Option Investor
Market Wrap

Flagpole Rally II

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      10-04-2004           High     Low     Volume   Adv/Dcl
DJIA    10216.54 + 23.89 10270.37 10191.40 1.91 bln 1676/1142
NASDAQ   1952.40 + 10.20  1965.76  1950.17 1.83 bln 1846/1195
S&P 100   544.74 +  1.63   547.36   543.11   Totals 3522/2337
S&P 500  1135.17 +  3.67  1140.19  1131.50
SOX       405.01 +  3.10   413.13   401.91
RUS 2000  589.09 +  4.06   592.02   585.03
DJ TRANS 3318.62 + 19.82  3329.46  3299.25
VIX        13.41 +  0.66    13.45    12.99
VXO (VIX-O)13.11 +  0.56    13.23    12.60
VXN        19.61 +  0.70    19.66    18.90
Total Volume 3,745M
Total UpVol  2,528M
Total DnVol  1,160M
Total Adv  3522
Total Dcl  2337
52wk Highs  491 
52wk Lows    42
TRIN       0.63
PUT/CALL   0.86

It was a very quiet, almost cadaverous market for traders watching the cash markets during regular trading hours, as the real action occurred in the premarket. After the initial gap up, there little tradeable action and a narrow range ensued.

Despite the lack of range, volume was strong with breadth positive, advancing volume more than doubling declining volume on the NYSE and almost doubling it on the Nasdaq. The volatility indices were similarly divided, with the NDX volatility index (QQV) rising even as the NDX advanced, while the OEX volatility index (VXO) declined.

Daily Dow Chart

The daily candle print for the Dow combined with the strong NYSE volume would qualify as a gravestone doji, a classic reversal print. However, there are two inconsistencies: a gravestone doji should be red instead of green, meaning that the day would ideally have finished negative. I've found this to be of only minor importance, as the key is that the Dow finished well within the bottom of its range, having been decisively rejected at the upper end. More importantly, however, there wasn't the panicked "DOH! Geee" reversal that markets the obvious doji tops. This pattern is based on the idea of the herd stampeding in one direction, and then stampeding equally urgently the other way. Today's endless, minute range that drifted lower wasn't the stuff of which classic reversals are made. Of course, it could have been a controlled distribution top- it's just not obviously so. The key will be whether we break today's low of 10191 on a closing basis tomorrow. A strong break below the upper descending resistance line tomorrow will close the door on bulls. A weak, sideways decline or a bounce will set up more pain for bears.

Daily S&P 500 Chart

The same candlestick issue is evident here for the SPX, and bears will be looking for a close below 1131.5. Note that the daily cycle oscillators are on early buy signals from a higher low for SPX. Because of the higher price high, there's the potential for a steep bearish divergence if the upphase fails early, as in this week. However, until it does, the SPX is still in an upphase, and the benefit of the doubt should go to bulls above the line at 1131.

Daily Nasdaq Chart

The Nasdaq would have printed a gravestone doji/shooting star, closing 2 points above its low for the day. It opened on its second consecutive breakaway gap up in as many sessions, with gap support at 1942 if today's low at 1950 fails. Of the 3 indices, the Nasdaq is on the weakest daily cycle upphase, and a close below the 1940 level should be enough to stall the current bounce attempt. Once again, it's bullish until it isn't, but bulls will want to keep their stops close to protect current profits.

Weekly TNX Chart

Treasury bonds kicked off the week on a soft note as ten year note yields (TNX) rose above 4.2% intraday before settling back below the line. Buying in bonds reversed the gains as the TNX closed in light negative territory, still at the upper end of Friday's range. Traders following the TNX closely should refer to this weekend's Futures Wrap, in which I reviewed the daily TNX chart. The weekly chart posted above shows last week's bullish reversal in the TNX, rising on a bullish hammer from below the 4% line to engulf the previous two weeks' declines. Bond bears/yield bulls will want to see the TNX clear the 22 and 50 week EMAs overhead on the way to a retest of the 4.4% resistance level. Note that this week's TNX candle is based solely on today's session. For the day, the TNX declined 1.8 bps to 4.173%, a .43% loss for the day.

Weekly chart of Philadelphia Housing Index ($XAL)

Homebuilders got clocked on the weakness in bonds and continued lower even after bonds returned to positive territory, declining 3.2% to close at 397.59 in a notable divergence from the broader market. The weakest components of the index included BZH, MDC and PHM, all of which lost more than 4% for the day. TIN and BCC were the lone advancers among the 21 stocks that comprise the index.

Weekly chart of Crude oil

Oil was among the topics discussed at this weekend's G7 meeting, with the Group of Seven calling for an expansion in supply from oil producers. Representatives of the G7 countries, Britain, Canada, France, Germany, Italy, Japan and the United States, stated that current high oil prices pose a risk to global economic growth. Both higher production and an increase in efficiency from consumer nations were cited in the G7's communiqué. OPEC's smallest producers, Qatar, said however that OPEC has done all it can to relieve rising prices, but added that it will continue to do so. OPEC's top producer, Saudi Arabia, announced that it was increasing production from 9.5 mbpd to 11 mbpd in response to prices above 50 per barrel.

