Option Investor
Market Wrap

Opex Pinning

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It's always hard to tell where they might try to pin the price as we near the end of the week of options expiration. Try as I might I have not been terribly successful at identifying where max pain might be for the major indices and only as price gets near a major strike price do you get an idea where they might settle it. S&P 500 (SPX), DOW (DJX), Nasdaq-100 (NDX) and Russel 2000 (RUT) options stop trading at tomorrow's open so today's closing price gets it close to where it will settle in the morning (most times, while other times you will see some funny business done at the open) and then we'll have S&P 100 OEX options trading until tomorrow's close. The QQQQ acts like a stock and trades its options until Friday's close as well. So between Thursday's closing price and then Friday's closing price it's always a challenge to see which strike price they're going to try to pin price to.

Today's economic reports included building permits, export and import prices, housing starts, initial claims, and then the Philly Fed index in the afternoon. The jobless claims data showed initial claims rose 19K to 297K and the 4-week average also rose 6,250 to 283K. Continuing claims fell 39K to 2.511M. There was nothing earth shattering in the numbers, or from the other 3:30 reports, and the pre-market futures barely budged.

Housing starts were above forecast and got all the housing analysts giddy with excitement about the reversal in the decline of housing industry. Did you notice what no one was discussing though? Inventory. Many of the home builders are continuing to build their backlog of homes because they have the material. But take a look under the hood and you'll see the price of lumber is down significantly. It's down from a high of 391.80 (March contract) in January to a current price of 339.70 (-13.3%), which was down on the day. If the housing starts numbers were so bullish for housing, the price of lumber didn't reflect that. Sometimes it's important to look underneath that used car you want to buy in case the frame is starting to rust.

But the housing stocks got a bounce today so investors liked the data. January's single-family starts were up 12.8% to a record 1.819M. Total housing starts for January rose 14.5% to 2.276M, blowing away analysts' estimates for 2.02M. Having the warmest January on record (8.5 degrees warmer than average) helped many builders break ground when they didn't expect to be able to. This made the housing starts number the highest since March 1973. December's starts were revised higher to 1.988M vs. 1.933M. Building permits rose 6.8% to a 2.217M annual pace.

So there's no doubt about the fact that that sounds like great data and the return of a strong housing market. But as mentioned above, the problem as I see it is in the inventory numbers. Pardon the slightly blurry chart but this shows the inventory of homes over the past year:

Housing inventory chart, courtesy realestateabc.com

With the higher inventory levels in housing I fail to understand the excitement in building more inventory. It will only result in more discounts (good for the buyer, bad for the housing builders) like the recent Centex $100,000 discount if you buy now. It will have a depressive effect on the housing market. That will in turn depress home owners who will begin to feel less wealthy and will cut back on spending. Consumer sentiment will drop, etc., etc. The net result will not help our economy.

One other point that I can't resist making. I have recently commented that we're hearing a lot of comparisons lately about how good such and such a number is, better than we've seen since April 2000, etc. Employment numbers is a recent example--it peaked just before the market took a nose dive in 2000 and here we have employment numbers reaching the same levels. OK, so now we're hearing housing starts are better than we've seen since March 1973. So I went back in history and looked at the stock market back then.

DOW chart, 1962-1992, courtesy stockcharts.com

Find 1973 on this chart and notice what the market did right after that. After peaking at 1047.49 it bottomed in 1974 at 577.60, nearly a 50% haircut. You can't make this stuff up.

We also got the January import price index report which showed a rise of 1.3% vs. the 1.0% that was expected and up from the -0.1% for December. A little more inflationary than we'd like to see but again, no reaction from the market. Export prices were up 0.7%, up from 0.1% in December.

Lastly, the Philly Fed index was released at noon and rose to 15.4, up from 3.3 in January, and was better than expectations of 9.2. The new orders index rose to 12.5 from 11.1 and price paid dropped to 30.5 from 44.9. Bernanke commented that he sees a rebound in productivity growth in Q1 that should relieve some pricing pressures.

The market was pretty much on hold the whole day, cycling up and down a bit but then took off in the afternoon. The climb off the afternoon low looked deliberate--a tight up-channel with practically no pullbacks and no flare-ups. It looked engineered to me (not that I'm making the accusation that the market is manipulated). So after an up day thanks to this afternoon's rally let's see what we have in the charts.

