Option Investor
Market Wrap

Bulls Stampede

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       WE 10-01         WE 9-24         WE 9-17         WE 9-10 
DOW    10192.65 +145.41 10047.2 -237.22   10284 - 28.61 + 52.87 
Nasdaq  1942.20 + 62.72 1879.48 - 30.61 1910.09 + 15.78 + 49.83 
S&P-100  543.11 +  8.74  534.37 - 11.43  545.80 +  2.45 +  5.19 
S&P-500 1131.50 + 21.39 1110.11 - 18.47 1128.58 +  4.66 + 10.29 
W5000  11058.70 +220.40 10838.3 -155.02   10993 + 57.00 +115.44 
SOX      401.91 + 19.36  382.55 -  5.95  388.50 +  4.89 + 25.77 
RUT      585.03 + 19.06  565.97 -  7.20  573.17 +  3.26 + 13.67 
TRAN    3298.80 + 96.69 3202.11 - 55.28 3257.39 + 24.00 + 82.53 
VXO       12.55           14.14           13.55           13.49
VXN       18.91           21.10           20.13           19.56

That will probably be the Saturday morning headline on the stock pages across the country. The truth may be entirely different but the results are the same. Funds poured cash into the market despite fund flows turning negative for the last week of the quarter. Too soon for end of quarter retirement deposits so where did the money come from?

Dow Chart

Nasdaq Chart

SPX Chart

Drowsy bears anticipating a long nap beginning a couple weeks from now were shaken violently awake by stampeding bulls on Friday. The Dow gapped open +108 points and the shock waves were felt across all indexes. The post debate meltdown in the futures was met with a strong buy program at the open of the cash market. Volume was again over 4B shares across all markets but the internals were seriously positive at 7:1 advancing volume to declining volume. The Nasdaq ratio was slightly lower at 5:1 but nobody was complaining.

There was nothing in the economics to provide a reason for the blowout but nothing to hold it back either. The University of Michigan Consumer Sentiment came in flat at 94.2 on the final reading and no surprise there. This was a drop from the 95.9 reading in August but inline with the initial reading for September.

Construction Spending increased +0.8% in August and the July number was revised up to +1.0% from +0.4%. Low rates are helping with construction funding but slow job growth is keeping employers from the need to expand space. The total value of current construction rose to $1.015 trillion dollars. Considering the various constraints in various sectors this is surprisingly strong.

The ISM Index fell for the second consecutive month to 58.5 from 62.0 in July. While this is still positive it represents a continuation of the decline which began with the January high at 63.6. While it has not been straight down the trend has been steady. New Orders fell from 61.2 to 58.1 but employment rose to 58.1 from 55.7. Overall the index produced a picture of a continued expansion and one that should continue at least through year end. While the report was not bullish it did not give the bulls any additional cause for concern.

Global semiconductor sales rose slightly at +1.1% for August and the collective sigh of relief was heard around the world. Analysts had feared sales had fallen and the gain, although slight, was well received. Processor sales increased +3.5% due to the back to school build. Intel jumped +4% on the news to $20.85. Chip sales grew in all regions where it had been focused to the Asia Pacific region in prior quarters. We have heard from many chip companies that orders to Asia had fallen off sharply in recent months but it appears rising global demand offset that drop. The SOX rocketed +18 to 402 for a +4.6% gain and came very close to the 405 highs from September. The strong semi rebound helped push the Nasdaq and the Russell to new relative highs.

SOX Chart

The jump in techs ignored the CIO magazine survey released Friday that said tech spending was slowing and would probably not exceed +7.4% over the next 12 months. The Tech Future Growth Index, which projects growth over the next 12 months, slipped to a six-month low of 3.0 after reaching its high for the year of 4.0 in August. Those officers planning on increasing spending dropped to only 44% from 47% in August.

Automakers rose and helped provide lift for the markets in general after GM sales rose by +25% over last years levels. Daimler Chrysler sales rose +13% and Ford was the laggard losing ground at -4.2%. GM rolled out the 0% interest rate for 60 months or your choice of a $6000 cash discount to unload its remaining 2004 inventory. Evidently the program was a strong success. Considering the low expectations for the automakers this was a very strong report. Consumer sentiment may be falling but if you sell things cheap enough there will always be buyers waiting. Toyota announced they were increasing production of their Prius hybrid and would double deliveries to the U.S. market. This amounts to about 100,000 new hybrids and puts Toyota well ahead of the competition.

Kerry won the debate and the market exploded. Surprise, surprise. Were they related? Probably not. Remember on Thursday night I told you that $16 billion in bonds were sold at Thursday's open in 150,000 contracts. The profit taking streak in the bond market has now stretched to three days and the volume is heavy. It appears the four month bond rally is over and funds are moving to equities in anticipation of a post election rally. Just looking at fund flows would not support the kind of jump we saw today. According to TrimTabs.com stock funds saw outflows for the week ending on Thursday compared to multi billion inflows for the last several seeks. Funds in general lost money for investors in Q3 with the average diversified fund losing -2.8% for the quarter according to Investors Business Daily.

