Option Investor
Market Wrap

January's "Early Warning System"

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      01-12-2005           High     Low     Volume   Adv/Dcl
DJIA    10617.78 + 61.56 10622.88 10499.47 1.95 bln 1612/1208
NASDAQ   2092.53 + 12.91  2093.44  2066.79 2.26 bln 1593/1434
S&P 100   567.31 +  2.63   567.54   561.96   Totals 3205/2642
S&P 500  1187.70 +  4.71  1187.98  1175.64
SOX       401.83 +  5.64   404.65   395.06
RUS 2000  613.19 +  1.66   613.70   604.64
DJ TRANS 3587.18 - 57.08  3645.37  3557.90 
VIX        12.56 -  0.63    13.94    12.54
VXO (VIX-O)12.79 -  0.24    13.78    12.77
VXN        19.28 -  0.39    19.70    18.995
Total Volume 4,221M
Total UpVol  2,794M
Total DnVol  1,349M
Total Adv  3205
Total Dcl  2642
52wk Highs  126 
52wk Lows    62
TRIN       0.86
PUT/CALL   0.93

The Stock Traders's Almanac states that January's First Five Days of trading is an "Early Warning System" for the rest of the year. It goes like this - if the First Five Days of January are up then there is an 85.3% chance the rest of the year will be up also. Since the first five days of January this year were not up, they were down, is the Early Warning System giving us an early warning that we have bearish year ahead? Since 1950 the first five days in January were down 20 times and of those 20 times 10 were followed by a yearly bear market. This is a 50% accuracy rate, which I guess is OK but I'm not too encouraged by 50% odds but it gets better. Since 1950 there have been 13 post election years and 8 of those have posted a First Five Day loss. Of those 8 years, 6 were followed by a yearly bear market, a 75% accuracy record. Now I like those odds a lot better.

I recently read an article in the Wall Street Journal that was pooh pawing using history as way to invest. I quote, "Jeffery Saut, chief investment strategist for Raymond James, says people who invest according to such information are 'fooled by randomness.' While historical patterns are often mathematically intriguing, the market has a helter-skelter tendency to move in ways that defy strategists' complex models." What kind of nonsense is that? The game of trading and investing is a game of probabilities and your edge is that you have probability on your side. If you didn't have probability on your side how in heavens name could you trade or invest. If you trade a particular pattern and know that it has a 75% accuracy rate you will you play it - you would be fool not to. Don't you need history to determine that you had a 75% chance of winning? Many say trading (investing) is like gambling and I used to really bristle at being compared to a gambler but over the years I have begun to realize that it is true. But what I also came to realize was the reason I bristled was that I was comparing a trader (myself) to your garden variety gambler that frequents the casinos only on vacation and expects to lose. Nothing could be further from the truth. Professional traders should not be compared the vacation gambler they should be compared to the professional gambler, the one that knows the rules and knows the odd and plays the odds, plays the probabilities. Anyone who thinks trading or investing is anything else is fooling themselves. Now you may say: I am an investor in for the long term so that doesn't apply to me. Sorry but it does. If you knew the market had a "history" of returning -5% annually per year would you have your money in the market. No. You invest for the long term because the market has a "history" of returning 10% annually. Isn't that just playing the odds, playing the probabilities? Ok I'll get off my soap box and move on to the numbers.

THE NUMBERS

Many people were expecting the declining dollar would stimulate demand for U.S. products overseas and decrease the U.S. trade imbalance. Unfortunately a global slowdown has cooled demand for products and the 8:30 news of a new record trade imbalance was not received well by the market. The market started to drop as soon as the bell range and fell until 11:00 when the bulls had had enough and began to fight back. Unfortunately though they were not able to muster the troops enough to reach new daily highs before the lunch hour doldrums set in. So many were expecting the trend for the last few weeks - a market selloff in the last 1/2 hour - was a sure thing. Well the selloff didn't happen as a matter of fact the opposite took place as the market started another rally and this time it reached and exceeded daily highs. This in turn was fueled by short sellers (the ones betting on the selloff) having to cover their butts... err positions.

