Option Investor
Market Wrap

Want to See Something Really Scary?

Printer friendly version
        WE 8-06         WE 7-30         WE 7-23         WE 7-16 
DOW     9815.33 -324.38 10139.7 +177.49 9962.22 -177.56 - 73.44 
Nasdaq  1776.89 -110.47  1887.4 + 38.27 1849.09 - 34.06 - 63.18 
S&P-100  521.83 - 15.84  537.67 +  7.29  530.38 -  5.52 -  6.73 
S&P-500 1063.97 - 37.75 1101.72 + 15.52 1086.20 - 15.20 - 11.41 
W5000  10307.84 -393.81 10701.7 +147.83 10553.8 -178.04 -110.82 
SOX      386.88 - 29.55  416.43 + 10.85  405.58 -  4.88 - 40.68 
RUT      519.65 - 31.64  551.29 + 12.07  539.22 - 16.26 -  8.25 
TRAN    2966.08 -145.61 3111.69 + 68.25 3043.44 - 44.89 +  0.36 

That title may be a famous line from the Twilight Zone movie but you only need to take a look at the index changes for the week in the table above for a real nightmare on Wall Street. The Nasdaq lost nearly -5% for the week and all the indexes are at their lows for the year. While most analysts would be blaming the Jobs disaster there was far more impacting the markets and the road ahead could be even worse.

Dow Chart - Weekly

Nasdaq Chart - Weekly

SPX Chart - Weekly

Let's get the worst out of the way first. The July Jobs report was not just below estimates but a disaster. At only +32,000 jobs about the only thing worse would have been a job loss instead of a job gain. With consensus estimates at +220,000 and whisper numbers as high as +300K the minor +32,000 gain was a disaster. If you factor in the downward revisions to May and June we actually lost jobs with this report. The May number was revised down from +235K to +208K for a loss of -27K. The June report was revised down from +112K to +78K for a reduction of -44K. Let's see, using the new math a drop in previously reported gains of -71K and a gain in July of only +32K leaves us with a net change of -39K when analysts were expecting +220K. OOPS!

Twelve Month Jobs Table

There was a lot of talk about the falling unemployment rate to 5.5% from 5.6% but the key there was a drop in the overall workforce more than an increase in employment. The services sector was the weakest link in the report with financial services, retail trade, leisure and hospitality, information and social services all showing losses. Another factor was a loss due to seasonal adjustments. Many of the government reports have fudge factors for various months to smooth out normal volatility. In July the seasonal adjustments knocked real job growth (raw data) down from +222,000 to only +32,000. In reality many more jobs were created but the raw data is not used as a yardstick due to years of historical seasonal adjustment precedent. Live by the adjustment, die by the adjustment. This was slowest rate of jobs growth in eight months.

The Housing Survey showed jobs increased by +629,000 jobs and was a serious divergence from the Payroll Survey quoted above. Unfortunately 577,000 of those jobs were only part time and weighted toward those with lower education. Highly educated workers have been having a harder time finding employment all year.

If you were Alan Greenspan today you were probably reaching for the Maalox. With the Fed scheduled to raise rates on Tuesday the Jobs report was a bitter pill to swallow. When the Fed embarked on its current "measured pace" of rate hikes the economy was thought to be charging down the road to recovery and the rate hikes were needed to curb potential inflation and return the benchmark rate to a normal level. With the recent economic reports mixed and with many trending down the Fed may want to take its foot off the brake but can't due to the current policy. The Fed would have a hard time not raising rates on Tuesday because it would bring up questions of "what do they know we don't" and fears that the economy is worse than it appears. That means the Fed will have to "rescue" the market from itself with a positive statement after the meeting. Former Fed Governor Wayne Angel disagreed with the consensus the Fed was locked into a hike cycle and suggested Greenspan could surprise investors next week.

The chances of a rate hike next week have declined from 100% according to the futures to about 80%. The chance for a September hike declined to about 12% at the open but returned to 30% by the close. Still far from a lock. The analysts are still expecting the Fed to stick to its measured pace of hikes but the target for December is now only 1.75% instead of 2.0%. Currently the rate is 1.25%.

Bonds soared on the negative Jobs news with yield on the ten year falling to 4.21% and a four month low. Home builders will be overjoyed as low rate mortgages become yet another sales tool for the rest of the summer.

Ten-Year Yield Chart

The Jobs number was only slightly more important than the new high in oil at $44.65 but news from Russia put pressure on late in the day. The Yukos story continues to flip flop back and forth and today was a win for Yukos. The company won a court battle and lived to fight another day. Oil closed at $43.94 but the uptrend is still alive.

The uptrend in oil is the only uptrend still alive. The Dow closed at 9815 and a level not seen since Nov 2003. This was the low for the year and a significant breakdown. The -324 (-3%) loss for the week was minor compared to the hit in the Nasdaq. The Nasdaq closed at 1776 and lost -110 points, -5.8% for the week. Considering we actually traded up on Mon/Tue it shows how negative the last two days have been. The Nasdaq is -10% YTD and the SOX is down -30% YTD. The bears have come out to growl and the bulls are running scared.

