Option Investor
Market Wrap

Drug Overdose

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       WE 12-17        WE 12-10        WE 12-03        WE 11-26 
DOW    10649.92 +106.70 10543.2 - 48.99 10592.2 + 69.98 + 65.32 
Nasdaq  2135.20 +  7.13 2128.07 - 19.89 2147.96 + 45.99 + 31.34 
S&P-100  567.39 +  1.89  565.50 -  1.58  567.08 +  4.43 +  2.96 
S&P-500 1194.20 +  6.20 1188.00 -  3.17 1191.17 +  8.52 + 12.31 
W5000  11783.36 + 91.38 11692.0 - 43.29 11735.3 + 99.63 +155.01 
SOX      423.75 +  1.00  422.75 - 22.53  445.28 + 14.30 -  0.90 
RUT      642.08 +  9.84  632.24 -  9.97  642.21 + 11.05 + 17.71 
TRAN    3751.07 + 65.04 3686.03 - 40.71 3726.74 + 78.75 + 80.34 
VXO       12.71           13.20           13.61           13.35 
VXN       18.21           19.57           18.26           17.85

What a way to end the week! There was a constant barrage of drug news both positive and negative that helped remove any remaining bullish bias. Add in the index re-weighting on the NDX, RUT, S&P 500, Mid-cap and Small-cap and it had investors wishing they were on drugs before the day was over.

Dow Chart

Nasdaq Chart

SPX Chart - Multiple Resistance Lines

The Consumer Price Index rose a higher than expected +0.2% despite the drop in oil prices over the reporting period. Core inflation also rose +0.2% and pushed the annual rate of inflation to +2.2% for the last 12 months. The headline inflation rate increased to an annualized +3.5% and the highest since May 2001. With inflation rising the Fed has no reason to really let up on the rate hike scenario despite the current wishful consensus that expects them to pause. Energy prices added to the number despite a drop in crude for the month. The higher energy levels are starting to filter through the system and it will take a prolonged drop to remove the upward pressure. Don't count on it any time soon.

The economic news took a back seat to the drug news and there was plenty of it. The headliner for the day was Pfizer and news that at very high levels there was an increased risk of heart attack. The new study released Friday showed at doses 2-8 times the recommended dose there was twice the risk of heart attack. The study was an anti cancer study where very high doses of Celebrex were being tested to see if cancer complications from high levels of inflammation could be improved by removing the inflammation. PFE stock dropped to $22 from $29 on the news but quickly rebounded to close at $26. You would have thought they had found that there was a heart attack in one of every 50 pills. Very few drugs when taken at 4-8 times the recommended dosage will not cause problems and I think Pfizer will recover. However, as we have seen over the last three months the MRK/VIOXX news has caused serious investor flight from these drugs. It could be months or even a year before the daily news stories will fade away. This weekend CNBC is doing a special called the "Death of a Wonder Drug" in relation to the MRK/VIOXX event. This will pose additional questions in the mind of users and investors. I believe PFE is a buy at $25 but I would give it a few more days to settle down. PFE traded 289 million shares on Friday and I suspect there are plenty of investors who did not bail but will soon.

Lilly warned that their Strattera drug for A.D.D. had produced liver problems in some patients. LLY fell -1.38 on the news. AstraZeneca fell -7.7%, -$3.11 after it said it's cancer drug Itressa failed to prolong survival in cancer patients. OSIP soared on the news with a +$21 jump to $68. OSIP and DNA just had their anti cancer drug Tarceva approved on Nov-19th. With Itressa out of the picture the OSIP drug which has shown positive benefits should jump to the front of the pack. Deutsche Bank said "Tarceva remains the only EGFR inhibitor to have demonstrated a survival benefit in patients" and maintained a buy on DNA/OSIP. CSFB said it was a clear win for Tarceva. FBR said Tarceva could end up with 100% of the market but Eributux from Imclone could still be a factor in future trials.

There were several lesser items of drug news but you get the picture. JNJ powered the Dow higher on Thursday and gave Dow components MRK/PFE a boost as well. Today PFE removed that positive bias and pushed the Dow back to 10650 and a level that appears risky were it any other time of the year.

