Option Investor
Market Wrap

Tension Building

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       WE 10-08        WE 10-01         WE 9-24         WE 9-17 
DOW    10055.20 -137.45 10192.6 +145.41 10047.2 -237.22 - 28.61 
Nasdaq  1919.97 - 22.23 1942.20 + 62.72 1879.48 - 30.61 + 15.78 
S&P-100  538.47 -  4.64  543.11 +  8.74  534.37 - 11.43 +  2.45 
S&P-500 1122.14 -  9.36 1131.50 + 21.39 1110.11 - 18.47 +  4.66 
W5000  10964.52 - 94.18 11058.7 +220.40 10838.3 -155.02 + 57.00 
SOX      389.52 - 12.39  401.91 + 19.36  382.55 -  5.95 +  4.89 
RUT      575.65 -  9.38  585.03 + 19.06  565.97 -  7.20 +  3.26 
TRAN    3336.00 + 37.20 3298.80 + 96.69 3202.11 - 55.28 + 24.00 
VXO       14.95           12.55           14.14           13.55 
VXN       20.69           18.91           21.10           20.13 

Last Sunday the bulls were charging out of the gate with massive back to back buy programs that lifted the Dow +200 points from the Thursday lows. Traders were talking about breaking overhead resistance and worries about an October dip were discounted as fading dreams promoted by hopeful bears. Amazing how a couple of negative days can quickly bring that October tension back for the bulls.

Dow Chart

Nasdaq Chart

SPX Chart

It all began with Thursday's drug overdose and the Dow drop at the open. Bulls were suddenly looking at red everywhere and the Nasdaq seven day winning streak was in jeopardy of being stopped cold. Oil hit $53 and the Nigerian strike was back on again. Cautious comments about the coming Jobs report and worries about GE earnings begin to push the market losses deeper into the red. No worry, jobs will rescue us and the bears will be sent off to an early hibernation. Bulls woke Friday morning to a worse than expected Jobs report and oil over $53 and suddenly that glimmer of light at the end of the October tunnel became an onrushing train. Worried yet?

The only material economic report on Friday was the Jobs report and it was not pretty. Only 96,000 jobs were created in September and far below the consensus estimate of 160,000. Worse yet the October revisions which were expected to be +288,000, according to administration leaks, fell to only +236,000. Last months +144K number was revised to only $128,000. In short there was no good news, at least not the kind of good news the president was expecting as he heads into the second debate on Friday night.

The labor market grew progressively tighter with total jobs created in Q3 at 309,000 much less than the 628,000 from Q2. The BLS acknowledged that the hurricanes impacted the numbers but only to a minor amount as Ivan hit after the survey week for September. They admit there could be a lingering impact from Frances and Charley but again it was seen to be only minor. This report created more questions than answers and the economic indications are for weaker job growth ahead. The conflicting reports from the ISM, various regional reports, Manpower and Monster Indexes all suggested hiring was increasing but they do not indicate the number of positions. They only measure ads and number of companies hiring.

After Friday's report analysts were left with the feeling of inherent job weakness coming back to haunt the recovery. The country needs to create 150,000 jobs per month just to cover the number of new workers entering the workplace. The spring months of Mar-May saw a bounce to +295,000 per month on average and analysts were projecting a strong continued economic rebound. Over the last four months that average has dropped to barely over +100,000 per month on average and less than breakeven rates.

This suggests the economy may be transitioning into a weaker pace of growth and may give us a clue why Bernanke broke from the Fed mantra this week. He said in his Thursday speech that "if the economic data paused then the Fed rate hikes would pause." Because this was different from the current Fed policy analysts quickly thought it might be an indication the Jobs numbers may not be as strong as expected. Whether the Bernanke comment was scripted or just coincidental we will never know but the data definitely paused. This will increase speculation about the Fed position for the Nov-10th meeting.

The unemployment rate remained at 5.4% not because more workers found jobs but because more workers dropped out of the workforce in frustration. In September 221,000 workers dropped out following -152,000 in August. In a related survey -201,000 dropped out of the household workforce in September. Those three numbers alone show twice as many workers dropped out of the picture than actually found jobs over the last two months.

With the second debate on Friday night Bush was saddled with a new handicap before the cameras even began rolling. With the race a dead heat and Kerry poised to hammer him on the economy just like he hammered him on Iraq last week the outlook does not look good. They say the market does not care who is president only that the election is over. That may not be exactly true. Over the last 26 incumbent elections sixteen were won by the incumbent. Of those sixteen times the market rose the year after the election fifteen times. For the ten times the win went to the challenger the market fell nine times. I am sure there are valid reasons for the extremely lopsided results but it clearly shows that the market normally goes higher when the incumbent wins and dives when the challenger wins. This trend will not be lost on fund managers.

This makes the debate on Friday even more critical with the contestants running neck and neck. The statistics show this to be the slowest recovery cycle in over 50 years and the economic tension is building.

There are positive signs on several fronts. On Friday the CEO of IBM tried to paint a positive picture for techs. He predicted capital spending would increase in 2005 from the +6% to +7% growth they were seeing for 2004. Reporters were unable to ask him for his specifics as to why his numbers were higher than consensus estimates of +4% to +5% for 2004. GE CEO Jeffery Immelt said the economy continues to be very strong and he is projecting growth for GE of +10% to +15% for 2005. Eight of GE's eleven divisions posted double digit growth in Q3. Several of those divisions grew at more than +20% for the quarter. GE raised estimates for the full year to the high end of their range.

