Option Investor
Market Wrap

Let Those Bulls Loose!

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     WE 6-11         WE 6-04         WE 5-28         WE 5-21 
DOW    10410.10 +167.18 10242.8 + 54.37 10188.5 +221.71 - 46.13 
Nasdaq  1999.87 + 21.25 1978.62 -  8.12 1986.74 + 74.65 +  7.84 
S&P-100  554.90 +  7.82  547.08 +  1.95  545.13 + 10.80 -  1.14 
S&P-500 1136.47 + 13.97 1122.50 +  1.86 1120.64 + 27.08 -  2.10 
W5000  11045.95 +109.64 10936.3 +  9.95 10926.4 +301.26 -  9.61 
SOX      476.28 +  5.37  470.91 - 17.95  488.86 + 30.68 +  7.19 
RUT      569.12 +  1.37  567.75 -   .53  568.28 + 22.47 +  2.05 
TRAN    3024.71 + 32.43 2992.28 + 44.27 2948.01 + 82.26 + 12.86 

That was the most remembered comment from President Reagan when he last visited the NYSE. Multiple interviews with floor traders this week brought tears to their eyes as those words were remembered. To spark emotion from hardened traders more than ten years after the fact is a stark testimony to the strong feelings Americans had for him.

Holiday volume produced a surprise on Thursday with the markets finishing positive for the day. I say a surprise because the extreme event risk over the next three days could have easily turned into selling as investors moved to safety. Is this a sign that investors have completely discounted the potential for future terrorist attacks? More likely it is a sign that greed is still alive and well.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

Thursday started off with a jolt as Jobless Claims rose to 352,000 for the week and a seven week high. The prior weeks claims were revised up to 340,000. This pushed the four week moving average to 346,000 and dangerously close to the 350K mark where economists start getting worried. The markets shook off the news very quickly on comments that holiday adjustments probably skewed the number and it will revert to lower levels next week. More importantly continuing claims fell under 2.9 million and the lowest level since the recovery began. This was a -106K drop for the week. This suggests there are still jobs being created and filled. The pace of job creation is expected to slow over the summer months to something just over 125K and pickup again in the fall.

With the Fed meeting only two weeks away the Import and Export Prices were viewed with inflation in mind. Import prices jumped +1.6% mostly due to higher oil prices. The core rate excluding energy still rose +0.4% and more than expected. Export prices rose +0.3% with agricultural prices slowing their upward sprint. With inflation seen in almost every recent economic report there is no doubt the Fed will hike at the end of this month. How high is still up for discussion.

There was little stock news this week to produce major moves. Once the decision was made on Monday to close the exchanges the volume died for the rest of the week. Each time a Reagan special coverage alert hit TV screens the volume came to a halt until the event came to a close. Thursday barely traded three billion shares despite the Russell shuffle announcement coming on Friday and quarterly option expiration ahead. While Friday is the official day of mourning the entire week had a somber mood.

For the week the Dow gained +167 points but most of those gains came on Monday and Tuesday. Wednesday and Thursday were spent treading water at the 10400 level and exactly where it managed to close for the week. As I said Tuesday the 10400-10550 level is very strong resistance and nothing has changed. The Dow did manage to blast through the 10325 resistance level I discussed last Sunday with a monster gap on Monday morning. I had speculated that a futures gap up on Monday could likely accomplish that feat where the prior week of chipping away at resistance had failed. With the Dow closing at 10400 ahead of weekend event risk it appears we could be looking at another repeat performance on Monday with no negative events.

The Nasdaq was not able to follow through on its resistance test like the Dow. The Nasdaq stalled at 2020 and then fell back below 2000 by Thursday's close. The major battleground for the Nasdaq was the SOX and the Russell. The Sox failed at the 100 dma three days last week at 487. There was a significant bout of selling on Wednesday and the Sox returned to languish at 475. Without the Sox the Nasdaq cannot advance. Surprisingly the Semiconductor Industry Association upgraded their estimates for chip sales for 2004 to record levels and it had no impact. The semi sector appears to be priced to perfection when multiple upgrades in one week cannot move it higher.

SOX Chart - Daily

Also impacting the Nasdaq and the Sox is the Russell rebalancing coming at the end of June. This annual event produces strong volatility in the small caps and the index dropped -10 points on Wednesday in advance of the release. The changes to the Russell indexes are normally announced this Friday with two weeks until they take place at the end of June. Because the change in the indexes is announced two weeks in advance there is plenty of opportunity for volatility as traders jockey for position.

The Russell 2000 is a very widely followed index and much more so than the Russell 1000. Russell calculates the top 3000 largest market cap stocks and then splits them into the top 1000 as big caps and next two thousand as mid/small caps. Because of the methodology there are always a large number of stocks which have grown their market cap moving out of the lower 2000 and into the upper 1000. Obviously those moving higher were already larger companies which were already heavily weighted in the 2000 index. When they move out of the index funds must sell them. Since the move is announced two weeks in advance there is plenty of time for aggressive funds to sell in advance of the actual change in order to get out before the general fund groups all dump on the same day. I have probably already confused everyone but the bottom line is a volatile Russell for the two weeks after the announcement. With the announcement coming on a market holiday this week we saw selling in the Russell leaders on Wednesday in advance of the Friday announcement. This produced a -10 point drop on Wednesday and a flat index on Thursday. Monday could see additional volatility as funds react to the holiday announcement.

I went through this complicated explanation to show why I think the Nasdaq may have trouble making headway next week. The Russell typically drops over this period with the drop from the pre announcement levels to the post announce low averaging about 26 points over the last four years. If the -10 point drop on Wednesday was part of this then we could see a muted impact but still an impact.

Russell-2000 Chart - Daily

We still have the problem with the indexes at the bottom of a very strong resistance range and the VXO at critical reaction levels as I explained on Tuesday night. We had the rally to these resistance levels on Tuesday and the VXO hit a 52-week low. We followed that event with a sell cycle but one that was weak and lacked any follow through. The indexes simply rested from their run and consolidated at the bottom of the resistance range. Thursday's small rebound positioned them for takeoff next week and sent the VXO back below 14 once again.

The stage is set for the state funeral on Friday and for the markets to make a critical resistance test on Monday. We know how the Reagan services will end with the cameras staring at a California sunset on Friday. We do not know how the resistance test will end on Monday. There are no major economic reports on Monday and the markets will be able to soar to their hearts content if they are able. Tuesday is a different story. We have several critical reports and Greenspan will testify before the Senate Banking Committee on his confirmation process. You can bet there will be some pointed questions. I still feel the markets want to move higher but will have trouble with the next hurdle. The week could boil down to Monday's market action. A resistance failure on Monday could trap us in a range for the rest of the week as the economic reports begin to flow again and the earnings warning cycle heats up.

I see strong Dow resistance from 10400-10550, Nasdaq 2020-2060, SPX 1140-1150. Those are big ranges and strong resistance. However, support levels continue to rise and selling pressure has moderated significantly. We are definitely coming to a crossroads in the market and Monday should be the next signpost. A wrong turn could doom us to weeks of congestion as we approach June 30th. The right turn could lead to a freeway above those levels and a real breakout into a summer rally. Either way it will be an interesting drive.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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