Option Investor
Market Wrap

Market Misfire

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      11-23-2004           High     Low     Volume   Adv/Dcl
DJIA    10492.60 +  3.20 10514.99 10436.38 1.78 bln 1945/1291
NASDAQ   2084.28 -  0.91  2092.02  2068.98 2.10 bln 1740/1376
S&P 100   561.29 -  0.35   562.55   558.58   Totals 3685/2667
S&P 500  1176.94 -  0.30  1179.52  1171.41 
SOX       429.71 -  3.20   436.38   426.89
RUS 2000  624.53 +  3.01   624.53   616.54
DJ TRANS 3621.08 + 11.80  3626.55  3582.60
VIX        12.67 -  0.30    12.91    12.57
VXO (VIX-O)13.08 -  0.50    13.71    12.81
VXN        18.43 -  0.34    18.97    18.35 
Total Volume 4,187M
Total UpVol  2,260M
Total DnVol  1,855M
Total Adv  4176
Total Dcl  3070
52wk Highs  512
52wk Lows    51
TRIN       1.30
NAZTRIN    0.90
PUT/CALL   0.79

Several times this week the markets tried to rally but sputtered and failed. The misfires all started off with a bang but could not produce enough momentum to push the Dow over 10500 for more than a few minutes. Like a rocket trying to escape the pull of gravity with only one booster each spike sputtered at the edge of resistance and fell back to earth. Unable to make a successful run with a frontal assault during cash trading hours there was a sneak attack after today's close that may prove more successful.

Dow Chart

Nasdaq Chart

SPX Chart

The economic reports came back to the forefront again today but it was not Chain Store Sales and National Activity Indexes that captured traders attention. It was the economics of oil that tanked the markets once again. Reportedly fears of shortages and disruptions in supply were the factors that sent crude back over $50 for most of the day. The spike back over the $50 level helped to shatter the confidence many analysts had developed suggesting the oil crisis was over. $50 oil is a red flag and the opening bounce in equities to Dow 10514 was immediately sold and we retreated back to 10450 where we stayed until oil closed for the day.

I don't normally feel that the markets trade intraday in relation to each other as most reporters claim. However, today there was an exact correlation and it was striking. Compare the charts below for oil and the Dow. I don't think this correlation will continue at the same rate but the resurgence of high oil definitely elicited a knee jerk reaction from equities today. We have seen in the past that once the shock of $50 has passed the stock market tends to develop a resistance to the hourly fluctuations. Hopefully that will begin soon. On Wednesday we will get the oil inventories for the week and this bubble could be over as quickly as it began.

Comparison Chart Oil/Dow

Chain store sales spiked for the last week +0.8% and well over the -0.4% drop from the prior week. This should come as no surprise to anyone given the approach of the busiest shopping day of the year on Friday. I drove out of my way to a Super Wal-Mart on Sunday with my wife to shop for Thanksgiving dinner which is normally a big spread around my house. There was barely an empty space in the parking lot and a shortage of baskets at the door. It was a mad house with workers literally running to restock shelves as fast as buyers cleaned them out. I know a lot of people don't like Wal-Mart but with a line to get into the parking lot late on a Sunday night it is evident that there is no shortage of Wal-Mart shoppers. If you have not watched that CNBC special on Wal-Mart I highly recommend it just for the business methods they discuss. Business majors should be required to view it. Love them or hate them you still have to respect their methods and success. It also suggests that next weeks Chain Store Sales numbers should show huge seasonal gains before the season even gets underway.

The Chicago Fed National Activity Index spiked sharply for October to +0.52 from -0.04 in September and only +0.17 in August. This number has been highly volatile over the last six months in what could be seen as serious cross currents in the economy. If this is the start of a new uptrend it definitely should get the attention of analysts. Production jumped to +0.27 from -0.10 in the prior month. 57 of the internal components contributed positively to the index while only seven contributed negatively. The three-month average at 0.22 has now indicated growth for fourteen consecutive months.

The October Existing Home Sales remained flat with September at 6.75 million units. Hurricane sales continue to hold up the sales levels but there have been declines in many other regions. This decline could be seasonal, due to higher mortgage rates, held back by the elections or the prospect of higher energy prices. It is unknown which factor is the most likely but the home builders celebrated for the third day despite the regional numbers. While existing home sales are not directly related to the home building stocks it appears prosperity in one sector suggests continued prosperity in the other. One factor helping the builders was a drop in existing home inventory to only a 4.3 months supply and near a record low. As existing homes dwindle those shoppers may be pushed into the new home market. Stronger job growth should be a driving force to keep these trends in force.

Despite the best wishes of most investors the chip sector just can't get a break and continues to drag on the broader tech sector. The SOX has struggled for two days to recover from the Friday beating but has not been able to find a bid. Today Intel was cut by CSFB who lowered their price target to $22 from $25. Intel had reached a three-month high of $24.81 last Thursday but has declined to $23.39 at today's close. According to CSFB, AMD is becoming a growing threat with the product gap merging and in some cases closed. The competitive edge is going to AMD where cost is -40% to -60% less than the Intel product. AMD has gone from $11 to $22 in the last three months and several analysts think the underdog could move even higher. The real problem with the chip sector according to analysts is the increasing capacity coming online and the inventory glut now. CSFB said there would be another 30% of capacity added by Intel over the next year and there is no demand for that capacity. This will eventually drive prices lower and impact margins with Intel being the most at risk for price. According to Merrill Lynch and the Gartner Group the demand for PCs in the consumer sector will drop in 2005 to less than 9% growth compared to 12% in 2004. The SOX fell on the Intel downgrade to close at 430 and well off the 445 highs from last week.

