Option Investor
Market Wrap


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The much-anticipated end of op-ex week started promisingly enough, with oil reaching new highs and equities set for a gap-down open. Gap down they did, and the decline accelerated in the wake of the disappointing Leading Economic Indicators report at 10AM, breaking Friday's lows. That drop was quickly bought, however, and a low-volume, low-credibility rise ensued for the remainder of the day, chopping its way to a gap-fill and new session highs within Friday's range. A selloff in the final hour closed the indices back to their early-afternoon levels.

Light volume remains the rule, as does low volatility. There appear to be simply no sellers of any significance, each drop quickly and easily bought. No doubt today's Fed open market operations, which added a net new $4.5 billion to its dealers' reserves, helped it along. But the market continues to hold its upside bias. Even on a daily basis, the charts below show an overdue daily cycle downphase generating very poor price traction and now turning up prematurely. Unless and until some actual selling appears, bears will have no choice but to be vigilant on their stops and quick to exit. For the past month, buying (not selling) the dips has been the directional strategy of choice.

Volume breadth was negative for most of the day and only shifted to positive territory at 2:30PM for the Nasdaq, while on the NYSE it took until after 3PM. The closing dip reversed it, the NYSE finishing with 1.27 declining shares for each advancing and the Nasdaq 1.06 declining shares for each advancing.

Daily Dow Chart

The Dow closed lower by 15 points at 10608, failing at a high of 10637 in the late afternoon. The post-10AM low came at 10562. More bearish than today's minor loss was the lower high and lower low for the day, the first in several sessions. It was that rising pattern that aborted the daily cycle last week, and while bears might cheer the lower high/lower low today, it's going to take a strong downside closing break of the rising wedge support at 10570 to threaten the buy signal on the 10-day stochastic. As bearish as the light volume, low volatility might feel, the recent price pattern has been anything but.

Daily S&P 500 Chart

The SPX lost .86 to close at 1216.10, testing neither the top or bottom of the bear wedge apex with today's doji star. As with the Dow, the SPX's daily cycle indicators point higher, and bears need a break of 1210 wedge support confirmed by a move below 1205 confluence to threaten it. 1220 remains immediate upside resistance, confirmed again by today's 1219.10 high.

Daily Nasdaq Chart

The Nasdaq lost 1.98 to close at 2088 after failing at the afternoon high of 2096. This was a lower high and lower low for the day as well, and brilliant distribution job if that's what it was. The daily cycle upturn is weakest here, and another down day should be enough to stall it. However, that's offset by a potential reverse head and shoulders neckline at 2100, potentially very bullish if broken on high volume on a daily closing basis. Without getting into the cycle behind it, reliable reverse head and shoulders formation are extremely rate at or near the top of an upleg. That's the case here, as the current pattern commences right after the December 2004 high. Reverse head and shoulders are much more reliable patterns at the bottom of a downleg, and for this reason, I'll be skeptical of the current setup unless and until 2100 has been broken with authority.

Chart of QQQQ with $QQV overlay

This chart, with QQQQ price candles overlaid with the NDX/QQQQ volatility index (QQV) in blue, is very telling. The QQV is at record lows. While the "when it's high, time to buy/when it's low, time to go" mantra is not without exception, the general rule has been that lows in volatility tend to coincide with highs in price. 

Is it possible that the relationship has become too well known to work? Possibly- just as I've wondered at other times prior to strong declines. However, there will come a time when the relationship doesn't work, and this could well be it. More likely, in my view, is that extended will become more extended before the correction. While this relationship could invert, my guess is that it's mere delayed. In fact, looking closely at the timing of the QQV lows (see highlighted bands) of the past 6 months, we see that the lows generally preceded the relative QQQQ high by several sessions. If so, the eventual upturn in the QQV will give us a heads-up for a possible downleg for QQQQ.

What is clear is that option premiums are as low as they've been in many, many years, helped along by aggressive premium selling. At some point, the tight, low-volume, quiet range will break, and premiums will begin to rise. Nothing prevents volatility from rising along with price, however- until the market breaks out of this range and volume returns to normal, it's only a sign of more exciting times to come, and hopefully soon. Price remains the primary indicator.

Daily TNX Chart

The Treasury auctioned $16 billion of 13-week bills and $14 billion of 26-week bills, below its recent string of $32 billion Mondays. The 13-week T-bills fetched a high discount rate of 2.965%, matching June 6th's high and 1 bp above last week's rate. The bid-to-cover ratio was 2.27, indicating the strongest demand since the April 25th auction, but the high rate on April 25th was only 2.88%. The 26-week bills were auctioned at a high rate of 3.175%, the highest discount rate in several months. The bid-to-cover ratio was 2.10, the lowest in a month. Indirect bidder participation was a respectable $9.16 billion of the $30 billion total.

