Option Investor
Market Wrap

The Better to See You With, My Dear

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      09-29-2004           High     Low     Volume   Adv/Dcl
DJIA    10136.24 + 58.84 10136.24 10050.56 1.72 bln 1590/1202
NASDAQ   1893.94 + 24.07  1894.06  1869.95 1.62 bln 1996/ 998
S&P 100   536.56 +  2.37   536.56   532.46   Totals 3586/2200
S&P 500  1114.80 +  4.74  1114.80  1107.36
SOX       380.62 +  6.93   383.26   373.69
RUS 2000  571.07 +  5.41   571.07   565.22
DJ TRANS 3239.59 + 31.01  3241.28  3204.36
VIX        13.21 -  0.62    14.14    13.20
VXO (VIX-O)12.81 -  0.42    13.81    12.55
VXN        20.67 -  0.69    21.51    20.57
Total Volume 3,357M
Total UpVol  2,268M
Total DnVol  1,042M
Total Adv  3586
Total Dcl  2200
52wk Highs  175 
52wk Lows    50
TRIN       0.66
PUT/CALL   0.85

Although a Fed president painted a rosy picture for the economy Tuesday night and the GDP was revised slightly upward Wednesday morning, some consider the specter of higher crude costs the wolf that lurks in "transitory" clothing.

Pre-market, investors brushed aside views of the final GDP and performances of global bourses with barely a glance, all the better to focus on the crude inventories numbers released at mid- morning. In addition, unconfirmed rumors circulated that the IMF might trim its estimates on economic growth for the economy due to higher crude costs. Inventories surprised to the upside, but the IMF did lower its 2005 outlook for global economies based on rising crude costs. At the end of the morning's economic releases, market participants had no better view of the size of that wolf than they did at the start, but that was going to change. The wolf himself was going to change it.

Crude moved lower. Oil services, natural gas and utilities stocks declined, joined by the home builders and gold and silver miners. The Dow Jones Transportation Index climbed 0.96 percent higher to close just underneath 3240 resistance. Techs soared, with the disk drive index and SOX gaining 2.91 and 1.85 percent, respectively, ahead of Micron's (MU) after-hours earnings announcement. Advancers were always ahead of decliners on the Nasdaq, and ended up so on the NYSE.

At day's end, however, some already expressed skepticism of the climb's sustainability.

The daily chart of crude futures shows no change in the uptrend yet.

Annotated Daily Chart of Crude Futures for November Delivery:

The Russell 2000 might have been a likely recipient of end-of- quarter buying, pushing it above its 200-sma.

Annotated Daily Chart of the Russell 2000:

Those leery of the sustainability of the gains will want to see the Russell 2000's upside break confirmed by a break above the September high.

Armed with an upgrade by Amtech, many chip and chip-equipment stocks also felt no fear of the wolf, whatever its size or impact on global demand, and charged higher ahead of MU's after-hours report.

Annotated Daily Chart of the SOX:

The SOX's behavior continues to conform to a potential inverse H&S. This suggests that some believe that the worst is baked into expectations for the semi's. Someone is buying, producing this pattern. However, the outcome of H&S's and inverse H&S no longer proves predictable. These formations should be used to guide traders as to bullish or bearish intentions and whether those intentions are realized rather than entice traders into plays ahead of at least a minimal confirmation of the pattern by a rounding down into a right shoulder. They're now frequently rejected.

The combined resistance of the 30- and 50-dma's and the 50 percent retracement of the rally off the October 2002 low proved too strong for the SOX Wednesday. MU reported earnings of $0.14 per share on earned operating income of $125 million, net income of $93.5 million, and net sales of $1.19 billion. Earnings per share were up from last year's loss, but below the expected $0.21 on sales of $1.23 billion. The company blamed lower selling prices for memory chips for the disappointment.

