Option Investor
Market Wrap

The Boyz--and Girlz--Are Back

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The juniors at Wall Street's firms performed admirably this summer, roiling the markets but not letting them get too far out of hand. That almost happened the last two days, but the light volume yesterday questioned the importance of the supposed breakout. Suspiciously few of the boyz and girlz appeared to be partaking of that breakout, as Jim Brown noted in his Wrap last night.

Then rate-hike fears reasserted themselves this morning when the revision to the nonfarm business productivity data resulted in a five percent increase in unit labor costs, the fastest growth since 1990. Although a CNBC guest attempted to calm fears by asserting corporate profits were not showing any negative impact, as they surely would if unit labor costs were really rising so rapidly, bond traders didn't believe him. Bond yields had been climbing since yesterday morning, but then gapped higher again this morning after that report. Yields on the five-year, ten-year and thirty-year bonds all gapped higher but all retraced some of their gaps without closing them.

Mid-afternoon, some traders appeared to hope that the Beige Book would deliver more encouraging information. Equities bounced off intraday oversold levels. They resumed their decline when the Beige Book survey provided a weak echo of the earlier report, with moderating, and in some cases, sluggish growth; strong labor results; and sustained higher costs among some raw materials, even if those costs weren't yet being passed on to consumers.


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By the end of the day, the Russell 2000, a recent upside leader, had erased almost a week's worth of gains, dropping 2.12 percent. The SOX had fallen 3.04 percent. The OIX had dropped 2.99 percent and the XOI, 3.45 percent, with these two oil-related indices among the leaders to the downside. Crude might have dropped, but that meant that energy-related stocks provided no help to the SPX and instead pressured it lower. The TRAN wasn't helped by the decline in crude and was hurt by signs of a moderating of economic growth, dropping 1.76 percent.

Not all was bad, however. GM gained 2.39 percent and Ford, 1.90. MO lost only 0.02 percent, with this stock sometimes being a defensive play. The BIX, the S&P Banks Index, posted a 0.02 percent gain. There wasn't much else that was green on my screen, however, including the important SPX.

Annotated Daily Chart of the SPX:

As the day ended, the SPX was showing tentative price/RSI bullish divergence on its 15-minute Keltner chart, but had set a downside target of 1296.78. Although 1300 is of course psychological support, the real support lies lower, I believe, as indicated on the SPX chart's annotations.

Some Keltner evidence existed that the SPX could bounce ahead of a further attempt at that 1296.78 short-term Keltner target, with 1301.80-1301.94 next resistance on 15-minute closes, at least as of the close today. Remember that those lines are dynamic and will change tomorrow morning, moving in the direction of the first SPX move. Next resistance above the 1302-ish zone is near 1306, a possible neckline area for a potential inverse H&S. While I don't give great credence to these formations meeting their targets, watching whether they're confirmed or fall apart tells us something about short-term bearish or bullish strength, so I do watch them.

Today the Dow completed a classic and nearly perfect three-candle reversal formation on its daily chart. A retest of the 10-sma seems likely, if not a deeper drop to the rising 30-sma.

Annotated Daily Chart of the Dow:

Like the SPX, the Dow was showing tentative bullish price/RSI divergence on its 15-minute chart as of the close, so it's possible that the Dow will attempt to rise to retest resistance tomorrow morning. Support still turns lower, at 11,395 as of the close, and then at 11,331.42, with nearby resistance at 11,412.61 and then stronger, at 11,418.51. The 15-minute chart looks like prices could keep sliding down that descending support level, but remain aware of that potential bullish divergence and be prepared for a bounce attempt. As the chart is aligned as of the close, 11,418.51 and then 11,431.47 look like strong resistance, but the Dow can be pushed around more easily than other indices.

The SOX let the techs down early in the week, but the RUT held up for a long while, helping support sentiment for tech stocks and the Nasdaq. Today, the RUT gave way, and so did the Nasdaq.

Annotated Daily Chart of the Nasdaq:

The inverse H&S referenced on the chart is the large one spanning all the summer months, not yet finished forming much less confirmed.