Crude Oil Chart

Last Sunday I predicted that the 200-day average would be strong support on crude oil. That average at just over $40 produced a very strong bounce. Oil prices rocketed back over $46 with a gain of +2.10 on Friday and +5.60 for the week. This was a +14% jump in price and the biggest jump in five years. Somebody must have gotten an advance copy of my Oil Crisis Report. (grin)

The jump was related to colder weather drawing down supplies of heating oil, the breakup of Yukos, the Osama tape and worries about Nigeria again. Yukos production arm is going to be auctioned this weekend to supposedly satisfy a tax debt. However, it is already beginning to appear as though Russia is trying to regain control of its oil assets. This is troubling for the oil sector as Yukos was the most westernized of the Russian entities. Yukos pumps about 1.5 mbpd and has reserves of nearly 11 billion barrels. That sounds like a lot but it is less than a four month global supply at our current rates. The bidder expected to win is Gazprom, Russia's state controlled gas giant. I say expected to win because only four companies have entered the auction and the other three are previously unknown. Considering it took at $1.77 billion deposit to enter the auction it did not take much research to determine that at least two of the unknowns were actually linked to Gazprom itself and put in the bidding to simulate a real auction. Indications are that the third company may also be a phony. If the government gave an auction with only one government controlled company bidding it would be seen as a complete sham. By adding in three phony bidders it is only a 97% sham. Thus far no western country has appeared to bid because they no longer feel confident in doing business there. With the expected price to be in the $8 billion range and fair value in the $18.5 billion range you would have expected some of the U.S. companies to take a shot. They all fear the current environment and the potential for losing all of their investment.

Production is already falling at Yukos since the current battle began and fears are rising that should another Russian company take control the production would slip even further. The problem in Russia is a desire to take all the cash from sales and use it elsewhere and not spend any on new exploration, repairs or even finishing out existing capacity. When the fields begin to decline there is no cash left to rebuild them. Secondly if this is a move by Russia to take back the oil fields for whatever reason then western oil companies are afraid to invest/explore in the region. This also increases the global decline rate because the entire region is taken out of the picture earlier than expected. It normally takes about six years from discovering oil to being in full production of the find. If the discovery phase is being eliminated in Russia then we will always be at least eight years away from seeing any additional production. Two years to restart the discovery process once the political climate changes and six years to drill and start production. This is yet another reason why the world is going to be very short on oil very soon. I explain this all in great detail in my Oil Crisis Report.


A new Osama tape that appeared on Thursday calls for attacking oil in Iraq and the entire Middle East to prevent America from getting it. This is yet another problem that will be facing the world in 2005. Osama repeated the claim that the U.S. invasion of Iraq was to take control of some of the largest oil fields in the world. I discarded this accusation over the last two years but after doing research on my oil report I am no longer sure. I initially thought Bush went after Iraq and Saddam for various reasons including Saddam's attempt to assassinate Bush senior. I did not give credence to the oil scenario. Since Bush and Cheney are oilmen fully aware of the coming problem I am finding there could easily have been an ulterior motive that included putting in a new regime that was friendly to the U.S. just before the world oil production begins to decline. I am sure nobody will ever admit to it. It also did not hurt to show some force in the region in anticipation of the coming oil crisis. Makes the other countries a little less vocal about their anti American feelings and tendencies. I have rambled on here but you can see I am becoming passionate about the future of oil.

EBAY caught the shopping fever this week and bought Rent.com for $415 million. Rent.com lists home and apartment rentals on the Internet. This is a great deal for EBAY and helps get them another step closer to building out their real estate segment. EBAY is expected to be a major force in real estate sales in coming years. Rent.com listings only generate a fee if the property is rented. The fees are generally much higher than an auction on a Tickle Me Elmo doll so I am sure EBAY will get another shot in the revenue arm once the deal closes in early 2005.

There was huge volume across all the indexes Friday and the Dow came close to a top-5 volume day. Volume across all three major exchanges totaled 5.985 billion shares. This is almost a billion shares more than Thursday's 5.005B level. Nearly 700 million shares were in only two companies. News Corp, NWS-a, traded 408 million shares and PFE hit 289 million. News Corp was added to the S&P-500 at the close. The Nasdaq leaders were SIRI 130M, MSFT 129M and CSCO 106M. SIRI has been 2-3% of the daily Nasdaq volume for over a month. According to Ameritrade it is the most heavily traded stock by a wide margin.

Unfortunately the majority of this massive volume was down despite the A/D line being nearly flat. For two days now we have seen massive volume and it has been weighted to the sell side. This is very troubling to market analysts given the level of the indexes, the length of the current rally and the season. It is still hard to attribute the losses to any material stock factors. This could just be related to the index events. With the 41 new IPO stocks going into the Russell there was a need to sell a portion of existing positions in thousands of stocks, literally. This would contribute to sell side volume but no real drop in prices. Same with the S&P changes. With News Corp's market cap at $55B this also meant index funds had to buy a lot of NWS stock. Over $7.6 billion in NWS stock was bought on Friday. This literally meant $7.6 billion in other S&P stocks had to be sold to maintain the balance in the index.

