Option Investor
Market Wrap

Little Reaction

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      08-25-2004           High     Low     Volume   Adv/Dcl
DJIA    10181.74 + 83.11 10199.21 10068.11 1.46 bln 1969/ 867
NASDAQ   1860.72 + 23.83  1861.79  1830.30 1.28 bln 2020/ 966
S&P 100   539.57 +  4.59   540.35   533.75   Totals 3989/1863
S&P 500  1104.96 +  8.77  1106.29  1093.24
SOX       384.28 +  4.01   386.62   374.67
RUS 2000  550.14 +  5.13   550.16   542.13
DJ TRANS 3114.00 + 11.83  3117.56  3082.06
VIX        14.98 -  0.35    15.76    14.81
VXO (VIX-O)14.63 -  0.58    15.73    14.42
VXN        21.41 -  0.56    22.57    21.27
Total Volume 2,768M
Total UpVol  2,174M
Total DnVol    544M
Total Adv  3989
Total Dcl  1863
52wk Highs  138
52wk Lows    65
TRIN       0.50
PUT/CALL   0.78

Last night, two planes taking off from the same airport in Moscow crashed within minutes of each other, killing all of the almost 90 people on board the two aircraft. One pilot pressed a hidden hijack alert before the plane disappeared from radar, but as Wednesday dawned, investigators still withheld opinions about the likelihood that the crashes were a result of an act of terrorism. Some feel terrorists acting ahead of this weekend's presidential elections in Chechnya could be responsible. Perhaps because the terrorism might have been due to those elections, U.S. futures, as well as Asian and European markets, showed little reaction.

Crude prices crept up, too, with many expecting the morning's inventory numbers to show a decline. Crude prices had dropped for several days as Iraq increased oil flow from the southern fields and drew closer to exporting oil from the northern fields, too. A strike against a pipeline in southern Iraq reduced supplies again and heightened concerns that terrorism could disrupt oil production and delivery. ECB President Trichet reassured market watchers that although he's remaining vigilant, rising oil prices won't cause the ECB to change its forecast for economic recovery. This came after announcements over the last week from French and Japanese economic ministers that quantified how much of an effect gains in crude prices might have on their countries' GDP growth if crude prices continued to increase. Still, although European markets eased off their highs, our futures appeared to have little reaction.

Nor did our futures react to Wednesday's earliest economic release. This morning's economic releases started with the MBA Refinancing Index at 7:00, with the previous number showing a 20.9 percent increase. The Refinance Index fell 8.0 percent for the week ending August 20, with refinancing activity falling to a 40.4 percent share of total mortgage activity from the previous 40.7 percent share. The Market Composite Index of mortgage loan applications fell 6.3 percent if seasonal adjustments were considered and 7.3 percent if those adjustments were not considered. According to the Mortgage Bankers Association, the average interest rate for a 30-year fixed-rate mortgage increased to 5.78 percent from the previous week's 5.75 percent.

Homebuilders have so far shown little reaction to the Fed's beginning tightening cycle. This morning, Toll Brothers (TOL) reported better-than-expected Q3 earnings, with sales of luxury homes reportedly responsible for the good showing. The company expected deliveries and average home price to rise in fiscal 2005, with net income growth of 30 percent or more during that year. Though many spoke of a bubble in the housing market late last year, the behavior of stocks in the sector has continued to confound those who expected a steeper drop. TOL did show a little reaction Wednesday, however, climbing to a high not seen since April 1 before tumbling lower after the 10:00 release of further economic numbers related to the housing industry.

At 10:00, July's New Homes Sales showed those sales dropping to 1.134 million from June's 1.326 million new homes. Expectations had been for 1.300-1.320 million sales, so the decline was greater than expected. Sales of single-family homes dropped 6.4 percent, also a disappointing number. By the end of the day, the DJUSHB, the Dow Jones U.S. Home Construction Index, had dropped 1.01 percent, one of the few declining sectors. The index's rejection of its H&S formation on its weekly chart may be in question unless the index can push higher this week, building on recent gains.

Annotated Daily Chart of the DJUSHB:

The 8:30 release of the Durable Goods number for July also provoked a little reaction. June's Durable Goods orders had risen 0.9 percent, and with predictions for July's for a 1.0-1.5 percent increase, depending on the source. The 1.7 percent increase was termed better than expected, but some also called the increase unsustainable since most gains were related to orders for new civilian aircraft. Boeing (BA) was one of the companies reporting those higher orders, with the company delivering 75 commercial airplanes in the second quarter and recently reaching tentative deals with two dozen customers.

