Option Investor
Market Wrap

A New Meaning

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     08-18-2004            High     Low     Volume Advance/Decline
DJIA    10083.15 +110.32 10083.15  9934.05 1.58 bln   2192/ 621
NASDAQ   1831.37 + 36.12  1831.37  1784.60 1.55 bln   2240/ 797
S&P 100   534.84 +  6.44   534.84   526.81   Totals   4432/1418
S&P 500  1095.17 + 13.46  1095.17  1078.93 
RUS 2000  541.61 + 11.61   541.70   526.98
DJ TRANS 3094.47 + 49.87  3094.60  3027.20
VIX        16.23 -  0.79    19.67    16.13
VXO        16.30 -  0.89    17.80    16.27
VXN        24.17 -  1.38    26.29    24.07
Total Volume 3,461M
Total UpVol  3,040M
Total DnVol    389M
52wk Highs     104
52wk Lows      122
TRIN          0.43
PUT/CALL      0.98

Jim attends a conference through the end of this week, and will return next week.

Those who looked forward to seeing the markets googled may have attached a new meaning to that anticipated effect Wednesday. While the long-awaited Google (GOOG) IPO was expected to reinvigorate markets when it was first announced, news related to its IPO may deflated markets instead pre-market-open Wednesday morning.

Beginning in the European overnight session, commentators began to mention the Google effect as one depressant on the markets. Although the Google IPO had been expected to debut Wednesday, the SEC closed its doors Tuesday afternoon without declaring the company's registration statement effective. At 4:07 Wednesday afternoon, CNBC announced that Google had finally obtained that registration statement, clearing Google to launch its IPO.

Monday, news had circulated that the SEC was conducting an informal probe into options grants for Google's employees, but by Wednesday morning, another possible problem had resurfaced. Although most had assumed that potential problems with the founders' interview with Playboy had been resolved by amended IPO documents that included the interview, some were mentioning that the SEC might have second thoughts about that interview, too. The thought was that the article may have violated quiet-period rules although the interview was conducted in April. In addition, many viewed the two-tier class structure for the shares as problematic.

While some termed these mistakes "amateur" mistakes, there might have been little room for amateurish actions in a climate of tech weakness. Enthusiasm for Google's IPO had apparently dimmed. During the overnight session, Google announced that it would trim the expected range of its IPO from the former $108-135 to $85-95, a decision that did not come as a surprise to many market watchers. The recent weakness in tech stocks, including Internet stocks, resulted in reduced interest in a high-priced IPO. Google also said that it would sell fewer shares. If the company is able to price shares at the midpoint of its new range, the reduced share offering would bring in $1.8 billion.

Also, pre-market, an AP report named Dutch bank and insurer ING as the Janus client planning to withdraw from the fund, with the planned ING withdrawal representing about 4 percent of Janus' assets. ING dropped in early European trading, although it had gained 0.71 percent by the U.S. close.

Crude futures also pressured European markets and U.S. futures. Several weeks ago, a European technical analyst discussed crude prices on CNBC Europe. That analyst mentioned a short-term target for crude at $47.50 and a top at $57.00. At the time, even though crude prices had been surging, those targets appeared overstated. They didn't appear so this morning, with crude futures for September delivery above $47.00 in the overnight session and hitting $47.35 just before the Department of Energy released its inventories figures.

Equity futures reacted as expected in the pre-market session, dropping with that and other news. In Europe, Air France and Deutsche Lufthansa this week added surcharges to cope with rising crude costs, and Finnair blamed rising fuel costs for an anticipated loss in 2004. Other companies begin to mention the impact that rising crude costs have on their earnings.

Readers have been advised for a long time to watch crude futures since rising prices pressure the equity markets. Equity markets often trade in an inverse relationship to crude futures. However, a different meaning might now be attached to crude's climb. At some point, crude futures will top out for the short- term, and each cent tacked onto its price brings it closer to that short-term top. Crude's rise has become almost parabolic since mid-August. If that analyst on CNBC Europe was correct, that short-term top may not be the final top, but that short-term top could come any time, including at the $47.50 mark that analyst indicated, almost hit Wednesday. In addition, at some point, markets will begin to anticipate the absolute swing top in crude prices, and will begin to discount that top, with equity indices perhaps disconnecting from the current pattern of trading in opposition to crude futures. We may see a period, perhaps only a short-term period or perhaps longer, when both equities and crude rise. That period may have begun Wednesday.

Annotated Five-Minute Charts of Crude Futures and the TRAN:

Because so many geopolitical developments factor into the costs of crude, it's difficult to pinpoint whether the disconnect has begun or if Wednesday's trading pattern was just an aberration. Did it begin today because the situation in Najaf could possibly be resolved more peaceably than was first expected? Did Jimmy Carter's willingness to reexamine referendum results in Venezuela calm that situation? Will the disconnect happen if Yukos is purchased and markets believe the purchaser can maintain production standards?

