Option Investor
Market Wrap

The Day After

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     08-09-2004            High     Low     Volume Advance/Decline
DJIA     9814.66 -  0.67  9858.68  9811.12 1.30 bln   1284/1530
NASDAQ   1774.64 -  2.25  1787.44  1774.48 1.25 bln   1209/1777
S&P 100   522.42 +  0.59   524.73   521.83   Totals   2493/3307
S&P 500  1065.22 +  1.25  1069.46  1063.97 
RUS 2000  518.38 -  1.27   522.56   518.15
DJ TRANS 2970.08 +  4.00  2987.32  2962.52
VIX        18.89 -  0.45    19.97    18.63
VXO        18.37 +  1.87    19.76    18.06
VXN        27.45 +  0.00    28.38    27.18
Total Volume 2,816M
Total UpVol  1,369M
Total DnVol  1,379M
52wk Highs      31
52wk Lows      443
TRIN          0.88
PUT/CALL      0.93

The dust from Friday had a chance to settle today, with equities rising weakly throughout the session and bonds, metals and foreign currencies pulling back. Friday was a big day, with news released today from the Chicago Mercantile Exchange confirming that Friday saw record volume for Eurodollar future contracts and the second largest volume ever overall. The CBOT reported record volume for 10-year treasury note options and its third highest overall volume ever.

The weak rise reversed at the close with the SPX closing slightly positive and the Dow and Nasdaq finishing slightly negative. Volatility fell sharply for the OEX (as reflected in the VXO), aided not just by the absence of a sharp continuation drop but by the absence of almost any action whatsoever. Volume was lighter, and the action looked and felt corrective. I would have guessed at a larger bounce following Friday's drop, and the intraday oscillators rose from very bullish configurations. But the price refused to cooperate and the only thing that ran was the clock.

Weekly Dow Chart

The 10200-10250 level about which I was writing last week and the rising weekly trendline held back last week's high, and bears successfully ran the fumble to lower descending support on the attempted weekly bull flag. 9800 support held, but the bounce today, even before it reversed, was weak and entirely uninspiring. The weekly cycle oscillators resolved their ambiguity to the downside, following the Nasdaq's lead, and new lows for the year were set. However, the drop in price got ahead of the 10-week stochastic and while a downphase is in place, a reversal from here would result in a bullish oscillator divergence against the higher stochastic low. That being said, the weekly price and oscillator trend is down, and the only source of strength is in the intraday cycles. Round number resistance at 9900 and at the Fibonacci levels of 10020 and 10150 are the levels to watch on any bounce.

Daily Dow Chart

The Dow held a miniscule gain through the session and almost squeaked through with a small bullish harami. It was not to be, however, and a small doji printed on the Dow's failure at the highs and fractional closing loss.

The drop last week wiped out the daily cycle upphase that had until then been delivering slow but steady gains. Barring a strong snapback rally tomorrow, the 10-day stochastic will complete its bearish rollover and signal a new daily downphase from a much lower price and oscillator high. This action confirms what the weekly chart above is telling us, as the weekly cycle downphase crushes the daily cycle's upward attempts. A move above 9900 would likely be insufficient to avert the bearish cross on the 10-day stochastic, while a break above 10175-10200, in addition to baffling bulls and bears alike, would reverse the current downphase, leaving a steep bullish stochastic divergence and possibly threatening the weekly downphase as well. That's obviously the less likely scenario. More likely is a consolidation of the recent losses, a possible bounce to a lower high below 10200, and a continuation of the downward influence of the weekly cycle downphase.

Weekly Nasdaq Chart

The Nasdaq cracked last week as well, plunging to new lows for the year. The Fibonacci and confluence support at 1760 remains key support below which the bullish interpretation of this year's decline off the highs will be invalidated. As with the Dow, the weekly cycle has resolved itself into a clear downphase, the plunge breaking the prior week's lows and reversing all of its gains with a bearish engulfing candle for the week. The weekly cycle wants more downside, and the Fibonacci levels line up well price confluence on the way down. Any bounce from here would be corrective within this timeframe, but with the decline still availing itself of a bull-flag interpretation, bears need to be vigilant for any daily cycle reversal to the upside that could rise sufficiently to challenge the 1920 level. There's strong resistance from 1840 to 1890, however, and the powerful moves have so far been to the downside.

