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Market Wrap

20 Minute Rally

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WE 02-11WE 02-04WE 01-28
DOW10796.0179.8810716.1288.9310427.234.21
Nasdaq2076.66-10.002086.6650.832035.831.56
S&P-100577.182.09575.0914.14560.953.63
S&P-5001205.302.27 1203.0331.671171.363.49
W500011875.489.5711865.9334.6611531.223.96
SOX435.5217.36418.1618.70399.469.80
RUT634.76-2.68637.4424.44613.001.92
TRAN3613.0316.223596.8151.873545.9474.77
VXO11.4310.9213.33
VXN17.1918.5819.37

A rumor that North Korea's communist dictator Kim Jong-il had been deposed set off a major spike around 11:00 Friday morning. The initial news was just believable enough to setoff some short covering from the morning dip. A wild rumor on Friday just when it appeared the markets were about to roll over was all traders needed for an excuse to cover shorts. That short covering was strongest in the tech stocks after everyone loaded up at the open after disappointing earnings guidance from Dell. The rebound was sharp enough to trigger the program traders into covering and the dominos began falling in rapid succession. Stops were hit and ETF shorts were quickly abandoned once again. The entire program trade driven rally lasted only about 20 min on the Dow and S&P. The short covering on the Nasdaq and chips started about 15 min earlier and finally reached the trigger points on the big programs about 11:00. Unfortunately that 20 minutes of excitement was all the day could produce and we languished in a very narrow range until the close.

SPX Chart - 5 min


 

Nasdaq Chart - 30 min


 

I have been mentioning the way the markets are being pushed around by the hedge funds and their ETF program trades and Friday was a prime example. The markets headed south at the open on the Dell news and downgrades on the housing sector but the Kim Jong- il rumor was just enough to produce a strong knee jerk reaction and force those tech shorts to cover. Once the opening gap was retraced on the Nasdaq and no sellers appeared by the first fund-trading window at 11:00 the triggers were pulled and it was off to the races. 11:00 and 2:00 are prime program trade times where programs normally hit the markets. I believe hedge fund traders shorted the techs on Wednesday morning after two days of trading at 2090 with no real attempt to move higher. Thursday's rebound attempt from 2040 was weak and they stayed with those trades through Dell's earnings hoping for another disappointment.

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Friday's open pushed the Nasdaq back to 2040 and support at the 100-day average and the rumor appeared almost exactly at that 2040 support test. This was far too opportune for me to believe it was just a coincidence. The knee jerk bounce in techs filled the opening gap at 2053 about 10:45 and then had the audacity to continue higher despite the rumor already being denied by the state department. For hedge funds short since Wednesday's open this bad news gap fill on a Friday was too market positive and they bailed. That was the end of that story and the market action for the day. Once the program trades ceased so did the market movement. The Nasdaq traded in a very narrow range between 2070-2080 for the rest of the day. The range on the S&P was even narrower at just two points between 1206-1208.

Dow Chart - Daily


 

Nasdaq Chart - 60 min


 

If you note the two charts above there is a serious divergence. The Nasdaq highs for the year are just above 2090 and we are -114 points away from that level and still struggling. Were it not for the short covering rally today support at the 100-day average would have been in jeopardy. So far that average has held and the short-term uptrend is intact despite the longer-term downtrend for the year also being intact. Until the Nasdaq breaks the resistance zone from 2090-2110 we are still operating under a cloud.

The Dow has separated itself from the rest of the index pack and is very close to a new 52-week high. The 10750 resistance from last February was broken with ease by the morning buy programs and 10820 became our new overhead resistance. The Dow also traded in a very narrow 20-point range of 10800-10820 once the morning buy programs completed. There was no ground swell of buying with the herd chasing prices higher. HOWEVER, there was no selling either.

The morning bounce would have been a prime entry point for new short positions or just plain profit taking from the Dow's two week run. There appeared to be a complete lack of interest in shorting the bounce. Volume tapered off quickly and the indexes simply went sideways with no conviction on either side. This could have been a pause to rest and regroup since the bounce caught most traders off guard. Rethinking your bias is a good idea when the market is not moving as you expect. It was also a Friday and not a day to be opening any significant new positions.

It was also pre-expiration Friday and there is always the chance the morning short covering was option related. Funds tend to move out of losing positions the Thur/Fri before expiration instead of waiting until the last minute. Recently we have seen more volatility in the Thr/Fri before expiration than in expiration week itself.

There were no economic reports to move the market on Friday and traders were left to concentrate on stock news. Dell fell -1.58 to $40 after disappointing on guidance but it was one of only a few techs to finish in negative territory. Google closed down 50 cents but about -$5 off its intraday highs. News hit the wires that insiders were already selling shares ahead of the 177 million share lockup release next week. Co-founder Sergey Brin sold $33 million in shares yesterday. Director John Doerr sold $30 million yesterday and $200 million over the last ten days. Looks like they wanted to beat the rush for next week when the rest of the regular insiders and IPO merchants are free to sell. Several thousand employees are sitting on various amounts given in lieu of wages or for contract labor and you can bet they are watching the countdown clock. With the -$30 drop over the last two weeks the majority of caution may already be priced into the stock. There are funds waiting for the release to provide enough float to remove some volatility and provide them a safer entry. The lockup next week will release the last 62% of outstanding shares for trading and will more than double the current float.