So what happened on Friday? It appears that bond money flipped to equities in an asset allocation play to capitalize on a post election rally. I also believe we saw funds who sat on cash until the quarter ended to not risk the normal September market decline also take the opportunity of the new quarter to make that same equity investment. It was clearly a fund day with the majority of broad market buying over by 10:30. Those issues most beaten down shared the spotlight with those winners of late. There was broad divergence of those losers and winners moving higher while the "average" performers failed to find a significant bid. You can see the drastic differences with SYMC +2.22 and new high, CME +4.43 and new high compared to INTC +4%, SLAB +8% and UTEK +12% all chip stocks rebounding off their lows.

While the SOX roared for a +4.6% +18 point gain it still remains under downtrend resistance. The big winner for the day was the Russell which found buyers for the fourth consecutive day and tacked on +12 points to finish at a three month high and a clean break above downtrend resistance. The race to the 585 close kept the Nasdaq and Dow from crumbling under their own weight as the day wound down. It also moved the Russell to within 15 points of a breakout over very strong resistance at 600 and only -20 points away from the all time high close of 606. On the surface it would appear bullishness is breaking out all over.

Russell Chart

That bullishness has pushed the VIX/VXO to new eight year lows. I hate to keep preaching to the choir but as a warning signal the klaxon has gone from muted beep to a solid siren. The challenge with the VIX/VXO is that there is no specific number that triggers a sell off. Highs and lows are more critical than a single number. Whenever these indicators are setting new highs/lows we should pay rapt attention. Needless to say eight year lows are screaming to be heard. Checkout Keene's VIX article in the Traders Corner this weekend.

For next week we could see an acceleration of warnings from the software sector. The ratio of warnings to positive guidance in the sector is currently 2:1 and that number could rise sharply. Software makers typically cram as many last minute sales into the quarter as possible and offer growing incentives as the quarter ends. They really do not know if they made their numbers until the smoke clears. This could pressure the sector and techs in general. This same practice is used in other industries and we could see a general spike in warnings next week.

However, the pace of warnings for the current week did not pickup as analysts expected. They continued but at a level pace with no increase in frenzy. This could be a positive sign for the quarter after many have predicted a potential drop to single digits for overall earnings growth. We have also seen a lack of warnings by major companies. Since Alcoa warned the big caps have been mostly silent. IBM, MMM and the other Dow components have been quiet and have now passed the normal time for confessing. It is just possible the asset allocation we saw on Friday was due in part to the lack of big cap warnings. The little guys have been beaten badly but maybe the multinationals have not been hurt as much as the analysts previously thought.

Even if that is true the trend may be changing. Oil closed over $50 at $50.12 for the first time ever on Friday. More and more pundits are talking $55-$60 and this will eventually squeeze profits for almost everyone. GDP for most nations will fall as prices curtail expansion. Japan has been the hardest hit as it must import all of its oil. The Japan markets have been in a nose dive on energy fears. It is entirely possible we will see an entire wave of cautious guidance over the next several weeks of earnings as companies lose traction in the widening oil slick.

There is also a recent trend by invertors to ignore warnings. Companies warning have been slapped on the wrist instead of taken to the woodshed for a beating. With disasters like MRK, CL and TZOO lurking around every corner a small drop in earnings from tech favorites is easily overlooked.

Before we get overly bullish about the prospects we need to remember what month we are in. October has seen four of five major bubbles burst. The top three single day Dow drops, -22%, -12% and -11% were all in October. There is some good news to tame the negative outlook. Eight of the last nine election years October broke out of the prior trading range to the upside. This is the carrot that lures timid investors to take risks in advance of a normally highly volatile period.

A major challenge confronting us is the known trend. It is almost universally accepted that the market will rally into and after the election with that rally ending in January. The abnormally low VIX shows that despite a terrible quarter behind us there is little or no fear heading into October. Everybody is counting on the trend and the universal acceptance that it will happen. Now we all know what happens when the entire market accepts the existence of a trend and starts counting on it. The market exists to confuse the maximum amount of traders at any one time. This could truly be one of those situations where all investors could end up on the same side of the boat at the same time with disastrous results. I am not predicting this only suggesting we don't run head first into the trap with our eyes closed to other possibilities.

For next week there are no major economic reports until Thursday with the Jobs report closing the week on Friday. This gives stocks free reign to run on Monday if Friday was not a one day fund wonder. Keep your eye on oil over $50 and watch for the number of warnings to increase and more importantly watch how the market reacts to those warnings. We should see some more short covering at Monday's open if nothing eventful occurs over the weekend. Once any opening bounce fades we will see if the rally has wings. Yes, wings not legs. A move higher from this level would break the SPX down trend and trigger even more short covering. If the Russell clears 590 we could see investors racing to chase prices and a move over 600 could see an explosion of activity. There is a lot of should and could in this paragraph but there are also a lot of surprised traders staring at charts this weekend. I suggest we do the same.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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