Developments in Iraq and Russia led to some of Wednesday's volatility in crude prices, but market watchers also noted that a monthly report from OPEC may have resulted in the pre-market spike in crude prices. OPEC raised expectations for 2004's demand by 27.17 million barrels. Although OPEC also noted that OPEC production could meet demand in both 2004 and 2005, markets did not want to hear about increased demand in a rising-price environment.

In addition, Wednesday, Shiite cleric Muqtada al-Sadr reportedly agreed to withdraw his forces from Naraf's holy shrine. Many deaths and injuries had already resulted in Wednesday's clash before the cleric's decision. Although some distrust this development, especially as the cleric also demanded a truce with surrounding U.S. troops, the possibility of a peaceful resolution in Naraf eased some fears about oil production in Iraq. Six hours before the cleric agreed to withdraw his Mehdi Army militia, Iraq's defense minister had warned that an assault on the shrine was imminent. The possibility that the cleric would withdraw tempered the early gains in crude prices that other developments had engendered.

Those other developments included a Russian court's refusal Tuesday to suspend the government's efforts to collect Yukos' tax bill for 2000, setting up the possibility that the company will file for bankruptcy. The developments also included Department of Energy and API figures showing decreasing crude inventories. The Department of Energy quoted a 1.3 million barrel decrease while the American Petroleum Institute quoted a 1.5 million barrel decrease. Because of Hurricane Charley and Tropical Storm Bonnie, some had anticipated a bigger decline, however, by as much a 3-5 million barrels. Others argued that the real effect will not be shown until next week. The confusion resulted in volatile trading patterns between 10:30 and 11:00, when the Department of Energy and API released their figures.

Other figures showed gasoline inventories down 2.6 million barrels, according to the Energy Department, and 3.5 million barrels, according to API; and distillate inventories rising 2.1 million barrels, according to the Energy Department, and up 1.6 million barrels, according to API.

The temporarily lessened import of rising crude prices, perhaps because some view those prices as topping out, allowed equities to rise in Wednesday's trading. The TRAN rose through its descending regression channel, climbing above the 30- and 50- dma's and closing above both.

Annotated Daily Chart of the TRAN:

The TRAN rises toward a challenge 3100 and the top of its descending regression channel, near 3125, both levels the TRAN could reach tomorrow or the next day. The TRAN tends to produce a consolidation-type candle as it reaches important milestones, so it would not be a surprise to see it produce a smaller-range candle Thursday that touches or perhaps pierces 3100 or the top of the descending regression channel. As yet, it's not possible to predict whether the TRAN will break through that channel or turn down again. Oscillators suggest more upside to go, but they often do as the TRAN approaches the top of the descending regression channel, and the TRAN has historically still turned down at that resistance. This has been a bellwether index lately, sometimes being more predictive of market action than the often-hailed SOX, so keep an eye on this index's action tomorrow with respect to that upper channel line. Remember that the TRAN can be volatile, so that it sometimes pierces a trendline only to fall back below it.

Crude was not the only influence on the markets today, of course. Earnings reports from retailers Borders Group (BGP), Charming Shoppes (CHRS), Ross Stores (ROST), and Talbots (TLB) showed all four companies either meeting or beating forecasts, helping to support markets early in the session. All were positive part of the day, although not all held onto their gains. The S&P Retail Index, the RLX, did, however, closing cents above its 200-dma. That close came at a level from which the RLX might pull back to form a shoulder of a potential inverse H&S, however.

Also, early Wednesday morning, the Mortgage Bankers' Association released figures showing that for the week ending August 13, the Market Composite Index of mortgage loan applications rose 11.9 percent. The seasonally adjusted Refinance Index soared 20.9 percent. The Refinancing Index had last shown refinancing activity up 2.5 percent. The average 30-year, fixed-rate mortgage decreased to 5.75 percent from the 5.80 percent figure a week earlier. The Dow Jones US Home Construction Index, the DJUSHB, climbed, but only a modest 0.49 percent. Benefiting more were the financial stocks, with the BIX, the S&P Banking Index, gaining 0.99 percent, and the BKX, the Philadelphia Bank Sector Index, rising 0.93 percent. The BIX broke through the upside of an orthodox broadening formation on its daily chart, although technical analysis suggested that a downside break was more likely.

Annotated Daily Chart for the BIX:

There's no reason to doubt this breakout, but traders might be wary, nonetheless. Watch Thursday for follow-through on this index or for a fall back inside the formation, a bearish occurrence if it should happen.

Other indices produced upside breakouts out of formations typically deemed bearish. The SPX was one.