EBAY is starting to show a positive trend once again after comments made at their analyst meeting prompted some broker attention. Meg Whitman officially affirmed guidance but unofficially said she expected EBAY to grow at +35% or better over the next year because of current initiatives in place. The official estimate is for +25% growth. I am kicking myself for not adding EBAY as a new LEAP play last week at $75 but the chart was still headed down last Friday.

AAPL declared a 2:1 split and rebounded to its all time high at $82 on the news. The stock has quadrupled since the Ipod was announced and Apple now accounts for 62% of all online music downloads. This is only the third split in the 25 years Apple has been a public company. It hit a high of $75 in Jan-2000 but was cut in half in Sept-2000 when it suffered a -$30 drop. After languishing between $12-$25 for two years the Ipod gave it new life and many are now saying that bounce is way overdone. Look at a weekly chart and you will see a double from $37 just since October. The record date is next Friday and very close to today's announcement. It is very unusual to see one that close and could keep AAPL at this level until the following week.

While earnings guidance has been lackluster the analyst community is making a big deal out of the rapid increase in dividends. So far this year 63 S&P companies have raised their dividends with 27 in February alone. Aetna was the leader this week with a 100% increase. Analysts are claiming that dividends are more important than earnings guidance because it shows companies are confident enough in future growth to give cash back to shareholders rather than hold it for future emergencies.

One of the biggest news events on Friday was a downgrade of six builders by Smith Barney. BSZ, HOV, PHM, TOL, RYL and KBH were downgraded on price to a hold from a buy. The analyst, Steve Kim, was credited with starting the last big run three years ago when he raised each to a buy and pointed out the strong potential for gains in the sector. He noted on Friday that this was the first downgrade on a homebuilder by his firm in those three years. He cited price as the major factor saying it was time for a rest rather than problems ahead for the sector. With the builders at an average PE of 8.5 he thinks they could move to 12-14 by next year but that expectation is already priced into the stocks. Finally a buying opportunity but now I have to decide if I still want them. KBH was the hardest hit at -3.64 followed by BZH at -3 and TOL at -2.30. Personally I think with the spring selling season just ahead, the monster backlog at most builders, continued low interest rates and an expanding job market there may still be upside ahead. Lumber fell -$10 Friday and one analyst gave it as a reason for increased profitability ahead for the builders. Not hardly! Look at this chart on lumber compared to TOL and tell me if lumber fell on its own or was it the builder downgrade instead? Wednesday was a contract high for lumber. You tell me, was lumber or builders leading? I know, it was a dumb question. Lumber prices rise based on builder demand not on their own. Can you believe some analysts get paid to make that kind of statement?

March Lumber/TOL Chart


 

Rumors are beginning to grow stronger that Pfizer could be shopping for Merck. Why anybody would want to buy that liability before it is fully determined is beyond me. Merck has multiple drug problems with what will probably be class action suits for years to come. Many companies got in trouble over the last few decades for buying companies with undetermined liabilities in asbestos. Some of the purchases were 3-4 companies away from the exposure and it still cost them millions. A small company with previously unknown exposure would be acquired by a larger company and that company would be subsequently acquired by another sometimes repeating several times over the last 50 years. When the exposure appeared the last company in business ended with the big bill and many times it was bigger than the original value of the acquisition. The same could be true with Merck. While they do have a nice pipeline of new drugs there is almost daily news of another problem, some decades old. There was a new claim made this week about high levels of mercury in children's vaccines back in the 50-60s that could have caused many of the problems in children over the last several decades. Proving this would be a major challenge but you get my point. Pfizer said it was going to try and cut $2 billion in expenses because of a coming revenue loss from drugs going off patent. Why in the heck would they want to take on untold billions in liability by acquiring Merck at this time? If you want their pipeline then buy their pipeline and leave the carcass for the vultures.

Taser was stunned by more shocking news after the Chicago police force stopped deployment of their weapons. Two individuals were tasered this week with disastrous results so they put the program on hold. One individual died and another 14-year old boy went into cardiac arrest after being hit with the stun guns. More research also hit the wires with an Air Force study claiming heart damage could result from Taser stuns. The company fired back that CBS had misreported the Air Force findings. The stock dropped another buck to $13.50.

The best news for Friday was an upgrade on Novellus by CFSB. This produced a +$2 spike in NVLS and that prompted short covering in the semiconductor holders. One spike led to another and pretty soon the entire sector was feeding the Nasdaq. Add in the Kim Jong-il rumor and the chip sector found itself in a buying frenzy that pushed it over resistance for the week at 430 and to a new high for the year. While I mentioned on Thursday night that we need to watch the Nasdaq battle at 2100 for a go/no go decision for future positions the move in the SOX deserves our attention. Unlike the other indexes that concluded their spike around 11:20 when the buy programs quit the SOX did not peak until nearly 2:PM. This additional buying pushed it to within a point of stronger resistance at 440 and set the stage for a serious resistance test next week. A push though 440 to 450 will give us a nice cup and handle on the SOX and a complete reversal of the recent down trend. A break over that 450 level would setup an even more important test at 500 but that would really be wishful thinking at this point. Let's be happy with small steps and take each small gain as it comes.

