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Market Wrap

Flagpole Rally

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      10-18-2004           High     Low     Volume   Adv/Dcl
DJIA     9956.32 + 22.94  9960.15  9861.63 1.68 bln 1495/1290
NASDAQ   1936.52 + 25.02  1936.52  1904.50 1.49 bln 1782/1207
S&P 100   535.18 +  3.38   535.48   529.94   Totals 3277/2497
S&P 500  1114.02 +  5.32  1114.46  1103.33
SOX       384.35 +  2.98   384.37   374.67
RUS 2000  572.03 +  2.61   573.19   565.97
DJ TRANS 3382.71 + 30.03  3384.27  3332.75
VIX        14.71 -  0.33    16.16    14.64
VXO (VIX-O)14.69 -  1.20    16.27    14.69
VXN        20.72 -  1.08    22.96    20.61
Total Volume 3,181M
Total UpVol  2,070M
Total DnVol  1,014M
Total Adv  3277
Total Dcl  2497
52wk Highs  192 
52wk Lows   103
TRIN       0.59
PUT/CALL   0.77

What started as a now-routine thrashing of the Dow and SPX, this time following bad news from MMM, whipsawed into a strong bullish reversal before noon. Price ran vertically higher through multiple resistance lines, reversing a synchronous set of intraday downphases from what appeared to be a nearly perfect bearish intraday setup.

Merrill Lynch's Walter Murphy had been out this morning, forecasting that the Dow would blow the roof off this year in a terminal upside move to the 11000-11500 level. Murphy expects the Dow to decline from there in 2005, and that the 4th quarter rally would mark the end of the rally from the 2002 lows. He also noted that in every election year since 1932, the incumbent has lost the election where the Dow has lost 0.5% or more in October.

This seemed like the usual fluff, but the sudden upward launch in the indices lent it credence. The bulls are still pretty far from being in control, however, as a quick look at the daily charts will reveal.

Daily Dow Chart

The Dow posted a bullish doji hammer today, with the daily print coming close to a key outside reversal. The Dow was below Friday's low when the burst of buying hit, with the Dow closing just north of 9950 resistance. A daily cycle downphase still in effect, but with a potential bullish stochastic divergence. If the bulls can close the Dow back above the rising trendline at 10080, the resulting daily cycle upphase will launch from a higher stochastic high against the lower price low. This is generally a setup for a powerful move, in this case to the upside, and would target the 100200 and 10250-60 confluences.

Daily S&P 500 Chart

The SPX printed a similar pattern, but bounced from a nominally higher low from Friday. The bullish doji hammer broke Friday's high and targets 1122 trendline resistance next. Because last week's selling wasn't as extreme as it was for the Dow, the SPX's potential bullish oscillator divergence isn't as sharp. But it's still there, and bulls will be gunning for a close above 1128 resistance to make good on it.

Daily Nasdaq Chart

The Nasdaq has been consistently stronger than its peers for the past two weeks, and today's candle underlines the point. The bounce took place from above unbroken rising daily support, and blew past last week's closing highs. The daily cycle downphase is the weakest of its peers. Next resistance is at 1950, followed by 1980. A close above 1950 should be enough to end the daily cycle downphase and print the first tentative daily cycle buy signals.

Weekly TNX Chart

FNM announced its intention to more aggressively court subprime borrowers, with CEO Franklin Raines announcing a 3 pronged strategy to encourage these mortgages. This follows data in recent weeks showing a stall in mortgage activity as reported by the Mortgage Bankers Association, despite the recent declines in bond yields.

Later in the session, the National Association of Home Builders announced a bounce in builder confidence, wit its Housing Market Index (HMI) rising 5 points to 72, more than offsetting September's 4 point decline. The Current Sales index rose 5 points to 78, and Expected Sales rose 9 points to 84.

As can be seen in the weekly chart of the ten year note yield (TNX), rates have been in a downtrend since the June high but have recently found support at the 3.9%-4% level. This attempt to put in a higher low for the yield is potentially bearish for bonds, provided that TNX doesn't break lower rising bear wedge support at 3.885%. A weekly cycle upphase is trying to form, and yield bulls/bond bears should be in business on a break above the 4.35% level. For the day, the TNX closed unchanged at 4.053%.

Weekly chart of Crude oil

Crude oil declined from a record high of 55.5 this morning to a session low of 53.10 in the afternoon on the Nymex. Aside from technical factors, analysts speculated that weakness in oil was attributable to the drag that the rally has been exerting across all asset classes. The selling in base metals and the equity indices last week were cited in support of this hypothesis. Greenspan's comments last week underlined the obvious deleterious effects of high energy prices on the economy, and today's downward action in oil prices was attributed to the damage already wrought by the rally. In theory, any rally in energy should eventually choke itself off, though I'd be very skeptical of any attempt to correlate daily market gyrations with macro- fundamental factors such as that. For the day, November crude close at 53.725, +.05.

