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Market Wrap

New Nine Month Low

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      07-22-2004           High     Low     Volume   Adv/Dcl
DJIA    10050.33 +  4.20 10073.49  9946.88 1.95 bln 1268/1948
NASDAQ   1889.06 + 14.70  1892.98  1853.58 1.96 bln 1348/1795
S&P 100   535.49 +  2.47   536.99   529.43   Totals 2616/3743
S&P 500  1096.84 +  2.96  1099.69  1084.16 
W5000   10663.45 + 12.45 10691.29 10541.91
SOX       420.44 + 12.60   422.58   407.81
RUS 2000  546.52 -  2.05   549.60   539.05
DJ TRANS 3051.63 - 35.50  3087.62  3014.21
VIX        15.75 -  0.66    17.10    15.29
VXO (VIX-O)15.82 -  0.32    17.86    15.41
VXN        22.44 +  0.29    23.10    21.96 
Total Volume 4,263M
Total UpVol  2,444M
Total DnVol  1,747M
Total Adv  2932
Total Dcl  4309
52wk Highs   45
52wk Lows   357
TRIN       0.77
NAZTRIN    0.59
PUT/CALL   0.89

The Nasdaq was hit with strong selling this morning and dropped to a new nine month low of 1853 before bargain hunters appeared. The Dow broke 9950 briefly and the Russell fell to strong support at 540. High profile earnings misses and earnings warnings added to the week's negativity and pushed the indexes to their limits.

Dow Chart - Daily

Nasdaq Chart

SOX Chart - Daily

The morning started out with a high profile earnings miss by Dow component CAT and it all went downhill from there. Ironically Caterpillar's earnings miss was due to too much business and in the rush to fill all the orders they let costs get away from them. They raised estimates for the future and said they expect profits to rise +80-85% for the full year. They are still experiencing very high sales and construction bottlenecks from the excess demand. Must be tough to have the market knock you for a -$5 loss on so much business you can't produce it all.

Sears added to the negativity with a lowered forecast that did not come even close to prior estimates. Sears said weak consumer demand nationwide was the cause for its -83% drop in earnings. Sears said they experienced very weak customer demand in June and weak spring sales had caused inventory levels to rise to unacceptable levels. Sears lowered estimates for the full year to $2.66-$2.86 and well below analysts estimates of $3.65.

Mixed economics did nothing to overcome the negative earnings sentiment. The Jobless Claims dropped slightly to only 339,000 from last weeks 350,000. This was not enough of a drop to build confidence that the last six weeks of higher claims were easing again. This report was neutral but was actually the most positive report of the day.

The Chicago Fed National Activity Index dropped to 0.00 from 0.75 and that May number was revised down from 0.91 and the high for this recovery cycle. The sharp drop in the national activity index is a wakeup call for analysts. The production component fell to -0.15 from +0.34 in the prior month. Industrial production fell 30 basis points and the ISM composite index fell to 61.1 from 62.8 in May. This is the first time manufacturing output fell since May 2003. Employment was negative for the first time since February. Of the 85 components 58 fell, only 26 improved and one was unchanged. This report is a clear sign the economy is slowing.

The Conference Board Leading Indicators fell -0.2% and it was the first drop since March-2003. This was a sharper drop than was expected with weakness in housing and hourly work week the main detractors. Half of the components lost ground for the month and analysts suggest this projects slowing through the end of the year.

Further weakness came from the Monthly Mass Layoff report with layoffs jumping +53% in June to 134,588 from only 87,501 in May. Manufacturing layoffs soared to 27,307 and was the weakest sector by far. This was still the lowest layoffs for June since 1999 but that was slim consolation after the jump from last months low numbers.

Earnings surprises with Dow component CAT knocking -35 points off the Dow at the open and the weak economics sent the indexes into free fall. The Dow plummeted to 9947 and a level not seen since May 25th. This was a continuation move to yesterday's reversal drop and could be seen as a climatic selling event. The Nasdaq fell to 1853 and a nine month low. This caps a -15% drop from the 2153 high in January.

After the bell today there was another deluge of earnings reports headed by Amazon and Microsoft. Both seemingly on top of the world and doing great. Both also missed their numbers by a penny. A penny! What happened to the days of managing your estimates to prevent these things from happening? (just kidding) Amazon missed earnings and revenue and but they did post a profit of +18 cents compared to a loss for the same quarter last year. This was the fourth consecutive quarterly profit. Two cents of their income was due to currency translation. The quarter was weaker than expected for Amazon but we already know late May and all of June was a challenge for all retailers. AMZN traded down -2 in after hours.

