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Market Wrap

A Difficult Trading Environment

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      09-01-2004           High     Low     Volume   Adv/Dcl
DJIA    10168.46 -  5.46 10208.27 10110.65 1.38 bln 1718/1080
NASDAQ   1850.41 + 12.31  1859.44  1833.33 1.41 mln 1772/1197
S&P 100   538.60 -  0.17   540.74   535.63   Totals 3490/2277
S&P 500  1105.91 +  1.67  1109.25  1099.11
SOX       374.16 +  3.14   379.62   369.07
RUS 2000  552.46 +  4.53   563.38   547.70
DJ TRANS 3106.53 +  1.07  3132.73  3085.08
VIX        14.91 -  0.38    15.39    14.72
VXO (VIX-O)14.98 +  0.00    15.62    14.57
VXN        22.65 -  0.27    23.16    22.10
Total Volume 2,790M
Total UpVol  1,818M
Total DnVol    882M
Total Adv  3490
Total Dcl  2277
52wk Highs  178 
52wk Lows    49
TRIN       0.71
PUT/CALL   1.05

Many market technicians determined at Tuesday's close that Wednesday might be a difficult day to trade. Little did they know how difficult it would be. Technical analysts had pointed to the obvious battle between those with bullish and bearish hopes, with the possibility that the battle would produce choppy trading conditions Wednesday. They didn't know that indecision would be complicated first by a fat-finger rise in the Russell 2000 at the open and then by a dive in the markets caused by a rumor of a multiple-casualty event in D.C.

By day's end, the Dow, TRAN, SPX, OEX, BIX, and SOX had produced either doji or small-bodied candles indicative of indecision, in any cases leaving long shadows above and below the candle body. Advancers were stronger than decliners on both exchanges.

U.S. traders had reason to be more optimistic than they appeared to be pre-market Wednesday morning. With only four exceptions, all global bourses either traded in the green or had closed in the green during the overnight session. During that overnight session, some semi-related stocks had recovered and closed in positive territory. That rebound occurred despite an avalanche of analysts trimming estimates and worry building up ahead of Intel's mid-quarter update on Thursday.

U.S. futures did not display optimism, however, and instead registered slightly negative values. Prudential had lowered the software sector to a neutral rating, perhaps contributing to the weakness in the Nasdaq futures, few news sources focused on the downgrade. Crude futures had been trending up during the overnight session due to a pipeline fire in Iraq and worries about the expected inventories numbers, but remained well below recent highs. A hostage crisis involving schoolchildren and their parents and teachers erupted in Russia, but although market participants of course worried over the fate of the hostages, U.S. markets had tended to ignore recent terrorists' activities in Russia.

More likely causes for the slightly lower futures included caution ahead of the day's economic releases, to begin with August's ISM Manufacturing Index at 10:00. Expectations for auto sales figures also garnered pre-market attention in some media. Commentators cited higher incentives, higher material and fuel costs, and building inventories as causes for worry, with some mentioning a possibility that car manufacturers could announce cutbacks in production.

Whatever worry was given the most weight in the pre-market environment, Wednesday's economic releases had been some of the most closely anticipated of the week. At 10:00, the August ISM Manufacturing Index's headline number disappointed, at 59 against the previous 62, with expectations at 60.00-60.5. The prices paid component was higher than expected, at 81.5, with expectations for a flat 77 against a previous 77. The new orders, employment, and backlog of orders components all fell, while inventories rose. The prices-paid and employment components were the most closely watched, with prices paid now the highest in three months. Employment dropped to 55.75 from 57.3, but remained above the benchmark 50.

Although most indices had dipped into the 10:00 numbers, they rebounded sharply after their release. The reaction to the number appeared to be keyed to relief that components remained above that benchmark 50 level and that the number wasn't worse than it had been. July's Construction Spending was also released at 10:00, showing an increase of 0.4 percent, with the previous number showing a decrease of 0.3 percent, and expectations for a 0.2-0.4 percent increase for July. The number was tagged as in line with expectations.

The rebounds in the indices catapulted the SPX toward another test of its 200-sma, with the SPX climbing within three points of that average. The TRAN, a strong indicator index lately, opened above 3100 and climbed to a high just above the August 26 high, seemingly indicating another upside breakout. The SOX charged straight up toward 380 resistance.

By 10:30, many indices had reached their highs of the day, however, with the RLX being a marked exception as it climbed into the close. The release of the Department of Energy and American Petroleum Institute's crude, distillate and gasoline inventories revealed a shocking decrease in crude inventories. The DOE reported a drop of 4.2 barrels for the week ended August 27, and the API reported a drop of 8.1 million barrels. Analysts had expected an increase in crude inventories. Distillate inventories rose 1.3 million barrels according to the DOE and 2.2 million according to the API. Gasoline inventories rose 900,000 barrels according to the DOE and 2.2 million barrels according to the API.

