Option Investor
Market Wrap

Bush Wins

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        WE 9-10         WE 9-03         WE 8-27         WE 8-20 
DOW    10313.07 + 52.87 10260.2 + 65.19 10195.0 + 84.91 +284.79 
Nasdaq  1894.31 + 49.83 1844.48 - 17.61 1862.09 + 31.07 + 73.80 
S&P-100  546.25 +  5.19  541.06 +  0.18  540.88 +  4.84 + 15.32 
S&P-500 1123.92 + 10.29 1113.63 +  5.86 1107.77 +  9.42 + 33.55 
W5000  10936.32 +115.44 10820.9 + 65.86 10755.0 +106.22 +344.09 
SOX      383.61 + 25.77  357.84 - 24.50  382.34 -  3.66 + 19.35 
RUT      569.91 + 13.67  556.24 +  4.57  551.67 +  3.75 + 30.53 
TRAN    3224.38 + 82.53 3141.85 + 33.05 3108.80 + 17.93 +123.95

No, there are no newspaper headlines claiming a win before the final ballots are cast but the markets appear to already be trading on the news. With the polls showing a widening gap between Kerry and Bush the Republican market was celebrating early on Friday. At least that is what the talking heads on CNBC would have you believe.

Dow Chart - Daily

Nasdaq Chart - Daily

SOX Chart - 60 min

The economics were positive on Friday with the PPI at -0.1% well below the expected +0.2% level. Don't let that lower inflation number surprise you because falling prices on new cars was primarily the reason. The auto manufacturers are literally giving away cars to keep the production lines busy. Food prices also continued to fall with a -0.2% drop for the month. The core rate continued to rise at +1.0% and stretched the string of gains to thirteen consecutive months. This will keep the Fed on track for a continued rate hike program.

International Trade reversed half of last months $8.9 billion deficit increase with a drop of -$4.9 billion in the current July report. Exports increased and imports fell with exports increasing +7.8%. Imports decreased -1.5%. Obviously falling oil prices accounted for the majority of the decrease in imports. The recent soft patch in the economy should continue to undermine imports and that should continue to help the ratios for the next several months. China is still growing at a +8% clip and we are supplying much of their raw materials and basic components which should keep our export numbers at the present level or higher.

Market sentiment was also positive on Friday despite an earnings warning by Alcoa and several chip stocks. The Alcoa warning knocked the Dow back under support at 10250 with a -2.50 drop in the Dow component. The Dow rebounded and held just over 10250 until 2:15 despite several attempts to push it lower. At 2:15 a major buy program hit and pushed the index back into positive territory and back over 10300 resistance.

The SOX roared out of the gate with barely even a token dip from the three chip warnings since yesterday's close. The SOX tacked on another +12 points, +3.4% to Thursday's +5% gain. The SOX closed at 383 and well above the 351 low on Wednesday. Chip analysts are scratching their heads on the rebound and wondering about the validity of their mass downgrades three days earlier.

The Russell has exploded from the 520 low back on August 19th to close at 570 on Friday. Volume in the small caps has been growing daily and there appears to be no end in sight. The volume on the Nasdaq where most R2K stocks trade has risen to over 1.6B shares for the last two days and levels not seen in nearly a month.

The Nasdaq has rebounded from its August low of 1751 to close just below 1900 on Friday. Much of the Nasdaq bounce this week has been related to the SOX rebound. The SOX rebound helped the Russell, which in turn helped the Nasdaq. They are all interrelated and one does not move far without the others.

After the smoke cleared on Friday I sat there looking at the charts in amazement. We had expected a post Labor Day rally but not the way it was delivered. The beginning of the week was weak at best with the SOX dragging down all the techs. The Nasdaq traded in a very narrow 1850-1865 range up until noon on Thursday when the buy programs began their rapid fire launch. The Dow gapped open on Tuesday and then declined to Friday's low in an exact reversal of the Nasdaq move. Remember this chart I posted on Thursday night?