The Nasdaq ended the day on its 10-sma and, more importantly, its 100-sma. That, plus daily Keltner support at 2165.10, could combine to help steady the Nasdaq. That's not what the 15-minute Keltner chart suggests, however, with the Nasdaq having set a short-term downside target of 2159.91. The Nasdaq may have a retest of its 31.8 percent retracement of its summer swoon in store, with that Fib level now at 2151.98. I wouldn't be surprised to see a drop somewhere between those last two numbers, at least, say near 2155, and some charts suggest a more pronounced drop, down into the 2144-2145 zone. Watch the Russell 2000 and SOX for clues, as this one proves hard to gauge. Studying charts for various time intervals produces different short-term outlooks, but I'm thinking that a punch down toward 2155 appears likely and I wouldn't be utterly surprised to see 2145 tested, depending on what happens with the SOX.

Although the SOX might have begun a pullback ahead of the Russell 2000, the SOX's pullback perhaps looks a little more corrective and a little less dismal than the RUT's. The SOX ended the day on potential trendline support, with its potential inverse H&S formation intact.

Annotated Daily Chart of the SOX:

The potential inverse H&S formation can be seen with the head at the July low, the left shoulder along the top of the rising red trendline and the right shoulder forming now, in the same region as the left shoulder. The SOX also maintains a rising trendline that could be drawn off its July low, so this chart does not look particularly bearish as yet.

The SOX also ended the day testing 15-minute Keltner support at 437.85, closing just below that support. Since the SOX often overruns support or resistance, I don't consider that violated just yet, especially with bullish price/RSI divergence. The SOX might be one of the first indices to bounce, if there is indeed going to be any bounce attempt, sustained or otherwise. Over the last few days, the SOX has found resistance on 30-minute closes at a line now near 439.50, so that level should be watched first for resistance. Bulls should be particularly wary if the SOX does not bounce but instead gives way, changing that corrective-looking pullback to something entirely different.

While the Russell 2000 also did not violate a rising trendline off its July low, its action was decidedly bearish, and RUT bulls need to pull their act together. Today, the Russell 2000 plummeted from yesterday's close just a few points above the 50 percent retracement of the summer's decline, all the way to the 38.2 percent retracement of that same decline. It violated its 100- and 200-sma's. It did find support at its 10-sma, near tentative historical support in the same 712 zone, and it did not, of course, violate potential round-number support at 700, but that's about all that could be said in defense of RUT bulls, if they didn't all bail out today.

Annotated Daily Chart of the Russell 2000:

The RUT appears to have retraced the minimal amount it needs to retrace to retest the resistance level that had held several times during the summer, but it did it all in one day. That has to have scared RUT bulls, and now the index may need to retrace further to at least retest that descending red trendline seen above. Today's steep drop right into the close suggested that there's still some selling to be done, but watch for a potential bounce attempt from 704-707, if not before. The 15-minute Keltner chart suggested the possibility of a bounce attempt as early as 711, but it did not necessarily suggest that such an attempt would be successful, as resistance still looked stronger than support on that chart.

The day's economic reports started this decline, or so the television commentators will say. Long-term OIN readers know that we don't see the real direction of the markets until the big-money boyz and girlz return from their summer vacations. I'm not sure they've all quite returned. Today's 4.4 billion volume certainly trumped yesterday's 3.9 billion, but it wasn't what would be called monster volume, either.

The reports began at 7:00 when the Mortgage Bankers Association released its weekly mortgage application volume survey for the week ending September 1. The overall index measuring mortgage loan application volume increased 1.8 percent week over week on a seasonally adjusted basis, but that doesn't tell the whole or the real story. On an unadjusted basis and when compared to the same week a year ago, that volume fell 26.1 percent. Other components were mixed, with the refinance component lower week over week by 0.9 percent. Refinancings also decreased as a percentage of total mortgage activity. Four-week moving averages were up for all components measured as the interest rate for 30-year fixed-rate mortgages fell to 6.31 percent from the previous week's 6.39 percent. Points increased, however.

The Labor Department's revision to the second-quarter's nonfarm productivity data proved the catalyst to early market direction, however. Expectations for the unit labor costs had been for an increase of 1.5 percent, so that the actual 5 percent increase proved shocking. That increase results in an annualized increase of 4.9 percent, well above the previous 4.2 percent. Productivity increases can sometimes offset a rise in unit labor costs, and productivity did rise an annualized 1.6 percent, more than the previously estimated 1.1 percent. That's not enough to offset the rise in unit labor costs, some experts contend.

Even worse, the first quarter's data was revised to show unit labor costs increasing a whopping annualized 9.0 percent. Year-ago comparisons for all these numbers also prove troubling, clearly showing unit labor costs rising faster than productivity. In the past year, unit labor costs have risen 5 percent; real hourly compensation, 3.6 percent; and productivity, only 2.5 percent.