With a hurricane about to rush up the Florida coast, perhaps disrupting oil production, and concerns about the pipeline fire in Iraq and recent terrorists' activities in Russia, crude futures accelerated the climb that had begun during the overnight market. Crude futures spiked up almost to $44.00 in that first push. The TRAN, particularly sensitive to fuel costs, steadily declined. By 12:20, that index had erased all but a few cents of the gains made since the previous day's close. The TRAN maintained its role as an indicator index, with many other indices and sectors also declining off their highs, even the financials and semiconductors. The SPX's behavior was typical, setting up a series of lower highs that indicated it might be forming a bearish right triangle.

Annotated Five-Minute Chart of the SPX at 13:00:

During the next five-minute period, disaster appeared to hit. Rumor of a mass casualty incident in Washington, D.C. sent the SPX lower by more than four points in less than ten minutes. Other indices plummeted. The drop was broad-based as market participants hit the sell button.

As the five-minute SPX chart indicated, indices had been set up for a fall before the rumor surfaced, but that rumor perhaps exaggerated the decline. As more information became available, and it became likely that the casualties were limited to watery eyes caused by a pepper-spray prank by adolescents, markets rebounded.

However, by then, new car sales figures had begun to hit the airwaves, and they weren't good. Higher gasoline prices had impacted sales. Daimler-Chrysler, Ford, and General Motors all reported slipping sales, as did Honda, Nissan, and Mazda. Ford's sales declined 13 percent, and the company admitted that it would reduce production by 7.8 percent in the fourth quarter, an outcome that had been anticipated and feared. General Motors' sales fell 7 percent and DaimlerChrysler's, 6 percent.

Crude oil kept sliding higher, adding pressure, too. From Monday's low of $41.30, crude futures for October delivery had gained more than $3.00 at the intraday high, although those futures slipped off the day's $44.40 high to close at $44.00. One headline remarked that crude had seen its biggest one-day increase since June.

With Intel's anticipated mid-quarter update Thursday drawing so much attention and with the SOX playing a leadership role in the tech-related indices, beginning with an examination of the SOX's daily chart appears to be a sound idea.

Annotated Daily Chart of the SOX:

The 20-sma continues to play an important role in the SOX's behavior, as does the 50 percent retracement of the rally off the October 2002 low, the purple horizontal line on the above chart. The 30-dma descends toward that 50 percent retracement level, so that the two might converge more closely by the time they're tested. A breakout above the 20-dma should probably be confirmed by a break above that 50 percent retracement level and converging 30-dma. An upside break through these levels brings the SOX back inside that descending regression channel.

Some expect a buy-the-fact reaction after Intel's update or perhaps even a short squeeze tomorrow, ahead of that update. Those holding bearish profits might be reluctant to give them up if Intel might something encouraging or even if the update is no more troublesome than is expected. Although many remember an Intel-driven decline, market participants have had weeks to remember that decline and position their accounts accordingly, so the buy-the-fact reaction remains possible, if its likelihood cannot yet be gauged.

A long position in the SOX remains problematic, however, because of closely placed resistance. That resistance might be found at the August 23 swing high of 386.00, with a move above that level confirming the higher low recently reached. Resistance looms at 400, too. The 50-dma at 412.81 might have dropped to join 408- 410 historical and Fibonacci resistance by the time it's tested, and 420 is also known historical resistance. A drop below the August 13 low of 360.61 would create a lower low and confirm the rollover beneath the 50 percent retracement of the rally.

Similarly, the Nasdaq appears poised for a break through a horizontal resistance line or for a downturn beneath it.

Annotated Daily Chart of the Nasdaq:

The Nasdaq's most recent pullback could be a bull flag forming beneath resistance. If so, logic suggests that the Nasdaq will maintain closes above that 30-dma. An upside break of the bull flag would be confirmed by a move and close above the May low. A drop below Tuesday's low, especially if confirmed by a close beneath the 30-dma, would suggest a potential rollover beneath that horizontal resistance.

A horizontal resistance line also plays a part in the Russell 2000's trading pattern, evident even after that early morning fat-finger spike higher Wednesday.

Annotated Daily Chart of the Russell 2000:

This chart presents a few interesting developments. Due to the early morning spike, the Russell 2000 spanned the distance all the way from the (green) 200-ema to the 200-sma, finding support at one and resistance at the other. Candle bodies continue to form at or beneath the horizontal resistance and the 50-dma, although the Russell 2000 edged above the 50-dma at the close. In addition, as is obvious by Wednesday's trade, whether caused by a fat-finger trade or not, the Russell 2000's pattern begins to look more volatile again, widening from the tight range it printed when first testing this level. Sometimes that kind of volatility precedes a breakout as one side or the other momentarily gains an advantage.

Oscillators give opposite impressions of the likely direction of that breakout, with stochastics completing a bearish kiss and attempting a roll down out of territory indicating overbought conditions while MACD attempts to move up through the signal line. Obviously, oscillators are as confused as traders by the recent action.

The Russell 2000 had appeared to be setting up for a rollover into a potential shoulder for an inverse H&S, reaching the potential rollover level ahead of some other indices. Now it's lingered there so long that the rollover scenario can no longer be given preference over an upside breakout one. The possibility that this recent consolidation has formed a blunted right shoulder or that bulls intend to forgo the right shoulder altogether cannot be ignored. The recent consolidation pattern remains roughly bounded by the 30-dma's support and the 50-dma's resistance, so breakouts might be determined by moves above or below those averages.