Daily Nasdaq Chart

The Nasdaq's small loss resulted in weak doji as well- it would have been a gravestone doji had the upper range been higher, but there was insufficient strength to result in so strong a reversal. Volume was considerably lower than we saw on Friday's breakaway downside gapper, and as with the Dow, barring a very strong rally tomorrow, it's only a matter of time before last week's steep drop reflects itself in an equally steep stochastic downphase. In retrospect, the daily cycle upphase lasted just long enough to generate confirmation signals before it fell apart. While my personal feeling is that the vast majority of news doesn't disrupt the cycles for long, in this case the overarching weekly downphase helped to exacerbate the damage done by Friday's employment report. Furthermore, the decline was already in progress before Friday- the drop only continued it, breaking the prior week's lows.

Weekly TNX Chart

Last week's rally in bonds followed through on the previous week's bullish reversal. On the ten year note yield (TNX) chart, that action is reflected as a bearish gravestone doji top in the yield 2 weeks ago, followed by last week's precipitous plunge in the TNX. Today, the TNX closed higher by 2.7 bps at 4.244% as part of what looked and felt like a corrective move across most markets, but it's difficult and imprudent to judge the week's candle after only one day out of 5's trades. Resistance above is at 4.34%, 4.4%, 4.48%, 4.5% and 4.65%, while support is at 4.18% and 4.0%-4.02%. A break of that lower support of 4% could turn out to be a bear wedge breakdown that would project an implied target at the 2003 lows for the TNX (2003 highs for 10- year treasury bonds). The weekly cycle oscillators so far suggest that such would be an overly-optimistic target for the current move, but it remains a possibility.

The Commerce Department announced at 10AM that U.S. wholesale inventories increased by 1.1% in June while sales were flat. May inventories were revised up to 1.4% from 1.2% and sales were revised down to 0.3% from the 0.5% previously reported. The inventory-to-sales ratio rose from 1.13 in May to 1.15 in June, the highest reading since February 2004. In June, inventories of durable goods increased 1.4% after a 1.9% increase in May, whiles sales of durable goods rose 0.5% in June from May's flat reading. The buildup of inventories against flat or declining sales suggests an excess of optimism of companies producing more supply than required by existing demand, and the market responded negatively to the news on its initial release. If the trend continues, we would expect to see softness in future industrial production and capacity utilization readings.

Oil was once again strong and in the news throughout the session, with supply concerns dominating. News of a Shiite Muslim uprising targeting two pipelines that combine to deliver all of Iraq's 1.9M bpd of exports was reported, and crude oil prices spent the session above the 44 level and broke briefly above 45. Iraq announced that it would halt production at the Southern Oil Company in Basra because of threats from al-Sadr's Mehdi Army militia, and that such halt would remain in effect until the threat is over.

News that Russian YUKOS' deadline to pay transport fees is set to expire on August 10th, and the consequent expectation of uninterrupted supply of oil and refined products by rail from that day forward didn't help. This positive spin reported by Reuters was countered by negative interpretations of the same news to the effect that production would interrupted in the interim due to the state-owned railway's refusal to deliver oil for YUKOS on credit. Further worries about the upcoming Venezuelan election and possible challenges to Hugo Chavez also made the news and were interpreted negatively for supply/positively for price.

The overriding concern, however, appears to be the fact that OPEC is currently pumping at its highest levels since 1979. OPEC accounts for half the global supply of crude oil, and while there's talk of the cartel's willingness to consider increasing production by 1 to 1.5M bpd at its September 15th meeting, there is so far no evidence of weakness in the crude rally that today challenged the $45 level. It continues to appear that business risk, terrorist threats, consumer demand and geopolitical instability all mitigate in favor of higher oil, and the results continue to be seen in the ongoing extension of the oil rally.

