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Market Wrap

End of Month Volatility to End the Month of Volatility

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Wow, good riddance to October! For anyone trying to hold onto a trade, especially over the past two weeks, it's been a wild ride and every other day it seems we saw a complete reversal of a reversal of a reversal of... Today's rally itself was reversed, especially after the market's close when we saw the day completely reversed in the DOW futures. Back to flat on the day. Futures rallied back up into the evening so perhaps tomorrow won't see follow through to the downside. But it looks like the market hit some important resistance levels as we'll see in the charts and today's late-day sell off now leaves us wondering if the buying on Friday and today was just end of month/quarter/fiscal year buying for some of the mutual funds.

If the buying was largely done for window dressing, we could see some of that reversed tomorrow before we head to new highs. But if the resistance levels reached was the end of a corrective rally that started from the October 13th low, then we'll now start heading for new lows. We don't know which yet but it could be an interesting week ahead.

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Futures had been up over night, thanks in large part to the strong rally experienced in the European markets and we saw prices spurt higher from a gap open that lasted all of 30 minutes. The rest of the day was spent consolidating near the high which was actually bullish and sure enough, we then rallied into the end of the day or at least until the last 20 minutes of the day. Starting at 3:40 PM we saw an unloading of some stocks that the mutual fund managers really didn't want but bought them for their portfolios to show what smart people they are. After 4:00 PM the DOW futures finished selling off which took prices back to where the day started.

Before the market opened we got some favorable earnings reports for the third quarter from Occidental Petroleum (OXY 78.82 +1.98), Humana (HUM 44,27 +0.47) and Valero Energy (VLO 105.20 +5.74) all of whom reported upside numbers. There was news from Novartis (NVS 53.81 +0.42) who agreed to purchase the balance of Chiron (CHIR 44.12 +0.80) shares that it does not already own, for $5.1B. A host of analyst upgrades lent early support to the open--WAG, SIRI, QLGC, HSII, WFT, PNC, and SPF. Nothing like a little boost from your friends on the last day of the month. Barrick Gold (ABX 25.31 -1.95) announced its $9.2B bid for Placer Dome (PDG 19.87 +3.44) which sent ABX tumbling and PDG rocketing higher. Saks (SKS 18.16 +1.49) was lifted on its announcement of its sale of its Northern department stores.

Caterpillar (CAT 52.67 +1.52) lifted its share price by announcing it expects dramatically improved performance, which includes $50B in sales by 2010. In 2010? Most companies have trouble with forecasts for the next year. That's like a weatherman forecasting rain on this date in 2010. OK, if you live in Seattle maybe that's not such a hard forecast. Brewers did well after Barron did a positive article on Anheuser (BUD 41.27 +0.69) while Molson Coors (TAP61.70 +0.80) gained ahead of its Q3 earnings report scheduled for tomorrow. But I guess it's better to drink than eat cereal--Kellogg (K 44.16 -2.29) got smacked after its disappointing FY05 and FY06 guidance that followed a better than expected Q3 report. Maybe if Kellogg suggests pouring beer into your corn flakes instead of milk, they'll do better.

September personal income and spending data was released at 8:30 AM and showed income rose 1.7% (consensus was 0.4%), while the spending rose 0.5% which matched expectations. The increase in income was attributed to the rebound from August which was down due to the uninsured losses from Hurricane Katrina. The rise in September followed a -0.9% decline in August which was attributed to the drop in rental income caused again by Hurricane Katrina and the uninsured real estate losses. If these hurricane related losses are stripped out, economists figure we had a +0.5% rise in September that followed a +0.3% rise in August.

The +0.5% gain in spending followed a -0.5% decline in August so it was a wash between these two months. The extra spending was attributed to extra gasoline expenditures. Stripping away inflation, which removes the energy component, spending actually dropped -0.4% after falling -1.0% in August. This makes it the first back-to-back drop in spending since 1990. Uh oh, the drop in consumer spending is not going to be good for the market if it continues. Normally this might have had a very negative reaction from the market but instead the market had an agenda today--paint that tape!! Let's get as much out of October as we can.

The personal consumption expenditure price index jumped +0.9% in September due in large part from the increase in energy prices. This was the biggest jump in almost 25 years, since February 1981.

At 10:0O AM we got the Chicago PMI for October and it came in at 62.9 versus September's 60.5 so a slight improvement. It came in better than expectations of 57.2 as new orders jumped to 72.6 (vs Sept. 63.4) and new deliveries rose to 68.3 (vs Sept. 57.4). Prices paid was 79.6 (vs Sept. 60.5).