Dow Chart - 15 min

I explained that a break of the support at 10275 could put the Dow at risk to 10150. That support broke and the Dow traded in negative territory all day until 2:15. At 2:15 a buy program hit that added +1100 issues to the A/D line and lifted all markets. You can clearly see from the chart above that the buying was not retail activity. It was clearly a very strong buy program very similar to the one on Sept-2nd.

Ok, here is the million-dollar question. Why buy? What overriding reason was there to launch a program covering 1000 different stocks on Friday afternoon before the 9/11 anniversary? There were many reasons mentioned on the various services I monitor.

Oil was initially given as the primary reason. Positive comments from OPEC knocked oil off it's $44.95 high for the day and into a -$2.50 freefall. It closed at $42.65 and gave back all the gains from Thursday. That may have induced some portfolio managers to add to positions but I doubt it was reason for that major buy program. You only have to look at the oil volatility for the week to realize the gyrations in oil prices did not translate into stock prices.

Oil Chart - 15 min

Another reason given was Bush gains in the opinion polls. According to one major survey Bush now has a +9 point lead over Kerry. While the market is commonly thought of as Republican I have a hard time seeing this as a death bed conversion sort of thing. With the Dow teetering on the edge of a major drop all day why would the poll news which had been out all day suddenly prompt a major buy program? I doubt some fund manager just walked into his office from a golf outing to hear the news and then shout buy stocks into his intercom. I agree with the various surveys showing the market tracking with the ebb and flow of Bush's chances but not on an intraday basis.

Other analysts suggested that the bad news for the third quarter was already priced in and traders had decided the worst was over. If this is the case then it would be contrary to most Septembers in recent memory as most late September declines come on the exact earnings weakness we are seeing now. If this was the case then why was the buying not broader and longer throughout the day? It would have been a more general sentiment and not something that could be exactly measured to the minute on the charts. Look at the chart above. It was not widespread market sentiment but only a single event.

Let me repeat the question. Why would a major buy program appear late on a Friday afternoon the day before the 9/11 anniversary? I think the key to the answer is in the question. Why would Al Qaeda release a new video tape two days before the 9/11 anniversary? It is simple. They wanted to remind the world of the attack and try to exert some terrorist pressure on the world scene. They would have liked nothing better than to see our markets sell off in fear of an anniversary attack.

I believe there was a market support program running on Thursday and Friday that was planned to prevent any pre-9/11 decline. Call it anything you want and put any entity you want behind it but I believe it existed. You can choose to believe or not but it does not change the facts. We saw underlying support on Thursday and every dip was met with just enough volume to prevent a Dow meltdown. The Alcoa news broke that deadlock on Friday morning. The Dow and SPX were weak all morning but every dip was met with strong order flow in the futures market. It was constantly lurking just under the bid and prevented a continuation drop from the morning gap down. For the two hours before the buy program appeared volume slowed to a crawl. The internals weakened several times but each time just enough volume appeared to prevent a dip. As the clock ticked down the selling pressure increased and a huge battle began at support. Volume increased on both sides but regardless of the amount of selling pressure the volume at bid was always just enough to maintain the status quo. I don't care how long you have been trading it does not take an Einstein to realize this was not normal activity for a September Friday.

I believe the 2:15 buy program was insurance to prevent an end of day volume surge on the sell side. Instead of waiting for everybody else to pull the trigger on the sell side the best defense is a strong offense. A sharply rising market is a strong offensive move against those that might be scared to hold over the weekend. Once the massive program triggered, those already short and waiting for the end of day decline, were forced to cover and the spike became self perpetuating. An excellent chess move by whomever was orchestrating the event.

Again, believe me or not, it does not matter. What matters is how we react to it for Monday. "IF" it was an artificial bounce and done for market support reasons prior to 9/11 then what happens when that support is withdrawn? Even if it was just a valid buy program from some large fund or a large asset allocation program it is just history now. Each day we get to start over with a clean slate. The excesses of the prior day are forgotten as new strategies are implemented based on millions of different variables by millions of investors. The only things constant are the long term historical trends and the current market sentiment.