Weekly chart of Crude oil

Bear Stearns analyst David Strine was bearish on airlines today, describing the sector as "broken" with oil above $40 per barrel. The Amex Airline Index, XAL, was weaker through much of the session as the broader indices rose but managed to close higher by 20 cents at 401. Strine felt that the index at current levels would require oil at $30 to be attractively valued. The XAL is down nearly 30% since its end of June highs. Just after noon, it was reported that DAL would be dipping into its cash reserves to pay certain current obligations, with 2004 cash flow being compromised by lower yields and higher fuel prices. DAL closed lower by 28 cents or 6.81% as of this writing at 3.83, while NYMEX September crude oil futures were trading 44.80 as of this writing, with an intraday spike high of 45.25, a new contract record.

There was trouble for UALAQ as well, with United's pilots union promising to resist any move that would threaten its pilots' pensions. Captain Mark Bathurst, chairman of the pilots' union, said that any such move could "potentially plunge labor relations at United into years of hostility and chaos," countering bankrupt UAL's effort to cut pension payments in an attempt to bolster its cashflow. UALAQ closed lower by .05 or 4.35% at 1.10. Google announced that it would be adding an additional 1.06M shares to its IPO for a total of 25.7M shares to be offered at an estimated $108-$135 for estimated proceeds of max. $3.47B. These additional shares are to come from insiders of the company. The Company also announced that 2.7M shares with a maximum value of $365M are to be issued under a settlement with YHOO pursuant to which YHOO will dismiss its patent suit against Google and Google will license several of YHOO's patents. YHOO closed lower by 1.23% at 25.70.

For tomorrow, all eyes will be on the 2:15 FOMC rate announcement, with the consensus expecting a 25 bp increase in the overnight rate to 1.5%. While the fates of most consumers continue to be tied most directly to the market rates which have declined since the April highs, the Fed's response to recent economic data and, I imagine, asset prices most acutely highlighted by the rally in oil will be closely watched across all markets. On the one hand, the recent wave of accommodation and stimulus from the Fed has arguably spurred inflation reflected in, among other things, housing, oil and other asset prices. On the other hand, as Friday's bleak employment report emphasized, the productivity gains on which the Fed has been focused have occurred while bypassing the key US labor market, exposing the economy to the vulnerability of high levels of consumer debt and a lack of wage inflation with which to offset it.

The first order of business tomorrow will be the 8:30 release of preliminary non-farm productivity for Q2, estimated at 2% from Q1's 3.8% reading. While at other points over the past year we've seen disappointments in the economic data catching a bid in the markets, presumably due to speculation that it would attract further stimulus from the Fed, recent reactions have seen a return to the more conventional behavior of buying good news and selling bad. With Q2 productivity obviously a key report in the Fed's crosshairs, there's the potential for wild swings not just at the 2:15PM FOMC announcement but also for the 8:30 data. However, the Fed's open market operations of the past 2 sessions do not suggest any great caution or fear on the part of the Fed, with a net drain on Friday and a very slight add announced this morning. Based on this action, if forced to guess, I would think that the 8:30 data will be inline with expectations.

Guessing aside, last week's move resolved a great deal of uncertainty (ie. weekly timeframe) to the downside. Today's bounce was so weak that I could almost believe it to be a stealth accumulation move toward a run higher. However, the weekly and daily cycles are both oriented bearishly here, and the widely expected intraday bounce was of such a small range as to have only been worthwhile on a scalp basis. Until either the upper resistance levels discussed above are broken or a surprise daily cycle upside reversal occurs, bounces to resistance should be sold. While there's great bullish potential in catching the bottom of a drop as steep as the one we saw last week, bullish stochastic divergences and all, the risks of fighting the trend and catching falling knives are the stuff of traders' clichés. The trend is your friend, and any countertrend trades need to be kept on a tight leash.


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