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Market Wrap

Going Out With A Whimper

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      12-30-2004           High     Low     Volume   Adv/Dcl
DJIA    10800.30 - 28.90 10850.18 10799.71 1.05 bln 1852/1311
NASDAQ   2178.34 +  1.30  2182.37  2176.40 1.42 bln 1725/1410
S&P 100   576.10 -  0.43   577.81   576.06   Totals 3577/2721
S&P 500  1213.55 +  0.10  1216.47  1213.41 
SOX       431.26 +  0.70   433.65   430.36
RUS 2000  653.06 -  0.28   654.45   652.99
DJ TRANS 3808.60 -  1.70  3823.96  3798.74
VIX        12.56 +  0.94    12.61    12.18
VXO (VIX-O)12.86 +  0.39    12.96    12.67
VXN        17.94 +  0.22    18.05    17.63  
Total Volume 2,635M
Total UpVol  1,490M
Total DnVol  1,007M
Total Adv  4140
Total Dcl  3079
52wk Highs  515
52wk Lows    13
TRIN       1.22
NAZTRIN    0.49
PUT/CALL   0.86

The markets were listless on Thursday on very low volume and you would have almost thought the market was already closed for the year. While Friday is a normal trading day it will be anything but normal with volume expected to slow to a trickle. The lack of excitement going into year end suggests there could be dip in our immediate future.

Dow Chart

Nasdaq Chart

SPX Chart

The last economic reports for the year provided a mixed bag once again as our recovery continues to provide conflicting signals. The Jobless Claims fell slightly to 326,000 from a downwardly revised 331,000 in the prior week. There was no specific reason and analysts suggested it could still be a seasonal adjustment bug. The consensus was for claims to be flat at 333,000. Continuing claims have risen slightly and suggests the employment picture is still cloudy.

Confirming this was the Help Wanted Index for November which was released today. The Index fell one point to 36 and the low for the year. This represents the low for this employment cycle and a failure of the attempted bounce in October. This indexes the quantity of help wanted ads in print newspapers across the nation. The growth of online job shops has reduced dependence on print advertising but the trends should still be the same although at a lower level. This is a confirming report rather than a leading report on the state of the labor market.

Adding to the negativity was a drop in the PMI to 61.2 from 65.2 in November. The consensus was again 65 and it was not even close. Most components were lower with employment taking the biggest drop from 60.8 to 49.1 and suggesting the October high for the headline number at 68.5 was simply pre-holiday production. Any headline number over 50 represents expansion so this dip to 61.2 is not a death knell but just a caution point to ponder as we enter 2005. New orders declined -5.5 points suggesting the internal production components will also decline in the coming months.

The key to all these business indexes will be the ISM report next week. This is the national version of all the regional reports and tells us where the economy is going. That report is due out on Monday morning.

The NY-NAPM report contradicted the Chicago PMI drop with yet another gain to a new high. Like the Empire Index they both show the business conditions in the New York region to be strong. The Empire report is beginning to show some cracks in the foundation but the region has had a very strong run over the last two years with the rebound from the post 9/11 lows and is due for a rest. It appears the New York managers feel the same way with a monster drop in the six month outlook component from 64.3 to 37.5 in December. The manufacturing conditions component fell from 54.4 to 41.2. Buying of materials fell from a lead-time of 96 days to only 15 days and material on hand fell to 30 days from 80 days. It definitely appears there is some fear of 2005 showing in the outlook for the region. This is the first month that manufacturing has slowed in over two years.

The markets were very weak on Thursday with the Dow failing to post any gains and barely avoiding a drop back below 10800 at the close. The Nasdaq managed to post a gain but it was only a point and well off the highs. The S&P was the only index with any strength but it also ended back at the flat line before the day was over.

This market weakness in a period where we typically would be seeing a Santa Claus rally is troubling for me. I have been expecting a potential minor dip next week but the weakness heading into the year end is suggesting that dip may be more severe. We are facing some potential profit taking from the 4Q rebound off the October lows. Funds who want to sell the overbought winners also want to wait for the calendar to roll over before kicking the winners out of their portfolio. This insures their year end statements remain rosy and enticing for the coming year.

There are a lot of profits waiting to be taken. The gains for the year for the various indexes are very strong.

TRAN +27% - despite the airline failures.
UTIL +26% - on higher energy prices
$RUT +17% - Funds inflows from retirement accts.
NASD +9% - Led by Internets and biotechs
$SPX +9% - Mostly on gains in energy
DOW +4% - Mostly on gains in CAT, MO, UTX, MCD, DD, XOM

Now contrast those gains for the year with the fact that the lows for the year were in October. Much of these gains were made in the last two months and the actual gains from those lows are much stronger. Several of the indexes did make earlier lows than the Dow with even stronger gains.

