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Market Wrap

Fed Drains, Oil Rises, Stocks Sink

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     08-03-2004            High     Low     Volume Advance/Decline
DJIA    10120.24 - 58.92 10178.28 10102.84 1.60 bln   1140/1649
NASDAQ   1859.42 - 32.67  1887.57  1859.17 1.48 bln    977/2053
S&P 100   537.92 -  2.49   540.87   537.53   Totals   2117/3702
S&P 500  1099.69 -  6.93  1106.62  1099.20 
RUS 2000  543.63 -  8.30   551.93   543.47
DJ TRANS 3120.54 - 13.61  3147.50  3118.85
VIX        16.03 +  0.66    16.05    15.28
VXO        15.21 +  0.59    15.44    14.80
VXN        25.08 +  0.95    25.16    24.31
Total Volume 3,366M
Total UpVol    782M
Total DnVol  2,518M
52wk Highs     127
52wk Lows      182
TRIN          1.59
PUT/CALL      0.73

The Fed's open market desk allowed 6.5B in maturing repos to expire unrefunded today, draining that amount from its primary dealers' accounts. Oil was higher, continuing its explosive rally, and the net effect of these two bearish factors was widespread weakness for equities. The Nasdaq indices led strongly to the downside as the volatility indices rose across the board.

The excess of weakness in the Nasdaq is a problem for the bearish oil interpretation, as the Nasdaq's 1.73% decline dwarfed the declines in the Dow (0.6%) and particularly the Dow Transports (1.0%). One would think that an oil-based equity decline would have impacted the TRANs more than the tech-laden Nasdaq.

The weakness was sufficient to hinder the daily cycle upphase we've been tracking for the past two weeks, with the brunt of the damage borne by the Nasdaq.

Weekly Dow Chart

Last week reversed the break of the rising weekly trendline and this week appears to be testing it from beneath, so far unsuccessfully. The 9900 support level held, but resistance at 10200-10250 remains the key upside level for bulls hoping that this year's descending pattern is indeed a weekly bull flag. The weekly cycle picture has been and remains an ambiguous mess, with a rising 10-week stochastic competing with a descending Macd. With the cycle picture this uncertain, my approach is to watch the range levels while awaiting a resolution to the cycle mess- in this case, a break below 9900 should see a test of 9800 on the way to the lower descending flag support line, while a break above 10250 should see a retest of 10450-10500. With 10200-10250 being the resistance line of a possible bull flag, a strong, high volume break of that level would suggest a retest of the year highs for starters. The characteristics of the breakout, if it occurs, will tell us more.

Daily Dow Chart

The Dow closed just above its session low, still holding yesterday's and Friday's low and preserving the daily uptrend. The daily cycle oscillators weakened within their upphase but didn't sustain the same level of damage as seen in the Nasdaq's daily chart below. The session high (printed at the open) is at the descending resistance line, currently 10178, and that line on a 30 minute chart (not shown) is the neckline of what bulls have been eyeing as a sloping reverse head and shoulders formation projecting to an implied target roughly 250 Dow points above it. Downside support below the session low of 10102 is at 10080, below which is the former descending resistance line at 10025.

Weekly Nasdaq Chart

The Nasdaq remains the weakest link in last week's bounce attempt, and this week has so far perpetuated that theme. The cycle picture remains more obviously bearish than with the Dow, but the bull flag is still intact and a small bullish divergence is evident on the Macd histogram. Resistance has declined to the 1920 area while lower descending support on the flag lines up with Fibonacci support at 1760. 1840 has been support so far on the decline, and that would be the first level at which to scope for a bounce should we decline from here.

Daily Nasdaq Chart

The Nasdaq's 32.7 point decline left the index resting on the former descending resistance line, at the equivalent of the Dow's 10025 level noted above. The 10-day stochastic left off on a bearish kiss, and the Macd lost its recently confirmed upphase. A rollover from here would turn the entire daily cycle bounce into a bearish whipsaw, and given the low price and oscillator levels, such would suggest that the bounce has been a bear flag or some similar distribution pattern projecting to lower lows below last week's support. With all intraday cycles oversold and looking for a bounce, a drop tomorrow would have very bearish implications and set up the Nasdaq for a retest of l830 support.

Weekly TNX Chart

Bonds have been rising this week as equities declined, is the type of action I'd expect from defensive market action attributable to bad "external" news, such as the terrorist news from Sunday night. That said, the weekly cycle for bonds is not ambiguous as it is for equities, with yields in a weekly downphase. The ten year note yield (TNX) closed lower by 3 bps at 4.422%. Resistance above is at 4.48%, followed by 4.5%, 4.65%, 4.75% and 4.8%, while support is at 4.4%, 4.34% and 4.02%. A break of that lower support could be a bear wedge breakdown that would project an implied target back at the 2003 lows for the TNX (2003 highs for 10-year treasury bonds).

