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Market Wrap

"Spooky Action at a Distance"

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That once-famous quote comes from Einstein. Einstein spent much of his latter life battling against some of the implications of the quantum theory that he ushered into being near the turn of the twentieth century. He didn't believe that something that happened to one quantum particle should impact what happened to another that was separated by a great distance from the first. He also was troubled by quantum theory's requirement that a particle wasn't in a particular position, but rather had a certain probability of being in that position until we observed it and it was located there. Something wasn't right, he felt, and the man who had done away with the nebulous ether then spent decades trying to discover some absolute reality that existed even when we weren't observing it.

We who watch the markets have observed some "spooky action at a distance" ourselves, with markets impacted by forces we can't always detect. Yesterday's steep afternoon decline and amazing late-day recovery were examples. Overnight, we were treated to the reality that what happens at a distance does, in fact, impact our markets, sometimes in ways that we can't anticipate.

Financials suffered a double whammy last night, and our futures were showing the effects in middle-of-the-night trading. When I first turned on the television during the wee hours of the morning, the S&P 500 futures were down more than eight points. As the cash open approach, the decline steepened.

What happened? Several things. In a surprise move, South Korea's government raised interest rates. Although China's bourse went on to make another new high and South Korea's Kospi managed a gain, some Asian financials did suffer and the Nikkei backed off the high of the session. The prospect of rising interest rates in Asia pumped up the value of the yen against the dollar. However, the worst of the damage was to come after the close of the Asian bourses.

French bank BNP Paribas announced last night that it was suspending redemptions from three of its asset-backed funds that were being hit by troubles in the U.S. subprime market. The bank said that the current liquidity crunch made it impossible to mark to market the funds and assign a value to them. Today, German banks have reportedly agreed to a 3.5 billion euro protection fund, otherwise termed a rescue package.

To add to these troubles, insurer and mortgage lender American International Group (AIG) reported this morning that delinquencies and defaults in residential mortgages were increasing in the category just above subprime. AIG reported 10.8 percent of its subprime mortgages were 60 days overdue and 4.6 percent in the category just above subprime. Industry watchers interpreted this to mean that the subprime problem was indeed spilling over into other categories. As Keene has noted and others have, too, we all knew this intuitively anyway.

As Keene has been doing, I want to note that my volume information source is suspect, so I'm not certain that the figures on the chart heading this article are correct. I seriously doubt that up and down volume were so closely matched on the NYSE, for example.


As has been discussed in these pages, when the yen rises against the euro and the U.S. dollar, that rise forces the unwinding of some yen carry trades. Unwinding those trades means selling what was bought, and equities were frequently the recipient of all those funds borrowed. The rise of the yen against other currencies was exacerbated when BNP Paribas announced that it was suspending redemptions and the ECB announced that it was coming to the rescue.

For some time, our equities have tracked the ups and downs of the USD(U.S. dollar)/yen pair and sometimes the euro/yen pair fairly closely. I've heard speculation in recent days that the unwinding of the yen carry trade was nearly complete, causing me to question how useful a barometer the chart of the USD against the yen would remain. However, if the danger from the unwinding of the yen carry trade has expired, U.S. futures traders hadn't yet gotten the news during overnight trading. Equities and futures traded lower as the USD/yen pair declined.

A succession of analysts appeared on CNBC Europe soon after the European open, assuring listeners of the strength of the global markets, all the while wearing expressions that belied their soothing words. The European Central Bank offered its own soothing words and was soon to put its money to work, too. The ECB said it would act in currency markets if its action was required. I can't imagine that statement would bring much comfort, raising the necessity for a central bank to intervene to stymie steep declines.


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In fact, the (London) TIMESONLINE this morning indicated that the ECB and our Fed injected funds into money markets today, information later corroborated by other sources. The ECB put its money to work stabilizing overnight interest rates, the article by Gary Duncan noted, "to assure orderly conditions in the euro money market." The article noted the effect I expected: the ECB's action increased anxieties among some. If the ECB felt it necessary to act, how dangerous was the situation, market watchers were soon questioning. We had just been told a few days ago, in fact by the CEO of BNP Paribas, that the banks subprime exposure was negligible.

The ECB's action also refers back to the title of this article, that "spooky action at a distance." We retail traders don't always know when the ECB or the Bank of Japan or even our own central bank will intervene, so that the nice bounce or nice decline we just caught with an options play gets reversed out of nowhere. The interjection of liquidity didn't have as beneficial an effect as the central banks might have hoped, however.

