Option Investor
Market Wrap

Bullish Close

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       WE 04-23        WE 04-16        WE 04-09        WE 04-02 
DOW    10472.84 + 20.87 10451.9 +  9.94 10442.0 - 28.56 +257.62 
Nasdaq  2049.77 + 54.03 1995.74 - 57.12 2052.86 -  4.31 + 97.15 
S&P-100  556.80 +  1.86  554.94 -  1.18  556.12 -  1.98 + 14.58 
S&P-500 1140.60 +  6.03 1134.57 -  4.76 1139.33 -  2.48 + 33.75 
W5000  11150.42 + 72.34 11078.1 - 87.98 11166.1 - 36.36 +362.24 
SOX      487.98 +  7.84  480.14 - 31.64  511.78 -  2.08 + 34.61 
RUT      590.71 +  7.34  583.37 - 14.51  597.88 -  5.57 + 30.53 
TRAN    3001.71 + 62.24 2939.47 + 12.59 2926.88 - 39.78 +130.76 

The markets closed at the high of the day, the day after a big gain and in front of a weekend. The Dow recovered all of its losses for the week and gained ground for the second consecutive week. The Nasdaq recovered 54 of the 57 points lost the prior week. It was a bullish close on the surface but the internals painted a slightly less bullish picture.

Dow Chart - Daily

Nasdaq Chart - Daily

Russell 2000 Chart - Daily

The only economic report on Friday was a bullish blowout with Durable Goods soaring +3.4% in March. This was a major win for the bulls with the headline number seven times the consensus estimate of only +0.5%. Not only was March a strong jump but February was revised up to +3.8% from +2.5%. The only component losing ground was communications equipment and that is no surprise to anyone. That component tends to be highly volatile with monthly swings from +46% to -64% in just the last five months. Headline orders hit their high for the year and completely erases any fears that economic growth may have peaked earlier in the quarter. Demand is now growing at better than a +10% pace over the year earlier period. Considering the good March number and the revision to February this was a very strong report.

The strong Durable Goods rekindled the rumors that we could see a rate hike in May and bonds sold off once again. The dollar rose on the economic strength and will eventually put more pressure on earnings for international companies.

The Fed mounted a solid front with multiple comments from different Fed heads. Moskow said "it is a question of timing as to when rates will actually rise". He added that the Fed has the luxury of being more accommodative in contrast to previous cycles. Analysts were quick to compare 2004 with 1994 when the Fed raised too quickly and tanked the bond market. Broaddus also made similar comments suggesting the Fed was not unduly concerned with inflation. He commented that jobs were likely holding onto gains and suggested we would see more gains in the May Jobs report. Broaddus also said he did not expect strong growth the remainder of the year but gains in the stock market would help spending. Fed Vice-Chairman Roger Ferguson said the deficit was not as troublesome as some recent news articles have suggested. This was in advance of the G7 meeting and he said the prospects for the U.S. economy as a result of the deficit were "not as apocalyptic as the ones you imagine." All of the commentators echoed the "disinflation risk has passed" refrain.

Bernanke was the most constrained of the multiple speakers saying that labor market slack and high productivity growth would restrain inflation. He said he still felt the recovery was tentative. "Although the labor market appears to be sitting up and taking fluids, it has not hopped out of bed and begun a round of jumping jacks." Bernanke also repeated the "timing of rate hikes are dependent on the speed of the recovery" mantra. It almost appears the Fed is not planning on raising but are planning on a constant verbal onslaught to make us think they are. If they warn enough they hope the shock of the actual hike will be minimal because the market will have already priced it in.

It all boils down to whom do traders believe. Are they going to believe the Fed has the luxury of waiting or will they lean in the direction of hike first wait later. I mentioned on Thursday that Wayne Angel was talking about a 50 point hike in May. While I don't think there is anybody who believes that is possible the cloud remains. The May Fed meeting is only six trading days away and the chance for a blowout rally before that meeting is slim. Institutions will want to be cautious just in case.

The fund flows for the week came in at +$3.3B and marked a strong pattern change for a post tax week. One reader said a Schwab representative had commented about the strong cash inflows into brokerage accounts over the last couple weeks. I am beginning to believe that not only have the planets aligned in the bulls favor but they have been super glued in place.

Microsoft gapped open to $27.50 on their strong earning Thursday night and held that level all day. Bill Gates was rewarded with a nearly $2B increase in his net worth based on the number of shares he is currently holding. Not a bad days work. The real key is what next? Will it continue to hold this level or shrink back to the $25.50 range it has traded for the last month? I would be thrilled to see it fill the gap back to $25.50 so I can buy some. I think the bad news is mostly over for Microsoft and they will make a big announcement before the July analyst meeting. It could be a very large one time dividend or just a highly increased dividend rate. Either way shareholders should reap a large benefit. I am betting against any material acquisitions due to the continued antitrust concerns. Symantec would be the only high visibility takeover target on my list. They could buy SYMC and have $40 billion left over and they need a quality virus solution.

Microsoft may be about to get another windfall from an unlikely source. Google is expected to announce its long awaited IPO next Thursday and rumor has it that Microsoft has been a long time investor in Google. The IPO is expected to raise over $20 billion and would immediately push Google ahead of Amazon in market cap. It will also be a windfall for the two 30 yr old founders of the company. No financial info is known about Google but analysts now guess revenue is nearing $1 billion a year. You can see why YHOO and AMZN are jumping into the search engine business.