Index Low Today Gain
Dow 9708 10800 +11.2% from October low
Nasd 1899 2178 +14.6% from October low
$SPX 1090 1213 +11.2% from October low
Nasd 1750 2178 +24.4% from August low
TRAN 2959 3807 +28.6% from August low
$RUT 516 653 +26% from August low
UTIL 260 336 +29.2% from May low

I do believe we will see higher highs in January but the potential for a profit taking dip next week is very strong given those numbers above. It appears from the lack of a real Santa Rally this week that others are thinking the same thing.

Last Thursday we hit a nine year low on the VIX at 11.14. The last time the VIX was this low was Dec-29th, 1995 at 10.36. This was prior to Internet trading and investors had to call their brokers to make trades. There were less than half the brokerage accounts then as we have now. This extreme lack of volatility now has not been a real lack of volatility because the markets have been erratic over the last few weeks. It actually represents a lack of bearishness in the market. Nobody has been buying puts until this week when put buying suddenly found favor again. Investors Intelligence reported yesterday that newsletter writers were currently the most bullish since 1987. That year should ring a bell for many as it was the last major market crash with the Dow losing -23% in one day.

VIX Chart

Wilshire 5000 Chart

The extreme bullishness comes from the election being over, no terrorist attacks, low interest rates, low inflation and an economy that appears to be recovering. Money is flowing into the markets from individuals with +$3.7 billion of inflows to funds for the week ended yesterday. Definitely no fear there. 84% of the top 1500 stocks are over their 200-day average and a very overbought condition. This is yet another reason why funds may be looking to lighten the load next week.

If there is a dip next week or anywhere in January it is not the end of the world. Actually there is a trend in place that has lasted 120 years that will be tested in 2005.

According to the Stock Traders Almanac the markets have closed higher every year that ended in a five since 1880.

Astoundingly not only did they close higher but since 1900 they have been significantly higher. There is no concrete evidence on why this trend exists but any trend that is unbroken over 120+ years deserves some credit.

Since 1880 these were the Dow changes in those years.

1885 +20.1%
1895 + 2.3%
1905 +38.2%
1915 +81.7%
1925 +30.0%
1935 +38.5%
1945 +26.6%
1955 +20.8%
1965 +10.9%
1975 +38.3%
1985 +27.7%
1995 +33.5%
2005 ?????

That is an average of a +30.7% gain for years ending in five. Also amazing is that virtually every year saw its lows for the year in January. Only three years, 1915, 1935, 1965 saw a later dip below the January lows with that dip normally lasting less than two weeks and occurring in February (1915), March (1935) and June (1965). The only real year to break the support from the January lows was 1925 with a lot of time spent lower but the Dow still rallied to close up +30% for the year. For those trying to mentally do the math an average +30% gain for the Dow from Thursday's close would put it over 14,000.

While it is far too early to guess if 2005 will continue the 120 year trend for market gains it is not too early to take advantage of the warning for January. The average date for the January low was January-22nd. The massive influx of retirement cash in the first two weeks tends to prevent any early month dips from sticking. There is normally a calendar sale in the first week where funds have waited to take profits until the year was over. That brings us right back to where I started this train of thought and the potential for volatility next week.

While we can expect an opening dip for 2005 I believe it is a dip that should be bought in hopes of a quick bounce. Once that liquidity bounce occurs we can watch for a continued long opportunity or a roll over in late January. While I am skeptical about any major gains in 2005 I am not willing to throw caution to the wind in either direction. We need to see what January brings and then plan our strategy. Regardless of direction there are a lot of trades ahead and I am looking forward to the challenge.

The market is open on Friday but the odds are very strong that it will be the lightest volume day of the year and directionless. However, at todays close there was a bout of futures selling that sent the indexes to their lows. For funds or just traders in general the ideal way to hedge against a calendar sale on Monday would be to short futures on Friday. What we saw today could have been an early entry by those hedgers. If I were going to bet on a position for Friday it would be to short any bounce and hold it over the weekend. We have not seen any terrorist events in the U.S. for a long time and our attention is wandering to other things. The holiday weekend is a prime opportunity for attacks and not just in the U.S. but also against targets abroad. If you have long positions tonight it might be good risk management to hedge them with a short or a put position over the weekend.

While the markets are open on Friday, Option Investor will be closed. This newsletter tonight is the full Sunday edition and we will not publish again until Monday. This allows our staff to spend time with their families over the holiday. The Market Monitor will be open for business as usual.

There are only a few hours left in 2004. If you have gotten this far without taking advantage of the year end renewal special then you have successfully waited until the last minute. Do it now so you can sleep late on Saturday.

Happy New Year and I wish everyone a prosperous year.

Jim Brown

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