Option Investor
Market Wrap

Which Way Did They Go?

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-  91.30



1.91 bln

979 / 2082



-  23.30



1.79 bln

914 / 2069

S&P 100


-    4.80




1893 / 4151

S&P 500


-  10.36







-    1.60





RUS 2000


-    8.78







-  66.29







+   0.31







+   0.47







+   0.13




Total Volume







Total UpVol







Total DnVol







Total Adv







Total Dcl







52wk Highs







52wk Lows




























Which Way Did They Go?

April feels more like October with the daily volatility and strong moves in alternate directions. The bulls appear trapped in a revolving door to the market with plenty of activity but no gains. Every bounce starts out with excitement but once the smoke clears buyers are left wondering where everyone else went. Every other day finds a new afternoon sell off removing the gains from the prior day and leaving new buyers stranded alone at the top. This is not the type of activity that instills confidence in a summer rally.

Dow Chart - Daily

Nasdaq Chart - Daily

The morning economics started off mixed once again with Consumer Confidence falling to 97.7 from last months 103.0 reading. Weaker expectations in both employment and business conditions along with high gasoline prices combined to create this substantial drop. It was not unexpected given the weak labor numbers and high oil prices we have been seeing. The present situation component fell from 117 to 113.6 and the expectations component fell from 93.7 to 87.2. The headline number at 97.7 is still above the 92.5 average we saw in Oct/Nov but it does represent a substantial drop from the 105.1 high we saw in January. Confidence had risen with a +10 point jump in December to 102.7 and held in the triple digits for four months as indications for Q1 suggested the economy was improving. Beginning in March confidence in the economy began to wane and consumer confidence has fallen with it. Buying plans for autos, homes and appliances did not change from last month indicating consumers are still comfortable with their own situation but are uncomfortable with the economy. Consumers on the lower end of the income scale showed the biggest drop in confidence and that suggests higher energy prices are hurting them the worst.

On Monday the UBS Index of Investor Optimism fell to 52 from the March reading of 74. The index hit a high in February at 82. The index has now dropped -30 points in only two months and the April reading at 52 was the lowest level since Sept-2003. The economic component of the index slipped into negative territory at -1. This is the first time in negative territory since March 2003 when it rebounded out of a three-month dip into the red and a low of -30. This negative sentiment heading into a typically weak period for the markets does not suggest a rally is in the cards.

Chain Store Sales fell -0.3% last week with colder weather and higher gas prices still the biggest drag on consumer buying. Monthly Mass Layoffs rose in March to 1194 layoffs impacting 130,848 workers. The losses were broad based across all sectors but manufacturing still accounted for the most with 31% of all layoffs. Next weeks Jobs Report is going to be even more critical given the slip in confidence/sentiment/optimism and flood of month end economics. It could be a rocky road ahead.

On the flip side New Home Sales soared off the charts to 1.431 million units. This +12% jump is a new all time high and a sign the slowdown in new home sales was only temporary. The February levels were also revised +4% higher. The bubble is alive and well and the fear of higher mortgage rates has not yet impacted new homes. However, most builders buy down the rates as an incentive to sell more homes. Existing home sales where there are no interest rate incentives, rose only +1% for March and were flat in February. The drop in housing starts last month could be telling us that builders are concerned that the end is in sight for the housing boom. The strong new home sales in March could have been due to strong builder discounts and sales incentives to dump inventory in fear of a slow down ahead. Homebuilders soared on the news but fell back to close negative in many cases.

The Richmond Fed Manufacturing Survey failed to impress with only a minor bounce to +2 from last months reading at zero. This stretches the string of lackluster readings to six months with an average of less than a point. This is well below the string of double-digit readings we saw with a peak of 30 in March 2004. Order backlogs improved to only -3 from last months -20 but it continued a string of negative numbers started in Sept-2004. The six-month outlook fell to 23 from 33 and prices paid increased faster than prices received.