SOX Chart - Weekly


 

The following chart on the S&P shows a dead stop at the top of the uptrend channel and at the 1205 resistance I have mentioned previously. In theory we could see another cycle to the bottom of the channel if we are going to be stuck in a continued indecisive market. With the Nasdaq as our weakest link the S&P will be dragging the tech stocks if it tries to move higher. Just getting over the 1205 does not guarantee a breakout of the stronger resistance at 1215 but it could allow the Dow to break the 10850 resistance and move to a new high. This S&P support for the Dow could then turn into Dow support for the S&P as it attracts buyers once in the clear at those new highs. Both indexes could then attempt to drag the Nasdaq back through its 2110 resistance.

All of this is entirely speculative and far from a perfect scenario. When the indexes diverge as we have now it is very difficult to pick a trend. The index interaction on Friday was amazing in retrospect. I have analyzed it in several different ways and I keep coming back to the same result. We know it was buy program driven but the sequence of events is what keeps me coming back to it. Tech stocks reacted first to the rumor, which gave the SOX added momentum. The SOX then reached levels where chip shorts were forced to cover and this pushed the Nasdaq higher. Between them they put enough pressure on the broader indexes to trigger covering there but in the end it was the Nasdaq spark that drove the entire event. I know I am boring you with this review but I found it fascinating to dissect it from a Saturday perspective.

I have one more point on the S&P. If you notice on the second chart below the S&P rebounded off the 100/130 exp averages (High/Low 30 min) after a two-day rest on that support. We have talked about these averages a lot in the Market Monitor for their uncanny ability to reappear as support/resistance on the indexes. For the S&P a break of these averages typically runs for about 26-29 points before reversing. Obviously that only applies in trending markets but you would be surprised how often it happens. The last average cross was 1176 and the high for the run was 1205, +29 points. The two prior breaks were -26 and -26 with a one-day head fake in the middle. I suggest you put those averages on your S&P chart for future reference. I have included a Qcharts setup window for reference.

S&P Chart - 120 min


 

S&P Chart - 30 min


 

S&P Chart - With Average Setup


 

The money flow into funds has been positive for the last 11 days according to AmgData but the flow is shrinking. Over the last week AMG estimates $4.46B flowed into funds but only $2.28B of that went into domestic funds. Cash going into money markets is increasing and there appears to be increasing concern about putting money into stocks. Tech funds concluded their 12th straight week of outflows with -$145 million flowing out in the week ended on Thursday. This compares to -$160 million in the prior week and -$1.2B for the year. The drain is not heavy but it is still a drain and we can see the impact in the lack of a positive trend in the Nasdaq. According to Investors Research hedge funds were the most bullish in Q4 as they have been since before the bubble burst in 2000. Mutual funds were also pouring every cent they had into stocks in anticipation of the Q4 rally continuing into January. Researchers theorize that after nine months of negativity investors were ready to buy the October dip and accelerated retirement contributions in an effort to get in ahead of the normal January effect. When January came all the bulls had already spent their cash and there was nobody left to buy the top.

Ameritrade reported that customers placed an average of 175,000 trades per day in January. This was -8% drop over December. Unfortunately it was a -30% drop over last January despite an addition of +16,000 new accounts so far this year. This should confirm something we already know about market sentiment. If it were not for program trades and mutual funds there would be very little trading. The retail client is moving back to being an investor not a trader.

What is next week going to bring? If I could answer that precisely this would be my last commentary. Unfortunately we are forced to predict the future on only a miniscule amount of information compared to that which the market devours each day. That leaves us with more uncertainty about next weeks action than the weatherman has about next weekend's weather. The only things we know for sure are the news events on the calendar. The one that could cause us the most grief is the Greenspan testimony to Senate on Wednesday. Given his recent flip flops on inflation, the deficit and the dollar it is a coin toss on whether he will please the market or curse it. If that is not bad enough we get to relive it on Friday when he repeats it for the House. You can't ignore Friday's repeat performance because those representatives derive their questions from the answers given on Wednesday. There is always the potential for a verbal bombshell when Greenspan is speaking. The older he gets the more likely a serious event as he tries to decide between preserving his legacy or chiding us for financial recklessness.

The calendar is full of economic reports including several updates on business conditions in the various Fed regions. There is also Industrial Production and Book-to-Bill with the PPI the finale on Friday. None of these reports should rock the market as long as they remain neutral. Should any of the business conditions surveys, Kansas, NY or Philly, show a dramatic change in direction then volatility could increase. I would continue to use Nasdaq 2100-2110 as the confirmation indicator. No market move in the Dow and S&P will get far without the Nasdaq. Until that 2100-2110 resistance is broken we are still in a trading range and in danger of another down cycle. The key breakout levels on the other indexes are Dow 10850, S&P 1215 but I would not place any bet until the Nasdaq confirms.

Enter passively and exit aggressively until a real trend is established.

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