SOX got a nice little boost today off news that semiconductor sales for September rose 5.6% to $19.6B from a year earlier. Sales were up 5.2% since August, largely driven by consumer products being built for the Christmas season.

The wild ride in the indices continues so let's see if today's move, tacked onto Friday's huge rally, makes sense in the larger picture:

DOW chart, Daily

The DOW looks like it was finally able to break back above its uptrend line from October 2004--that's bullish. It failed to get back above its uptrend line from April--that's bearish. It close 3 points above its 50-dma at 10437--that's nothing. The sharp pullback from today's high does not leave a bullish taste in my mouth, especially after finding resistance at the top of a parallel up-channel that is containing price action since the October 13th low. Needless to say, it's critical for the DOW to hold above 10330 which is that uptrend line from October. If the bulls can't hold that line on another test, it could totally frustrate those who are trying to get long. If the DOW manages to bounce a little further, it runs into resistance at its 200-dma just under 10500.

SPX chart, Daily

SPX also looks bullish, having rallied above its 200-dma and sticking this time. It found resistance at its 50-dma. The job for the bulls is to first defend the 200-dma on any pullback from here, as well as the uptrend line from August 2004, both of which are just under 1200. The next task is to get above its 50-dma just under 1210. As shown below, there's another reason SPX may have failed where it did today.

SPX chart, 120-min

SPX has been contained in a broadening formation, commonly called a megaphone pattern. These are typically marked with lots of volatility (sound familiar?) and in its current location within the larger pattern is usually a continuation pattern. That would mean down out of this pattern. Notice price rallied up to, and pulled sharply back from, the top of this pattern. Along with bearish divergence on the daily chart and this 120-min chart showing overbought, we should get at least a pullback. The EW count inside this pattern shows today's rally finished the pattern and that suggests we will now head for new lows.

Nasdaq chart, Daily

Like the SPX and DOW around their uptrend lines from last year, the COMP has been consolidating around the support/resistance line at 2100, and between its 200 and 50-dma's. If the COMP can rally a little further, it will test resistance at its downtrend line from August at 2145. It's 200-dma at 2073 needs to be defended by the bulls so we've got a potential range to watch for a break to then give us some longer term clues.

SOX index, Daily chart

The SOX remains inside a steep down-channel that looks a little like a descending wedge which should be bullish. But before it breaks out to the upside it's looking like it will head lower and I would look for potential support at its uptrend line from October 2002 through the April 2005 low, currently near 410. A lower uptrend line from August 2004 sits just below 400. If the semiconductors can instead rally a little more, it will be able to get above its 200-dma at 435 which would be a bullish statement.

BKX banking index, Daily chart

The rally in the banking index since the October low has been nothing short of stellar. Speaking of short, it looks like short-covering. This rally is way too much too fast. If it manages to rally a little higher, it will test resistance at its downtrend line from December 2004, currently near 100.45. But watch to see what we get tomorrow. Today left a potentially bearish spinning top doji candlestick. If tomorrow produces a red candle, that would be a reversal signal.

U.S. Home Construction Index chart, DJUSHB, Daily

The housing index continues to consolidate near its low and the consolidation could continue a little longer, maybe over to its downtrend line. I expect this index to head down for a test of its longer term uptrend line, currently near 775.

Oil chart, December contract, Daily

Crude oil has been consolidating near its low, and just under its broken uptrend line. It could consolidate a little longer and may work its way over/up to its downtrend line. This looks like it will drop down to test its 200-dma, which may coincide with another test of the bottom of its down-channel, currently at 57.50.

Oil Index chart, Daily

As expected, it looks like the oil index is breaking out of its down-channel. After getting a 5-wave move to the downside, it appears we're in a corrective bounce against that decline. I'm expecting a 3-wave bounce which should set up the next shorting opportunity. If you're long any oil stocks, the way I'm reading this pattern, the end of the current bounce will be an excellent opportunity to get out. As I look for potential upside targets I see the 50-dma at 540 but keep an eye on 538--this is where we'd have two equal legs up in the bounce from the October low. Just below that is 534 which is a 50% retracement of the Sept/Oct decline. So watch 534-540 for potential topping of any bounce from here. I expect the 200-dma to be broken to the downside on the next decline. Now, I'm basing my opinion strictly on the chart pattern and not on fundamental reasons. Jim does an excellent job at covering the oil stocks so by all means follow his lead as well. He's done an outstanding job following the stocks in this industry.