The DOW fell 67 points in the morning but finished up 61.63 to close at 10617.85. The S&P 500 added 4.71 to 1187.70 and the Nasdaq Composite Index jumped 12.91 to 2092.53. The NYSE traded 1.6 million shares traded, 1,933 stocks rose and 1,395 fell. On the Nasdaq Stock Market, where volume was 2.2 billion, 1,639 stocks advanced and 1,475 declined

Securities and Exchange Commission Chairman William Donaldson is reconsidering a proposal to overhaul the way stocks are traded in the U.S., a proposal opposed by the New York Stock Exchange. At issue is whether investors should always be guaranteed the best price when buying or selling shares. The SEC backs the idea that brokers and markets should be required to get the best price available for a stock, regardless of where it is trading, or match the better price. The rule is being criticized by some who argue that getting the best price often takes so long that, on big trades involving multiple transactions, the price of a stock can be driven up or down quickly to their disadvantage.

The rule gives the NYSE an advantage because it often posts the best price for its listed stocks. But because the NYSE isn't an automated marketplace, its human-based floor-trading system can take slightly longer to execute trades than it would take in an electronic marketplace such as the Nasdaq Stock Market. So why is the NYSE opposed to the SEC's proposal? NYSE Chief Executive Officer John Thain believes that the rule could jeopardize his plan to automate the Big Board and allow for more electronic trading. To implement the best-price rule "would make it very difficult" for his new model to work and would "also make it very difficult to have the continuous auction process that exists today on the floor of the exchange." The NYSE wants its cake and eat it too because at the same time the NYSE is trying to automate they will still retain their human-based floor-trading by the elite floor-trading firms known as specialists and the SEC proposal would diminish the role of these specialists. Can't have that happen how can we?

But fears of the unknown and unintended consequences are taking a toll on Mr. Donaldson so he is backing off somewhat and is considering an alternative approach that would guarantee price protection as long as it could be filed automatically and without human intervention.

ECONOMIC REPORTS

Although analysts expected to see a rebound from the slow holiday period, applications for home loans dropped last week due to a decrease in purchasing activity that offset an increase in refinancing activity.

At 7:00EST this morning the Mortgage Bankers Association (MBA) released its weekly report on the seasonally adjusted index of mortgage application activity. It showed the index declined 3% to 587.8. This was after a 10% decline the week before and also the lowest level the index has seen since the week ended June 25, 2004, when the index was at 575.0.

Some are saying this is due to a slight increase in mortgage rates, which averaged 5.7% last week (for the 30-year fixed) up from 5.67% the week before. However when you look under the hood you see that rates are comparable to where they were several months ago when the index was substantially higher. For example, the week ending November 12th, 2004, fixed 30-year mortgage rates were the same and the MBA's market index stood at 758.3.

Drilling down into the report we find the gauge of loan requests for home purchases, the purchase index, hit 13% its lowest level in over a year. This, of course, is raising concerns that the housing market may be slowing down or even - heaven forbid - starting to decline. But please consider that this is weekly data and subject to swings that are not always indicative of a trend change but it does make you want to keep your eye on this weekly report and any further drop will likely instigate additional concern about the strength of the housing market.

The Commerce Department's 8:30EST release of the November International Trade Balance caught a lot of economists by surprise who had been anticipating a pull back in the November deficit because of a decline in the price of oil. But quite the opposite happened when it was revealed that the U.S. trade gap climbed to a new record showing the fall in the price of oil was more than offset by an increase in demand for foreign oil while sales of U.S. goods and services overseas fell for the first time in five months. Although economists had forecast the deficit would narrow to $53.60 billion, the U.S. deficit in international trade of goods and services grew 7.7% to $60.3 billion. The trade deficit through November totaled $561.3 billion, well above the previous annual record of $496.5 billion set in 2003.