Wednesday's action points out the problems attendant upon such a choice of boundaries, however. An upside break could be expected to find resistance at either the descending 100-sma or the 200- sma. Bullish traders should have profit-protecting plans in place as those levels are tested, if they are. A downside break could be expected to find first support at the July low and then near 520. Bearish traders should have profit-protecting plans in place as those levels are tested, if they are.

Like the Russell 2000 and many other indices, the Dow appears trapped between moving averages.

Annotated Daily Chart of the Dow:

The Dow's range, like that of many indices, has widened, with the Dow mostly contained in a range from 10,110-10,210, but with a dip down to the 200-ema, currently at 10,077. As with other indices, stochastics present a picture of possible weakness while MACD presents a picture of possible strength. Breakouts above the recent range will soon encounter the 200-sma, and breakdowns below the recent range will soon encounter 10,000. Perhaps Intel's guidance will break the Dow out of this range one direction or the other, but expect choppy, non-directional behavior until the Dow does break out of that range.

SPX traders might expect the same range-bound, non-directional trading pattern until the SPX breaks out of its recent range, one of the most clearly defined of the indices.

Annotated Daily Chart of the SPX:

A breakdown below the closely matched 200-ema and 30-sma would suggest that the SPX was rolling down into a right shoulder for a possible inverse H&S. A breakout above the 200-sma would suggest that the SPX was forgoing the right-shoulder formation and breaking to the upside.

The SPX's clearly defined range, bounded by the converging 100 and 200-sma's on the top and the 30-sma and 200-ema on the bottom, might serve as a guideline to those watching for breakouts on other indices, too. I would be careful trading an upside breakout on any index, for example, if the SPX were just then challenging its 200-sma and hadn't yet broken above it.

Breakouts remain suspect if crude continues climbing. Recent activity shows crude futures' prices retreating to the 50-dma on Monday and bouncing from that average, an average that has supported it through many touches except for one in late June. Crude futures had also touched the early June high before rebounding. While crude futures could always round into a lower high, they're so far behaving just as would be expected if they were following an important MA higher, with each trough stopping above the preceding peak. As long as that pattern continues, equities might remain under pressure. Watch the 50-dma, currently at $41.89, and the early June high at $41.24, as violations of those levels could indicate that crude futures would again retreat to the 100-dma as they did in late June.

As of Wednesday's close, most indices remained caught in ranges that have produced and may continue to produce choppy trading conditions. Perhaps traders saw the possibility for inverse H&S's to form across many indices, and decided to buy or leverage in ahead of the drop into the right shoulder, keeping that right shoulder from forming. Bulls appear to want to send the indices higher, believing they will go higher, without waiting for that inverse H&S, which after all is a bullish formation if it completes. The dip-buyers have not had enough strength to accomplish their goal, however, with the choppy trading conditions a result of the almost equal strength between bulls and bears. Whether bulls will eventually win out remains unknown at this point. Unfortunately, while indices remain within ranges known to produce choppy trading conditions, then choppy trading conditions will probably continue.

Wednesday's decline in financials might be problematic to bullish hopes, and bears watching. Intel's update could propel the SOX, Nasdaq, Dow and then, by extension, other indices out of their recent ranges. Crude costs could, too, an often-repeated but still true fact. So far, the TRAN, an indicator index for the impact of crude costs on the economy, has held up fairly well under crude's rise, but it's also having difficulty moving far away from its 50-dma. Today's car sales figures showed some of the impact that higher crude costs have had on consumers, and same-store sales figures released Wednesday after the close and Thursday pre-market may also show some of that impact.

So far, that impact has not been evidence in same-store sales (SSS) released after the close. Hot Topic (HOTT) reported SSS falling 8.7 percent, but said that overall sales had been strong, up 8 percent. American Eagle (AEOS) raised Q3 expectations to $0.56-0.58, far ahead of the earlier $0.47 guidance, after reporting SSS up 24 percent in August. Men's Wearhouse (MW) August SSS climbed 9 percent.

Trade carefully tomorrow ahead of Intel's after-the-close update. Worries over Intel's mid-quarter update have been weighing on techs across the globe this week. Several firms, including Morgan Stanley, lowered expectations for Intel ahead of the update. Japan's Industrial Output disappointed Tuesday, with rising inventories and reduced production among high-tech companies responsible for at least part of that disappointment, so market watchers have reason to worry. Still, any disappointment might already be built into the markets.

Thursday's economic releases begin with the usual 8:30 release of jobless claims, but also include the Q2 Final Nonfarm Productivity and Unit Labor Costs. Those numbers were last at 2.9 percent and 1.9 percent respectively. Those numbers will be followed at 10:00 with July's Factory Orders, with the previous number showing a 0.7 percent increase. The DJ/BTM Business Barometer will also be released at 10:00. Natural gas inventories will be released at 10:30.


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