Amazon did not jump into anything except trouble with its earnings report on Thursday night. The stock sold off on Friday to the tune of -2.57 but don't fret over the current holders. That is still above its Wednesday's close. I am a diehard Amazonian and while I think the concept will continue to improve I would hesitate to jump into the stock at this level.

EBAY, the ranking Internet gorilla, gained +8 on Thursday to a new all time high of $83. It managed to hold most of that on Friday with a close just over $82. I am also an avid EBAY trader and while I may not agree with Meg Witman's estimate of a $1.5 trillion potential market I do think EBAY will continue to grow. They will see $32 billion in sales this year according to Meg. I alerted readers to a potential EBAY entry point back on March 23rd when it touched $65. I am going to reverse that today with a put recommendation in my Editors Play. Not because I don't like EBAY but I think the coming Google IPO could dampen demand for the current leaders.

Friday was far from a strong day in the markets with the Dow negative for most of the day. It returned to positive only in the last 90 min of trading. It only gained +11.64 and MSFT accounted for the majority of that gain. For the majority of the day the A/D line was negative by nearly -2000 issues. In the end the Dow did manage to climb ever closer to the 10500-10550 resistance level. The working range for April has been 10300-10550 and we are very near the top of that range.

The Nasdaq rebounded from the drop to 1973 on Wednesday and traded nearly +75 points above that low at Friday's close. Tech earnings have been mostly outstanding with only a few company specific problems. The Nasdaq is also closing in on the top of its range at 2075.

The index that could cause the most trouble at the open on Monday is the NDX. It closed at 1496 on Friday with strong resistance at 1500. A break over 1500 at the open could set the stage for a decent day but it is strong resistance.

I was encouraged by the positive close even though the actual points gained for the day were light. Remember we had a banner point day on Thursday and following it with another gain in front of a weekend shows strong underlying sentiment. I already mentioned the internals were negative but not enough to keep the indexes from closing positive. I think this is bullish for Monday and could provide a strong start for the week.

Earnings have been nothing short of spectacular. According to First Call 50% of the S&P have reported and 78% beat estimates, 11% announced inline and 11% missed estimates. Historically about 58% beat and 20% miss. The Q1 earnings growth is currently +26% and well over the prior analyst forecasts. Some analysts suggest the strong surprise is due to the new financial regulations leading to very conservative guidance.

Whatever the reason the fact remains that this will be the strongest quarter of the year. Analysts are raising their estimates for the rest of the year but they are still in the low to mid teens. Next year by most accounts is still expected to be even slower. One way of judging market direction is by the measurement of small cap earnings growth. For all of 2004 growth is projected to be 44%. This drops down to only 14% for all of 2005. Is this reality or is it the "conservative" viewpoint?

The bottom line is an economy that appears to be suddenly booming and earnings growth for the first quarter could be a record. This presents a quandary for investors. Do they believe the forecasts for slowing earnings growth or the signs the economy is starting to explode? Are these two events mutually exclusive or will a potential exploding economy explode the earnings as well?

This is the decision traders will face next week. Do they turn cautious with only six days until the Fed meeting or do they roll the dice and bet against the Fed and buy stocks. The sell in May and go away crowd must be going crazy. Had they done that last year they would have lost out on a strong bull market. Will they miss out on the same thing this year or does lightning really strike twice.

Last year April 22nd was the breakout day on the Nasdaq and April 28th on the Dow. We all know what happened and that memory has got to be weighing on traders consciousness. They have been told time and again that this is the peak quarter but memories of past bull markets die hard. Do analysts really know what is ahead? Just a few weeks ago First Call was predicting earnings growth for Q1 at 15.9% with the potential to hit 20%. If they are wrong about the future quarters then stocks could actually be undervalued.

You know I am just posing those questions for debate today but I am getting the feeling that investors may not be willing to give up without a fight. They may be just stubborn enough to hold on to stocks while hoping for a repeat of 2003. The next two weeks are going to be crucial to the markets. Beginning next Thursday we will have seven days of critical economic reports with a Fed meeting right in the middle. GDP, ISM, PMI, Factory Orders, Productivity and Jobs. The question we face is do we want strong economic growth and the risk of an early rate hike or weak growth and the risk of lower earnings. I personally will take two helpings of very strong growth with extra gravy please. We are going to have the rate hikes eventually so let's get this ball rolling and tell the earnings analysts get out their erasers.

Obviously what we think or what we want is immaterial but how to play it is not. Despite the rebound for the week we are still range bound. That means as traders we sell the tops and buy the bottoms until a breakout or breakdown appears. A breakout for me would be defined as a Nasdaq over 2150 and the Dow over 10750. Obviously that would be the extremes and I would start getting excited with a move over 2100/10550. The real clue would be a Russell over 605. If fund managers are buying small caps then the stage is set. A breakdown for me would be a failure of the lows for the week at 1975/10250. With all the major economic news ahead, the Fed meeting and 26% of the S&P reporting earnings over the next week we could see a lot of volatility. Until we get a breakout or breakdown continue to buy the bottoms and sell the tops and avoid trading in the middle.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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