MU's result could help propel the SOX either direction, but which direction? Whisper numbers had been for results as low as $0.09 per share on revenue of $1.15 billion, so tomorrow could as easily see a buy-the-fact reaction as a sell-the-fact one. MU traded $0.04 lower during after-hours trade, but other most- actives in after-hours trades included semi-related stocks TXN and INTC, with both relatively unchanged.

The SOX's chart reveals that a break above the 50-dma would indicate an upside breakout in progress. Watch for a test of 394 and then 400, with semi bulls needing a profit-protecting plan as each of those levels is approached. Investors sometimes reject these formations at the neckline. A push above September's high sets an upside target near the 200-sma.

However, the combined resistance near the 50-dma looks strong and rollover entries might be more likely either from there or from the 400 level. New bears taking entries from those levels want to see the SOX quickly press through the 30-dma and below Tuesday's low. Look for a decline beneath Tuesday's low as a sign of a downside breakout entry. That could see 360 tested, but semi bears need profit-protecting plans in place as 360 and then the September low are tested. A break below September's low suggests a test of the 342-343 level.

The SOX and the Disk Drive Index helped push the Nasdaq higher, and both could impact it Thursday.

Annotated Daily Chart of the Nasdaq:

Current Nasdaq bulls should have profit-protecting plans in place as the Nasdaq approaches the 100-sma and 200-ema's, as well as historical horizontal resistance. A break through the converging resistance suggests a test of resistance also converging just above 1950. Profit-protecting plans should be in place if that level is tested.

With a weekly downtrend still in effect, sell-the-rallies appears to be remain the best tactic. Look for rollovers beneath 1900, 1925, or 1950 as possible new bearish entries. Any bear should have a profit-protecting plan in place as the 50-dma is approached. A break below the 50-dma sets a downside target near 1790, but I'd also have profit-protecting plans in place as August's gap was tested.

Annotated Daily Chart of the Dow:

With a weekly downtrend still in place on the Dow, sell-the- rallies also appears to be the best policy until that weekly downtrend is broken. The breakout above the converging 50-sma and 200-em's suggests a test of 10,160-10,200, but bulls should have profit-protecting plans in place now and then as the lower edge of that band is approached, if it is. Look for a potential rollover entry near the 100-sma or a breakdown entry on a break below 9950. A break below 9,950 suggests a tumble down toward 9,800, where profit-protecting plans should be in place. If the Dow instead breaks to the upside through the 30- and 100-sma's, have profit-protecting plans in place as the 200-sma and the top of the channel are approached.

Annotated Daily Chart of the SPX:

As with the other indices, a weekly downtrend remains in effect, so a sell-the-rallies policy continues to be the best tactic until a breakout above that descending regression channel. Current SPX bulls should have profit-protecting plans as the 200- sma is approached and then again as September's high and the top of the descending regression channel are approached, if the SPX makes it past the 200-sma. Bears should look for rollover entries below the 200-sma or the top of the channel, back down through the 200-sma. A rollover beneath the 200-sma suggests a test of 1080-1085, where profit protection plans should be in place and remain in place through a test of the bottom of the regression channel.

What were the forces driving the markets today? Wednesday's first economic release is always the Mortgage Banker's Association numbers on the previous week's financing activities. The composite number increased 4.9 percent week over week, with the purchase component increasing 2.7 percent and the refinance component increasing 7.7 percent, to its highest level since the middle of April. The sharp climb in yields today hit the homebuilders hard, however, driving the sector lower.

Next arrived the 8:30 release of the Q2's final GDP, with a ho- hum reaction to the upward revision to a 3.3 percent increase. The Bureau of Economic Analysis had previously estimated a 2.8 percent rise, with expectations being that the number would be revised upward to 3.1 percent. Some articles credited business investment with the higher-than-expected revision. Others also mentioned a decrease in imports and increase in inventory accumulation and exports. Investments in residences increased 16.5 percent. Personal consumption and the chain deflator, a measure of pricing pressures, had last been at 1.6 and 3.2 percent, respectively. Both remained unchanged. Still, despite the headline number, growth was termed the slowest in five quarters.