The ECB was also telegraphing the need for a quarter-point rate hike last night. Some speculated that the fallout from subprime difficulties could stay the bank's move temporarily, just as some have speculated that our own FOMC might be stayed from any rate hikes for similar reasons. By the middle of the day today, bond traders were reporting that the Fed fund futures were pricing in a 100 percent chance of a rate cut at the FOMC's September 18 meeting. That does not appear to be the tack that the world's central banks are taking, but I do not profess to be an expert on economic theory, either.


The SPX's daily chart shown below is messy, but I wanted to include the various trendlines and the Fibonacci bracket. The converging of some trendlines with important Fib levels does seem to have impacted trading to some degree, although nothing but the bell stopped the steep decline today. While I don't have faith that they will continue to impact support or resistance levels when such strong selling or buying could easily overrun targets, it's important for short-term bulls and bears to know where reversals have tended to occur and where their gains should be protected. Therefore, the messy lines and brackets are included.

Annotated Daily Chart of the SPX:

If the markets had not closed when they did, that 200-sma support might have been overrun, too, just as one had the feeling yesterday that if trading had just extended a little longer, the previous day's high would have been reached or exceeded. This is emotion-based trading, and it's difficult to predict. If you're on the right side of a directional trade, it's wildly profitable. If you're not and if you don't exercise good account discipline, or sometimes even if you do, you're in danger of chopping a big hole in your trading account.

My personal belief is that markets are going to gradually chop out some kind of recognizable pattern, either a triangle or a flag. Until then, be careful, because it's wild and formless out there.

That wild and formless trading resulted in the Dow's second worst loss this year.

Annotated Daily Chart of the Dow:

The Dow's chart, perhaps more than some others, shows the potential for choppy action to continue for several months, chopping out a right shoulder that's somewhat symmetrical to the left shoulder shown here. The Dow's sister index, the TRAN, is known for eliminating a right shoulder and just falling through support and heading to the target or else zooming past the head and invalidating the incipient head-and-shoulder, refusing to play nicely and keep to the rules. The Dow may do the same, influenced by the recent spooky action. But in which direction?

Annotated Daily Chart of the Nasdaq:

Helped by component stock KLAC, the SOX punched higher than yesterday's high late this morning. Then its action deteriorated into a lower high, with the SOX now perhaps forming a triangle in its Wednesday and Thursday action. Even techs, which had been holding up well, succumbed to the day's tenor. As has happened so many other times in the past months, the SOX ended the day with action that defies any attempt at predicting next direction.

Annotated Daily Chart of the SOX:

The Russell 2000 also outperformed other indices, somewhat surprising given its susceptibility to liquidity issues. However, as Keene Little has noted, the RUT has been more oversold than other indices, and so perhaps other indices are playing catch-up. However, another chart after this one may offer a partial explanation, too.

Annotated Daily Chart of the RUT:

Curiously enough, with the RUT's chart often most closely resembling that of the USD/yen chart lately, the damage shown on that currency chart wasn't as severe as that seen on some equities, either.

As I mentioned earlier, I'm beginning to hear talk that the unwinding of the yen carry trade has just about concluded, and if you've watched CNBC Europe or CNBC Asia in the last week, you've likely heard it, too. If that's true, will the action of the USD/yen pair prove useful for those watching for what might happen with U.S. equities? I'm not certain. Last night, the two were certainly linked, and earlier in the week, the worries about the yen carry trade appeared to be immediately supplanted by worries about U.S. dollar strength.

It still might be helpful to see what we can see from the daily chart of the USD/yen.

Annotated Daily Chart of the USD/yen:

Although this currency pair turned lower, it did not break down out of the recent flag-like formation. Could this relative steadiness be one reason for the RUT's relative steadiness? This might bear watching, but I've reached no conclusions yet.

Today's Developments

Today's economic events began with the release of July's chain store sales, beginning before the market opened. According to a Marketwatch.com article, Target (TGT) and Wal-Mart (WMT) slightly beat same-store sales estimates for July. Costco (COST) reported same store sales higher than expected. Macy's (M) same-store sales declined but by slightly less than expected while Gap's (GPS) fell 7 percent, much more than the anticipated 4.9 percent decline. Sales at AnnTaylor (ANN), Stein Mart (SMRT), Pacific Sunwear (PSUN), Children's Place (PLCE) and Zales (ZLC) were all characterized as missing estimates by varying degrees.