Imports overall increased 1.3% to $155.85 billion during November and exports fell 2.3% to $66.5 billion, the first decline in five months reflecting a drop in shipments of U.S. autos and auto parts, civilian aircraft, telecommunications equipment and industrial machinery.

At 10:30 the U.S. Department of Energy release of the weekly Crude Oil/Gasoline/Distillate inventories reported that the U.S. supply of crude oil declined by 3 million barrels last week to 288.8 million barrels. This is 7% higher than a year ago. The supply of distillate fuel, including heating oil, diesel and jet fuel, rose by 1.9 million barrels, though inventories are 8% below a year ago at 123 million barrels.

The last on the economic report docket was the 2:00EST Treasury Department's release of its monthly budget. The Treasury Department said the shortfall between receipts and outlays in the month of December 2004 was a narrower-than-expected $3.44 billion and well below the $17.64 billion budget gap recorded in December 2003. Analysts were expecting a $4.50 billion shortfall.

THE CHARTS

SPX DAILY CHART

Last Wednesday January 5th I wrote in the Market Wrap that I thought the SPX chart was pretty bearish. It had broken the 50EMA, broken out of a regression channel and was sporting a huge MACD divergence. Well it just may have resolved all the bearishness and started a recovery. But the challenge now is to determine what a recovery looks like. Well first of all take a look at the magenta box on the chart. Can you see how the lower regression line was broken then tested on January 10th for validity? So that would be our first hint - a break above the lower line on the regression channel. Secondly you will want to see a break and a retest of the 50EMA. Thirdly you will want the MACD (I use 8,18,6) to cross back up and then back above the 0 line. Then the big challenge will be to make new yearly highs. Possible - yes it is. Easy - not in your life is anything in the stock market easy.

DOW DAILY CHART

I feel that the negative MACD divergence has worked its self out on this chart as well but we will have to see the MACD make a bullish cross and get above the 0 line before we can say the MACD is once again bullish. In the same vane as the SPX, this market also needs to climb above the 50EMA before the bulls can go back in the water. New yearly highs would be nice as well.

I have left the red trendline on the chart as a reminder of the Stock Trader's Almanac theory called the Incredible January Barometer, which I reviewed in the January 5th Market Wrap. The magenta line is a small revision to that theory.

NASDAQ DAILY CHART

The bearish wedge and the negative MACD divergence were just too much for this market and when it succumbed to the pressure it did it in a big way. However, I do feel that all this bearishness may be behind us and like with the other markets it will have to prove it to me. First of all MACD has to make a bullish cross then print above the 0 line. Secondly the NAZ has to break the 50EMA and complete a successful retest. Then on to new yearly highs? - well we'll see.

RUSSELL 2000 DAILY CHART

Here we see the same bearish wedge and negative MACD divergence that showed up in the NASDAQ chart and once again I feel that maybe all the bearishness has worked its self out but this chart has a little more work to do than its bigger brethren. For one the MACD has a lot further to go before it is once again above the 0 line. Next this market has reached a 68% retracement of its rally from October lows while the NAZ has only retraced 50% and the SPX and the DOW have both only retraced 38%. This market was hit a lot harder this year than the bigger cap markets for sure.

After the bell Apple Computer Inc. (AAPL) posted a quarterly profit that more than quadrupled due to skyrocketing sales of its iPod digital music players and strong demand for its PowerBook notebook PCs. AAPL traded to a high of 74.90 in after hours.

Thursday's economic releases begin with the usual 8:30 release of jobless claims, accompanied by the release of December's Advance Retail Sales ex-auto, and December's Import Price Index. They continue with natural gas inventories at 10:30 and the 4:30 Money Supply release. Earnings Thursday include before the bell MI and MTG and after-the-bell reports by tech stocks CREE, DGII, RMBS, SUNW and TMTA, giving investors a look at demand for display components, network access and communications devices, chips, servers and microprocessors.

Remember play the probabilities.

Jane Fox



 
 



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