Option Investor
Market Wrap

Ready, Set, Wait

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        WE 7-23         WE 7-16         WE 7-09         WE 7-02 
DOW     9962.22 -177.56 10139.8 - 73.44   10213 - 69.61 - 89.01 
Nasdaq  1849.09 - 34.06 1883.15 - 63.18 1946.33 - 60.33 - 18.81 
S&P-100  530.38 -  5.52  535.90 -  6.73  542.63 -  4.54 -  2.58 
S&P-500 1086.20 - 15.20 1101.40 - 11.41 1112.81 - 12.57 -  9.05 
W5000  10553.82 -178.04 10731.9 -110.82   10842 -154.87 - 76.05 
SOX      405.58 -  4.88  410.46 - 40.68  451.14 -  6.17 - 21.60 
RUT      539.22 - 16.26  555.48 -  8.25  563.73 - 18.99 -  4.98  
TRAN    3043.44 - 44.89 3088.33 +  0.36 3087.97 - 58.20 - 18.01 

After a terrible week for the major indexes we closed at critical support levels and very close to lows for the year. The markets are poised to wait out the Democratic convention in hopes it will pass uneventfully. If it does we are poised for a rebound until the next event on August 13th when the Olympics begin. The waiting game for the convention will begin on Monday.

There were no economic reports on Friday and I doubt the markets would have paid attention anyway. The focus on Friday was earnings and convention and both were negative.

Microsoft fell -1.00 to $28.05 and closed at the low for the day as their earnings report was picked apart. The big news was the anticipated decline in earnings due to the drop in interest income after they make their big payout. With $32 billion due to be paid out this year Microsoft had to shift from longer-term instruments into short term investments as they readied the cash for final distribution. Their earnings reported nearly -$500 million in derivatives losses for the quarter related to the money shuffle. While that sounds like a lot of money it is only a drop in the bucket for Microsoft. However after doling out the cash Microsoft will lose one component of their earnings for the future. Last year Microsoft reported a +21% increase in earnings. Fully 10% of that number was from interest income. This suggests future earnings must overcome that 10% hit before breaking even. This was part of the cause for Friday's loss. The stock has made a complete round trip this week with a strong bounce on Wednesday after the dividend news and the drop on Friday took it all back.

Microsoft Chart

Another earnings disaster was Amazon, which dropped -5.84 on Friday after reporting earnings that missed estimates. The challenge for Amazon was falling sales. Amazon said sales in North America, its traditionally strongest market, only rose +9% for the quarter. Sales actually fell in some overseas markets for the first time in recent memory. Amazon raised revenue guidance for Q3 but did not raise earnings guidance. This suggests margins are being squeezed and the free shipping program so critical as a sales tool is beginning to impact those falling margins. Prudential reiterated their price target of $30 on AMZN, -$9 from Friday's close. Piper Jaffray rated the stock an underperform. Clearly the bloom is rapidly fading from the Amazon rose.

Amazon Chart

Coke was yet another disappointment with sales growth of only a meager +1% and earnings guidance well below estimates. Coke was KO'ed for a loss of -3.80 on Friday and proved that you do not have to be a tech stock to invoke investor anger. Coke is also the target of a criminal investigation into allegations of inflating overseas sales to make earnings in the past.

Coca Cola Chart

Maytag reported sales revenue that dropped -1% on weak appliance sales and a strong loss from cost cutting. They posted only +9 cents a share and missed analyst estimates by -30 cents. The weakness in appliance sales is yet another sign that consumers are hoarding cash and keeping their wallets on their hip. MYG dropped -2.07 on the news to $19.17.

Maytag Chart

After Thursday's earnings 242 S&P companies have reported earnings and 169 beat estimates, 47 reported inline and 26 missed estimates. Last year at this time the numbers were 206, 7 and 29. Clearly there is a shift away from the high end after expectations became too optimistic. Earnings warnings on future guidance by numerous big name companies have soured investor appetites for stocks. It is not that earnings are bad, they are far from it at +24.4% in year over year Q2 gains. These are very strong gains but the challenge is not what companies are reporting but what they are saying. It appears these earnings are not sustainable and the decline back to single digits could come faster than expected.

