Option Investor
Market Wrap

Reversal of Fortunes

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02-22-2005 High Low Volume Adv/Dcl
DJIA 10611.20 -174.00 10783.45 10610.54 2.15 bln 714/2587
NASDAQ 2030.32 -28.30 2064.67 2030.17 2.07 bln 887/2352
S&P 100 567.25 -8.17 575.65 567.20 Totals 1601/4939
S&P 500 1184.16 -17.43 1202.48 1184.16
SOX 425.79 -1.90 437.96 423.71
RUS 2000 617.93 -12.20 630.17 617.93
DJ TRANS 3540.15 -79.80 3620.86 3539.71
VIX 13.14 1.96 13.20 12.09
VXO (VIX-O) 12.83 1.78 12.92 11.51
VXN 19.00 1.13 19.09 18.09
Total Volume 4,558M
Total UpVol 979M
Total DnVol 3,552M
Total Adv 1913
Total Dcl 5575
52wk Highs 354
52wk Lows 124
TRIN 1.46

Reversal of Fortunes

After struggling to move higher over the last two weeks the markets finally gave in to the lackluster buying and sellers appeared in force. Without a real reason to buy stocks the sellers outnumbered the buyers and market breadth turned ugly. The Dow suffered a -174 point drop and the largest drop in 21 months. 29 of the Dow 30 stocks finished in the red with 10 of them down over a buck. It was not a good day for the bulls.

Dow Chart - 180 min


Nasdaq Chart - Daily


The morning started off negative with soaring oil prices putting strong pressure on equities. After a gap down open buyers rushed into the dip but oil continued higher and those buyers were overrun by sell programs. Adding to the morning negativity was a continued series of weak economics and new assaults on the dollar. The Consumer Confidence fell to 104.0 from 105.1 and while not a material drop is was simply a continuation of the negative news trend of late. If you only looked at the headline number it would appear negative and that is how it was reported in the press. However, the January reading was revised up from 103.4 to 105.1 making today's 104.0 actually a gain from previously reported levels. I know it is confusing to have the markets react negatively to a number that was higher than last month but lower than the revised last month. Constantly revising prior month numbers in various reports is confusing to everyone. Had they revised January down or left it alone then today's 104.0 would have been hailed as an improvement. The markets should simply look at the current number and take it at face value. It was largely underreported that today's number was the third highest month since June-2002. Can that really be bad? The present conditions component jumped to 116.4 from 112.1 while expectations fell to 95.7 from 100.4. Those planning on purchasing a home or appliance fell but expectations for autos remained flat. Despite all the confusion I really doubt today's confidence number had any real impact on the markets. Analysts may have blamed it but I believe that blame was misplaced.

On the bright side the Richmond Fed Manufacturing Survey posted its third consecutive monthly gain. Granted the headline number of 4 may not indicate manufacturing is exploding but it is somewhat better than the -4 low posted back in November. It is also a long way from the recent cycle high of 12 back in September. Unfortunately the only major component to gain was shipments at +12 from -7. New Orders turned negative at -1 from +7 and Back Orders fell to -4 from -3. This proves again you can't tell a book by its cover or value an economic report by the headline number. Overall the continued mixed picture provided by current economic reporting is not giving investors a reason to load up on stocks.

There were three real problems impacting the market today and that was oil, bonds and the dollar. South Korea added its voice to the growing number of countries making the shift away from dollar denominated investments. The high profile announcement from a lower tier country may not have created too much interest except that they added their name to a growing list and that list contains some prior friends of the USA. Taiwan is also planning on reducing dollar investments and they follow China and Japan as previously big buyers now cooling. The ECB is also rumored to be ready to shift out of dollars after losing -$1.3B over the last two years on the falling dollar. Russia has already planned on exiting and the list goes on. The falling dollar makes our products cheaper and imports more expensive thereby shifting the balance of payments in our favor. As a byproduct of fewer dollar buyers there is softness in bonds and that raises interest rates. It is a perfect example of the domino theory and cause and effect. South Korea may not have been a high profile dollar buyer but it just punctuated the current wave.

USD Index Chart - 180 min


Crude Oil Chart - Daily


A direct byproduct of the falling dollar was the soaring price of oil. Because oil is priced in dollars a sharp drop in the dollar requires a sharp spike in oil prices to maintain a level return. Put simply a -20% drop in the dollar means it will take 20% more dollars to buy the same barrel of oil. The value of oil did not change only the value of the currency used to purchase it. If a barrel of oil cost 50 euros yesterday it would still cost 50 euros today.

Oil prices soared to $51.70 intraday as the March futures contract expired for trading. Holders after today will take actual delivery and the demand for contracts was very strong. Those short the contract and facing having to deliver were forced to cover or be in serious trouble trying to come up with a load of oil on the spot market. This flurry of expiration activity coupled with the strong drop in the dollar pushed prices not just to $50 but well over $50 with a close at $51.30. This should be an expiration spike that could be reversed tomorrow but the trend is still higher and with the $50 resistance broken there is bound to be some fear in the market. Aggravating this spike is an increase in demand for heating oil due to colder weather in various geographies that depend on oil for heat.