Transportation Index chart, TRAN, Daily

Most of you know I'm longer term bearish the equity market. This chart has me on the edge of my seat and makes me a very nervous bear. Today's break of the downtrend line from March is potentially very bullish. It's only 1 day and I like to see confirmation of a break by seeing this hold above the line for 3 days and preferably a retest of the line that holds. This could be a head fake and a result of the 2-day rally for end of month window dressing. If TRAN does not hold here and rolls back over, it could leave a bearish divergence on the chart. But if it manages to hold, we'll need to see confirmation of the DOW rallying as well, otherwise it will be a non-confirmation of the rally as per Dow Theory. And as per Dow Theory, this year has been full of non-confirmations between the DOW and the TRAN. This one requires very careful watching.

U.S. Dollar chart, Daily

The U.S. dollar continues to consolidate under resistance and continues to look bullish. No change in outlook here as I expect the dollar to rally to new highs--the eventual upside target should be in the mid to upper 90's before the bear market for the dollar resumes (probably next spring).

Gold chart, August contract, Daily

Gold needs to hold near current pullback levels in order to maintain at least a short term bullish outlook. I expect gold to hold above 465 to finish its current pullback. If it drops to a new low below 462, certainly below its 50-dma at 461, I would turn more immediately bearish gold. If instead this will be able to turn around and get another leg to the upside in progress, I'm thinking a high around 495 and that could be a high that lasts a long time. In other words, longs should pull their stops up tight at that time and I would look to short the new high.

Tomorrow's economic reports include the following:

Tomorrow's economic reports include auto and truck sales and shouldn't offer any surprises. Construction spending and certainly ISM could be a market mover. But the market may just go on hold for most of the day while waiting to get FOMC out of the way. Again, no surprises are expected (+0.25%, no change in wording) so the market may not react much. But the typical pattern is for a slow rise into FOMC, thrash about for an hour and then sell off.

Today was a day where almost all sectors were positive. Wal-Mart (WMT 47.30 +1.80) issued guidance for October and increased their same store sales to +4.3% and this contributed to a 2.5% surge in the retail index (RLX). At the top of the sector list were the airlines with nearly a 4% gain today. Following these two sectors were the computers, biotechs, securities brokers, SOX and telecoms. The only red sector on my list was the gold bugs index (HUI). Laggards today, but still green, were the financials, drugs and pharms, natural gas and gold and silver. All in all it looked like a pretty bullish day.

After the bell Dell (DELL) came out with some guidance which did not please investors. Dell closed the regular session at 31.86 and after hours dropped as low as 29.96 before closing at 30.50. They forecast 3rd-quarter pro forma earnings to come in at 39 cents a share, which is at the low end of its previous forecast. Expected revenue of $13.9B is below its prior outlook of $14.1-14.5B. Analysts had been expecting earnings of 40 cents a share on revenue of $14.28B. Dell blames the shortfall on its U.S. and U.K. businesses. Dell also plans to take a 3rd-quarter charge of $450M, or 14 cents a share, which will cut their net earnings in half. More than $300M of the charge is related to the cost of servicing systems which of course immediately raises the question why there is suddenly an unexpected increase in these servicing costs.

Looking under the hood of this market the past two days leaves me with the impression that there may have been some "false" buying, as in buying just to lift the market's indices for month/quarter/fiscal year end, but not everyone participated. For example, for the NYSE on Friday's strong rally there were 50 new 52-week highs while 139 new 52-week lows. Today was a little better at 100 new highs versus 71 new lows. Volume on such a strong up day on Friday was average, as was today's. So these relatively weak internals, combined with the resistance levels reached by the indices suggests caution to those in long positions. On the surface it seems a rally above SPX's 200-dma is positive. However, watch to see if it sticks on Tuesday. The DOW pulled back sharply at the end of the day and closed right at its broken uptrend line from April, the same line of resistance where the DOW failed on its rally attempts on October 19/20 and the 26th. The daily charts are full of bearish divergences. Not all is well (yet) in equity land so be careful. The volatility of the past month may continue into November so watch out for whipsaws, head fakes, reversals, retracements, you name it. Trade fast and trade light until we get a better sense of where this market is headed. Good luck in your trading.
 

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