Option Investor
Market Wrap

What Was That?

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Market Wrap
1/25/2005 High Low Volume Adv/Dcl
DJIA 10461.56 93 10509.83 10369.42 2.01 bln 1636/1598
NASDAQ 2019.95 11.3 2037.18 2017.58 1.99 bln 1683/1378
S&P 100 559.87 3.58 562.79 556.29 Totals 3319/2976
S&P 500 1168.41 4.66 1174.3 1163.75
SOX 389.87 6.8 391.7 383.36
RUS 2000 605.5 1.97 612.42 604.53
DJ TRANS 3530.25 75.5 3547.18 3458.38
VIX 14.06 -0.59 14.36 13.88
VXO (VIX-O) 13.63 -0.9 14.23 13.41
VXN 19.52 -0.35 20.51 19.21
Total Volume 4,273M
Total UpVol 2,596M
Total DnVol 1,604M
Total Adv 3731
Total Dcl 3455
52wk Highs 141
52wk Lows 104
TRIN 1.13

What Was That?

Strong earnings by several Dow components sent the Dow surging back to last week's resistance and a gain of +140 points intraday. Where did this come from? Was this the start of a real rally of the lows for the year thanks to JNJ and DD? Not hardly! I was very surprised to see the spike but not at all surprised to see the failure before the day was out. It looks a lot to me like an oversold bounce more than a rally with legs.

Dow Chart - Daily

Nasdaq Chart - Daily

S&P Chart - Daily

The day started off with several high profile earnings announcements with Dow component JNJ leading the rebound with a +3 cent beat and a +2.23 jump in its stock price. The beaten down pharmaceutical sector received a strong lift from the JNJ news and shook off cautious news from MRK and a -21% drop in profits.

Merrill Lynch posted profits that beat the street by nine cents and resulted in a record year for the broker. MER jumped +2 but failed to hold the gains. Dow component Dupont (DD) beat the street by four cents and raised guidance for 2005. Ford warned that profits would slide in 2005 despite a better than an expected 100% gain in profits from its auto business. The problem was in the financing arm with heavy incentives and higher interest rates. Ford shook off the negative news as traders looked forward to Ford's projected profit target in 2006 of $7 billion.

Overall it was a very good day for stocks with earnings taking a strong turn to the upside. Good news was breaking out all over and the bearish sentiment from the last four days was suddenly broken. There was a lot to cheer about on the surface but there was still some underlying problems as well.

The Existing Home Sales fell to 6.69 million units and a -3.3% drop from November. House prices have slowed their rapid climb and inventory levels are beginning to grow slightly. Rates have only just begun to climb but there is already a visible pullback in buyers. After several years of near vertical growth there may not be as many buyers ready to buy at the top as there were in the recent past. For the entire fourth quarter the news was still good with a +7% gain and a new record. It may be far too early to write off the housing sector but it bears watching. The builders of new homes are still predicting a new record year and until they start guiding inline the boom is not over.

Contrary to expectations the Consumer Confidence rose slightly to 103.4 from 102.7. Analysts had expected it to drop several points to something in the 100 point range after four weeks of bear markets. The majority of the gain came from an increase in the present conditions component, which jumped nearly +5 points. Those planning to buy a home or major appliance fell but those planning to buy cars rose slightly. Automakers are holding auto shows across the country and it appears to be attracting interest. This jump in confidence was a real surprise and helped send the markets higher on top of the positive earnings news.

We are rapidly approaching some critical reports and events. The Chicago Fed National Activity Index is tomorrow along with the Monthly Mass Layoffs. Thursday has Durable Goods and Friday GDP and NAPM. Sunday is the Iraq elections and Tuesday begins a two day Fed meeting with Jobs the following Friday. It is going to be a tough few days economically.

If today's rally fails we could be in serious trouble. The rebound today was supposedly on good earnings news but many analysts were not expecting it to last. Monday's close was the low for the year and the end of four days of strong selling. Just having the sun come up today was a valid reason for a bounce. Having a couple Dow components beat the street was icing on the cake.

Despite the positive gains on the indexes the internals were not as strong. The A/D line was running around 3:1 early in the day but it closed almost dead even. The end of day sell cycle we have seen almost daily in 2005 appeared on schedule but was far weaker than normal. While this may be uncertainty on the part of the bears after getting run over at the open, it could also be a change sentiment.