Microsoft posted profits of 28 cents and a penny under estimates despite increased revenue. To make matters worse they guided lower for the current quarter by about -2 cents. Microsoft dropped sharply in after hours to $27.34 but recovered to trade just over $28 late in the session. Microsoft had just wowed investors on Tuesday with the big $75 billion investor payout and saw its stock move up to almost $30. If the current trend continues it could be a long time before we see $30 again. Investors holding on for the $3 payout and watching the stock drop in after hours are seeing their dividend slowly slip away. Remember MSFT will open -$3 lower on the day they pay the dividend in November. It will be interesting to see if the dividend play is enough to make investors ignore the lowered guidance on Friday.

Tonight's earnings were just about evenly mixed between beats and misses yet futures saw a serious drop despite gains by several chip stocks. So far this cycle nearly 50% of the S&P-500 have reported. Before tonight 159 companies have beaten estimates, 45 announced inline and only 24 missed estimates. This time last year the numbers were 194, 7, 27. Considering how weak Q2-2003 was relative to the end of 2003 you would expect results from this Q2 cycle to exceed those comparisons easily. You can see that although profits are coming in strong there is a definite case of overly optimistic estimates.

As we move into the summer we are seeing estimates cut almost daily to match the constant drone of lowered guidance. Still analysts are stumped as to why stock prices are dropping. Hello, connect the dots please. I have mentioned numerous times that falling expectations coupled with summer event risk does not provide a strong outlook for stocks.

This does not mean we will not move higher from here but it does mean there is no overriding reason to rush into the market. We are at the point where traders should be positioned to withstand any problems at the Democratic convention next week. This means we are ready for a rebound if the convention ends without any terrorist event. The markets have sold off to major support levels and pressures appear to have equalized.

The Dow drop to 9946 gave traders looking for an entry the chance to buy stocks cheap. The bargain hunters moved in and we saw a rebound on strong volume. Wednesday was drastically weighted to the sell side and also on strong volume. Down volume was 5:1 over up volume. Today that reversed but just barely to 3:2 in favor of up volume. While we may have had our climatic selling event there was no V shaped rocket taking off from that bottom. There is just two much risk in the immediate future for that pile of cash waiting on the sidelines to jump back into the fire. However, we are getting close.

The Nasdaq dip to 1853 was the bottom of its downtrend channel since January. This is the level where it should rebound OR at least stop dropping. In a nutshell we are finally positioned for a post convention rebound at the bottom of our long term ranges.

The wild card tonight is the AMZN/MSFT earnings misses. The S&P futures fell to 1088.75 but have since rebounded to 1092.50. The Nasdaq futures fell from their 1405 close to 1389 but have since rebounded back to 1400. The knee jerk reaction to the negative news appears to have already passed and we may not see any adverse reaction when the markets open tomorrow. Should we see another drop I would consider it a buying opportunity for those with a strong appetite for risk.

SPX H&S Chart Daily

There is a train of thought that suggests we are forming a reverse head and shoulders on the SPX. This faction believes we will rebound after the convention and return to the highs around 1160. They are using the great historical earnings and the growing economy as the reason for the rebound.

The other viewpoint sees a major breakdown in internals taking place with the SPX closing under its 200dma at 1105 for the first time since April 16th 2003. The 200 dma is a critical technical level and it has been broken for several days. The fundamental justification for a continued decent is the falling guidance and the rapidly decreasing earnings picture for late 2004 and 2005. The current earnings estimates for all 2005 are for less than 10% compared with 20+ percent for our last three quarters. The 200dma is a critical technical indicator for mutual funds and many will begin scaling back positions if the index remains under that level.

SPX Chart Daily

So what is a trader to do given the conflicting viewpoints and the coming event risk? I believe that even if the bearish viewpoint is the true view we will still see a post convention bounce. That bounce may only last a short time but from our very oversold position it is very likely. The earnings news after the close today could give us one more entry point on Friday but I would still be cautious about entering before Monday. Any long positions should definitely be protected by insurance puts in case of the worst case coming to pass.

My outlook is going to be completely technically based. I feel as long as we are under the SPX 200dma we should be cautiously bearish. Should we move back over that level I would be cautiously bullish. This is a very risky environment but at least traders are seeing some nice volatility return. While traders like volatility I have seen on the news every day this week that residents in Boston have been fleeing the city by the tens of thousands to get away from the potential volatility there. I can relate to that since we have seen the same thing in the market all week. Normally these events turn into an anticlimactic news event and quickly forgotten. A week from now we will probably be trading several hundred Dow points away from our close today. The only question is which direction?

Enter Passively, Exit Aggressively.

Jim Brown


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