Option Investor
Market Wrap

Market Skids Lower

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     05-17-2004            High     Low     Volume Advance/Decline
DJIA     9906.91 -105.96 10009.92  9862.77 1.72 bln    836/2016
NASDAQ   1876.64 - 27.61  1887.74  1865.40 1.49 bln    734/2654
S&P 100   530.40 -  5.07   535.47   528.27   Totals   1570/4670
S&P 500  1084.10 - 11.60  1095.70  1079.36 
RUS 2000  535.34 -  8.42   543.76   530.68
DJ TRANS 2812.33 - 36.56  2848.09  2785.50
VIX        19.96 +  1.49    20.45    19.65
VXO        21.03 +  2.10    21.42    20.32
VXN        29.19 +  0.15    29.85    29.05
Total Volume 3,707M
Total UpVol    527M
Total DnVol  3,137M
52wk Highs      39
52wk Lows      337
TRIN          2.59
PUT/CALL      1.22

The head of the Iraqi Governing Council Izzadine Saleem, was killed today in a car bombing near a U.S. checkpoint in central Baghdad and sent the markets to a late morning plunge. The killing was the second member of the U.S.-appointed council killed since last year and has dealt a blow to U.S. efforts to stabilize Iraq and the handover of sovereignty to the Iraqis that is supposed to happen on June 30. A previously unknown group, the Arab Resistance Movement has claimed responsibility for the bombing, saying that its fighters carried out the operation against "the traitor and mercenary" Mr. Saleem.

Then if that wasn't enough to make the market skiddy, a roadside bomb containing sarin nerve agent exploded near a U.S. military convoy in Iraq where two people were treated for minor exposure, however, no serious injuries were reported.

But even before the news came out of Iraq, stocks started a decline overnight in Asia when India's markets took the biggest one day plunge in its 129-year history on the first trading day after an election. The Bombay Stock Exchange fell as much as 16.6%, before recovering late to close 11.1% lower at 4505.16. Economists and traders are concerned about the economic policies of the government of Sonia Gandhi, whose party and its communist allies took over Parliament Friday.

Closer to home the Wall Street Journal announced the U.S. has been filling its oil reserves since September 11, 2001 and, along with other nations, have amassed 1.4 billion barrels. Some are saying these reserves need to be released to bring oil prices down, others are saying if Bush releases these reserves it is because it is an election year. However, U.S. policy dictates that the strategic reserve be used for a crisis, not to lower prices. Some look at oil at 41.50/bbl as a crisis.

On to the markets.

The retracement brackets I have placed on the following charts are from the March lows 2003 to the March highs 2004. I have also put in a retracement level at 28.65%, which is 1/2 way between 19.1 and 38.2%. The teal MA line is the 200 EMA.

NYA.X (New York Stock Exchange Index)

The NYA has been bouncing off the 200 EMA since May 10th and needs to break above March lows of 6364, which happen to be the 19.1% retracement, before I see a trend change.

After a drop like we have seen in this market you would expect MACD to be showing at least a little positive divergence but alas it is not. I cannot see much bullishness in the NYA chart other than the 200 EMA is holding.

If the NYA were able to break above its March lows I would turn neutral, not bullish and not bearish. To turn bullish I would need to see a series of higher highs and higher lows and a break of the swing high at 6568

SPX.X (S&P 500 Index)

The SPX is very similar to the NYA and needs to get back above its 19.1% retracement and March lows before I switch from a bearish stance to neutral. Until then the path of least resistance is down. However, the SPX is showing a possible positive MACD divergence so this market is not quite a bearish as the NYA but I still don't see a lot of bullishness in this chart. Here also to turn bullish the last two swing highs at 1103 and 1128 would have to be breached.

RUT.X (Russell 200 Index)

The Russell 2000 is without a doubt weaker than the SPX and NYA trading below its 200 EMA and all the way to the 28.65% retracement. (The 28.65 retracement is 1/2 way between 19.1 and 38.2.) To repaint the above chart with bullishness, this market needs to break its last swing high at 552, which just happens to be the March lows and the 19.1% retracement and then next swing high at 575. A break of the down trend line would definitely be bullish but not necessary to turn me bullish on this market.

COMPX.X (NASDAQ composite)

The COMPX not only needs to break above its March lows but back above the 200 EMA. It has spent way too long below this level and it is making NASDAQ bulls very nervous. If/when it breaks these levels, it then has the job of making higher highs, which would be a print above 1970 and then 2060. The only thing I see bullish about this chart is the possible positive MACD divergence.

NDX.X (Nasdaq 100 Index)

The NDX is the only major index to NOT break its March lows. It is below the 200 EMA and trading at the 28.65 retracement but not below its March lows. And it also could be making a positive MACD divergence. However, (there is always a however isn't there?) NDX needs to prove bullishness to me just like the other markets need to do. It needs a higher high above the last swing high at 1426, which would put it above its 200 EMA, then it needs a sustained move above the 19.1% retracement level at 1442. A break of the down trend line would be very bullish but I don't think necessary to repaint this chart bullishly.

This is the market that you would be looking to for leadership when making a bottom. Why you ask? NDX's relative performance to the performance of the SPX measures the willingness of market participants to take on risk. This is because the stocks that populate the NDX usually have higher growth and higher risk profiles than the stocks in the S&P. So when investors are becoming less risk averse and becoming more concerned about capturing potential upside than avoiding potential downside the NDX trends higher relative to the SPX. Conversely, when investors start to become more concerned about downside risk than upside potential the NDX begins to under-perform the SPX. So let's look at a chart gives us a picture of this relationship.

NDX/SPX spread

The top chart is the daily NDX and the bottom chart is what I call the spread between the NDX and the SPX [the formula I use is (NDX + SPX)/SPX] and measures the strength of NDX to SPX. NDX is making lower lows today but the spread is not. This is the NDX becoming stronger compared to the SPX.

TRAN (Dow Jones Transport Index)

Like the NDX, the Transport Index (TRAN) is another market that has not breached its March lows. You would think the price of oil reaching 41.55/bbl today, an all time high, would have had a devastating effect on this index but it has not. I find this quite bullish for the market overall.

All in all the market is bearish but in a holding pattern. The fact that the transports and the NDX have not breached their March lows keeps me optimistic but with a great deal of caution built in. The individual markets will have to prove to me they are worthy of my bullishness but not until then will I move out of the bear camp.

I believe we are in for a relief bounce and where that bounce takes us will tell us if it is just a relief bounce or a true trend change. I have put forward where I think you could turn neutral and then bullish in each of the major markets.

Jane Fox


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