Orders for computers, defense goods and autos dipped, however. Ex-transportation, durable orders rose only 0.1 percent. Still, June's number for durables less transportation had been down 0.4 percent, and the 0.1 percent rise was the first monthly increase since March. Shipments of durable goods rose 0.1 percent, with this figure providing a look at current production. Unfilled orders rose 1.2 percent, with this number providing a measure of future production. Inventories rose 0.8 percent. After the release of the durable goods numbers, S&P futures dropped from a 7:20 high of 1,100 down to a 10:10 low of 1092.75.

After that little reaction, markets coiled into tight ranges, and not even the usually market-moving releases on crude, distillate and gasoline inventories broke them out of those coils. Crude inventories had been forecast to fall, and they did. The API, the American Petroleum Institute, said that crude inventories fell by 3.4 million barrels, with the earlier release by the Department of Energy noting a smaller 1.7 million-barrel decline. Although the API and Energy Department figures displayed their usual disparity, both were greater than the maximum drop expected, pegged at around 1 million barrels according to one article. The API noted that distillate inventories fell 633 thousand barrels, but gasoline stocks rose by 1.5 million barrels. The Department of Energy had tagged those numbers at a 500 thousand barrel climb for distillate inventories and a flat number for gasoline inventories. Some market watchers commented on the higher gasoline inventories noted by API, saying that at least was a relief.

Still markets coiled, showing little reaction to the news. The advancing:declining ratios showed the lack of direction. Except for a short period near the release of the crude, distillate and gasoline inventories, advancing and declining issues remained equally matched. At about noon, however, as crude dropped below Tuesday's low, markets did show a little reaction, breaking out of those coiling formations to the upside and shooting higher. Crude futures had spiked above $45.50 early Wednesday, but had been drifting down from that level as the morning progressed. The buying appeared to be broad-based as all main industry groups moved into positive territory. Advancers pulled ahead of decliners on both exchanges.

A dip in crude costs shouldn't be given all the credit for that little reaction. A study of intraday charts points out that the SOX had been gaining since its gap-lower opening and first five- minute dip, preparing the way for a breakout. At five minutes after noon, just a few minutes after crude prices dipped below Tuesday's high, the SOX broke above Tuesday's high, signaling an upside breakout.

Annotated Five-minute Chart of the SOX:

Other indices participated in that little reaction in the afternoon, as did most sectors of the markets. The XAU, the gold and silver index, and the XBD, the Securities Broker Dealer Index, appeared to the sectors showing the biggest gains. Volume remained suspect, however. In last night's Wrap, Jane Fox pointed out the importance of volume corroborating gains. That's not happening now. While that little reaction this afternoon produced breakouts on the indices, some charts display reasons for caution other than volume considerations.

Annotated Daily Chart of the SPX:

The SPX nears the level from which it should turn back if it's to form another shoulder for a possible inverse H&S formation. It's also approaching the converging 100- and 200-sma's. Many oscillators show potential price/oscillator bearish divergence, but that can be undone if price moves higher than the August 2 high of 1108.60. A rollover beneath those converging 100- and 200-sma's would present a good opportunity for a bearish position while a breakout above them would suggest a bullish one. If entering bearish plays on a rollover, make plans to protect profits in the right-shoulder area, in case the index rolls up again toward the neckline.

The Russell 2000 has also approached the appropriate spot for a horizontal neckline for a potential inverse H&S.

Annotated Daily Chart of the Russell 2000:

This chart displays the same tentative bearish price/oscillator divergence, but bearish divergence that can be erased if the Russell 2000 moves above the 7/30 high of 552.14 before oscillators turn lower. With the importance of the 50-dma to the Russell 2000's trading pattern, a breakout above that horizontal resistance would not be confirmed until a breakout above the 50- dma, too. Any participating in a long Russell play on any such breakout should have profit-protecting plans in mind for an approach to the 100- and 200-sma's at 562.15 and 564.67, respectively. As mentioned in this weekend's Wrap, the breakout above the rectangular pattern formed in the middle of August appeared to be the best bet for long positions for the Russell 2000, as new entries since then have always faced resistance that looked important and might turn it lower. Rollovers from below the 50-dma would be appropriate for bearish entries, with plans made to protect profit in the right-shoulder area.