The Dow broke under 9800, a level most would not have believed possible only a few weeks ago. By breaking the May lows the index has now setup a retest of 9500 and a -38% retracement of the rally from the Mar-2003 low. This would have been an unheard of retracement back June but times have changed. I preached about the coming summer event risk for the last three months until I felt everyone was tired of hearing it. Well boys and girls it is here to liven up our August.

The Jobs report is smoke. Yes, it was bad relative to the prior six months results but it was still positive. The economy is still growing as evidenced by the various economic reports just slower than hoped. This is a normal summer slump aggravated by the terror event risk. Companies are doing exactly what they did before the war. They are holding off on purchases and hiring until the risk of a major attack passes. Add in the election uncertainty and you get a market with no buyers. Those investors who were considering remaining long and toughing it out are then shaken out of their convictions by things like the Jobs numbers.

Those convictions were definitely shaken today. Not only did the Dow drop to new lows and the Nasdaq break the 1800 support line but the SPX completely lost the 1070-1080 numbers I wrote about Thursday night. SPX 1080 was the 200 week moving average and 1068-1070 was a double Fib retracement level. All of this support should have held better than it did. The 1070 level did hold until 2:PM but finally caved in at the close. Volume increased and internals crumbled once that level failed.

SOX Chart - Weekly

Russell Chart - Weekly

This sets up a serious situation for Monday. We can hope for an opening rebound back above the 1070 level to calm those itchy trigger fingers but without a major change in sentiment it could be only a temporary reprieve. We can hope for a rebound into the FOMC meeting on the chance they will not hike rates again but the odds of that happening are still slim. Even if the Fed did not hike it will not provide a lasting bounce. It just removes one minor reason for concern and adds another level of economic uncertainty.

The challenge in our future is not the Olympics. With a million people coming to town it should not be hard to sneak in a dozen or so. However bad and unfortunate an attack would be, unless they found a nuke or were successful in some kind of biological spread, this is not going to be an earthshaking risk for the U.S. However, people are seeing it as a strong negative and electing to move to the sidelines. I do not think the risk is worth the selling but it is not my money. The real risk is the week following the Olympics when the Republicans come to New York. If NYC goes to the same security lengths as Boston did then the convention should be safe. Again, it is not the event itself but the perception of the risk.

Al Qaeda is not going to attack where we expect them to attack and that is the real problem. I have little doubt they will try to disrupt the election because they proved they could do it in Spain. That means sometime in the next 90 days we will wake up to a surprise and this is what the market fears not the loss of jobs.

Traders seem to need an excuse to push themselves off dead center and there are plenty of excuses appearing on a daily basis. What these events have done is push stocks back down to where real value has begun to appear and those funds sitting on cash have got to be drooling about the opportunities ahead. The PE on the S&P has declined to only 16 times expected 2005 earnings after an earnings cycle that exceeded all expectations. Yes, I know there was much more inline guidance and a few more earnings misses but overall earnings were well over +20%.

Experienced investors understand that historically August is not kind to investors. Over the last 15 years August has been the worst month of the year for the Dow and S&P and the second worst month for the Nasdaq. It appears that despite the event risk, soaring oil and weak economics we are right in line with the historical trend. The key is not why the markets are dropping but what are you going to do about it and more importantly when?

Based on the commentary above I would say our buying opportunity is not over. I see no reason to rush into stocks regardless of how low priced they seem. The normal summer weakness tends to climax with a sharp drop in September and October. Considering the NYC convention ends on Thursday Sept-2nd and Labor Day is Monday Sept-6th I would want to have all my ducks lined up by Sept-7th. The seven weeks between Labor Day and the election should be considered bargain days in the market. I would begin taking small positions with an eye on the market direction. We know that historically the markets tend to react strongly once the election is over and with literally hundreds of billions waiting in cash on the sidelines the last two months of 2004 could be very strong. Of course that assumes there is no earthshaking terror event on U.S. soil before the election concludes.

That leaves us in window-shopping mode for the next three weeks. We will see more selling and some short term rallies but I would be surprised to see any rebound stick. When the markets go directional as they did this week they tend to do everything to excess. This means there are probably lower lows ahead and I would not discount the potential for the Dow to test 9500. Nasdaq 1703 is a 50% retracement of the March-2003 low to the Jan-2004 high. I would think that is a safe bet given the current sentiment. 1600 is actually stronger support as a confluence of the Oct/Mar Fib levels but it would take a real washout to see that level again. However the timing would correspond to the next major target on the SPX of the 50% retracement level at 965. The 965 level has been targeted by hard core bears for months and I am beginning to see that as a possibility. Slim but still a possibility.

Since the market exists to confound the most traders and all analysts those numbers are far from set in stone. As I sit here and look at the SPX chart I find it hard to believe 965 is a target but my bias is clouding my vision. Meanwhile the increase in volatility is providing great trading opportunities. The back to back triple digit moves on the Dow and the -5% Nasdaq drop for the week gave everyone something to trade. I don't know if I could stand that much volatility for the next three weeks but I will definitely try. More than likely we will find a range before next Friday to wait out the Olympics on minimal volume. Once we hit that range I would spend more time researching stocks/LEAPs you want to add to your long term portfolio than worrying about the day to day changes in the market. If you are not a trader the next three weeks should be ignored. If you are a trader then cinch up that seatbelt and join the party.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


Market Wrap Archives