Option Investor
Market Wrap

Meeting Expectations

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      09-08-2004           High     Low     Volume   Adv/Dcl
DJIA    10313.36 - 29.43 10361.22 10305.18 1.54 bln 1083/1708
NASDAQ   1850.64 -  7.92  1870.04  1850.05 1.44 bln 1121/1893
S&P 100   543.12 -  1.88   546.27   543.12   Totals 2204/3601
S&P 500  1116.27 -  5.03  1123.05  1116.27
SOX       352.06 -  1.70   358.36   350.91
RUS 2000  557.79 -  5.14   565.79   557.64
DJ TRANS 3188.79 +  7.79  3203.20  3176.82
VIX        14.06 -  0.01    14.31    13.41
VXO (VIX-O)13.70 +  0.12    14.11    13.58
VXN        21.28 -  0.16    21.83    21.24
Total Volume 2,980M
Total UpVol  1,093M
Total DnVol  1,832M
Total Adv  2204
Total Dcl  3601
52wk Highs  120 
52wk Lows    54
TRIN       1.19
PUT/CALL   1.05

Global bourses waffled around in overnight trading. U.S. futures drifted higher and then lower, setting up the expectation that our markets might show the same lack of direction.

That's how it felt as the day progressed, but a study of intraday charts showed a relentless sinking lower throughout the day. That was particularly true of the retail index, the RLX, and the Dow Jones US Home Construction Index, the DJUSHB. By the end of the day, the DJUSHB had lost 1.69 percent; the RLX, 0.82; the SOX, 0.48; the Dow, 0.28; the OEX, 0.34; the SPX, 0.45; and the Nasdaq, 0.43. The TRAN however, bucked the trend, climbing along an ascending trendline all day and closing higher by 0.24 percent.

The oil services and pharmaceutical sectors joined the TRAN among the few gaining sectors, while the biotechs, banks and utilities joined the losing sectors. Although more closely matched earlier in the day on the Nasdaq, decliners led advancers all day on the NYSE and did on the Nasdaq, too, by the afternoon.

Most times, the term "meeting expectations" refers to earnings expectations. Wednesday, that term applied to expectations for Alan Greenspan's testimony before the House Budget Committee at 10:30 EST in Washington. Most economists expected that Greenspan would testify that the economic recovery proceeds about as anticipated and that the FOMC would continue its measured set of rate increases. Still, many awaited confirmation that Greenspan still believed the soft patch in the economy to be transitory. They waited to hear what he would say about the impact of higher crude costs and the new record budget deficit. Market watchers expected Greenspan to address that deficit, saying that the deficit outlook was worsening.

Although our markets appeared to waffle prior to Greenspan's testimony, a couple of notable developments occurred just prior to the release of his prepared comments. The Russell 2000 climbed five cents above its 200-sma and the OEX stopped five cents short of its 200-sma. That was to be the high of the day for those indices.

As expected, Greenspan confirmed his belief that the soft patch had been transitory, blaming higher crude prices for that soft patch and saying that the expansion had regained traction. Although some financial ministers across the globe have lately quantified the effect of rising crude costs on their economies, Greenspan declined to do so, noting disagreement among economists about the impact. He stated that non-oil import prices had decreased, lowering concerns about core consumer price inflation, but said that the outlook for crude prices remained uncertain. Rising demand in China and India as well as other factors could buoy crude prices.

Perhaps not conforming to expectations, some credited his comments with a temporary spike in oil prices. Crude futures for October delivery moved up to their $43.70 high of the day before beginning the decline into the $42.25 low of the day. That low occurred on continued assurances from OPEC that the market is saturated.

Also meeting expectations, Greenspan mentioned the deficit outlook, calling the federal budget outlook "troubling." A CNBC commentator likened Greenspan's outlook to two separate forecasts and summed up by saying that Greenspan's outlook was "short-term good: long-term bad."

While Greenspan's testimony met expectations, JetBlue (JBLU) warned that Q3 earnings would miss expectations. The airliner pegged those missed expectations on higher jet fuel costs and the impact of two hurricanes hitting their key market in Florida.

