentiment proves that. The majority of the gains were in the present conditions component which jumped from 103.6 to 106.8 while the future expectations component was barely changed at 88.8 from 88.5. That expectations component is down from 100.1 in January but as I have said before it is likely due to candidates trashing the economy in their speeches.

There were a couple of notable stock events on Friday and one was the jump in GE stock. GE rose $1.25 intraday after a Merrill Lynch analyst put the stock on its Focus One list. He said the pressure on the stock over the last several weeks was artificial due to acquisition pressures. GE issued nearly $4B in new stock on March 8th to cover the Vivendi acquisition and stock has trended down almost daily since then. That was not the extent of the problem. GE has also agreed to buy Amersham for $9.5B in stock and that deal is expected to close on April 8th. The Merrill analyst said that up to 50% of the Amersham stock, representing about 150 million GE shares, is in the hands of arbitragers. He expects about 15 million shares of GE to be shorted daily for the next two weeks as the arbitragers continue to hedge their Amersham position.

If you owned a share of Amersham stock worth $30 today and you were going to be given a share of GE stock in two weeks for every share you owned then you have the risk that GE stock will decline during that period. Since the acquiring company normally declines as the exchange date approaches you can hedge your long position by shorting the GE stock. If it was worth $30 at the announcement and you short it at $30 then you don't care if it drops to $25 before the exchange. You get your new GE share at $25 in exchange for your Amersham share and you cover your short at the same time on the market. You now have a GE share at $25 and $5 in cash and odds are good your GE will now rise with the acquisition pressure off.

What surprised everyone was the +$1.25 jump intraday. With the 150 million share overhead supply the upgrade from Merrill probably caught a lot of shorts unprepared. If the stock was going to move up over $30 then they don't want to be hedged with shorts. See the problem? 68 million shares of GE changed hands and while existing shorts were running for cover those that wanted to short higher were eagerly jumping on the wagon. The stock ended up only 40 cents but there was plenty of excitement.

On the Nasdaq the big winners from Thursday were the losers on Friday just as you would have expected. The majority of the losses occurred at the close and appeared to be just normal profit taking. The biggest weakness for the day was the Semiconductor Index which remained positive for only about 30 min at the open and was weak the rest of the day. The index tried to make a run to positive territory at 4:15 but closing selling quickly sent it to the low of the day.

The Russell was by far the strongest index with the small caps leading the charge from the opening bell and never looking back until the profit taking at the close. The Russell rebounded to 575 before stalling and that is almost exactly the resistance level where it failed the prior week. The Dow rallied to 10250, also the beginning of last weeks resistance and tried valiantly to break out but was unsuccessful. The Nasdaq rallied to 1977 and only three points below the 1980 resistance I mentioned on Thursday night.

This is exactly what I hoped would happen only I wanted the indexes to close in positive territory. The closing profit taking was sharper than most expected given the intraday gains. We wanted to move closer to resistance and be prepared for a continuation move on Monday as end of quarter window dressing increases. Those bulls faced with rising indexes Friday afternoon were pleased to see the closing drop. In hindsight I think we cleared some intermediate sell stops on the afternoon bounce and the drop at the close set us up for a better entry point on Monday. The bullish viewpoint is looking for window dressing, expecting quarter end fund flows and the potential for positive economic reports to convince investors the economy is growing and the correction is over. That requires faith and it is just one viewpoint. It also may not be a long-term view and just a potential a trading bounce.

If that was the bullish case there is also a bearish side. The bearish side is more technical and would point to all the critical resistance levels ahead. The bears would see the negative close as lack of follow through and evidence that the resistance levels will hold. I put those resistance levels on the charts below and you can quickly see that moving higher will not be that easy.

Current resistance levels and Friday's close:

Resistance - close
Dow 10300 - 10219
Nasdaq 1980 - 1962
NDX 1430 - 1419
S&P 1120 - 1108
R2000 575 - 572
SOX 490 - 480

Nasdaq Chart - 45 min

Dow Chart - 45 min

S&P Chart - 45min

SOX Chart - 45min

Russell Chart - 45min

NDX Chart - 45min

The bulls expect the market to move up on Monday and I would agree with that analysis as long as we have no weekend events. I think the end of quarter window dressing and fund flows will help start the week with a positive spin. I also think the potential for a positive jobs report on Friday will give us a positive bias. The problem remains the resistance just overhead and the barrage of economic reports midweek. The market has been short term oversold and the rebound on Thursday remedied that and the intraday bounce on Friday was definite follow through in my view. I expected selling into the close, just not so severe. It is that weekend fear factor that caused profits to be booked.

I have netted out the opposing viewpoints above with this scenario. I could see a positive Monday as we again test resistance. That sets us up for the real test. There will be no specific need to sell as the profit taking already occurred on Friday. If we get to those resistance levels above then we will see if the rebound has legs. Another positive jump in Consumer Confidence on Tuesday could help build investor confidence but the NAPM, PMI and Factory Orders on Wednesday will have to confirm. Holding at resistance until those Wednesday reports will be tough unless the rally is real. If the bulls have decided the bottom is behind us then all of this will be mute and we will forge ahead regardless of the news. Even then the bulls have an uphill battle ahead and it is not going to be easy.

Thursday and Friday will be critical turning points with the ISM and Jobs. The consensus estimate for the ISM is only 60.5 and that would be the second consecutive monthly decline. A better than expected ISM number might really help quiet the bears. The Jobs report on Friday is expected to produce 100,000 jobs and after seeing estimates trounced soundly for the last several months the pundits are being very quiet. Eventually we are going to see a change in this number. We have had positive job creation for the last six months despite the actual numbers being lower than expected. While a 100K gain would sure make politicians breath better a negative number would not be a disaster. We have put up with the less than expected news and the outsourcing debate for so long that a slightly negative number would not be the end of the world. Remember the drastic drop in the Mass Layoff report, the better than expected Help Wanted Index and the continuing downtrend in Jobless Claims? They could actually be signaling a real improvement in jobs. This is what investors will be hoping for as they decide to buy or sell stocks at resistance next week.

There was a new threat beginning to appear on the horizon that investors will eventually have to face. The Fed fielded six speakers this week and more than one analyst saw the implied warning in their speeches. The subtle new message starting to creep into the tone of their words is "rates have been too low for too long." They have not come right out and said there is a change in the wind but they appear to be prepping the bond market to be ready. Bonds saw their biggest one-day drop for the month on the new Fed tone.

We are at a critical turning point. A move over these resistance levels next week for whatever reason would be very bullish. We could see some strong short covering and the improvement in bullish sentiment could drag buyers back from the sidelines. We have seen the bearish sentiment surge over the last three weeks as it does with every correction. The gloom and doom preachers are trotted out for every news program to do battle with the perma bulls. The bulls have the opportunity to send them back into hibernation for several more weeks if they can only break through last weeks ceiling. We have ringside seats to the greatest show on earth and next week could signal the direction for weeks to come. Is the correction over or just getting started? This week should provide the answer.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


Market Wrap Archives