The gloom and doom from the earnings slow down pushed the Dow to its lowest close since May-24th at 9962 and a new intraday low for July at 9932. The Dow is only one sell program away from making a new closing low for the year at 9906. The Nasdaq has already performed this feat with the 1849 close on Friday. Not only was it a new closing low for the year but also a new low. Also jumping on the bandwagon was the SOX with a new dual low for the year at 405.

Dow Chart - Daily

Nasdaq Chart - Daily

SOX Chart - Daily

We all know this market depression is not based entirely on earnings but also on the terror threat to the Democratic convention next week. Headlining the news today was a FBI announcement that there was a plot to disrupt media coverage of the convention by blowing up and setting fire to media vans. While this was discouraging it was far from the critical event anticipated from groups like al Qaeda. Reportedly the media attack was coming from a domestic group and not overseas terrorists. The market sold off all week purportedly on earnings but always with an eye on coming events.

Not only do we have the Democratic convention next week we have the Olympics beginning on August 13th, just two weeks after the Democratic convention is over. In the U.S. the convention is an important symbol but globally the Olympics is a far bigger target and one far harder to protect. With hundreds of thousands of attendees heading to Athens the potential for multiple deadly attacks is very strong. Right in the middle of these events we have another Fed rate hike on the table on August 10th. This is creating a virtual mine field for the markets to traverse over the next four weeks.

Reports out on Friday suggested funds are sitting on abnormally high amounts of cash both for protection against an event drop and to be able to take advantage of any opportunity an event creates. Several funds currently sitting on piles of cash include Long Leaf Partners at 29%, Clipper 26%, Weitz Value at 28% and FBA at 30%. These funds have billions under management and they are holding billions in cash. Multiply this even in moderate terms over the 11,000 funds and you have a virtual mountain of cash on the sidelines. This cash is ready for a market event but what if no event occurs?

It seems clear to me that a lot of this cash will be put back to work in the market once the convention is over with even more going into equities after the Olympics. This is setting up a potential rebound from these lows as soon as next week. With the convention over on the 29th we have about a two week window where we could see a summer rebound before the calendar heats up again.

This does not mean we are going to the moon or even back to the midrange of our recent travels. I am just suggesting we could see some money put back to work and I want to capitalize on that potential.

We still have some serious technical market problems that have to be addressed. The S&P has been trading under the 100dma for three weeks and Friday's close at 1086 was a new two month low and -20 points under the 200dma. These bearish technicals could continue to keep pressure on fund entries. Don't forget Sept and Oct are two of worst months of the year on a historical basis. Unfortunately August has been the worst month for the last 15 years on the Dow and SPX and second worst on the Nasdaq. While September and October are remembered for major bottoms August is just remembered for being down. Over the last seven years the markets have averaged a -4% lost in the last five days of the month. Add in the August event risk and the odds are good any post Democratic convention rebound will not be earth shaking. We have piles of cash on the sidelines but the majority of that cash is likely frozen until September.

What this means for next week is the potential for a range bound market on very low volume as everybody watches the news channel rather than the stock channel. As the week progresses we could begin to see some bargain hunting which could accelerate if we get a further dip to the May lows on the Dow. I hesitate to mention the potential for a rebound because there are so many factors at work but the potential is still there. The qualification remains the terror risk. We all know that the convention site is very well protected with major streets blocked off on all sides for blocks in every direction. However, terrorists do not have to hit the convention itself to be successful. Putting an airplane in the side of the John Hancock tower would bring everything to a crashing halt. A few car bombs at critical intersections would also make their point. It does not have to be an attack on the fortress of the convention itself so investors can't afford to be aggressive in reentering the market until it is over.

This is a week for waiting and watching and praying and not necessarily a week to rush into the markets. Keep your eyes open for good stocks punished with the rest of the crowd and be ready for an end of week uptick.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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