In economic news, the International Council of Shopping Centers and UBS announced that same-store retail sales rose 0.2% in the last week. Chains' same-store sales were up 3.1% year-over-year, with tax breaks and back-to-school sales credited for the increase.

The Commerce Department announced at 8:30AM that U.S. consumer spending declined by 0.7% in June, a downside surprise against expectations of a 0.1% decline and reportedly the largest since September 2001. However, personal incomes met expectations with a 0.2% increase in June, and the personal savings rate rose to 2% from 1.2%, the largest increase since August 2003. Notwithstanding the increase in savings, today's readings marked the slowest income growth in 14 months.

The personal consumption expenditure price index, an index that the Fed emphasizes over the CPI, rose 0.1% in June, while the core PCE index excluding food and energy rose 0.2%. The core PCE index is up 1.5% since last year, and real disposable incomes were unchanged.

At 10AM, the Challenger & Gray July jobs report was released, showing an increase in job cuts of 8.1% over June's reading. The 12-month average of job reductions fell from 89,886 in June to 88,590 in July, which was judged to be a weak improvement. Year- to-date layoffs are down 24% from the first 7 months in 2003, but Challenger also announced that corporations intend to hire only 26,880 employees, 30% lower than the 38,377 employees in June.

Around the same time as these reports, from 8:30-10AM, news stories from the BBC and Reuters discussing Tom Ridge's Sunday terrorist warning as being old news and possibly politically motivated began circulating. Ridge responded to the allegations later, defending the data upon which the warnings had been based as "the most significant detailed pieces of information about any particular regions that we have come across in a long, long time, perhaps ever and that is why we decided to share it publicly." Of greatest significance for the financial markets in my view, the responses to the initial warning on Sunday night / Monday and to today's story that the warning might not be timely were muted- the markets neither sold off sharply yesterday nor rallied today. This is a welcome reprieve from the endless OBL/Saddam rumors and whipsaws we remember from last year, in which vague stories were credited with instant directional moves in the markets.

There was some coverage of the new contract highs for front-month crude oil futures today, with the 44 level broken several times throughout the day and a session high of 44.225 amid OPEC supply concerns. While these are historic price highs, on an inflation- adjusted basis they are not. Nevertheless, the rise in oil prices has been dramatic in the past year. More expensive oil, with its inelastic demand, means less available money in the hands of consumers, corporations and government.

Weekly chart of Crude oil

At midday, GM reported a decline of 3.4% in July sales, while Ford reported a drop of 6.8%. BMW lost 4.4%, Mazda -12.2%. Daimler-Chrysler reported a gain of 2%, Toyota a gain of 13.7%, Nissan +31% for its best month ever, Suzuki +27%, Honda +0.1%, Acura +8.1% and Porsche a gain of 6%.

TYC bucked the downward market trend after reporting Q3 earnings of 43 cents per share, up from 27 cents in Q3 2003. Excluding one-time items, the company earned 45 cents per share, beating estimates of 42 cents. Revenue rose 11% to $10.5B, beating estimates of $10.3B. The company raised its 2004 forecast to $1.61-$1.63 per share, above estimates of $1.59 per share. For the day, the stock closed higher by .58% at 31.42.

Chipmaker VSH got hit after announcing earnings of 22 cents per share, missing by two pennies but announcing that it does not expect to see improvements in earnings or revenues until Q4. The 22 cents it earned this quarter represent an improvement of 20% in revenues to $646.7M. The stock closed lower by 15.52% at 13.45.

Tomorrow's session is rich with implications. The indices spent the entire day declining to close at their lows. While the action can be characterized as a merely corrective intraday pullback for the Dow and SPX, the action damaged the daily cycle upphase on the Nasdaq, and the 1.73% drop is sufficiently large to qualify as impulsive. In particular, the gains of the past 3 sessions were reversed on the Nasdaq, leaving only last week's double bottom support between current levels and new lows for the year.

With that said, it's worth noting that the daily cycle upphase, even on the Nasdaq, is not yet over and should, all other things being equal, continue for at least another week. It's possible that the Fed's substantial repo drain, announced at 10AM amidst the furor over the possibility that the Sunday terror alert might be a dud, could have been a miscalculation by the Fed's open market desk in an attempt to mitigate a possibly large relief rally. That's pure speculation on my part, but if the Fed makes a large repo announcement tomorrow, it will appear more likely. In any event, the Nasdaq is at a level where it needs to bounce to avoid kicking off a new daily cycle downphase from a much lower price and oscillator high. A bounce will preserve the bullish daily cycle outlook, and we'll watch for confirmation in the form of today's high being exceeded. No bounce, and the bulls will have fumbled the ball very close to their endzone.


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