There are few market trends more constant than the relationship of the VIX to the markets. When the VIX is low it is time to go. When the VIX is high it is time to buy. This adage has survived years of market cycles and while it should not be used as an instant indicator of market direction it is a very valuable tool in a traders toolkit. Extreme swings normally produce the expected reaction within a very short period of time. Friday was an extreme swing day and the VXO (old VIX) set a new 52-week low. This was a climax low after four weeks of declines from the August-13th high of 20.03, which corresponded EXACTLY with the SPX low of 1060 and the Dow low of 9783. Had you been watching the VXO then and acted upon it your results over the last four weeks would have been very strong.

The challenge is knowing when a high is a high and a low is a low. Those things are not normally known until several days later. The touch of a new 52-week low on Friday is a major warning signal for the bulls. In the following chart I have highlighted each time the VXO neared 14.0 over the last year. I contrasted it with the SPX. Obviously the more dramatic the move from the VXO highs to the lows the more dramatic the reversal in the SPX.

VXO:SPX Chart - Daily

The next chart compares the VXO to the Dow and adds the downtrend resistance since February. By comparing the VXO levels to the resistance levels on the Dow we are able to narrow our focus and predict a higher correlation of expected events.


Adding in the VXN in comparison to the NDX chart gives us a broader view and another correlation of the same event. The VXN has only broken below 20 three times in the past year. In late June it stayed below 20 for nine consecutive days before the July-1st correction began that knocked over -200 points off the NDX and -300 points off the Nasdaq Composite. During those nine days the NDX added points but the strain was beginning to show.


What I want to get across today is the warning signal. I am not suggesting that Monday will begin an implosion that takes us back to new lows. I am only suggesting that next week could be dangerous.

Consider the facts. September is the worst month of the year followed by October which is the second worst. The majority of earnings guidance we have been seeing has been negative. The economy is going to lose billions in Q3 earnings, wages and GDP as a result of the hurricanes. It will eventually add billions more in GDP as the rebuilding effort gets underway but that will not be seen until Q4. The SOX has rebounded well above reasonable expectations and to strong resistance at 385-390. The next ten points will be more difficult. The Russell is way overextended from its +50 point rebound and at resistance at 570. The SPX has resistance dating back to January at 1125 and it closed at 1124. The Dow has resistance at 10315 and exactly where it closed on Friday. The Nasdaq has strong resistance at 1900-1925 and closed at 1894.

Moving higher from here will not be easy. Not impossible but not easy. The scenario as I see it can go two ways. The Friday buy program was just another of many real efforts to get invested before the election and funds are going to disregard the historical Sep/Oct weakness. If this scenario is correct a move over 1125 on Monday will attract a lot of short covering and buyers wanting to be long before fall will have to race to chase prices. This is a very valid scenario and would result in new lows on the volatility indexes and increasing pressure in the marketplace. Eventually the volatility spring must release and it is only a question of when not if. Still we could be 100 points higher by then and buyers can't risk standing idly by and watching the train leave the station.

The second scenario assumes the Friday buy program was a unique event and not something that will be repeated on Monday. The rebound on the SOX will lose traction at 385-390 and resume its decline or at least see some profit taking from the short covering bounce. This will pressure the Nasdaq and the Russell and the bubble will burst into a normal September decline. This decline will be bought aggressively once the profits are harvested.

We definitely want to be long before mid October and with everyone having the same game plan that could mean early October. How much investors will ignore the October earnings cycle is still under discussion. We think we know how bad Q3 earnings will be and we hope Q3 was the end of the soft patch. However, until we begin to get Q4 guidance from the early October earnings reports the outlook is still cloudy. There are no material economic reports next week and the Fed does not meet until the following Tuesday. There is nothing to stimulate a higher move but fear of missing the train but there could be plenty of warnings to push us lower.

Regardless of your market bias next week should be an exciting week in the market. Volume is increasing and large moves are possible. I hope I have accurately painted both sides of the picture and not hopelessly confused you. We are in the best four months of the year for traders and it is time to place your bets.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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