DOW chart, Daily

So much for the bearish diamond top pattern. When patterns fail they usually fail strong in the other direction. Witness the strong rally out of this. The DOW has now bumped into the trend line along the highs since July 2005. This trend line stopped the rally in January and should therefore be a strong resistance level that traders will be watching. We could see a slight pop tomorrow to clear out any buy orders and finish options expirations settling, but this should retreat almost immediately tomorrow, otherwise we've got the next trend line along the highs from January 2004 up near 11,200.

SPX chart, Daily

A Fib projection on the daily chart and one off the rally from Feb 7th both point to 1289 as a potential high for the current rally. The trend line along the highs from January 2004 is a skosh higher around 1293. If the SPX fails to rally much further and turns down instead from here it will leave a continuing bearish divergence on MACD. A continuation of the rally would bring an upside target of 1313 into play.

Nasdaq chart, Daily

The techs have been much weaker during the latest rally and that has made the rally suspect. You like to see the high beta stocks leading the charge, especially the generals among the high beta stocks. They've all been conspicuously absent this rally. The COMP bumped its head against the downtrend line from January and the broken uptrend line from October. Watch for a bearish kiss goodbye here. MACD remains buried in negative territory. But like the others, if the COMP can continue its rally it should be able to make a new high and then the 2355 Fib target would be in play.

SOX index, Daily chart

The last test of the high in the SOX left a nasty bearish divergence on the chart. It then broke its uptrend line from December and bounced back up to it today and yet couldn't even get stochastics to curl back up. Best case scenario I see for the SOX is a sideways consolidation before pressing higher. Another drop will likely take it down to its uptrend line from October and it 50-dma, both near 520.

Before looking at the banks, I wanted to visit the subject of bond yields and debt levels, both of which should be near and dear to the banks' hearts. The discussions about treasury yields, inversions, debt levels and economic growth have been getting a lot of attention lately. We've recently seen reports about the record trade deficit in 2005 and the record levels of consumer and government debt. Mostly what I read are efforts to discredit any who are concerned about this. With the concern about a slowing economy in our future, high levels of debt will be that much more difficult to service. I know Bernanke feels it's different this time about the inversion of the yield curve but remember, the same argument has been made every time we've had a yield curve inversion in the past. There's always something different going on in the world or the economy, but the "experts" have always pooh-poohed the inversion only to find out it wasn't different after all.

A yield curve inversion may not accurately predict a coming recession but it always raises a red flag about the potential to see a slowing economy. To dismiss it out of hand is irrational and reckless by our financial leaders. Bernanke is showing his true colors already. I know his job is to talk up the economy to maintain a positive attitude so I probably shouldn't fault him too much. But I think he also has a responsibility to help others stay aware of the risks. Tough balance I suppose. And maybe it really will be different this time but the record says otherwise. We might not have a full-fledged recession but it's a warning that the economy will likely slow down.


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The stock market does not act favorably to a slowing economy. The decline in the price of oil and natural gas is also warning of that possibility as demand for those commodities slows. The price of copper, a good barometer of industrial production (and housing) requirements, has recently seen the largest price correction in about a year. I already mentioned the steep price correction in the price of lumber in the past month. So with these pieces of the puzzle fitting into a larger picture of a slowing economy I have to ask myself what the agenda might be for someone like Bernanke telling us it's different this time. And if I can't trust him on this issue, how can I trust him in the future on other issues. For example, why is the reporting of M-3 money supply going to stop in March? Does the Fed want to hide the fact that they're going to start creating lots and lots of money to possibly begin monetizing the government's debt? Inquiring minds would like to know.

A slowing economy would mean less tax revenue to the government (local, state and Federal) which of course would mean the current estimates for deficits may be better than what they'll probably end up being (assuming we're going to get a slowing economy). Individuals who lose jobs as a result of a slowing economy will obviously have trouble servicing higher levels of debt. The problem will be cumulative and is the reason for concern. After a poor 4th quarter we've seen a couple of indicators that show improvement in the economy and a week's worth of data suddenly makes the 4th quarter an anomaly. A burst of activity in January may not follow through into February so it's a bit premature to declare everything is all right. And it's not just a problem that the U.S. faces. The problem we might be facing is a global one and it will only make it worse and more difficult to correct.

I came across some information this week about consumer debt levels in the UK. Debts taken on by British families have overtaken the size of the economy (their GDP) for the first time ever. This accomplishment has come as bankruptcies have soared to record levels. The Bank of England voted last week to leave interest rates at 4.5% partly out of concern about the high levels of debt and what that might mean for the health of their economy. Unlike the U.S. they do not have the ability to create their own money out of electrons and must abide by real financial rules.

