Option Investor
Market Wrap

The Stage Is Set

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        WE 9-17         WE 9-10         WE 9-03         WE 8-27 
DOW    10284.46 - 28.61   10313 + 52.87   10260 + 65.19 + 84.91 
Nasdaq  1910.09 + 15.78 1894.31 + 49.83 1844.48 - 17.61 + 31.07 
S&P-100  545.80 +  2.45  546.25 +  5.19  541.06 +  0.18 +  4.84 
S&P-500 1128.58 +  4.66 1123.92 + 10.29 1113.63 +  5.86 +  9.42 
W5000  10993.32 + 57.00   10936 +115.44   10820 + 65.86 +106.22 
SOX      388.50 +  4.89  383.61 + 25.77  357.84 - 24.50 -  3.66 
RUT      573.17 +  3.26  569.91 + 13.67  556.24 +  4.57 +  3.75 
TRAN    3257.39 + 24.00 3224.38 + 82.53 3141.85 + 33.05 + 17.93 
VXO       13.55           13.49           13.91           14.79
VXN       20.13           19.56           21.06           21.27

The indexes clung to the levels reached last week with the tenacity of a rock climber 200 feet up a cliff. The Dow managed to fight off several attempts to break 10250 and closed the week with only a minor loss. The Nasdaq fought off several attempts to break 1900 and posted a gain for the week. This is a very strong performance given the numerous market factors.

Dow Chart - 60 min

Nasdaq Chart - 30 min

SPX Chart - 30 min

The only economic report on Friday was the first look at the Michigan Consumer Sentiment and it offered no clues as to the current trend. The headline number at 95.8 was barely below the August reading of 95.9. The current conditions component fell slightly and the expectations component rose slightly. All the changes were technically insignificant. The last four months have flat lined at the 96 level and it suggests consumers are in a wait and see mode as we approach the elections.

The bad news did not come from government economics but from private research groups. ISI reported on Friday that retail softness was increasing and may be weaker than previously thought. The International Council of Shopping Centers reported that same store sales increases have slowed in the past two months on a year over year basis. This corresponds with the 2003 tax rebate and the surge in buying in late 2003. This rising tide of negativity toward retailers and the consumer could come back to haunt us as the holiday season approaches. There are conflicting opinions at present on the expected strength of the holiday buying season and the strongest opinions are leaning to a weak holiday. This would lead to weak earnings and missed comps with a long spring and summer ahead.

On the earnings front the numbers are starting to appear. The numbers of warnings that is. So far we have had 583 warnings for Q3 compared to only 362 this time last year. 305 companies have given positive or inline guidance compared to 495 at this point in 2003. In just the first 12 days of September we have seen 94 warnings with 30 of those supposedly related to the hurricanes. The current tally of expected earnings growth is rough with an estimate wide enough for Ivan to blow through. Analysts are quoting earnings increases of +13% to +17% for Q3. I think they are afraid to publish the real numbers and inciting a panic. This will be the first time in five quarters that earnings will be under 20% and several of those quarters were well over 20%. Reuters is now quoting only +8.5% revenue growth for the quarter compared to more than +10% last quarter. Hurting earnings are tough comparisons with 2003, lost income due to the hurricanes and higher energy prices.

Oil prices jumped +1.71 on Friday to $45.63 and showed no indications of weakening at the close. Those energy prices are not expected to drop back to prior levels any time soon. Andrew Clark, an analyst with Lipper, went public with their oil price forecast on Friday. He said we could see a return to sub $40 oil AFTER the election with the low maybe in the $36-$37 range. Once that post election dip has arrived they expect oil prices to rise to $67 per barrel over the next couple of years. The problem as I have been discussing in this column recently is rising global demand and decreasing global reserves. He noted that the UK had returned to a net importer and rising demand in India, China and Japan would outstrip production increases. We know from commentary last week on OPEC that they are powerless to produce enough oil on demand to lower prices. They can talk a good game but there are no actions to back it up. For the short term most analysts expect terrorist attacks on various OPEC suppliers between now and the elections as a way of putting pressure on the U.S. This should continue to keep the prices high until November.

Following that thought Germany issued an "urgent" warning for all German citizens to leave Iraq. When a country uses the word urgent in its warnings it is because they have information suggesting an imminent danger. With the election only six weeks away there is sure to be further escalation of the kidnappings, car bombs, rocket/mortar attacks, pipeline destruction and attacks on American troops.

Downgrades replaced earnings warnings on Friday as EBAY was cut to a hold at Leg Mason with a price target of $100. They said recent gains have fully valued EBAY. Cisco was downgraded by Lehman on the basis of uninspiring sales in recent weeks. Lehman cut Cisco to a hold and they said the stock should remain trapped in the $18-$20 range. According to Lehman recent comments from executives of communications chip suppliers like ALTR, BRCM and XLNX suggest that large equipment manufacturers like Cisco are actively rebalancing their inventory. In English that means they are suddenly buying fewer chips from those vendors. Lehman also said that Cisco's increasingly cautious commentary could also be a negative sign.