Market watchers brushed aside those numbers, however, all the better to focus on the crude inventories to be released near 10:30. That number prompted a short-covering rally in equities and a decline in crude futures. The release showed a jump in crude inventories by 3.4 million barrels according to the Department of Energy and by 3.7 million according to the American Petroleum Institute. Although both the DOE and API showed drops in distillate and gasoline inventories, those numbers remained within expectations.

Market watchers knew all they wanted to know about the wolf, although they hesitated just long enough to hear one more piece of information. Indices hit resistance levels just ahead of the International Monetary Fund's 11:00 EST update on its 2005 global outlook. Many had feared that the IMF would trim its forecast due to rising crude prices, and that's exactly what happened. The IMF cited higher oil prices as the reason behind the lowered forecast for global economic growth in 2005, with the new forecast for a 4.3 percent growth. That was lower than this year's projected 5.0 percent increase.

IMF Chief Economist Ragharam Rajan characterized those numbers as healthy and agreed with our Fed's characterization of the soft patch in the U.S. economy as transitory, reassuring investors. However, the IMF also noted that the global economic outlook appeared less solid and risks to the forecast were to the downside. That wolf clothes himself well, but he may still be threatening.

At 10:30 the Fed's McTeer also addressed a banking conference in Dallas, but little coverage was given to his address. The previous evening, Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, addressed a business group, saying encouraging things about the labor market, consumer spending, inflation, and the limited effects of rising crude on the U.S. economy. He felt that any negative impacts were being offset by accommodative monetary and fiscal policies. As long oil prices do not rise significantly, he believes that those negative impacts would remain minimal. When someone in the Q&A session tried to pin down his forecast for oil prices, he declined to give one.

Nothing investors heard was strong enough to hold back gains later variously attributed to short-covering, end-of-quarter window-dressing, oversold bounces, and healthy gains. The VIX and VXO dropped again into levels not seen since September 17, with the VXO, the old VIX, dropping below the September 21 level. The VXN, the Nasdaq 100 Volatility Index, did not decline to new recent lows. That lack of fear of the lurking wolf shown by the VIX and VXN levels scares many market participants, including this writer, but price action should remain the final arbiter.

With volatility indices low, semi weakness being confirmed by MU's report, numerous companies warning after hours, and an intact weekly downtrend in place, sell-the-rallies remains the preferred tactic, and that's the one this writer suggests. Many indices appear to be moving up into resistance that forms at appropriate right-shoulder levels for H&S's on the daily charts, with those right shoulders perhaps requiring another day or two to begin flattening. Remain skeptical of any upward moves in equities while crude futures remain above the 50-dma and perhaps even while above the 100-dma, also a frequent bounce point.

Bearish entries near the top of descending regression channels, near breakout levels, are scary. Those chart characteristics offer an easy way to determine if the thesis is wrong, however: a move above the appropriate right-shoulder levels or above the tops of the channels, as the case might be.

While the Russell 2000's daily chart does not sport a H&S formation at the top of the climb on the daily chart, it may still be important to study this week. Watch the Russell 2000 and TRAN for first signs of breakouts or rollovers in the making. The Russell 2000 moved the closest to a breakout and the TRAN tested new recent highs, so a Russell 2000 upside breakout, should make bearish traders cautious, no matter what volatility indices suggest. They're not good market-timing tools.

Any option position taken tomorrow may accrue special risk due to the presidential debates to be held Thursday night, including the risk of no movement while options prices leak lower. Whether indices are heading up for new breakouts or preparing for a rollover, tomorrow could be a difficult-to-trade set-up day for a later directional play. Know the risk you accept when entering ahead of the first debate, and be willing to be wrong and jump out again if proven wrong.

Thursday's economic releases begin with the usual 8:30 release of jobless claims, with August's personal income and personal spending also to be reported during that time period. Trade carefully in front of the 10:00 release of Chicago's PMI, last reported at 57.3, and the August Help-Wanted Index.


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