Option Investor
Market Wrap

An Old Pattern Revisited . . . or Revised?

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For many months, the SPX established a pattern with other indices often following along. A strong gain was followed by three or four days of sideways-to-sideways-up consolidation. Then the SPX would dip to or toward the 10-sma, spring up and begin again.

During the pre-market and early cash sessions this morning, futures and early equity action indicated that the SPX and other indices were prepped for that next strong gain. By noon, indices had hit the tops of recent consolidation zones and paused. Was the recent pattern about to be revisited or revised?


The pattern repeated with but only on some indices. The SPX revised its pattern to create a gain but not a solid breakout. Breadth indications were positive, other than the fact that volume proved somewhat lighter than it had been recently. Other than some minor breakouts, such as that seen on the tech-heavy Nasdaq and the almost obligatory Dow close above 14,000, the new breakouts failed to appear. That Dow close was only 0.41 above 14,000, so bulls achieved the psychological target but only barely.

The mood was right during the pre-market and early cash sessions, with the enthusiasm for equities prompted by upbeat earnings reports from IBM, CAL and Juniper Networks, among others. However, as soon as FOMC Chairman Ben Bernanke's second day or testimony before Congress began today, senators addressed a steady stream of questions to the chairman, changing that mood. Their questions focused on the impacts of the housing slump, the sub-prime problem and a negative savings rate.

In addition, although Japan experienced an earthquake, it was China that sent out shock waves last night. The tremors might have been subtly felt by equity traders, too, like the rumbling of a heavy truck on a distant highway. During the overnight session, China's government announced that its GDP for the quarter that ended in June expanded 11.9 percent, far more than the predicted, already hot 10.8 percent and last quarter's 11.5 percent. Headline writers immediately speculated about when and how the Chinese government might choose to tighten money supply, either by raising interest rates or reserve requirements. In our current global-economies climate, fears about rate hikes can be quickly transported from one country to another.

Any tremors were dampened by the distance, however. Bond yields did not break out of their recent congestion zone. Ten-year yields closed the day at 5.04 percent, just above yesterday's close at 5.01 percent.

Add in crude futures above $75.00, a disappointing Philly Fed report, concerns about inflation expressed in the FOMC minutes and the usual opex pin-them-to-the-numbers action that begins about mid-morning on opex Thursday, and the day was set up for a revision of the SPX's typical pattern.


Last Thursday, I asked those subscribers who were long call options to make a plan that night for how they would react if the indices began a sideways-to-sideways-up consolidation the next day, as I expected them to do. That typical pattern, if revisited, would have meant consolidation for a number of days, I warned, days that would eat away at extrinsic option premium for July options.

That's exactly what happened. Although we did see some higher numbers early in the week, the SPX essentially consolidated sideways to sideways up and then dipped to its 10-sma yesterday. I tracked an ATM option's price for a Trader's Corner article I was writing into that expected dip, and the result of all that consolidation and subsequent dip on the option's premium wasn't pretty.

Today should have been a follow-through day after yesterday's spring from support. Let's see what happened with the SPX.

Annotated Daily Chart of the SPX:
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Daily nested Keltner charts (not shown) peg next resistance at 1559 on daily closes and then at about 1565 and then about 1570-1571 on daily closes. If the SPX can break above this week's resistance zone, those levels should be watched for next resistance. I'm not at all sure that breakout will occur, however, and neither were the investors participating in today's gains. They weren't willing to buy above certain levels.

Annotated Daily Chart of the Dow:
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The Dow, unlike the SPX, is in breakout mode on the daily nested Keltner chart, but it ended the day at potential resistance. As long as it's producing closes above a Keltner line currently at 13,817 but still rising, it's remaining in breakout mode, but it's beginning to be overdue a trip down to retest that breakout level and possibly even to a channel line now at about 13,641 but still rising.

Annotated Daily Chart of the Nasdaq:
[Image 4]

Like the Dow, the Nasdaq is in breakout mode on its daily Keltner chart, but perhaps due to retest the breakout level, at about 2697 as of the close, but still rising. A trip down to a channel line at about 2660 might be due, too, but can't be predicted yet.

Annotated Daily Chart of the SOX:
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The SOX's triangle forms at the breakout level on its daily Keltner chart. This outer channel boundary line often serves as resistance, but when prices close consistently above the channel line, momentum has been proven to be strong. So far, the SOX is not closing consistently above that channel line but rather is forming candles right along it. Resistance is tentatively holding. I took a look at On-Balance Volume for the SMH, not a perfect proxy for the SOX, but one that allows me to look at volume patterns. OBV has been rising as SMH price rises, so there's no divergence in that pattern as yet, although OBV isn't as high now as it was in April and May.

