Option Investor
Market Wrap

Close, But Was It Close Enough?

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      10-12-2004           High     Low     Volume   Adv/Dcl
DJIA    10077.18 -  4.80 10102.33 10017.15 1.62 bln 1519/1703
NASDAQ   1925.17 -  3.60  1929.98  1904.11 1.52 bln 1312/1778
S&P 100   539.22 -  0.70   540.49   536.27   Totals 2821/3481
S&P 500  1121.84 -  2.55  1124.39  1115.77 
SOX       386.36 -  5.20   391.53   380.17
RUS 2000  576.71 -  0.85   578.10   570.49
DJ TRANS 3338.98 +  2.80  3330.78  3296.09
VIX        15.05 +  0.34    15.69    14.91
VXO (VIX-O)15.17 +  0.18    16.10    14.87
VXN        20.93 +  0.88    21.77    20.71 
Total Volume 3,440M
Total UpVol  1,166M
Total DnVol  2,204M
Total Adv  3155
Total Dcl  4023
52wk Highs  170
52wk Lows   120
TRIN       1.76
NAZTRIN    0.51
PUT/CALL   1.00

Intel and Yahoo announced earnings after the bell and both were close to analyst's estimates. The question is were they close enough? Were they good enough to pull the markets back from the brink of disaster or did they lack enough excitement keep them from going over the cliff?

Dow Chart

Nasdaq Chart

The morning opened with a flurry of earnings warnings and earnings from a couple of heavy weights. JNJ beat the street this morning by +2 cents at 78 cents for the quarter. JNJ saw strong sales in multiple divisions both locally and globally. Revenue rose +10.5% for the quarter and they raised their estimates for Q4. This was much needed good news for the drug industry and consumer products. They did say they saw slower growth for 2005.

Merrill Lynch posted earnings that beat the street but were down from last years levels. The company said slow trading volumes contributed to the revenue decline but overall performance was very strong given the market conditions. Merrill jumped +1.48 on the news.

Those two earnings releases did a lot to offset the damage done by a SEMI report saying global chip sales had fallen -29% in August on a month over month basis. Chip sales in China fell -51%, North America -31%, Japan -20%. This knocked about -10 points off the SOX at the open and cratered the tech sector. Warnings from HLIT and a SEC inquiry at AMKR also pressured chips. PHG said sales would be flat sequentially and they were also seeing price erosion for consumer electronics chips. SB downgraded SNDK to a sell citing weakening pricing and slowing manufacturing benefits. They spoke positive about FLSH in the same report.

Greasing the slide was a sharp spike in oil to new highs at $54.45 before the open and once over $54 the equity market imploded. This appeared to be the point where even the strongest bulls lost their appetite for stocks. Oil was up on strikes/fires in Nigeria and a 55,000 MBpd loss of production from Norway. Bulls got a reprieve late in the day when oil suddenly fell out of sight to trade on Globex at a $52.14 low. This was -2.31 off the highs on no real news. Analysts theorized that the $54 level was simply too much for those already long to pass up and profits were taken. This same thing happened when we neared $50 the first time. We are also only three weeks away from the election and the calendar is ticking down on any risk for terrorists to impact prices before the election.

When oil began its sharp drop the equity markets began a bullish run that took the Dow and Nasdaq back to positive territory. Fear of Intel and Yahoo earnings produced some profit taking prior to the close and we ended level for the day in everything but the SOX.

After the bell Intel announced earnings that missed estimates by a penny but said the right things in the earnings release to send their stock higher. They earned 30 cents per share but 3.6 cents was due to a tax item and not operating earnings. Their gross margins fell to 55.7% and well below estimates of 58%. The reason for the drop was discounting to get rid of inventory and a product mix slanted to lower margins. Intel rose in after hours trading despite the miss and some cautious comments about the 4Q. They are targeting 4Q margins at 56% which is still below analysts estimates. They targeted revenue at $8.6B-$9.2B and the consensus was for $9.1B. On the conference call Andy Bryant said there was too much inventory still in the system and seasonal 4Q demand was softer than expected but they were making progress.

Considering the negative expectations for Intel the fact they missed earnings slightly and guidance was only "soft" represented a positive surprise. INTC traded up +70 cents in after hours. The real question is how will it trade tomorrow? Was the soft guidance good enough to provide a continued bounce when real volume hits the tape?