In stock news Home Depot announced earnings that were inline with expectations but indicated consumer buying trends may be slowing. HD fell -1.70 on the less than exciting guidance and a failure to beat estimates as they had for the prior three quarters. HD closed at a four month low just over $40. The guidance suggesting weak consumer spending is just one more reason for weakness in the markets. While there are no specific signals that point to serious trouble ahead there is the fear of a new economic down cycle. There are also no specific indicators to contradict that fear. Investors would like to see some signs of improvement not the mixed signals currently showing.

Winn Dixie (WIN) filed for Chapter 11 bankruptcy due to strong competition from Wal-Mart, Target and others. WIN has 79,000 employees and the company tried to assure everyone it was going to rebound better able to compete with its low cost rivals. The stock fell from $3.50 to $1.50 on Feb-10th and today's announcement was not a surprise.

What was a surprise was today's relative strength in the SOX. After spiking higher at the open to 438 the index stubbornly refused to give back its gains until the very end when it finished down -1.94. Considering the -174 drop in the Dow and the nearly -30 point drop in the Nasdaq this SOX strength was amazing. Apparently winners in other sectors were being sold with the semiconductors benefiting from the sector rotation. If you remember we saw a sharp drop in the book-to-bill number last week to a new cycle low and several analysts suggested it was time to buy. The strength today in the face of broad based market selling was an indication quite a few funds must have taken that advice.

The selling today was very broad based with decliners nearly 3:1 over advancers. Declining volume was nearly 4:1 over advancing. The number of new 52-week lows rose to 125 and a level not seen since the mid January sell off. Unfortunately volume was also strong and reversed the recent trend of light volume on down days.

The Dow broke all semblances of support between 10650-10750 and posted its biggest one-day drop in 21 months of -174 points. It came within 35 points of seeing trading curbs applied at -210. This type of drop typically sees follow through selling as investors coming home after work react to today's selling and initiate plans to exit tomorrow. The Dow has no real support until 10400-10450 although there is congestion between 10500-10600. The double top I discussed last week is looking much more likely today and a break of 10400 would get really ugly really quickly.

The Nasdaq fell -28 points and is closing in on the 2020 level I mentioned last week as critical support. If we were going to see any buyers appear this would be my target. If you are still short from my 2090 suggestion then I would think about taking some profits around 2025 and watching 2020 for a trading long. I have mixed emotions about whether it will hold but it may be good for a small bounce when bargain hunters appear. Should 2020 break the bears will come out in force and any hopes of a spring rally will die. The Nasdaq broke support at the 100-day average at 2056 and that is a strong sell signal.

The S&P has gone from promising at 1212 to strongly disappointing at 1184 in only three days. It did this despite the soaring energy stocks that make up nearly 15% of the index. The sell off today was led by financials and they outweigh energy at 22% of the index. Ironically with oil soaring +$2 a bbl today the oil stocks were knocked for a loss as well. This tells me there are some broader underlying issues at work here. Interest sensitive stocks, energy stocks, techs, drugs, manufacturing and even commodity stocks all fell. For instance Phelps Dodge (PD) fell -2.22 despite near record copper prices again today. This was a day to not only throw the baby out with the bath water but the soap, towels, clothes and diapers as well. It was a market flush on news that should not have been that damaging.

This brings up the option expiration question again. Today was settlement day for options and there could have been some overriding pressure from Friday's expiration. I would like to blame the drop on something but expiration does not normally produce a drastic drop on settlement. I would like to blame it on oil and interest rates but they also are only transitory issues. We are likely to see oil back under $50 this week once the March contract expiration gyrations are removed and the dollar will likely bounce from today's extreme drop. I don't see anything material on which to blame the drop other than the question I have been posing to you over the last two weeks. Why buy? There is no real reason to buy stocks this week or the next couple weeks. Tech investors want to hear Intel's mid quarter update in March before committing any new funds. The retail investor is on hold because of the January market malaise and today's drop is not going to help. If anything this will convince those who bought the January dip to hasten their exit.

Whenever a sudden and unexplained drop appears there is a cooling off period where the knee jerk reaction is to move to the sidelines and there is not a rush to buy the dip. While I believe today's drop was overdone and a reactionary event due to dollar, bonds, oil and mixed economics I would not suggest jumping back in just yet. We need for the market to establish a trend and until we break 10400/2020/1160 that trend is still very mixed. Above those levels we are still in the January congestion zone and we could go in any direction. My bias has turned more bearish after today but still skeptical. My recommendation remains the same to be flat/short under Nasdaq 2100 with a potential trading bounce at 2020. Should 2020 fail we will need to load up on bear repellent.


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