Although the Nasdaq also faces horizontal resistance, it has not yet approached either the 50-dma or the appropriate spot for a horizontal neckline for a possible inverse H&S.

Annotated Daily Chart of the Nasdaq:

A breakout above May's swing low at 1865.40 might make an appropriate long entry, but SOX and Russell 2000 strength should be confirmed first before such an entry is considered. Light volume days already make these breakouts suspect, so all other ducks should be in a row before such entries. Entries at rollovers from beneath the 50-dma and 1900 resistance, if offered, might make appropriate bearish entries, but profit- protecting plans should be made as the right-shoulder level is approached again.

The Dow also approaches horizontal resistance, as well as resistance from several important moving averages, an appropriate level for a horizontal neckline for a potential inverse H&S.

Annotated Daily Chart of the Dow (Using DJX as Proxy):

The Dow, Russell 2000, and Dow all approach horizontal and other forms of resistance. Daily charts show possible bearish divergence developing, but divergence that can be erased by the simple act of price climbing higher before oscillators roll down. Yet the form the indices have been producing appears to be possible inverse H&S's, which would require the formation of another shoulder before completion, warning that there might be another dip to come even if indices are to breakout eventually. On weekly charts, these indices appear to be following through on the morning-star reversal signals produced last week, but this week isn't over yet, and one indicator index we watch hasn't yet achieved a breakout.

Annotated Daily Chart of the SOX:

A careful look at a SOX 60-minute chart shows an inverse H&S-ish formation on that chart, too, apparently nearer to confirmation than that of other indices, but the formation appears so ragged that a neckline is difficult to define. A breakout above Monday's high of 394.58 might mark the neckline while others might prefer to wait for a breakout above 400 to consider the formation confirmed. That 50 percent retracement of the SOX's rally off the October 2002 low appears to be a sticky place that the SOX has difficulty moving past, however. After hours, semiconductor company Credence Systems (CMOS) reported earnings that sent the stock lower on disappointment in the revenue figure and the outlook for Q4 sales and earnings. That report won't help the SOX get past that sticking point.

In other after-hours stock developments, Cyberonics (CYBX) was falling after the medical device maker commented on its plans after receiving a not-approvable letter from the FDA over an anti-depression drug. The company raised guidance for the Q2, saying that it expected a narrower loss than previously announced.

In last weekend's Wrap, I speculated that some of crude's recent abrupt ascent could have been tied to short-covering as last Friday's expiration of the futures for September delivery approached. Shorts who had hoped for a resolution to the situation in Iraq were trapped when a resolution dragged on past Friday's expiration. I had reasoned that if that had been a factor, crude futures might ease this week, allowing equities to rise. Whether that speculation turned out to be true or all the other reasons attributed to crude's descent this week, such as the renewed flow in Iraq, are responsible, the dip in crude prices eased some pressure. Wednesday, crude futures for October delivery dropped from Tuesday's closing level of $45.21 (according to QCharts) to Wednesday's close at $43.47, a significant drop on top of three previous days of drops. Crude could continue dropping, down to the $41.25-42.00 support or even lower, to the 30-dma, currently at $37.34 but still rising steeply toward the $39-41 region.

In the meantime, how much damage has crude's rise done to our GDP? Fear of that GDP number may begin to assert itself tomorrow, with the number to be released Friday morning. Japan's and the eurozone's GDP disappointed. Our markets react as if they expect an upside surprise, moving up in preparation for breakouts above horizontal resistance and important moving averages, but those light-volume climbs remain suspect ahead of the GDP. If you want to bet along with those who expect an upside surprise or at least not a disastrous number, be aware of the risks. Sitting out the day ahead of the GDP number might not be a bad idea.

Thursday morning's economic releases will include the usual 8:30 release of initial jobless claims, with those jobless claims at 331 thousand last week and with expectations for 335 thousand for the current week. July's Help-Wanted Index comes next, at 10:00, with that index at 38 for June. Expectations are for a flat to slightly higher number for July, at 38-39. Natural gas inventories will be released at 10:30. Other events for Thursday include mid-quarter updates from GDT and NVLS, but it will be developments in crude and anticipation over the GDP that control markets tomorrow.


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