Annotated Daily Chart of the RUT:
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The Russell 2000's Keltner outlook is similar to the one seen on a traditional chart. The RUT chops around as various channels line up one inside each other rather than converging, showing where resistance or support may lie. No strong preference is shown to resistance or support on the Keltner chart, so that it's difficult to predict whether the RUT might be more likely to move up or down.

Today's Developments

Today unveiled several important economic releases or events, but the first releases of the day--weekly jobless claims and the Conference Board's Leading Indicators--aren't often market moving. Economists had predicted that initial jobless claims for the week ending July 14 would rise to 315,000 from the previous 308,000, but instead they dipped to 301,000, a two-month low. That was a decline of 8,000 in initial claims. The four-week moving average also fell, declining 6,250 to 312,000.

The 301,000 number of initial claims approaches a key level of 300,000. Initial claims below that number suggest a labor market that might be tightening enough to add wage pressures to other inflation pressures.

However, continuing claims rose 20,000 to their highest level in three months. The four-week moving average of continuing claims rose to its highest level in four months. Once a job is lost, applicants are finding it difficult to obtain a new one, these numbers suggest.

The Conference Board June's Leading Indicators decreased 0.3 percent. This marks the fourth month out of the last six that the index has declined, with housing permits pushing the index lower in June. Only three out of ten indicators climbed, with average weekly manufacturing hours, stock prices and new orders for non-defense capital goods comprising those three.

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The lagging index increased 0.5 percent and the coincident one, 0.2 percent. The Conference Board noted that the strengths in the coincident index have been broad even if the rate of growth of this index has slowed. Four indicators comprise the coincident index: industrial production, personal income (less transfer payments), non-farm employees and manufacturing and trade sales. The Conference Board noted that the order in which these were listed was also their ranking as to which contributed the most to that positive coincident index.

Weekly natural gas inventories were released next. Those inventories rose by 65 billion cubic feet.

FOMC Chairman Ben Bernanke of course continued his two-day testimony today. Much attention focused again today on the sub-prime problem, with many questions addressed to Chairman Bernanke about the committee's responsibility to regulate banks' mortgage practices and their packaging of loans. Chairman Bernanke repeated a statement that has been addressed by other OptionInvestor writers: the committee's responsibility is to see that banks remain safe and sound. He did not add "not necessarily to protect the consumer," but that might be one subtext, although he did say that regulations better protecting consumers should be produced soon. He pointed out that the FOMC has no jurisdiction over the companies that rate the securities such as those that produced the problem with the two Bear Stearns' hedge funds this week.

Although Chairman Bernanke reiterated a belief shared by others, that the impact of foreclosures and delinquencies could continue to worsen before improvement, he also reassured senators that the sub-prime mortgage problem hasn't produced a system-wide credit crunch. He estimated the losses at $50 billion to $100 billion. Ouch.

In last night's Wrap, Keene mentioned that rising food prices were impacted by the government's focus on ethanol as a proposed solution to a potential energy crisis. One senator honed in on this topic during Chairman Bernanke's testimony. He repeated the lament that real people drive cars and eat food, and that rising energy and food costs did constitute inflation for the consumer even if core rates don't show the pressures to the same extent.

Chairman Bernanke's testimony was followed by the two most important releases or events of the day. At noon, the Philadelphia Federal District released the Philly Fed Survey, an indication of manufacturing strength or weakness in that district. The Philly Fed for July disappointed, the headline number coming in at 9.2 versus the expected 15.0.

A number above zero still indicates expansion, but July's number had tumbled from 18.0 in June. The prices-paid component eased but not enough to indicate that inflation pressures have been erased. The expectations index, the component that measures how businesses feel about the future, also rose, from 30.4 to 16.7. Shipments rose to 20.3 from 5.0 but the new orders index declined to 11.3 from 18.3.

At 2:00, the minutes from the June FOMC meeting were released. Those minutes revealed that some FOMC members do not share Chairman Bernanke's purported belief that inflation pressures are contained. Those members pointed to elevated headline inflation numbers and Treasury inflation-indexed securities that had moved higher.

Earnings reports picked up this week. So many important companies reported today before and after the bell that any discussion of earnings must remain brief. Upbeat reports from early reporters and those reporting last night, such as IBM, CAL and JNPR, were credited with creating a positive tenor this morning. As many of you will already know, IBM raised its full-year profit outlook last night with its quarterly performance termed its strongest in five years. JNPR also raised its full-year forecasts, producing a profitable quarter.

BAC also beat expectations, but equity investors didn't know what to think about financials with the sub-prime problem looming. They sent BAC's price up and down, doing nothing but churning price within a recent congestion zone. The day's candle was more negative than neutral, but did not break either recent $48.50 support or the July low.

In this weekend's edition of the newsletter, Jim Brown mentioned the importance of one company's earnings report today: MGIC (MTG). As Jim noted, this company insures most sub-prime loans. Jim thought this company could help pinpoint the impact or extent of the sub-prime problem.