Reuters reported that Nigerian rebels withdrew their threat to target oil operations in the delta region and signed a peace agreement on Friday. Oil companies were considering returning workers to Nigeria's delta today as it appeared that the deal would stick. Nigeria produces approximately 2.3 mbpd.

David Malpass of Bears Stearns was out this morning with bullish comments for the US economy, projecting growth in Q3 above 4% and a possible "blowout" in Q4 to the 6% level. He cited rate hikes as being bullish for the economy, based on their evidencing the Fed's lack of concern for deflation and the degree to which current rates are currently low. He believes that global economic expansion is offsetting the drag caused by the oil rally, and cited certain expiring tax provisions that allow the expensing of capital equipment purchased prior to year-end. He expects a spike in spending from businesses seeking to exploit these provisions.

In much the same vein, Fed Governor Bernanke was talking down the impact of oil prices today: "It's the difference between rising prices and high prices. The economy can accommodate prices at the current level." Nevertheless, he added that he hopes that oil prices will fall gradually.

Philly Fed President Santomero weighed in as well in a speech to the National Association of Business Economics (NABE), stating that he expects to see growth in the 3.5%-4% range through 2005 supported by a steady rise in consumer and business investment spending. In his opinion, growth at this level would be optimal, sufficient to stimulate gains in employment without causing a spike in price inflation. He believes that at its current 1.75%, the overnight lending rate is "below neutral." As he put it, "I don't think we are yet at neutral. We will have to evaluate how the economy evolves from here to try to figure out how to proceed, but my suggestion to you is that we still have a way to go."

Governor Bies addressed the NABE in the afternoon, reiterating the view that the US economy is coming out of its recent "soft spot" and her opinion that growth would accelerate in the current quarter. She added that she sees very weak inflation: "The core PCE has been one-tenth of one percent for the past three months and that is a good signal that we are down from where we were," she said. Note that the "core" PCE strips out the so-called "volatile" food and energy components.

The IMF's managing director Rodrigo de Rato and World Bank president James Wolfenson reported a general lack of consensus on critical issues from this year's World Bank-IMF annual meeting. Strongest progress was made on the issue of debt-relief for the world's poorest nations, though a specific plan was not agreed upon. Rato spoke up in favor of better surveillance to provide early warning of potential financial crises.

More exciting were comments from Li Ruogu, assistant governor of the People's Bank of China, who delivered what was characterized as a rebuke to Congress, suggesting that it is not China's currency, but rather the low US savings rate behind current global imbalances. Mr. Li suggested that US foreign direct investments in China generate profits not for China, but for the US, and concluded that changing the exchange rate would effectively "destroy the goose that can give you golden eggs". He said that China remains committed to supply-and-demand based exchange rates, but would not state a timeframe, stating that in China's 8000 year history, a decade isn't a long time. He added that the US has done nothing in 20 years despite its commitment to reduce arms sales to Taiwan.

It was a quiet day for economic data, with August Factory Orders as the lone report for the day. The Commerce Department reported that new orders at US factories declined 0.1% after rising a revised 1.7% in July. Economists were expecting a rise of 0.1% in August. The data revealed the bulk of the weakness to be in civilian aircraft orders, which declined 42.9% following July's 103.5% increase. Excluding transportation, Factory Orders rose 1.3%, and y-o-y grown remains strong at +12.5%. The market cheered the data immediately following its release at 10AM.

In corporate news, VTSS reduced Q4 estimates from 0-1 cent per share to -2 cents per share, citing weakness in the storage market. VTSS closed lower by 5.92% at 2.70.

WAG announced that same-store sales rose 6.3% in September, with total sales rising 13.2% from September 2003. NUS, a direct seller of personal care and nutrition products, reduced its forecast for Q3 earnings to 27-28 cents per share, compared with the First Call consensus of 34 cents. The company cited weaker than expected revenue in China and Japan, and higher than expected expenses in these territories. NUS declined 32.32% to close at 16.46.

Merrill Lynch was bearish on tech this morning, citing earnings revisions that were -14% in September compared with +5% in August. This decline was more than double its standard deviation, and spurred Merrill's Steven Milunovich to project negative revisions to continue in 2005. He expects technology stocks to underperform in such an environment.

SEBL was up more than 14.04% on news of an extension to its strategic alliance with MSFT whereby SEBL will optimize its Siebel Business Analytics for use with a number of MSFT's products. The stock closed up 1.15 at 9.34.

The Disk Drive Index (DDX) rose 3.23% on gains from HTCH, which guided higher to 15-20 cents per share for fiscal Q4, up from its July guidance of breakeven to 10 cents per share, citing strong shipments. HTCH closed higher by 16.28% at 4.57. MXO was another big winner, adding 6.17% to close at 5.68. WDC got a boost, rising 2.74% to close at 9.37 on news of a new 2.5" hard drive that is currently shipping briskly in a market that is expect to grow from 53M units in 2004 to 77M in 2007 according to Gartner Group.

Tomorrow is scheduled to be another light news day, with ISM services for September at 10AM, est. +.1%. The key issue for traders will be whether the indices can hold onto their gains following the dismal drift lower from this morning's strong open. While the daily cycles are pointed north, the higher price highs leave these cycles vulnerable to a divergent reversal, particularly on the Nasdaq.


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