Annotated Daily Chart of the SPX:

The SPX nearly met the upside target suggested by the break out of a rectangular pattern. Limited upside follow-through tomorrow might be one outcome, with a pullback to follow, perhaps next week. One developing pattern on the 240-minute and daily charts suggests this possibility.

Annotated 240-Minute Chart of the SPX:

A close much above 1109 would appear to negate the potential formation, while a close between 1000 and 1109 would require a redrawing of the possible neckline, then depicting it as horizontal rather than declining. A candle that pierces that trendline and possibly 1100, but closes at or below both, would tend to confirm the possibility of the SPX turning down into another shoulder. Anyone who has traded through the last year knows better than to count on either a regular H&S or an inverse one confirming, but watching this formation allows traders an opportunity to measure strength or weakness. A drop much past 1070 would tend to reject the formation, but even if it's to be eventually confirmed, it's possible that bulls will endure a pullback first.

The Nasdaq and SOX both climbed to test the former support from their violated descending regression channels.

Annotated Daily Chart of the Nasdaq:

Annotated Daily Chart of the SOX:

Although the TRAN's behavior has often been more indicative of the markets' general direction than the SOX lately, it may be time to return to watching the SOX for guidance. The SOX's gains Wednesday were produced despite disappointment with Applied Materials' (AMAT) guidance. With the semi book-to-bill number due Thursday after the close, it might be possible to see a continued run-up into that number, perhaps to 393-394 or even up to the 30-dma, but a high-wave candle, doji, or other candle indicative of indecision appears possible for Thursday, too, after Wednesday's big gain.

The daily charts of the Dow and Russell 2000 showed many of the characteristics shown on that of the SPX.

Annotated Daily Chart of the Russell 2000:

Like the SPX, the potential for an inverse H&S exists on this chart, but the Russell 2000 may have further to climb before consolidating and rounding down into another shoulder, perhaps up toward 548-550, depending on whether the neckline is to be horizontal or descending. The Russell 2000 has met the upside target projected by the break out of its rectangular consolidation formation, however, and soon faces resistance from those converging moving averages marked on the chart, so it's possible that it will see some type of candle indicative of indecision tomorrow or Friday, too.

Annotated Daily Chart of the Dow:

The Dow ended the day jammed up against next resistance after having met the upside target predicted by the breakout of its rectangular consolidation zone. An inverse H&S also remains possible on the Dow. If that inverse H&S is to form, look for either an immediate downturn or possible follow-through on the gains Thursday morning, perhaps up to 10,100-10,120, with the Dow backing off the high of the day by the close and producing one of the candles indicative of indecision. Gains much higher than 10,120 might indicate that the neckline will not be descending, but that the Dow might instead rise toward 10,200 before steadying and forming a possible horizontal neckline.

Although many indices present the possibility of a consolidation- type day or pullback beginning Thursday after some initial follow-through, stronger gains or an immediate reversal can't be ruled out. Those possibilities of a consolidation-type day can also be predicated upon the usual tendency of a tight-range day to follow a large-range day, and on the often-seen tendency for indices to get pinned to certain numbers beginning about midday on the Thursday of an option-expiration week. However, overnight developments in Iraq or Russia might change the tenor of trading Thursday, and just because tight-range days tend to follow large- range days doesn't meant that they always do.

Indecision might now be unexpected tomorrow for reasons other than what's seen on charts, too. Thursday, market watchers may feel as if their heads are spinning, trying to weigh the impact of many economic releases. Initial jobless claims begins the day, released at 8:30. Last week's number showed 333 thousand new claims, with 335-340 thousand expected for this week's number. At 10:00, July's Leading Indicators, the DJ/BTM Business Barometer, and Chicago Fed Index will all be released. June's Leading Indicators Index fell 0.2 percent, with expectations for July's also suggesting a decline, from 0.1-0.4 percent, depending on the source.

Thirty minutes later sees the release of the natural gas inventories, not garnering as much attention lately as the crude inventories number. A noon, the August Philly Fed Index will be released. In July, the Philly Fed stood at 36.1, with predictions for August's number spanning a wide range, from 20.0- 30.8, depending on the source. After the close sees the Money Supply number and the Semi Book-to-Bill number, released at about 6:00 EST. Although that semi number will not be released during trading, anticipation might impact the SOX tomorrow.

Then there's the Google effect. As this report was prepared, it was not yet certain whether Google would begin trading Thursday, but that remained a possibility. The potential scenario for the markets outlined in these pages might be radically changed by Google's IPO if it begins trading or by some geopolitical event occurring during the overnight session, events that cannot be foreseen tonight. Test early market action against the scenario to see if it fits. Discard the scenario if it doesn't. Many markets ended at or just under possible resistance, allowing an easy test of that scenario.


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