Crude Oil Chart - Daily

The drop from the day's resistance highs could also have been caused by rising oil prices. Crude climbed again to $49.80 before easing only slightly at the close. Tomorrow is inventory day and the winter storm in the North East could have cut supplies of heating oil substantially. We also have the Iraqi elections on Sunday and Al Qaeda has urged followers to attack oil assets in protest. Speculators are reaping the benefits once again as we near a new break over $50. Once the election is over I do expect prices to fall again as the spring demand lull arrives but I still believe it is a buying opportunity. Regardless of the future a positive inventory report on Wednesday could push prices lower as traders take profits. A negative report should send oil back over that $50 resistance and shorts will be forced to cover. If it spurts much over $50 the equity markets are sure to notice.

China posted a +9.5% GDP for all of 2004 and this was above the previously expected +8.5%. With the higher than expected growth it is hard to buy into the slowing oil demand that OPEC predicted for China last week. These are all pieces to the global puzzle and as investors we need to be watching the picture take shape.

After the close today we saw earnings from several high profile companies and they were mostly positive but very few raised guidance. The most notable announcements were TXN +2 cent beat, FLEX +1 cent, ERTS +5, NTIQ +5, RFMD +1, SMTL +1, MTSC +7, HYSL +8, CPWR +5, CTX +3, CYMI +12 cents. All decent street beating results. The winner by far was INSP, which beat by a dime and sent the stock soaring +7 points in after hours. Looks like a few toasted shorts in that move. Those missing estimates included EXC -6, PLXS -1, STK -3 and COHR -5 cents.

You would think the markets would like those ratios of beats to misses but the futures are only up slightly overnight and not showing any conviction. Japan is expected to trade up on our news and we should be primed for one more rally attempt at tomorrows open.

SPX Chart - Weekly

Dow Chart - 90 min

The Dow bounce today failed at 10500 and resistance on both Thursday and Friday last week. The Dow chart shows an almost perfect step down of resistance from 10650, 10600, and now 10500. This could be a tough level to break if sentiment really has not changed. On the downside the Dow found support at the 100-day average at 10368 on Monday. This gives us a neutral zone between 10370-10510 and a break in either direction will take conviction. The bears got smoked at the open with the jump in the Dow on the earnings news. While they appeared hesitant to jump back in there was a weight on the markets in the afternoon. The Nasdaq lost nearly -18 points from its high to close back at 2020 but the most selling was seen in the small caps.

The Russell gave back all but two points of its gains and closed just above yesterday's lows at 604. That 604 level has stopped the Russell drop twice in the last two weeks and corresponds to the 100-day average. This would be a good launch point for a double bottom rebound but a break here could be deadly. With the small caps the weakest link it is yet another clear sign that fund managers are not putting speculative money back into the market. What money they are investing went into stocks like CAT, MMM, JNJ, MRK, DD, UTX and AIG. These are fund savings accounts where money can be stored until the smoke clears. They are highly liquid and funds can move in and out with relative ease. It is like a safe house until the storm blows over. Until the small caps begin to see inflows again the selling is not over.

The various chip stocks reporting after the bell today could help the SOX slow down its slide but I would not count on it. Once the 400 level broke it doomed us to wander lower until the long-term picture begins to brighten. So far with the book to bill dropping the picture is still one of weakness ahead.

The tech view is getting darker by the day. Cisco closed at a new 52-week low today of $17.50. Where is that guy that used to appear on CNBC each week and said he would take all the Cisco anybody wanted to sell at $60, then $50, then $40 a share? I guess he is using all those shares as additional insulation against the current cold front in the North East. Other techs are trading back at their lows for 2005 as well including IBM, HPQ, AMD and INTC. Event the Internets have failed to hold the line with EBAY at $80 and a five-month low, YHOO a four-month low and GOOG at $177. Google is finally cracking under the weight of 187 million new shares coming to market in about two weeks and is well off the $205 high just last week.

I went into Friday's close thinking we were seeing some exaggerated option expiration activity that increased the selling pressure. I figured Monday could be range bound to down as final settlement of those options occurred and we did see another drop to new lows. I told everyone that a failure to rally on Tuesday with no external forces at work would be a very bad sign. The rally appeared on schedule and started off slightly stronger than I expected. However, in retrospect most oversold rebounds tend to trigger excessive knee jerk short covering and that is exactly what we got today.

Wednesday is going to be critical. If we give back the meager gains on the Nasdaq and Russell and sell off into the close again it is going to be lights out for the bulls. The Dow could find some stronger support as the big cap savings account for fund money. With the S&P at 1168 I am in neutral territory for guidance. Should we bounce back over 1175 on decent volume I would try a partial long position but we need to get back over 1195 for confirmation the worst is over. Under 1160 I would be a strong short. We are currently in uncharted territory with mixed messages on all sides and no conviction in either direction. In times like this cash is a position.

Enter very passively, exit very aggressively!



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