Option Investor
Market Wrap

Majors Stabilize as Financials Get a Bounce

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Stocks recouped some of Friday's losses to start the week, where after last Wednesday's delay for a $12 billion offering of bonds for Chrysler's financial division, financials stabilized and were atop today's list of sector winners.

But credit markets at the corporate level remain soft, and it still looks to me that bids are hard to find.

In recent week's I've noted how various companies have been canceling bond offerings due to "market conditions," and the cold response to Chrysler's deal certainly appeared to have equity bulls pulling there bids as the S&P 500 (SPX.X) suffered its largest weekly decline in more than five years last week.

U.S. Market Watch - 7/30/07 Close

The "junk bond" Pacholder High Yield (PHF) $9.35 -1.57% was atop today's list of losers, thus the observation that credit markets remain soft, with few traders or investors willing to do more that dip a big toe in the water.

Tonight, I provide some focus on the Chrysler deal, and the "junk bond" PHF as it was a key observation on July 19th that I thought traders and investors should be alert to.

7/19/07 Market Monitor - OptionInvestor.com

I haven't written a Market Wrap since July 16th, so I want to bring you up to speed on my (Jeff Bailey's) observation(s) of what has roiled the equity markets, starting on Thursday, July 19th.

If I could summarize in just a sentence, it would be what has taken place in the credit markets, that has spooked equity bulls.

Even a "junk bond" holder, or bond trader/investor that holds what the bond market would consider "high risk" paper, is a creditor. That is, the holder of the "junk bond" would stand to recoup some portion, if not all of his/her money even if the company were to go bankrupt.

As "risky" as a junk bond may be, it is still "safer" than corporate stock, as the creditors are in front of stockholders should liquidation occur.

With that in mind, it then becomes apparent that a "sharp decline" in a closed-end junk bond fund like Pacholder High Yield (PHF) in our U.S. Market Watch gets some attention.

Pacholder High Yield (PHF) - Daily Intervals

I did not, or would I have screamed "the sky is falling, the sky is falling" on July 19th, but I quickly became alert to weakness in the riskiest-end of the bond market.

Those that have followed my commentary in the Market Monitor know that I've been monitoring the Net Asset Value (NAV) of PHF at the end of each week, when this closed-end fund tabulates the value of its bond holdings each Thursday.

Even at tonight's close and the further sharp decline I'm not screaming "the sky is falling, the sky is falling," but I do think equity traders and investors need to have a grasp that WEAKNESS in the CREDIT markets does NOT bode well for the equity markets should it persist.

The "pulling of deals" in the bond market is really no different than a company that is slated for an Initial Public Offering (IPO) of its stock, where the company decides to delay the IPO due to "market conditions."


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We usually see a company delay its IPO debut do to "market conditions" when the equity markets have been under notable selling pressure, and the "appetite" for stock has been weak.

Say what you will about Chrysler and its future, but when they can't float a bond offering to debt market participants, what does that say about the eventual appetite for STOCKS, which in essence, stand below bond holders when we assess RISK?

Here's a table of major global equity markets and currencies that I've shown here in Market Wraps.

Did the RUT.X, a broader and smaller cap index lead a decline in the U.S.? Even though Chrysler would not be considered "small" could the lack of appetite for their bonds, due to a roiled credit market be impacting equities?

Global Equity Benchmarks / Currencies

In "yellow" are the major U.S. equity benchmarks, and if it weren't for the RUT.X's 7.66% decline since our last visit on July 16th (1.51% 6.15% = 7.66%), I could perhaps disregard the weakness in our "junk bond" indicator and the struggle with the Chrysler bond offering.

However, institutional market participants don't!

Right, or wrong, when the corporate credit markets are weak, that weakness then tends to turn toward equities.

It becomes somewhat of a "domino effect." Logic become "if the credit market sees risk, then the next domino is the EQUITY market."

Remember, as U.S. asset classes are viewed, Treasuries are deemed "safest" as they are backed by the full faith and credit of the U.S. Government. Corporate bonds carry various "ratings," but corporate bonds are backed by the full faith and credit of the company. "Junk bonds" are viewed as the RISKIEST of corporate debt.

From there, the next higher level of risk become EQUITY, or stock of a company.

The thought process is that there are SOME companies that will "rely" or need a stabile bond market in order to sell some debt.
Once debt is sold in the form of a bond, a company can utilize that cash to either pay down higher yielding debt, or perhaps fund an expansion of a facility.

So here is the most recent Net Asset Value's (NAV) of the Pacholder High Yield (PHF) fund.

Pacholder High Yield - Historical Net Asset Values

A rather sharp decline is now viewed in PHF's net asset value from 7/19/07 tabulation to 7/26/07. NAV is the actual value of those securities held by the fund.

The "Stock Price" is what value market participants like you and I placed on the fund (considering its attractive higher yield) at the close of each date's trade.

There are MANY closed-end funds that trade at premiums, or discounts to a fund's actual NAV.

Now, I will say this. At each night's close, you and I really don't know what the NAV of PHF is. The NAV is based on the prices of the fund's securities.

But we can at least see how "soft" the higher-risk end, or the junk bond portion of the credit markets are.

I will also say this. I've owned shares of PHF at times, and I've followed this fund for more than 10-years. I did not place it in my U.S. Market Watch because the fund hadn't proved itself as one of the more worthy closed-end junk bond funds available.