All is not as bleak as the Jobs numbers would suggest. The last week of earnings warning season was not as bad as expected and the earnings flood will begin next week. The earnings debate is heating up with the S&P Q3 estimates at +12.3% as of Friday and the Reuters estimates of +15.5% to +16.5%.

The key earnings to look for next week will begin with INTC on Tuesday. Intel lowered estimates for the quarter and they are not expected to miss the lowered estimates. The key will be their guidance for Q4 business and their progress on the inventory issue. AMD expected stronger Q4 sales so Intel will be expected to say the same or suffer the consequences.

JNJ will report on Tuesday and after the CL and UN warnings the consumer products companies have been under pressure. Add in the pressure on drug companies and JNJ will be watched from all directions. On Friday JNJ changed the warning label on its arthritis drug Remicade to show increased rates of lymphoma. This again pressured Pfizer as the current king of the hill but they adamantly insist Celebrex has no problems.

Yahoo also reports on Tuesday and results will impact Google as their key rival. With GOOG still on a vertical ramp any negative comments in Yahoo's report is sure to bring back the shorts. Of course you have to decide if positive comments from Yahoo are negative for Google or negative comments positive for Google. Is there room enough for both to prosper?

Merrill reports on Tuesday and analysts are split on their chances of a miss or a beat. The summer volume slow down should have impacted trading volume but gains from internal trading and cost cutting could help. GS and Lehman surprised to the upside and Morgan Stanley surprised to the downside so Merrill's results are up for grabs.

Another factor that will continue to haunt us is oil prices. Oil closed at $53.31 on Friday on news that Nigerian workers will go on strike again on Monday. Depending on how much oil slows from Nigeria the price will continue to rise. Current resistance is projected to be $54 but the $60 whisper target continues to gain respectability and it may turn into a self fulfilling prophecy.

For the week the Dow spent three days lingering in the 10200 range with one brief spike to 10270. However, by Friday's close the Dow had erased all of its gains since the last Friday buy program and it is right back at 10050 and the support from late September. There is no harm in the pullback because the sprint higher was artificial to begin with. Three massive asset allocation programs over two days ran stops to the upside and forced shorts to cover. For two days we wandered sideways while the market looked for direction and then a sequence of events brought us back to earth and to September support.

The Nasdaq held its gains much better than the Dow because of the different weighting for individual stocks impacts the Dow more dramatically. The Nasdaq has been supported by the SOX since the September lows and despite the Friday swoon the SOX is still moving higher. This will continue to support the Nasdaq until Intel reports earnings on Tuesday. After that report all bets are off and we will have a new market.

I said above that this weeks pulling back to support was nothing to worry about. That is true as long as the Dow remains above 10,000 and the SPX above 1110. Actually 1120 is current support equating to 10050 on the Dow but 10000/1110 is the key. The Nasdaq is well above the equivalent Dow/SPX support and could stand to give up another -30 points to 1890 before making a critical break.

Volume slowed on Thursday and Friday compared to the 4B+ days during the rally. Unfortunately most of that volume was to the downside with a 4:1 ratio on Friday. I view the pullback, regardless of reason, as a bout of profit taking and positioning ahead of next weeks earnings. Funds were handed a gift as we moved into October and that bounce worked to the bulls advantage and allowed those sellers that wanted out a higher level for their exit. There was no damage to the markets and we are entering the first real week of earnings with no real bias. We could just as easily go up or down and Friday's close although negative for the week was perfectly neutral.

Monday has no economic reports and it is also a bank holiday. The bond market is closed and will not be impacting our trading. The Nikkei is also closed and will not be an influence on our markets. This sets up Monday as a low volume day while traders pass time waiting for the real earnings flood to begin on Tuesday. Only seven companies report on Monday with several hundred reporting over the next three days. Bottom line Monday is a setup day and a tossup for everyone. Once the earnings parade begins we could see some serious volatility but without a serious earnings miss by somebody that volatility could just be churning. Expectations are low and there is a good chance we could see some upside surprises.

One last piece of election trivia. Bush supporters should be buying all the stocks they can afford to push the markets higher. Kerry supporters should be taking every opportunity to short the market. The incumbent party has never lost the presidency when the Dow gains +3.3% or more in October according to the Stock Traders Almanac. However, if the Dow loses more than -0.5% in October the incumbent has never won. Since 1901 there were 17 elections where the Dow posted gains but did not reach the +3.3% level. Of those 17 elections the incumbent lost only four times. Conversely in the eight elections where the Dow ended lower but with less than a -0.5% drop the incumbents won only twice. Clearly there is a tie between the elections and the markets and a positive market favors the incumbent. Or to put it a different way, the market is reacting in advance to the perceived results of the election. The market does not depend on the election but is an uncanny predictor of the outcome based on the perceived ramifications to investors from the victorious candidate. The Dow closed September at 10078 and closed Friday at 10055, a statistical dead heat. Before the Friday night debate the various presidential surveys had the race at 45% Bush 46% Kerry with those numbers exactly reversed in another major survey. A statistical dead heat. The market is tracking exactly 10 days into October. Need I say more?

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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