MTG failed to meet expectations. The company reported that its Q2 earnings were almost halved. Net income was $76.7 million or $0.93 a share, down significantly from $149.8 million or $1.74 per share a year ago. The miss of expectations was significant, too, with analysts projecting $1.38 per share for this quarter.

Losses climbed from $235.2 million in the year-ago period to $146.5 million. California, Florida and the Midwest produced the biggest insurance losses, with those areas also the hardest hit by the housing slump.

Reporting companies today included AMD, GOOG, MSFT, BRCM, HON and MOT, among others. HON's quarterly profits beat expectations, rising 24 percent. Like many other companies today, HON raised full-year guidance.

A new financial security debuted today. MF Global listed at $30 a share, below the expected $36-39 range.

Crude futures pushed higher today, closing above $75.00 although the day's trading produced a candlestick formation that sometimes indicates that a pullback is near. Production at a key platform in Angola was cut down significantly due to an electrical problem, CNBC announced this morning, with a commentator there speculating that was the reason for the new recent highs produced today.

MSFT reported after the close. Revenue rose slightly more than anticipated, with the company calling the acceptance of its products, including Vista, "solid." Due to an already anticipated $1 billion chart from its Xbox video game business, fourth-quarter profit was only a few cents above its year-ago level, at $0.31 a share compared to $0.28 a year ago. If those charges had been excluded, earnings would have been $0.39 a share, right in line with expectations. Revenue, however, was only slightly above the expected $13.27 billion, at $13.37 billion. As I typed, MSFT was trading at $31.00 after closing at $31.51.

AMD results were just crossing the wire, too. The company reported a net loss of $600 million or $1.09 a share, down from its profit of $0.18 a share a year ago. Sales of $1.37 billion beat expectations, however, helped by a 38-percent increase in microprocessor shipments. AMD's share of global microprocessor shares increased from 10.9 percent to 11.4 percent, iSuppli said, as quoted in a Marketwatch.com article. As might have been anticipated, AMD wrote off older microprocessor parts and lowered prices for desktop chips, reporting margin pressure. AMD moved higher in after-hours trading.

Tomorrow's Economic and Earnings Releases

Tomorrow's economic releases will be mid-morning ones. June's Mass Layoffs, released at 10:00, will be followed by the ECRI Weekly Leading Index at 10:30.

Companies reporting tomorrow include C, CAT and SLB.

What about Tomorrow?

Indices sometimes clamp down in a pin-them-to-the-numbers action beginning about midmorning on opex Thursday and continuing through to Friday's close. That pattern certainly asserted itself today, working against the other pattern--that of a strong gain following the last week's type of action.

Such pin-them-to-the-numbers action renders my beloved Keltner channels less useful on an intraday basis than is typical, but let's look at what they show. We'll be looking specifically for evidence that the pin-them-to-the-numbers action could continue tomorrow morning. Remember that important earnings announcements after the bell this afternoon could change the outlook seen on these intraday charts.

Annotated 15-Minute Chart of the SPX:
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I didn't show lower indicators to make the upper chart clearer, but including indicators such as RSI wouldn't have proven much anyway. RSI flattened.

So, at least we see visual evidence of the resistance the SPX dealt with today, pinpointing breakout or rollover levels for tomorrow. Be careful of upside breakouts that are soon reversed, especially if occurring on the first 15-minute candle tomorrow. Those sometimes prove unreliable. If you're thinking about going long and use an upside breakout as an entry, be ready to bail quickly if markets reverse against you. That goes doubly if you intend to enter a bearish play on a supposed rollover. That tangle of lines below the SPX's current position indicates visually how tough it might be to get much lower during early trading at least if there's not a strong impetus.

The formation seen on this chart could be described as an inverse head-and-shoulders formation, but I distrust continuation-form inverse or reverse H&S's. Still, they're useful to watch if less useful for predictive purposes than they once were.

A break of mid-channel support, currently near 1546, on 15-minute closes, sets a potential downside target of 1538-1539.

The Dow's intraday chart proves similar.

Annotated 15-Minute Chart of the Dow:
[Image 8]

Annotated 15-Minute Chart of the Nasdaq:
[Image 9]

Annotated 15-Minute Chart of the RUT:
[Image 10]

All in all, these intraday charts suggest that the pin-them-to-the-numbers action could continue without offering convincing proof that it will. I just don't see and so don't have a strong conviction either way. Even when I get drawn back by the siren of daytrading, I don't trade opex Friday's much, and these kinds of setups are why. Even though the SPX and Dow setups seem to show perfect points from which to enter a long position on an upside breakout, for example, opex Friday's often feature upside breakouts or downside breakdowns that then go nowhere. Which is the real move and which will fizzle? That's hard to know on an opex Friday. Spend lottery money only on new plays tomorrow.

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