The Brits are worried about the double whammy from rising government and consumer debts. Bank figures show the combined amount owed by families rose by 10.2% which easily dwarfed their economic expansion of 1.8% last year. Now there is concern about slowing in their retail sales and their Bank Governor, Mervyn King, said he expects the Bank's growth forecast to be scaled back. The British Retail Consortium last week said they had their worst start to the year since 1995 as high debt has curbed shoppers' appetites. Richard Jeffrey, economist at Bridgewell Securities, accused the monetary policy committee of "stimulating domestic demand to maintain the overall growth rate, encouraging people to take out more debt and making Britain much more vulnerable to shocks." Does this sound at all familiar? We in the U.S. are not the only ones who have a lock on this problem.

Back to the yield curve, for those who would like to track this, a good site that Jeff Bailey first mentioned to us is http://www.bloomberg.com/markets/rates/index.html and it will give you the current rates and a graph of the yield curve.

U.S. Treasury rates, courtesy Bloomberg

The slope of this curve is normally heading up from left to right. As you can see it's now heading down, hence all the discussion about the yield curve inversion. I think a conservative approach should be let's see if it will be different this time since history shows it probably won't be. It's not necessarily predicting a recession though. I've mentioned it before but it's worth repeating and you can keep an eye on this yourself (and ignore the noise you hear from the pundits who "know better" this time). Watch the 90-day average of the difference between the 3-month rate and the 10-year rate. Studies have shown a 100% accuracy rate at predicting a recession within 6-9 months after this 90-day average is inverted. Currently the 3-month rate is 4.54% and the 10-year is 4.59% so no inversion there yet but awfully close.

With the yield inversion, which typically hurts banks because they earn less on their longer term loans while paying more for their own short term loans and to their customers' savings and checking accounts, I'm a little surprised to see the banks bouncing as hard as they have in the past week. But bounce they have.

BKX banking index, Daily chart

The banks have seen some strong buying in the pat 7 trading days. There was one inside day among those 7. By the way, watch the number 7 since it often marks a reversal after 7 days in one direction. It's that rhythm thing. But if the banks manage to rally a little further they'll get another test of the December/January highs. I don't think it will have much luck beyond that, if it even gets there. There is an internal Fib projection for the current move though and it's at 106.60 which is right at the top of its parallel channel again.

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

The home builders got a bounce off today's housing start data and it could carry a little further. It has several layers of resistance including Fib retracements and moving averages up to the 940 area. If we're going to see a small 4th wave consolidation for this decline since the January high, it could just go sideways to relieve some of the oversold conditions before heading down to what should be firmer support at the uptrend line from March 2003 and its H&S neckline (more easily seen on the weekly chart), both located near 822.

Oil chart, March contract, Daily

Oil barely treated its uptrend line from a year ago, and its 200-dma at the same location, as a speed bump. It was one of those low speed bumps that you can take at normal speed. If oil bounces back up to that uptrend line/200-dma, both approaching $62, it will likely be strong resistance. However, I suspect it will do more of a sideways consolidation before heading lower again. The first Fib target of $55.70 would be an initial target, especially since it lines up with a longer term uptrend line from January-December 2004.

Working gas in storage was reported by EIA today and showed a net decline of 102 Bcf 2,266 Bcf from the previous week. Stocks were 444 Bcf higher than last year at this time and 691 Bcf above the 5-year average of 1,575 Bcf. The price of NG was up 9 cents on the day, closing at $7.135 (March contract). It hit a low yesterday at $6.975 before turning back up. These are lows not seen since the months of October 2004 through February 2005.

Oil Index chart, Daily

The oil stocks found support at their short term uptrend line from October and may find resistance now at the 50-dma at 554.57. But it may completed its first leg down in its new decline so a bounce that retraces 38-62% of the decline from the January high could be in the works, especially if oil bounces up further to its broken uptrend line.

Transportation Index chart, Daily

All the choppy and corrective (3-wave) price action since the December low now makes sense to me in this index. For the life of me I couldn't figure out why it wasn't rallying or declining in an impulsive fashion which would have indicated either much higher or lower prices coming. The continuation of the bearish divergences was a warning something was wrong with the rally (never mind the continuing divergence with the DOW which is still a long ways from making its own all-time highs thus leaving a bearish non-confirmation according to Dow Theory) and yet we kept getting new highs in the Trannies. Now with this new push higher it's making more sense when I consider the formation of an ascending wedge, which is very typical for the last wave (wave-5). The bearish divergence supports this idea.