As troubling as these numbers were on the surface, market participants still had some sorting through to do before they came to a final conclusion. Outside the financial corporate sector, first-quarter productivity rose 11.1 percent, the most it's risen in 35 years. For the last year, productivity outside the financial sector rose 4.8 percent; real hourly compensation, 3.4 percent; and unit labor costs, 3.4 percent, so productivity was rising faster than wages.

Even when the headline number is reconsidered, some believe the evidence difficult to weigh. A rise in productivity is clearly good for industry, and a rise in real compensation helps the consumer deal with inflationary pressures. The market just didn't buy that more benign explanation today, however.

The Institute for Supply Management reported later on the August ISM services index. That number proved surprising, too, with economists predicting an increase to only 55.4 percent, while the actual increase was to 57.0 percent. July's number had been 54.8 percent. The boom-or-bust number is 50 percent for this index. Some components of this number may have eased the jitters engendered by the productivity number, at least for a few minutes, because the price index, the component measuring price increases, fell to 72.4 percent from July's 74.8 percent. The employment index decreased to 51.4 percent, down from its pervious 54.5 percent. However, new orders also fell, to 52.1 percent, down from the previous 55.6 percent.

Monday's holiday resulted in a postponement of the crude inventories number until tomorrow. Crude closed lower by 1.5 percent, at $67.55 (QCharts, intraday) or $67.57 (QCharts, daily) a barrel. The OIX and XOI were hard hit, with their component stocks not able to help the SPX today.

Another release, advertising spending, came in about midmorning. TNS Media Intelligence reported that advertising spending rose 4.1 percent for the first half of this year, but that was less than the expected 4.5 percent. The expected number had been trimmed twice. Ads in local newspapers dropped 3.9 percent. Ads in consumer magazines were up by 4.4 percent, but had softened from previous numbers. Advertising during the World Cup and Olympic blitzes increased spending on the Spanish Language Media and network TV. Internet display advertising did rise 18.9 percent.

Indices rebounded a bit into the afternoon release of the Beige Book, the Federal Reserve's survey of current economic conditions across its twelve districts, conducted before the end of August, but then indices resumed their downward course. Although economic growth continued, the report concluded, the pace of that growth softened, with five out of the twelve districts seeing what the Federal Reserve termed a "deceleration" of growth. One of those five, the Dallas district, was seeing a deceleration from a particularly strong growth to a strong growth so that its deceleration could be partially discounted, while Boston, New York, Philadelphia and Kansas City saw more of a deceleration.

The report concluded that manufacturers did not appear to be able to pass cost increases in metals, energy and other raw materials onto finished consumer goods. Presumably that would have dampened rate-hike fears, but the fear of a slowing economy may have increased after the report.

Consumer spending was affected by slower auto and home-improvement-related sales. It's no surprise to anyone watching the housing market that home improvement sales might be slowing, and the Beige Book confirmed that real estate markets are weak across the country. The survey didn't find many changes in the labor markets, with those appearing strong but with only spotty reports of upward wage pressures and labor shortages.

Although this report was mostly in keeping with the earlier reports, it did echo worries about a slowing economy along with higher materials costs and rising wage pressures, even if only on scattered fronts.

Companies in the news included Ford (F), General Motors (GM), Cisco (CSCO) and a number of energy-related companies. Ford announced a new CEO, Alan Mulally, formerly of Boeing. Analysts appeared surprised by the move that included Henry Ford's great-grandson giving up his post to Mulally. Some credit Mulally with the revival of the commercial plane business at Boeing after 9/11. Some analysts applauded Ford's move, speculating that Ford's turnaround would move faster; others noted that Mulally had been passed over a couple of times for promotion while at Boeing and questioned how easy it would be to transition from jets to cars. In an interview on CNBC, Mulally claimed that while at Boeing, he had needed to meet consumer demand, and he can do that with Ford, too. Citigroup upgraded F's stock from a sell rating to a hold rating.

GM announced a new consumer initiative. Some expected the announcement to include longer warranties, and the announcement did include a five-year, 100,000-mile powertrain limited warranty. Articles mention that this is a tactic borrowed from Hyundai. Hyundai's 100,000 warranty, enacted in 1999, was credited with helping increase sales of the Korean car. GM will begin its version with 2007's cars and trucks and will include all eight GM brands. It will also be retroactive to the 2007 cars or trucks already sold.