After the close today ADI reported earnings that were inline with estimates at 34 cents but their outlook was less than exciting. They warned that the current quarter could be less than expected. High inventory levels were again the culprit but there is hope ahead. Order volatility is stabilizing and the excess inventory is expected to work its way out of the system by the end of the first quarter according to ADI.

On the bright side TECD announced earnings at 64 cents that blew away estimates of 55 cents and raised their estimates for Q4 to well over current analyst forecasts. The stock jumped +2.30 in after hours trading. The company distributes high tech products and software around the world and had revenue of $4.8B for the quarter.

Google was the beneficiary of new coverage by Goldman Sachs at an outperform and a price target of $215. The stock surged +$10 in after hours as shorts got their weekly beating. Goldman looked into their crystal ball and projected 25% earnings growth through 2009 base on global secular growth. That prediction could be very difficult to match since Google has warned twice in the last two weeks that earnings will slow.

SIRI continued to move to a higher orbit since the addition of Mel Karmazan as CEO. The stock has soared from $4.75 to $6.75 in three days and traded 421 million shares on Tuesday. This was a new Nasdaq record for single share volume. Eventually this high flyer will come back to earth but it may not be soon. With only 800,000 subscribers and nearly $5 billion in debt the outcome is probably an acquisition by somebody like Viacom. Winning the war over XMSR may not occur in our lifetime but it won't be due to a lack of trying by SIRI.

Despite the listless markets money continues to flow into funds with $4.5B in inflows for the week ended on Monday according to TrimTabs.com. They also estimate that more than $12B has come into the market so far in November. They are now tracking exchange traded funds and reported that the new GLD fund had seen inflows of $1.3B in the last three days.

I know the question on your mind is not will Google move higher or SIRI plummet back to earth. Inquiring minds want to know what happened to the market and will there be a Thanksgiving rally. I can answer the rally portion of that question with 100% confidence and I will do so in the Sunday newsletter. Everybody knows hindsight is always 20:20.

The weakness in the markets this week is being attributed to tax selling by funds. I know it seems earlier than usual but that is because it is still November. You probably thought you forgot to tear that page off the calendar when I said tax sales. Seriously, I mentioned last weekend that the January effect had moved into December and that tax sales over the last several years had moved into the early days of December. If market analysts are right this week those sales have moved in front of Thanksgiving this year for one specific reason. The Microsoft dividend is due out next week and professional money managers are expecting a surge in liquidity that will float the markets for up to two weeks. Nobody wants to be selling then. They want to get the sales out of the way early and finish their new position entry before those funds hit the market.

That positioning has created some serious volatility over the last three days that has been mostly program related. With the normal Thanksgiving trend being "buy Tuesday's close and sell on Monday" the selling should be behind us. The Dow touched 10600 last Wednesday and was promptly sold. The Greenspan event last Friday gave funds another reason to accelerate their dumping and the three bounces to 10500 this week were also sell triggers. During this volatility one thing remained firm. Support at 10450 emerged and became even stronger as Tuesday trading began to wind down. The underlying bid began to aggressively rise and we saw a rally at the close that took the Dow futures back over 10500.

The Nasdaq has been struggling as well but did manage to post a higher low at 2070 today. With the exception of that higher low the chart for the last two weeks looks like a mirror image of the SOX. However, like the Dow there was concentrated buying in the futures after the close and we should see a pop back over 2090 at the open.

The SPX also posted a higher low late in the afternoon with a close at 1177. The S&P futures ran up to 1180.50 after the bell and also suggest a higher open. The most bullish index was the Russell and that is the one that telegraphs the action of mutual funds. The Russell moved to a four day high just before the close at 623.50 and appeared ready to retest the 627 all time high from last week. After the close the Russell futures soared to 626.50 and also suggest the Russell will open higher tomorrow. Are you starting to see a common scenario developing here?

Russell Chart

Wilshire-5000 Chart

Personally I believe the artificial pumping of the futures contracts after the close was an attempt to send the averages higher at the open and hopefully trigger some short covering on a low volume day. If they can get the markets going sharply higher at the bell then traders may believe the Thanksgiving rally is breaking out and jump on the train. This could be a cleverly disguised market manipulation scheme by big money to create a rally where none existed to either benefit from current longs already entered or to send the market higher over the holiday and give them a higher exit level on Monday. Personally I still believe it was the former as the latter leaves them in cash but at a higher level with stocks artificially higher in price. It makes more sense that they have already dumped the losers and used the dips to start new positions they now want to send higher.

Wednesday has a flood of economic reports but none are expected to be market movers. Wednesday is a sentiment day where low volume tends to be bullish and there are few professional traders left in the office to try and sell into the rallies. Monday is the risky day once everyone comes back into the office to see what changes they still need to make before the Microsoft billions hits the market. Technically Dec 2nd is the pay date but I would not expect a sudden flagpole rally on that day. The money has to be disseminated and received by fund managers before they can spend it. The following Monday Dec-6th is the likely date for money flow to begin hitting the market. However, just because those are the critical dates it does not mean funds will not be jockeying for position as early as tomorrow in hopes of getting a pole position for that liquidity rally.

I have to emphasize that all of this is just speculation and anything is possible. We never know what forces are at work behind the scenes and how much money is moving into or out of position or why. What we do know is the next three weeks could be an exciting time in the market and hopefully a profitable event. I plan on remaining long over SPX 1175 and suggest you do the same. This gives us a red light, green light traffic signal for the coming week. Decisions are simpler when made in advance and not in the heat of battle. Mine are made, are yours?

If you have not seen the end of year renewal special we announced on Sunday please be sure to check it out tonight.

Buy the dips until the trend changes.

Jim Brown

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