Rising fuel costs also impacted Delta Airlines (DAL). That company announced a transformation plan to avoid bankruptcy, but the CEO warned that bankruptcy could still be an option unless pilots accepted the company's proposed pay cut. That transformation plan included a closing of the hub at the Dallas/Fort Worth airport, news that hit all Dallas television stations early Wednesday morning due to the impact on the DFW airport and the metroplex. A redesign of the Atlanta hub will allow the carrier to add flights and reduce congestion at that airport. DAL will cut 6,000-7,000 jobs and will also reduce the number of different types of aircraft it flies to trim maintenance costs. The company will add to the fleet of its low- cost carrier, Song.

JetBlue closed 0.34 percent higher, but Delta lost a whopping 9.82 percent, making the TRAN's gain all that more surprising.

Annotated Daily Chart of the TRAN:

As the TRAN approached the June 30 closing high and the July 1 intraday high, daily oscillators failed to reach the highs of that late-June/early-July period. That sets up potential but not confirmed bearish divergence. The TRAN's daily candle was a shooting star, a potential reversal signal, but the TRAN produced nearly the same candle at nearly the same level on June 28 before climbing a few days into that subsequent closing and then intraday high. While the comparison with that late-June and early-July period might not be particularly comforting to bulls, it also shows the danger in assuming that the TRAN will see immediately follow-through on the TRAN's intraday decline from its high of the day.

Recently, dipping crude prices have helped the TRAN, but this index also benefits from actual or anticipated improvement in the economy. As Greenspan's speech was released, suggesting that the economic recovery had regained some traction, the TRAN tested 3200 the first time, fell back before reaching it, and then rose above it again in the afternoon before retreating into the close. Traders might watch this indicator index for signs that bullish trades have been given the green light. They should look for a move above the July 1 intraday high of 3212.45 for a potential upside breakout.

Those traders should be prepared for potential whipsaws out of the trade, however, as the TRAN can reverse as quickly as it can drive forward. Some charts suggest a drop below 3180 might see a quick drop to 3170-3172, with the result of that drop then determining what happens next. Just as there's the potential for an upside break, there's also the potential for a double-top formation on the TRAN's chart, with such a formation having bearish implications for the market.

JetBlue's warning wasn't the only one seen Wednesday. Some market watchers and commentators, including Jim Brown, have expected earnings warnings to accelerate this week, and Wednesday saw several. Coca-Cola Enterprises (CCE) warned, as did McKesson (MCK), Dean Foods (DF) and Avon Products (AVP). CCE lowered its earnings forecast for the year, and drug wholesaler MCK said that earnings would miss estimates. DF cut its earnings guidance for the third quarter and full year, with Q3 earnings expectations lowered to 44-46 cents against expectations of 54-57 cents a share. Volatile milk prices and more-intense-than-expected competitive pressures hurt the company, as did higher fuel costs and resin prices. AVP warned analysts to trim expectations for Q3 profit from U.S. businesses by as much as 10 percent. CCE closed lower by 5.39 percent; KO, 4.82; MCK, 15.24; DF, 18.13; and AVP, 6.13. This suggests some danger to the markets, as warning companies likely will be punished severely.

At 2:00 EST, the Fed's Beige Book was released. While some characterized the report as contrasting with Greenspan's testimony, others noted that it, too, met expectations by saying that the economy was seeing a gradual recovery. With the report expected to help the FOMC make decisions about monetary policy on September 21, market watchers gleaned the report for information. The result of anecdotal information collected from the twelve Federal Reserve districts, the Beige Book showed mixed conditions across districts and sectors. The word "mixed" appeared frequently in the report. Household spending, retail sales and home sales might have cooled, but manufacturing improved. Consumer loans may have decreased, but demand for commercial loans increased. Back-to-school sales might have been slow in New York, but Kansas City saw stronger sales when compared to those of the previous year. Dallas and Kansas City might have seen slower sales of SUVs and light trucks, but Atlanta and Chicago saw those sales increase.

Although the Dow Jones US Homebuilders, the DJUSHB, had been headed lower all day, the BIX and BKX both steepened their descents after the Beige Book was released, perhaps at least in part due to the notation that demand for consumer loans had softened. Earlier that morning, the MBA Refinancing Index information was released. Last week's figures showed refinancing decreasing 0.6 percent, but that activity increased week-over- week in this week's report. Investors appeared to focus instead on the Fed's headline statement characterizing sales of new and existing homes as cooling.

At 3:00, July's Consumer Credit figures were available for examination. Forecasts had ranged widely from $5.0-7.5 billion, with the prior number at $6.6 billion, but this number zoomed past expectations, with the figure at $10.9 billion.