For those who don't want to see an explanation of the TRAN's pattern using EW analysis, skip down the chart of the dollar. But the pattern in the TRAN has set up a very nice pattern and unless it continues rallying tomorrow, I thought I'd show why I think the rally is now done.

Transportation Index chart, 120-min

Looking at the ascending wedge (ending diagonal in EW terminology) a little closer, I've counted out the internal waves. These ending diagonals are the exception to the rule where waves-1 and -4 can't overlap, and each wave consists of a corrective pattern (3 waves or some variation of that). And that's what we have playing out inside this pattern. Today's rally took the index above the top of the pattern and then fell back inside the pattern which is bearish. It closed right on the line today and leaves us guessing about tomorrow.

Transportation Index chart, 60-min

Looking even closer at the last leg up, wave-5, I show the a-b-c pattern for it and that wave-c consists of an impulsive 5-wave count, as all c-waves do. The bounce into today's close has retraced 50% of today's decline and is therefore set up for a drop tomorrow. If it continues rallying higher, consider this an exercise in EW counting that didn't play out like I thought it would. But so far I like the setup for a decline pretty much out of the gates tomorrow.

U.S. Dollar chart, Daily

The U.S. dollar continues to press up against its broken uptrend line from early 2005. It should continue to find support at its 20, 50 or 200-dma's on any pullback now, which it looks like it's ready for.

Gold chart, April contract, Daily

Gold has found support at its 50-dma which is also where it has an uptrend line from November. I expect we'll see a volatile pullback so I wouldn't be surprised to see gold bounce back up to $560, even $570, but the longer term pattern looks set--we should be at the start of a multi-month pullback correction. As we head into the summer it might be a good time to start accumulating gold again but let this correct now.

Results of today's economic reports and tomorrow's reports include the following:

Tomorrow's economic reports have the potential to move the market. Core PPI and PPI will be reported at 8:30 AM and these numbers need to be just right. If they're too high it will renew fears of an aggressive Fed to curb inflation. If they're too low it will spark fears of an economic slowdown. The Michigan Sentiment number comes out just after the open and could also derail the rally if it were to surprise to the downside. That's not expected, but then again that's why it would be a surprise.

The DOW got a major boost by Hewlett Packard (HPQ 34.02 +2.35) today, up 7.4% today to new 52-week highs. Investors seemed pleased/relieved with its earnings report last night and its guidance. Dell (31.96 +0.19) reported after the bell a Q4 net income of $1.01B, or 43 cents a share, up from $667M, or 26 cents a share, in the same period last year. Sales rose 13% to $15.18B from $13.46B, and profit increased by 51%. Having an extra week in the quarter, compared the year ago quarter, helped their sales and profit numbers. Expectations had been for Dell to earn 41 cents a share on revenue of $14.8B so they beat both revenue and net income. Their stock price jumped after the 16:00 close to a high of 32.99 but then settled back down to close at $31.69. I did not get a chance to hear how their conference went nor what kind of guidance they were giving. The fact that the stock price dropped back down and closed negative means investors weren't real happy with their guidance. The futures weren't greatly influenced either way by the Dell numbers which was a bit surprising. I think they had their own agenda today and achieved it.

Sector action backed up today's bullish numbers. There were only 3 sectors on my list in the red today. Leading to the downside (-1.6%) was the healthcare index followed by the airlines and the Transports. As I had mentioned for the Trannies, there is a distinct possibility we've seen the top in that index. But the green sectors were led by the energy indices, computer hardware, gold and silver, telecoms, biotechs, the SOX and securities brokers. Today was bullish--price and internals agreed. Up volume was 3x down volume and the number of advancing issues was a little more than double the declining issues. The number of new highs swamped new lows 461 to 37 which is obviously much greater than a 10:1 ratio and borders on blow-off. The number of stocks above their respective 5, 10 and 20-dma's is in overbought territory so these numbers suggest caution and a potential reversal just ahead. The resistance levels discussed on the charts above suggest it could be difficult to make further headway tomorrow so these overbought numbers are a yellow flag to the bulls right now and may be getting ready to drop the green flag for the bears.