Ten year treasuries were weak today, the yield (TNX) once again testing 4.14%-4.16% confluence resistance before doji-ing back down support at the 22 day EMA at 4.066%. For the day, the TNX finished higher by 2.5 bps at 4.103%.

Chart of Crude oil

The threats of sabotage in Nigeria from Islamic militants on Friday were not resolved, with the US, Britain and Germany closing their consulates in Lagos. Faced with the possibility of supply disruptions, traders hit the offers on Monday, driving the price of July crude to a high of 59.275 overnight following last week's more than 9% rally. Nigeria is the 8th largest exporter of oil and supplies approximately 10% of US imports.

Crude oil dipped later in the morning but bounced from a low of 58.10 to set a new afternoon high at 59.525, settling +.975 at 59.45. On the daily chart, we see the May rally continuing to new highs and challenging April's high. The daily cycle is in a trending upphase with a negative divergence on the 10-day stochastic, but bears will need to see a break back below the 55.50 level for confirmation and the start of a new downphase. 

It was a quiet day for economic data, and there will be no major reports due until Thursday's Initial Claims. Today, the Conference Board released Leading Economic Indicators, which showed that 9 of the 10 indicators declined in May, the LEI falling 0.5% compared with expectations for a 0.3% drop. The one indicator which rose was stock prices, while there were negative results from the other components such as factory workweek, new orders for consumer goods, new orders for nondefense capital goods, initial jobless claims, vendor performance, building permits, money supply, consumer expectations and the spread between the 10-year note and the federal funds rate. This is the 5th consecutive month without a grain from the LEI, though April's -0.2% drop was revised to unchanged.

Research firm Lipper reported that inflows to equity funds doubled from April to $21 billion in May, with investors targeting "riskier" funds and domestic funds to the exclusion of internationally focused funds. Senior research analyst Don Cassidy was quoted by Marketwatch as saying, "Once again investors showed they will wait to buy until they see a rally, rather than having the courage to buy on the dips."

In corporate news, the WSJ reported early this morning that Wyeth (WYE) may cut up to 30% of its sales force this year. The company has been long expected to reduce its number of sales personnel, and the current announcement could affect the jobs of 750 employees. WYE closed lower by .11% at 44.07.

Register.com (RCOM) rejected a bid to be purchased by RCM Acquisition for $7.10 per share, but indicated that it remains open to future bids both from RCM and others. CEO Peter Forman resigned from RCOM last week and was replaced by interim CEO David Moore. RCOM gained 1.52% today to close at 7.37.

Sony (SNE) took a tumble as the anticipated Supreme Court ruling in the MGM v. Grokster case was not issued, with Thursday the next potential date for the ruling. MGM, a subsidiary of SNE, has sued Grokster for enabling a network it claims to be used primarily for the illicit distribution of copyrighted content. SNE lost 2.48% to close at 35.39.

H.J. Heinz (HNZ) announced its agreement to purchase Danone's HP Foods, which owns HP and Lea & Perrins brands. The move helps to consolidate the two companies' brands, with HNZ emphasizing condiments, meals, snacks and infant foods, while France's Danone is focused on water, yogurt and biscuits. The deal will be for $855 million in cash. HNZ expects the transaction to be accretive to earnings in the first full fiscal year. HNZ gained a cent to finish at 36.34.

Cablevision (CVC)'s controlling shareholders, the Dolan family, proposed a $7.9 billion deal to take the company private. Under the terms of the deal, which would see a number of businesses including its cable networks and sports teams spun off, CVC shareholders would receive $21 per CVC share in cash as well as shares of Rainbow Media. Reuters reported that on the basis of a presumed value of $12.50 per Rainbow Media share, the deal would set a price of $33.50 per CVC share, a 25% premium above Friday's closing price. CVC rose 19.09% to close at 32 on more than 17 times its average daily volume.

For tomorrow, the question is whether today's last-hour decline will continue. Volume was strongest at the open and at the close as the indices declined. I noticed the same thing on Friday morning, when QQQQ declined on heavy volume. There was much lighter volume on the rise that followed. This would look much more bearish if price were actually declining for longer than a few minutes at a stretch. 

My feeling is that this nothing more than expert distribution at the top of a rally, as confirmed by the recent intraday volume patterns as well as the generally light volume we've had for much of the past month and a half. Although it's far from perfect, I find the QQQQ:QQV to be a compelling indicator at least for caution among bulls, if not of a strong decline potentially brewing. The key there, however, is "potentially." In the meantime, the price trend remains up until support has been broken on a closing basis.


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