Another focus sector was the SOX, ahead of TXN's after-the-close mid-quarter update. The SOX moved lower, closing at 352.06 ahead of that announcement. The day's candle produced a potential reversal signal, however.

Annotated Daily Chart of the SOX:

MACD produced a bearish cross from below signal, not an encouraging development to SOX bulls, but one that can be erased if TXN prompts a strong enough bounce during Thursday's trading. Lowering the low end of its earnings-per-share estimate and the top end of its revenue estimate, the company blamed inflated inventories among its customers. Some commentators characterized these adjustments as a paring back of expectations while others focused on the reduction in TXN's effective tax rate that would allow it to meet or perhaps raise profit expectations.

As this report was prepared, TXN traded at $19.11, up from the $18.83 close. While it's dangerous to assume that after-hours trading is indicative of during-market-hours trading, some feel that the bad news is priced into the SOX. A move below Wednesday's SOX low will undo the potential for a confirmation of the potential reversal signal. A move above 353-354 will be needed to break through Wednesday's resistance, but the 20-dma and the 50 percent retracement of the rally off the October 2002 low might be powerful resistance. A trend change can't be verified until the SOX clears those levels, so any bounce might be treated with caution until then.

Another average and retracement level have shown importance with the Nasdaq's trading pattern.

Annotated Daily Chart of the Nasdaq:

The Nasdaq has been finding resistance at both the 38.2 percent retracement of the June-August decline and the 50-dma. A move above both might represent an upside breakout, but the Nasdaq would then soon find resistance at the 1900-1905 level, where the 200-ema now converges. If the Nasdaq pushes above the 50-dma and keeps going, bullish traders in Nasdaq stocks should have profit- protecting plans in mind as that 1900-1905 level is tested.

Before Wednesday's close, however, the Nasdaq had fallen beneath an ascending trendline off the August 31 low. Before the Nasdaq can advance far, it needs to reclaim that trendline, currently crossing at about 1856. A decline would need to be confirmed first by a fall beneath the September 7 low of 1847.48, with support expected again near 1842 and then perhaps at the 30-dma. Bulls do not want to see a daily close beneath the 30-dma, but then the Nasdaq approaches possible gap support from early August, support already proven to hold in late August. The Nasdaq trades within a congestion zone, and conclusions and trading conditions always remain hazardous within such a zone.

The Russell 2000 has also moved into a congestion zone, both from the last week's trading and from a period in mid-July.

Annotated Daily Chart of the Russell 2000:

A break above the 200-sma and Wednesday's intraday high, particularly on a closing basis, would represent a breakout for the Russell 2000, with resistance soon expected on the test of the upper trendline of its descending regression channel. Bulls eventually want to see a breakout above that channel.

A breakdown is more difficult to pinpoint since the Russell 2000 has now spent some time building support, but the confluence of the 200-ema, important in the Russell's trading pattern, and the 50-dma just below the important 350 level might mark one support level that bulls want to see hold. A break of that support would likely find at least temporary support near the 30-dma and historical support at 541.50-542, with a break of that level then setting up a possible test of 533-534.

While we don't always think of the Dow as an indicator index, it sometimes functions as one. While its sister index, the TRAN, was testing a major swing high, the Dow has been approaching the top of its descending regression channel. The top of that channel lies at about 10,400, but bulls should feel nervous until they get confirmation by a move above the late June highs, several of them in a row, at 10,487.

Since the trend since the first of the year has been for the Dow to turn lower at each test of the top of the channel, the assumption might be that the Dow will do so now, too. Dow bears betting on that action should not feel safe until a move below the 200-sma, an average that has been prompting bounces since the OEX moved back above it. A decline beneath that MA might soon find support near 10,200.

Annotated Daily Chart of the Dow:

The SPX did not approach the top of its channel as closely as did the DOW, but its chart looks similar otherwise.

Annotated Daily Chart of the SPX:

The SPX moved lower, toward a test of its 200-sma, with other averages just below to support the SPX. Those averages, as important as they might be, will not have the same effect on sentiment as will a Dow and/or SPX decline beneath their 200- sma's. Bulls hope to see a bounce and a test of the top of the descending regression channel, with a move up through that channel's top resistance trendline. Tuesday's 1,124.08 high could be expected to serve as resistance, with the top-of-the- channel resistance soon following at about 1,133. Those with bullish positions should have profit-protecting plans in place for a test of the top of the channel if the SPX should bounce.