In corporate news, MMM announced its Q3 results, earning 775M or 97 cents per share compared with 663M or 83 cents in Q3 2003 but missing estimates of 98 cents. The company expects to earn $3.68-$3.69 per share for 2004 and anticipates an increase in sales of 7% from 2003. Profits rose, but the miss was the first in seven quarters, with the company attributing part of this quarter's strength to weakness in the US Dollar. In particular, the company's chairman and CEO, James McNerney, said, "We are optimistic about the strength of our diverse business and technology portfolio, but remain cautious on the global economy." Given the diversified nature of MMM's business, the company's outlook and results were seen as a shot across the bow of the indices today, and both the stock and the Dow led the indices lower for most of the morning. MMM closed lower by 2.41% at 76.10.

Air conditioner, bathroom and vehicle control system maker ASD missed estimates with Q3 earnings of 156M or 71 cents per share on sales of 2.396B. Net of one time revenues, however, earnings were 65 cents, missing consensus estimates of 67 cents. The company narrowed its range for 2004 earnings, expecting earnings of per share from the previous projection of $2.17-$2.27 per share to $2.21-$2.25. ASD lost 4.55% to close at 36.46.

Printer supplier LXK beat estimates, announcing Q3 earnings of 156.1M or $1.17 per share, up from 79 cents in Q3 2003. This amount was increased by a non-recurring tax benefit without which earnings were $1.02 per share, 4 cents higher than consensus estimates. Revenue was 1.27B, 200M less than forecast. LXK lost .75% to close at 81.78.

Toymaker HAS characterized its 2003 earnings as "disappointing", earning 45 cents per share (up from 38 cents in Q3 2003) but on decreased revenue of 947.3M from 971.1M last year. Estimates had been for 51 cents on revenue of 992M. MAT beat by a penny with earnings of 61 cents but revenue missed forecasts for 1.76B, coming in at 1.67B. Sales were lower by 9%, with Barbie sales falling 13% and Fisher-Price rising by 7%. HAS got smoked for 6.5%, closing lower at 17.26.

There was action among the miners today, with South African miner HMY announcing that it would be submitting an 8.1B stock-based takeover of GFI. This would represent a 29% premium over the past 30-days' price of GFI. The proposal, which is contingent on the proposed IAG-GFI merger being scuttled, would see the issuance of 1.275 new HMY shares for each GFI share. GFI's largest shareholder, Norilsk Nickel (NILSY) supports the deal. GFI closed lower by 4.35% at 14.29, IAG closed lower by 8.93% at 7.24, and HMY lost 8.44% to close at 11.50.

Homebuilder and mortgage banker NVR beat expectations, reporting Q3 earnings of 147.7M or $19.04 per share, rising from 109.4M or 12.55 in Q3 2003 and beating estimates of $16.91. Revenue was higher by 19%, new orders by 9%. The company expects a 22%-24% increase in earnings for 2004. NVR closed higher by 2.27% at 559.40.

After the bell, IBM announced earnings that beat estimates by 3 cents at $1.17 per share and meeting estimates of 23.4B in revenues. The EPS number excludes an 11 cent or 320M pension fund dispute. IBM had closed higher by 1.26% and added another 1.61% afterhours, trading 87.30 as of this writing. TXN was slightly lower afterhours at 21.05 after topping estimates of 27 cents EPS with 32 cents. TXN's profit represented an alltime high, doubling Q3 2003's result while revenue increased 28% over last year. As was the case with MMM, the company noted challenges in the current environment but expressed confidence as to its measures, including tightening expenses and reducing production.

JDAS also took off despite missing by a penny, adding 5.88% as of this writing to trade 11.70. Q3 revenue for JDAS was down from 11 cents per share in Q3 2003 to 6 cents, with earnings falling to 1.6M from 3.4M. The company cited delays in software licenses.

With earnings season upon us, the markets should continue to deliver knee-jerk reactions in both directions. What was a bearish market mover in MMM this morning was treated as bullish for TXN afterhours. What appeared as a common thread was an acknowledgement of challenging conditions and a less optimistic outlook going forward. Boosts from the foreign exchange differential, cost cutting or layoffs may increase short term profitability, but they grow increasingly difficult to repeat. As Henry Ford would have pointed out, companies cannot profit endlessly in an environment of wage deflation. Cost-cutting increases competition between companies and is ultimately a double-edged sword.

For tomorrow, the key question will be whether today's big moves will hold. The upside action in equities had an impulsive feel to it. If bulls can hold within the flag atop today's flagpole rally, then the daily cycle downphases will convert to the upside, led by the Nasdaq. However, a return to today's lows will do so minus most of the shorts who got blown out of their positions today, and will therefore have that much less support as prices fall.


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