I believe this index re-weighting has depressed the market over the last couple days and produced an artificial selling bias. Quadruple witching expiration did not help either. Little was said about the FASB option ruling on Friday but you can rest assured it will reappear. A reader emailed me on Friday about the American Jobs Creation Act asking how it would impact the market in 2005. Given the potential downside pressure from the FASB options ruling this is an excellent time to discuss the Act. I had meant to do it several times but there is just never enough space.

The American Jobs Creation Act was passed on Oct-22nd and it basically gives American corporations a free pass to the local candy store. Companies with operations in other countries can repatriate up to $500 million per year in cash at a 5.25% tax rate. The current tax rate for bringing overseas profits back into the country is 35%. This nearly free opportunity takes dollars that would have been spent in other countries and brings them back to the U.S. The only catch is that the money must be used for job creation, capital expenditures, pay down debt, buy back stock, increase dividends or fund pensions. All of these uses would be positive for the U.S. economy. According to TrimTabs and Morgan Stanley there could be over $420 billion in profits waiting to be put to work. Of that number TrimTabs estimates $150 billion could be repatriated. Intel has already announced they might bring back $6 billion. Heinz said they were returning $1 billion. These are just the tip of the iceberg given the Act has only recently been signed. Of that $150 billion TrimTabs thinks $50 billion could make its way directly into the market and the rest would support the market by the various other uses. Obviously the largest amount will be in the first year of the program and it will dwindle as the years pass. Is it enough to compensate for the FASB ruling? I doubt it but it should soften the blow.

Russell Investment Services released the results of a recent survey of investment managers on Friday. The survey showed that 10.4% thought the market was over valued, 69.8% thought it was fairly valued and only 19.8% thought it was under valued. In general the managers were expecting an 8-11% return in 2005 and felt dividend stocks were the main focus with large cap and growth stocks the next in favor. That is a "return" not an increase. They are expecting a +5-7% market gain and the rest in dividends. Another analyst said dividends had represented 43% of market returns from 1930-1980. Since 1981 dividends had only accounted for 23% of the overall returns. Both analysts felt 2005 would be another year for increased dividends rather than any material increase in stock prices. In periods where the market stagnates those dividends can provide an income to offset the lack of appreciation. With the current tax laws favoring dividends it only makes sense managers would refocus their efforts.

For next week we are facing a lot of mixed market indicators. Historically the Santa Claus rally occurs on the last four days of the year and the first two days of the next. The anticipation of this rally normally sees buyers appear the two days before Christmas. For 2004 this gives us a window from Wednesday this week until Tuesday Jan-4th as potentially bullish days. With expiration on Friday we should continue to see settlement issues on Monday. Monday and Tuesday could be a critical days for market sentiment. With the Dow resting on 10650 and the SPX in danger of breaking 1195 we need to see confirmation of the prior underlying bid or the Santa rally could fail. This makes Mon/Tue pivotal for the rest of the year. There is an adage, "If Santa Should Fail To Call, Bears May Come To Broad and Wall." When buyers are hesitant to enter the market during the holiday season it typically suggests trouble ahead. This makes next week a critical sentiment week for all. Everyone will be watching and many will be waiting for somebody else to take the first step.

To make it as simple as possible I would continue to watch SPX 1195. We broke back below the 1200 level I was using as an indicator to add to positions on Friday but I am hoping it was due to index balancing. 1195 is still support. Should we fall below that level I would not want to be long. As long as we remain above I would chance small bullish positions until we get confirmation the underlying bid has returned. Mutual fund managers have a lot riding on the next nine days. Many earn their bonuses based on performance through 12/31. They will want to keep painting the tape as much as possible to keep prices high. However, they do not have to remain locked into this program. If the outlook suddenly turns grim they can and will take profits to salvage as much of their bonus as possible. Until a new upward trend appears next week traders and managers will be walking on eggshells in fear of an early breakdown. Let's hope those eggs are petrified.

There is only two weeks left in 2004 and the clock is ticking on the End of Year Renewal Special. The potential profits from the "Coming Oil Crisis" report could pay your subscription for years to come. Don't wait, do it now.

Only 5 shopping days until Christmas

Jim Brown

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