If the SPX instead falls through its 200-sma, the 100-sma lies just beneath, at 1,110.09, near historical support/resistance, and the 30- and 50-sma's and 200-ema all look to be converging between 1,095-1,100 to provide support that should be stronger.

The OEX may be one of the best indices to watch Thursday, however, as it perhaps came the closest to testing the top of its descending regression channel. Like the Russell 2000, the OEX has not managed to move above its 200-sma. A break above that average and then above the top of the channel, currently at about 548, might signal an upside break, although the OEX would soon move into congestion beginning at about 549.50 and extending all the way up to 556. Some charts show potential upside likely to be capped at just over 553 on a first test of that level.

Annotated Daily Chart for the OEX:

The OEX had also broken below its ascending trendline off the August 31 low by Wednesday's close, so would need to climb back above that trendline before the intraday bearish sentiment improved. A confirmed H&S Wednesday set a downside target between 541.50-542, at historical support/resistance and near the location of the 100-dma at 541.74. OEX 540.80 is also historical S/R and the location of a longer-term ascending trendline off the August 13 low, with a violation of that trendline setting up the potential for a retest of the converging 50-dma and 200-sma.

This is an exciting time for options traders, because it appears that a directional move could get started, despite all the various resistance and support levels grouped around the current levels of the equity indices. The Russell 2000 and OEX show a potential for a break above their 200-sma's or for a rollover beneath them. The OEX and Dow show a potential for a break out of the long-term descending regression channels on their daily charts or for a rollover down through those channels again, with the SPX also near a test of the top of its descending regression channel.

The TRAN is close to a breakout above a major swing high or for a double-top formation with all the bearish ramifications of that formation. The BIX did break out above a major swing high, but Wednesday produced an inside-day candle that so nearly retraced Tuesday's gains that it's also a possible tweezer-top formation. That threatens to create a weekly double-top formation if the BIX closes the week below the weekly closing high of 361.23 from late this winter.

Continuing the potential for a directional move has been the action on the VIX. Lately, VIX moves into sub-14 levels have indicated a market top nearing, although the VIX is not a reliable market-timing tool. That truism of late should make bulls nervous enough to make plans to protect their positions, but doesn't prove that bears should pile in with bearish positions. Those who believe it does should hark back to spring, 2003 when the VIX was then approaching and descending below 20, the level that for several years had indicated market tops in the making. The VIX offers a warning, but if price behaves in opposition to that warning, we shouldn't keep trying to play the opposite direction.

If the spring of 2003 taught us anything, it should have taught us to trade the trend. Which trend, though? The SOX's trend, both short-term and intermediate-term, has been down. Short- term, many indices have been rising through those descending regression channels, with short-term trends that are moving up. Since the first of the year, however, many of those indices have been trading in descending regression channels, so that intermediate trend is down. This is true of the two S&P's and the Dow, for example.

I've long learned to heed the wisdom of the past, so those intermediate-term trends and the months-long implications of sub- 14 levels on the VIX make me nervous about long positions just now. They don't make me nervous enough to discount the possibility of upside breakouts, however, but certainly nervous enough to wait for the breakouts to occur to believe that they will. The TRAN is one of the indices I'll be watching for that upside breakout, as it's the nearest to a breakout and the fastest moving. It's also temperamental, and a quick reversal will have me reversing my judgment just as quickly, too.

Be careful about drawing too many conclusions about the TRAN's action ahead of mid-morning, however. Although the Department of Energy and American Petroleum Institute normally releases crude, distillate and gasoline inventories on Wednesday, that release was delayed until Thursday due to the holiday-shortened week. Crude prices and the TRAN both typically react to those inventories numbers.

Thursday's economic releases begin with the usual 8:30 release of jobless claims. Last week's initial claims amounted to 362 thousand, with Hurricane Charley blamed for the increase. If that thinking and timing remained intact with regard to Hurricane Frances' impact, the expected increase would not occur in this week's number, but I wouldn't be surprised if any increase weren't pegged to the hurricane's impact anyway.

Other economic numbers released at 8:30 will include August's export and import prices, with export prices ex-ag. rising 0.6 percent in the prior month and import prices ex-oil rising 0.1 percent in the prior month. At 10:00, July's wholesale inventories will be released, with expectations of a 0.6-0.8 percent rise measured against the previous month's 1.1 percent increase.


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