Despite all these negative factors all the major indexes closed in positive territory with the exception of the Russell-2000. Even the lower book to bill could not keep the SOX from closing higher and it added +7 points, nearly +2%. The Dow may have closed negative for the week but it was only slightly negative. Actually the Dow closed almost exactly where it opened on Sept-3rd. We have tried multiple times to crack the long term downtrend at 10350 with no success. We have also held current support at 10250 despite multiple attempts to break it. For three weeks we have traded in this 100 point range despite earnings warnings, high oil prices and the calendar.

The Nasdaq did manage to tack on +16 points for the week but that was due mostly to the Monday spike more than the performance for the rest of the week. The Nasdaq has traded in a narrow 20 point range for the week and ended right in the middle at 1909. Considering the negative factors and the heavy tech warnings this should also be considered bullish.

The Dow has what appears to be forming a bullish flag as it consolidates its three weeks of gains. The Nasdaq is showing a bullish pennant. The SPX has a solid ascending triangle with 1130 as the upper resistance. This is the same resistance as the downtrend from March. All three indexes are showing bullish patterns in a market that has far more negatives than positives. Traders can't hardly help but be bullish with confirmation on multiple indexes. If there is such a thing as too many positive charts then we are in trouble.

The challenge is still the calendar. Next week we will enter the most active period of the warning cycle and the last two weeks of the quarter. Those companies hoping for a miracle to avoid missing estimates are watching the calendar tick away and they will have to make some decisions quick. The next two weeks normally contain the most warnings.

Much of that bad news is already baked into the cake. We saw the SOX rise today despite the BTB numbers. One brokerage went public saying they thought the worst was over for chips. They still expect more warnings and slower sales but they felt the majority of the price punishment was over. This gave the chips a bounce but the rebound foundation is still very shaky.

While I see traders turning bullish all around me I would still urge caution. I would gladly go long on any SPX move over 1130 but all indexes would have to be firing on better volume than we had this week to make it successful.

The closing setup on Friday had the SPX closing at a three day high at 1128.58. The Russell, which I had mentioned as the key for Friday experienced several bouts of expiration related weakness but it still managed to cling to the high ground near 575 resistance. This keeps it in range of a break of that 575 level and a short covering romp to 590. Sounds bullish but that is exactly the way it is setting up. The Russell has joined the big cap party with the identical bullish formation.

Russell Chart

The cautionary points are still the same. The earnings warnings are likely to increase and the volatility is extremely low. Volume was higher on Friday due to the OpEx but it was evenly matched. The A/D numbers were almost an identical tie across all markets. It is almost scary to have all the positive factors lining up at the same time the negative factors are increasing.

With no material economics due out early in the week and the Nikkei closed on Monday we could start out the week in positive territory. Tuesday is the FOMC meeting and the conventional wisdom is for another rate hike. There is a growing thought that the Fed could give some neutral guidance along the lines that they were going to watch the economy for signs of growth before making any more hikes after Tuesday. While I think this is wishful thinking there is a growing contingent of analysts that think there is an outside chance of this happening. This could provide a stronger bullish bid on Monday in hopes of a Fed blessing on Tuesday.

This bullish bid could be offset by the normal post OpEx settlement process. Traders who wake up on Monday with stock in their account they did not expect or stock missing they really wanted will scramble to square those positions. This typically provides volume but no direction. Bulls need to get a solid spike over the 10350/1920/1130/575 resistance to start a wave of short covering and have a chance of offsetting the OpEx confusion. Bears are hoping for resistance to hold and some big name company to warn. We all know there are some big name confessions in our future and a Monday warning could set the tone for the week.

I think it is important not to lose sight of the big picture regardless of your bias. The indexes are at strong resistance with more negative factors than positive. The bulls have chosen to climb this wall of worry and that is great as long as they don't slip. The strongest rallies appear when bulls power over the strong ranks of protesting bears. It produces a short wave similar to Ivan's storm surge that powers over everything in its path. While that may be overly graphic we have all seen those vertical moon shots in the past when conditions combine to produce the perfect squeeze. TrimTabs.com said equity funds saw the strongest inflows of cash since July for the week ended Sept-15th. $2.6B poured into funds and that was on top of the $1.7B from the first week of September. That cash has to go somewhere and the end of the quarter is only two weeks away. Money is coming to market in anticipation of a either a buying opportunity or a rally.

About the only guarantee we have for next week is that we probably will not trade in the same 100 point range on the Dow. We are poised to go directional and the only question is which direction. Logic suggests the negative factors will come to a breaking point when some currently unforeseen event appears to tilt the scales in the favor of profit taking. However, logic is very overrated when determining market direction. Investing is a team sport and the crowd always favors the bulls even more when they are the underdogs. That sentiment has been clearly evident over the last three weeks. The SOX rebounded +10% when chip companies were warning daily. The Dow is within 75 points of its three month high.

The stage is set, the props are in place and the audience is ready. Will the next act be reminiscent of a WWF tag team smack down with opposing forces running in circles and going nowhere? Or maybe a replay of the Alamo with a few bulls holding the high ground while waves of bears mount an assault? I think traders would rather see Rocky appear and lead the charge up the wall of worry with his Gonna Fly Now music playing in the background. Trying hard now, Gonna fly now, Flying high now. Is that music I hear?

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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