Cisco gained attention when CFO Dennis Powell reaffirmed the company's forecast first made in early August for the quarter and the full year. The company's first fiscal quarter ends in October, and Powell believes that 19-21 percent growth is possible if Scientific-Atlanta sales are included, or 11-13 percent without them. He believes that sales will increase 15-20 percent for the full year if Scientific-Atlanta sales are included. Excluding those results, the company's revenue will rise 10-15 percent. Powell detailed continued plans for the active stock buy-back program and also volunteered to his audience of reporters and financial analysts that the company would eventually pay a dividend. Investors weren't impressed, and CSCO dropped 1.85 percent.

In other company-specific news, Citigroup downgraded refiners Sunoco Inc. (SUN) and Valero Energy Corporation (VLO). After the close, Market Biosciences Corp. (MATK) fell after it shaves its earnings estimates for the fourth quarter to a level below analysts' estimates. KB Homes (KBH) announced that the third quarter's preliminary net orders had declined 43 percent.

Tomorrow's releases include initial claims for the week ending September 2 at 8:30, followed by a couple of releases at 10:00. The fourth-quarter 2005 business employment will be released, as will July's wholesale trade. Consensus for the wholesale trade number is a gain of 0.8 percent, matching the previous number. If the inventories portion of this number changes enough to impact the GDP, this could be a market-moving number, but otherwise, it typically has little impact on the markets. Crude and natural gas inventories follow at 10:30.

Earnings have slowed down considerably, and it's now earnings warnings such as MATK's after-hours announcement or raised guidances that have the potential to impact the markets.

As Jane Fox noted on the Market Monitor today, the Bank of Japan begins a much-watched two-day policy meeting Thursday, which would be during our overnight session tonight. The Bank of Japan and its governor, Toshihiko Fukui, is expected to leave the rates at 0.25 percent, but the statement coming out of that meeting will be much watched. The government and the Bank of Japan often disagree about the pace at which Japan's monetary policy will be tightened, with the government fearing that a too-quick move would threaten Japan's long-time-coming recovery. Some argue that Fukui will take amore hawkish tone and warn of future rate hikes while others theorize that he'll keep to the established statement. Our markets' movements have not had as much correspondence to Japan's lately as they once did, since the two countries are presumably at far different points in their rate-hike cycle, but I mention it for those who might watch the Nikkei to see how it reacts to our developments. Tonight, its reactions might be governed more by their own rate-hike fears than ours.

Tomorrow is the Thursday before option expiration week, and that's a Thursday that often produces crazy market action as big-money people are rolling out of September positions and into October ones. The VIX sometimes isn't a great help in measuring the markets and there sometimes is not much relevance in that day's action when compared to what happened the Wednesday that preceded it.

With that information to keep in context, I see charts that appear to need at least a little more retracement before strongest support is reached. The RUT's day was horrible and many other indices produced legitimate reversal signals, so my expectation, at the least, would be to see prices punch a bit lower sometime during the day, with the most bullish possibility then being a bounce attempt, leaving a long tail springing up from support. That bullish possibility doesn't have to occur, however, so if you're tempted to step in and buy a dip, be ready to step right back out if needed.

That's the best-of-the-bad short-term outlooks that charts are giving, but the markets can do anything they want. Charts don't present a good case for a strong bounce tomorrow, but if prices can drop heavily one day, they can rise as quickly the next, although that's less likely than a heavy drop. Many indices sport potential inverse H&S's on their daily charts, with those formations spanning the summer months, so we could be in another chop zone as those right shoulders attempt to form. We had some short-term bearish action today, but it should be looked at in the context of rising support from July holding on most indices and potential bullish inverse H&S's forming on many daily charts. Some may have been waiting for the "magic" numbers such as SPX 1300 to buy, although I believe stronger support to be below that, so some attempts to buy dips may begin tomorrow. If you're in short-term bearish positions, keep following the price movement down with your stops so you don't lose too much of your profits if a stronger reversal begins.

Watch the RUT and watch the SOX for clues. If you're a Dow or SPX trader, check the RLX and TRAN, too, as those often serve as indicator indices in the same way the RUT and SOX do. And all should study bond yields from time to time, as they're often reacting ahead of the equities, as they did when they began rising Tuesday, ahead of the equity downturn.

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