We have an interesting development for tomorrow--I see several reasons for caution when I look at the charts since I see the potential for a reversal to the downside tomorrow. The Stock Traders Almanac mentions that the market has been down 13 of the past 14 years on the Friday before Presidents Day (which is tomorrow). It has been down hard the past 11 years. It also mentions that if the Tuesday following Presidents Day is down it tends to be down hard. So tomorrow and next Tuesday hold a little extra risk for longs. Monday, Presidents Day, is an exchange holiday. I hope everyone has a great 3-day weekend ahead of us. Good luck tomorrow, be careful if you're long and if we get the roll over try playing the short side since it could end up being a nice ride back down. I'll see you on the Monitor tomorrow.

I won't normally close with a funny story but this one had me literally rolling on the floor (sick mind that I have) and I just had to share it with you. Hopefully you don't mind.

The Pocket Taser Stun Gun, a great gift for the Wife.

This was submitted by a guy who purchased his lovely wife a "pocket
Taser" for their anniversary.

Last weekend I saw something at Larry's Pistol & Pawn Shop that
sparked my interest. The occasion was our 22nd anniversary and I
was looking for a little something extra for my wife Toni. What I
came across was a 100,000-volt, pocket/purse-sized taser. The
effects of the taser were supposed to be short lived, with no
long-term affect on your assailant, allowing her adequate time to
retreat to safety.... WAY TOO COOL! Long story short, I bought the device and brought it home. I loaded two triple-a batteries in the darn thing and pushed the button. Nothing! I was disappointed. I learned, however, that if I pushed the button AND pressed it against a metal surface at the same time; I'd get the blue arch of electricity darting back and forth between the prongs. Awesome!!!

Unfortunately, I have yet to explain to Toni what that burn spot is
on the face of her microwave. Okay, so I was home alone with this
new toy, thinking to myself that it couldn't be all that bad with
only two triple-a batteries,...right? So there I sat in my recliner, my cat Gracie looking on intently (trusting little soul) while I was reading the directions and thinking that I really needed to try this thing out on a flesh & blood moving target. I must admit I thought about zapping Gracie (for a fraction of a second) and thought better of it. She is such a sweet cat. But, if I was going to give this thing to my wife to protect herself against a mugger, I did want some assurance that it would work as advertised. Am I wrong?

So, there I sat in a pair of shorts and a tank top with my reading
glasses perched delicately on the bridge of my nose, directions in
one hand, taser in another. The directions said that a one-second
burst would shock and disorient your assailant; a two-second burst
was supposed to cause muscle spasms and a major loss of bodily
control; a three-second burst would purportedly make your assailant
flop on the ground like a fish out of water. Any burst longer than
three seconds would be wasting the batteries. All the while I'm looking at this little device measuring about 5"long, less than 3/4 inch in circumference; pretty cute really and loaded with two itsy, bitsy triple-a batteries) thinking to myself, "no possible way!"

What happened next is almost beyond description, but I'll do my
best.....I'm sitting there alone, Gracie looking on with her head
cocked to one side as to say, "don't do it master," reasoning that a
one-second burst from such a tiny little ole thing couldn't hurt all
that bad....I decided to give myself a one-second burst just for the heck of it. I touched the prongs to my naked thigh, pushed the button, and HOLY MOTHER, WEAPONS OF MASS DESTRUCTION@!@$$!% !@*!!! I'm pretty sure Jessie Ventura ran in through the side door, picked me up in the recliner, then body slammed us both on the carpet, over and over and over again. I vaguely recall waking up on my side in the fetal position, with tears in my eyes, body soaking wet, both arms tucked under my body in the oddest position, and tingling in my legs. The cat was standing over me making meowing sounds I had never heard before, licking my face, undoubtedly thinking to herself, "do it again, do it again!"

Note: If you ever feel compelled to "mug" yourself with a taser, one
note of caution: there is no such thing as a one-second burst when
you zap yourself. You will not let go of that thing until it is
dislodged from your hand by a violent thrashing about on the floor.
A three second burst would be considered conservative. SON-OF-A-.... that hurt like hell!!! A minute or so later (I can't be sure, as time was a relative thing at that point), collected my wits (what little I had left), sat up and surveyed the landscape. My bent reading glasses were on the mantle of the fireplace. How did they up get there??? My triceps, right thigh and both nipples were still twitching. My face felt like it had been shot up with Novocain, and my bottom lip weighed 88 lbs.

I'm still looking for my testicles. I'm offering a significant
reward for their safe return.

Still in shock,

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