Yahoo actually posted better earnings even though they only matched street estimates at nine cents. They did exceed revenue estimates of $644 million with a spike to $655 million. Advertising revenue was up +10% over Q2 and Q2 was up +9.2% over Q1. They gave guidance for Q4 for $710-$760 million that straddled analysts estimates of $730 million. They also raised full year estimates slightly. YHOO only rose +50 cents in after hours and represents expectations already priced into the stock. The real impact could be to Google which rose +$2 in after hours in advance of their earnings on Thursday of next week. Google will be expected to match or beat Yahoo's performance and guidance or face the wrath of traders. On Monday American Technology Research downgraded GOOG to a SELL citing concerns about valuation and competition. Last week Jeffries also downgraded Google citing excessive valuations. ATR went so far as to suggest shorting Google at this level. However, Google got to this level over the bodies of bleeding bears so caution is definitely the key. I expect we will see further GOOG spikes on Wednesday as shorts cover on fears they will post better results than Yahoo.

The economics for the day were evenly mixed with the Richmond Fed Survey moving +4 points higher and the Kansas Fed Survey dropping -2 points. The Richmond Fed rose inexplicably after New Orders fell to 8 from 13, Order Backlog to -6 from +1 and the Six Month Outlook to 23 from 28. The only major component to rise was Shipments from 18 to 22. Employment did return to positive territory but remained soft. The Kansas Fed Survey showed only a small drop in the headline number and that was repeated in the majority of the components. Again employment rose slightly and New Orders fell.

Oil prices may have fallen but commodities in general continue to rise. This will continue to be a sore topic for months to come regardless of what happens to oil. The Goldman Sachs Commodity Index has risen over +103% in the last 33 months. According to one analyst a gain of more than 55% in any 30 month period has NEVER failed to produce a recession. CNBC ran a sequence of screens several times on Tuesday showing price rises in various common products like butter +50%, turkeys +38%, etc over the last year. Feedstocks are soaring and that is pushing up the cost of food across the board. Storm damage has wiped out most of the orange, grapefruit and peanut crops in the south and prices for those items and products made with those items are going even higher. Peanuts are a major staple ingredient for many products including candy, baked goods, peanut oil for frying and cooking, etc. This just a random sample but other sectors with soaring prices include building materials. The hurricane damage is expected to suck up a six month supply of building supplies like plywood, sheetrock, shingles, insulation, etc. This will raise prices for home construction across the country as supply as demand equalizes. Add in oil prices that suddenly seem cheap at $52 overnight today and the economy has a tough road ahead.

I relate that paragraph above because just having Yahoo serve up +10% more ads and Intel happy about only "soft" 4Q demand is not going to send the bulls roaring back into the market for long. We may get a bounce on Wednesday but we are going to need a stronger showing of major firms with positive earnings and guidance to convince the herd.

We are three weeks away from the election and the candidates are still dead even going into the last debate on Wednesday. The election is up for grabs and the market does not know which way to jump. The next round of earnings continues tomorrow with the emphasis on chips and technology. ASML, AAPL, LRCX, NTOP, NVLS, QLGC and SNDK report on Wednesday. On Thursday we get AOS, ABT, BAC, BBT, C, CY, ETN, ENDP, SSP, FITB, FDC, GM, HIB, KEY, KRI, LSTR, MRCY, MTG, NCC, NOK, BTU, PII, RDC, LUV, SVU, TRAD, UIS, UNH, WGO, CNET, CREE, FCS, JNPR, LEXR, NFLX, NMSS, RMBS, SYK, SUNW. There are some well known companies in that list but we are lacking the big name market movers like IBM, MSFT, MMM, etc. The rest of this week has a lot of smoke but the next real wave of market movers does not come until next week. Intel may have relieved some pressure from the tech sector but the small fry above could sour that picture once again.

The rebound on the Dow today lifted the index away from breakdown risk at the 10000 level but we are still a long way from breaking last weeks 10250 resistance. The 10100 level has been initial resistance for three days and based on the futures overnight we should retest that again at the open. If a higher move is successful that puts us right back into the middle of our congestion range while we wait for the earnings generals next week.

The Nasdaq is already in the middle of the recent range at 1930 and has +40 points of upside potential before hitting the strong 1965 resistance level. The overnight Nasdaq futures are showing a +10 point gain and again that leaves us right in the middle of our recent range.

The current setup suggests the rest of the week may not see a breakout in either direction. We could be left to suffer slow torture as dozens of small companies with mixed results push the markets around like a rowboat on a stormy lake. Lots of chop but no real direction. To make matters worse this is option expiration week and we have yet to see any real option related moves. With the Intel and Yahoo volatility added to Wednesday trading that expiration volatility could appear at the open. If there were any institutions betting on a major Intel miss then they could be squeezed at the open and that could give us the last major move for the week. Thursday and Friday are not expected to be directional. Bottom line for me is look both ways before stepping off the curb tomorrow but expect traffic to slow by the end of the week.

Enter Passively, Exit Aggressively.

Jim Brown


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