We still have a lot of economics ahead of us as we head into the Fed meeting with Durable Goods on Wednesday, GDP on Thursday and half dozen reports on Friday. Next week will be even worse with more than 20 reports and a Fed meeting.

After the bell on Tuesday Amazon reported earnings and it was not pretty. AMZN fell to $31 in after hours and a loss of -$2.50 for the day. Amazon posted earnings of +18 cents, which included a $56 million tax expense. This was well below the +26 cents they earned in Q1-2004 but inline with most estimates after charges. Operating margins fell from 7.2% to 5.7% despite a +22% increase in revenue. Amazon said it expected higher future revenue but that margins would continue to drop. This pressured other online retailers on thoughts that Amazon was likely to lower prices again in an effort to increase revenue at the expense of profits. The drop to $31 is a level not seen since May-2003 and the break of support at $33 could mean the next stop is $25.

IBM recovered some ground from last weeks two-year low at $72 on news that they were going to by back an additional $5 billion in shares and raise their dividend. IBM rallied to $77 on the news but faded back to $75.40 by the close.

Lexmark posted earnings that missed estimates and guided analysts lower for the current quarter. They blamed weakening demand and aggressive pricing for the decline. Lexmark fell -$11 on the news and dragged down other printer makers HPQ and Dell with it. Cyclicals were also sold hard with CAT, DD and MMM leading the Dow losers list. Chip stocks fell on news that Taiwan Semi saw a sharp drop in revenue for Q1 because of declining shipments and the weak dollar. Taiwan Semi is the worlds largest contract chip maker and sells to some of the biggest high tech firms. Revenue fell -12.9% from Q4. They said wafer shipments fell -8.8% for the quarter. Infineon also said it posted a loss for the quarter as a result of falling demand and price pressure. They also failed to rule out a loss for the current quarter. They said a sharp drop in prices for memory was a major factor. The price drop was due to weak demand and aggressive pricing by everyone trying to capture their share of that weak demand.

Oil prices declined from yesterday's attempt on $56 but closed at $54.25 and near the high for the day. Various comments from different sides tried to put an end to the Bush bounce but were mostly unsuccessful. Last week President Bush made comments that suggested Saudi Arabia was pumping at capacity and could not pump any more. Those comments have been tossed around for a week with a sharp bounce in crude prices. The Saudi crown prince met with Bush yesterday and the official story is that those fears were calmed. The Saudi Foreign Affairs Advisor was interviewed today and he also tried to suggest there was still excess capacity available but prices failed to drop materially.

Obviously the speculators don't believe the comments and the lack of proof. The Saudi spokesmen have tried to talk prices back down for months without success because there is no proof. Secondly, any excess capacity is in heavy, sour crude that few refineries can use. They could have 10 mbpd of sour available for sale and it would not fix the problem. Saudi can claim it has an ocean of oil available but if it is the wrong kind it will go largely unsold. If you pull into a filling station for an unleaded fill up it makes no difference if they have 10,000 gallons of excess diesel if you can only use unleaded gas. Diesel could be 50 cents and gas $5 and you would still have to buy gas. This is the same problem with Saudi oil. They have plenty of sour, heavy crude but the world refineries need light sweet crude. Ignore the constant comments about excess capacity from Saudi Arabia because they have no bearing on reality. Watch the price of crude for indications of the real supply/demand picture.

I also get a kick out of listening to Saudi officials saying the price of oil is too high and they would rather be selling it at $40. Give me a break! Given the option to sell 9.5 million barrels per day at $55 or $40 which price would you chose if it was your oil? It makes a good sound bite but has no basis in fact. Yes, it might cause a slight cutback in demand but the higher price will never return to prior levels and it is a limited resource. Ring that cash register and let the Saudi Foreign Affairs Advisor keep saying they support lower oil prices. Add in Treasury Secretary Snow saying he supports a strong dollar you have a matched set of figureheads trying not to crack a smile while lying on camera.