With that said, its recent weakness at a MINIMUM is a signal to me that there's continued weakness in the corporate credit markets, and we should be cognizant of that when looking at equity markets.

Assuming PHF's net asset value is still $9.57, then at tonight's close of $9.35, this closed-end junk bond fund would trade at a 2.29% DISCOUNT to net asset value.

At a closing price of $9.35, its SEC yield (based on $0.075/month dividend) would be 9.625%.

Russell 2000 Index (RUT.X) - Daily Intervals

Some index traders attempt to sell short, or put the STRONGEST index instead of selling short, or putting the WEAKEST index, even when the strongest index is breaking out to the upside. The "hope" is that the WEAKEST index will eventually "pull" the strongest indexes back lower.

I like to sell/put the WEAKEST index first! When/if weakness does come per the scenario, the WEAKEST usually leads the decline.

Some bulls like to BUY the WEAKEST index, hoping the STRONGEST index pulls higher and brings in SHORT covering for a much "bigger" bounce.

If we were to see the RUT.X begin to LEAD a near-term advance, I would have to analyze such an advance as SHORT covering.

Short covering advances after a BREAK DOWN like we've seen in the RUT.X is usually short-lived, and when the shorts stop covering and the bulls continue to LIQUIDATE, all eyes turn to the recent LOW and begin wondering where the next support level is at.

Watch those "junk bonds!" If they "firm" then perhaps the RUT's next downside LEVEL of risk is 763.85. Sell small caps on a rally.

Now look at a point and figure chart (supply= O / demand= X) of the Russell 2000 ($RUT) from StockCharts.com.

Russell 2000 Index ($RUT) - 4-point box

Today's lows for the $RUT was 770.59. Since the point and figure chart was "in a column of O" we would only chart further supply down to 772. The "blue ?" is simply a way that I like to see where the $RUT would have traded to its close.

Market internals are VERY WEAK for the broader indexes like the NYSE Composite ($NYA.X) and NASDAQ Composite ($COMPX) and the Russell 2000 is comprised of both NYSE and NASDAQ-listed stocks.

An "oversold bounce" is due, but this is the index I think will be of FOCUS to bears, and an index that BULLS still long will want out of.

Now, the S&P 500 ($SPX.X) is the second-weakest index and there have been some major changes here.

Bear Confirmed!

While the NYSE Bullish % (BPNYA) from DorseyWright & Associates is the major market bullish % that institutional investors and traders will monitor, the broad S&P 500 Bullish % (BPSPX) is also a widely followed bullish %.

On July 24th, Dorsey/Wright's S&P 500 Bullish % (BPSPX) reversed lower to "bear alert" status (falling from above 70% to below 70%) and on July 25th, this closely monitored bullish % achieved "bear confirmed" status.

In a few words, THE DEFENSIVE TEAM should be on the playing field.

In Friday evening's Market Monitor at Option Investor, I began laying out what I think traders and investors should be looking for.

07/27/07 Market Monitor -

There were many notes and observations that I began "walking through" in Friday evening's Market Monitor at OptionInvestor.com. One reason I wanted to spend some time in the Market Monitor late on a Friday evening was so that I could test my analysis today!

As you read the above post, here is the "link" of the widely followed S&P 500 Bullish % (BPSPX) as this is the foundation of how RISK and WEAKNESS/STRENGTH of a market is established.

S&P 500 Bullish % (BPSPX) - 2%-box size

The above BPSPX snapshot was taken at Friday's close. Today's action (Monday) was some further weakness with an additional decline of 0.81% (so net loss of 4 stocks' chart seeing reversing lower point and figure sell signals) to 53.02%.

However, when you read my Market Monitor postings, the key point is that we are looking for a recent point in time that would depict CURRENT levels of RISK and internals strength/weakness.

From there, we look for SIMILARITY, but more importantly, DIVERGENCE to the past.

07/27/07 Market Monitor -

Today (Monday) I think we see SIMILARITY to May of 2006.

S&P 500 Index (SPX) - 10-point chart

With the exception of the "blue ?," this is what we had to look at Friday evening for the S&P 500 Index (SPX).

Now, today's low was 1,454.32. Did the SPX trade 1,450?

Answer is No!

Since we didn't chart an "O," when then ask, "did the SPX see a 3-box reversal back higher to 1,490?"

Again, the answer is "No!" So, from an institutional trader/investor's perspective, there was NO MEANINGUL price action.

But remember! If history were to repeat itself, and RISK is the same as that found in late May of 2006, what MIGHT we look for from the SPX?

I'm thinking a bounce back to around 1,506, or 1,500 on the above chart.

Now what is the WEAKER market relative to the SPX?

Hopefully you've answered RUT.X.

What do you think LONG bulls might do with the SPX should it get a bounce back near 1,500-1,506?

Watch the RUT.X and find out.

All I'm doing here is "turning" the tables. In the June 9th Market Wrap I alerted traders to pending strength in the NARROWER INDU and noted the resumption of strength in the NASDAQ-100 Bullish % (BPNDX).

Now we're focusing on the BROADENING WEAKNESS and looking more bearish.

I should note that all major market bullish %, except the narrower NASDAQ-100 (BPNDX) from Dorsey/Wright are in a "bear phase" at tonight's writing.

The NASDAQ-100 Bullish % (BPNDX) has fallen to 70% from a recent high measure of 78%. It would take a measure of 68% to achieve "bear alert" status, and a weaker 66% to achieve "bear confirmed" status.

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