With the Valero (VLO) acquisition of Premcor (PCO) I advised everyone in the Market Monitor on Monday to close their PCO LEAP. The acquisition caps any upside for PCO and expectation premiums will fade away. We will continue to hold the VLO LEAP despite the minor decline from the acquisition. I continue to believe that oil will move higher as we move into summer and this will overcome any acquisition decline on VLO. Check out my LEAPs section in the Sunday newsletter for further background.

Premcor Chart - Daily

Crude Chart - Daily

The Dow struggled at the open to break 10260 and the highs from Monday. Unfortunately by 11:30 the fight was over and the Dow began a decline that ended at the lows of the day at 10150. For seven days the Dow has tried to rebound from the mid April tax selling drop but it cannot find any traction. The Dow pattern has been two days up, one day back and repeat. While the Dow has put in two higher lows in this advance it has only captured 150 points from the 10000 low and we are in danger of a return to that low any time now. There is no conviction to the bounces and both have been nearly picture perfect short squeeze scenarios. Shorts getting squeezed do not produce lasting rallies. It shows that the hedge funds are betting on the short side and without any institutional support any rally will not succeed. Even if we did manage to put together more than two up days in a row there is very strong resistance at the various averages beginning with the 200-day at 10375 and ending with horizontal resistance at 10500. This resistance is going to be a major challenge on any real bounce given the current economy and Fed cycle.

The Nasdaq is fighting the same battle and closed at the low for the day just under 1930. There is strong resistance at 1960 and even stronger resistance from multiple directions at 2000. With the chip stocks unable to mount a credible rally on very mixed results the odds of a tech rally are dwindling. Amazon's results and comments tonight should tank the Internet sector and comments from Lexmark have undermined the major box makers. Microsoft has earnings on Thursday along with about a dozen chip stocks and a couple hundred other companies. Today alone 8% of the S&P reported and that pace will continue the rest of the week. I doubt we will hear anything different than what we have already heard and those reports have revealed many negative surprises. Microsoft is not likely to miss estimates but they have been strangely quiet and given the recent high profile misses there could be some fear growing about Microsoft. Tech bulls are finding it harder and harder to find something to be bullish about but they keep buying the dips. At today's 1930 close we are only about 25 points away from the low of the year and what should be strong support at 1900. A retest of that support before the Fed meeting is looking more likely as each day passes.

The S&P is still clinging to the high ground above 1150 but it could easily test support again at 1140 on any decent dip. The rebound has been lackluster except for those two bouts of short covering and a breakdown now could easily send us to 1100 before another bounce appears. The 200-day average at 1154 has been the speed bump for the S&P and remains near term overhead resistance.

Earnings have been strong with the S&P currently at +12.7% earnings growth in Q1 but guidance has been weak. Add in the weak economy, high oil prices, Fed rate hike cycle and fears of a repeat of last summer and there is still little incentive to own stocks. There is no bullish trend to buy and we are well above any levels that could be seen as bargain shopping. If you look at the longer term trend we are simply moving sideways at progressively lower levels. Eventually we will find real support but until that support appears the volatility will continue. We are seeing a sharp increase in that volatility with triple digit days becoming common once again and internals are tagging daily extremes. Today's declining volume was nearly 5:1 over up volume and decliners more than 2:1 over advancers. Since April 15th we have literally swapped internals on a daily basis. All rallies are being sold and on heavy volume.

April Internals

Note the alternating days in the image above. There is simply zero evidence of any conviction and the new lows have been consistently higher than the new highs. Even on the rally days the new highs have barely risen. This is not the foundation for a strong rally. Notice how strong the down volume was for the days leading up to April 15th. This "could" have been washout or even capitulation levels but there was no conviction on the buy side once the tax selling passed.

I continue to believe that the path of least resistance is down with a test of 9800 in our future. That does not mean it will be tomorrow or even next week but I believe it is in our future. During the summer doldrums we can wander aimlessly for weeks with no discernable trend. I believe we are approaching those doldrums with only the Fed meeting next Tuesday and Jobs next Friday as the only potential for a rally spark. Slim potential at that. I would continue to remain cautious and definitely, enter passively and exit aggressively.


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