In a related announcement, Talbots (TLB) reported same-store sales that fell 4.8 percent in July, while sales for the quarter edged up slightly above those for the year-ago level. The company warned that it would see a loss for the consolidated second quarter rather than the $0.02 gain that analysts expected, blaming almost all the loss on costs related to acquisition and financing costs.

The regularly scheduled weekly initial and continuing jobless claims added to the mix of information in the pre-market period, but I doubt little attention was paid to this weekly release. Initial claims rose 7,000 to 316,000, moving above the 300,000 benchmark. Initial claims below 300,000 marks a too-tight labor market that might be adding wage pressures to other inflation pressures, some feel, and we narrowly skirted a below-300,000 figure for both the weekly and the four-week average a couple of weeks ago.

The four-week moving average inched up only 1,750 to 307,750, so it's still not that far from the 300,000 benchmark. Continuing claims rose 39,000 to 2.55 million with the four-week moving average of this number rising 2,000 to 2.54 million.

The only other releases for today were the Senior Loan Officer Survey for the third quarter of 2007 and the Weekly Natural Gas Inventories, with that second release at 10:30. The Federal Reserve Board prepares the report on the Senior Loan Officer Opinion Survey on Bank Lending Practices. Senior loan officers of about sixty large U.S. banks and twenty-four U.S. branches and agencies of foreign banks are asked questions about their banks' standards and terms of lending, household demand for loans and the state of business. However, as of the close of trading today, this information had not yet been posted on the Fed's site. You can look for quarterly survey by following this link: http://www.federalreserve.gov/boarddocs/SnLoanSurvey

Natural gas inventories rose 42 billion cubic feet, somewhat less than the anticipated build of 50 billion cubic feet that I was hearing as a prediction last night.

Sector news included more bad news for the financial sector. Sanford Bernstein noted that it was cutting its 2007 and 2008 estimates for GS, MS, MER, LEH and BSC. The Sanford Bernstein notice hurt the brokerage stocks and the XBD, the brokerage index, although the damage was perhaps not as extensive as might have been anticipated. I didn't note any of this group that broke to new recent lows, even BSC.

Goldman Sachs bestowed an attractive rating on the oil service sector, saying the recent downturn had provided an entry point. Not many appeared ready to take that attractive entry point today, however. The firm mentioned DO, PDE, GHI, WFT and NOV in its statement. Most churned around and ended somewhere near where they had closed yesterday, which I guess rates as outperformance when compared to the rest of the equities. I personally would recommend reading to Jim Brown's Leaps newsletter before making any decisions on this sector.

Moving to specific company-related news, Home Depot (HD) said today that it might be forced to lower the $10.3 billion price of its supply business. The company blamed current conditions on the possible need to lower that purchase price.

Dynegy (DYN), an electric utility, reported earnings today. The company reported earnings of $0.09 a share on revenue of $828 million. Analysts had predicted earnings of $0.05 a share on revenue of $1.19 billion. The EPS that DYN reported included gains from after-tax mark-to-market gains and a settlement. The company increased its full-year expectations range to $1.2-1.3 billion from $1.0-1.1 billion.

In other company news, KLA-Tencor (KLAC) announced plans to buy back 10 million shares. The company will also increase its cash dividend to $0.15 from the former $0.12.

Tomorrow's Economic and Earnings Releases

Tomorrow's economic events include the release of July's Import and Export Prices, due at 8:30. That's followed by July's Treasury Budget at 2:00, with the ECRI Weekly Leading Index appearing between the two numbers. None of these is expected to be market-moving events, unless the trade balance is deemed to be so far from expectations that it impacts GDP estimates.

What about Tomorrow?

We're seeing some spooky action, some quite near to home and some at a distance, but all difficult to quantify. Market participants don't like that uncertainty, as was evident today.

Coupled with that uncertainty or perhaps fighting against it into next week is the known pattern for the Thursday before option expiration week. That pattern includes a low typically made that Thursday as prices are driven lower. When the pattern is followed, stocks and indices then rise into opex week and all merrily collect the money made from buying low-cost front-month calls. Will that pattern reassert itself this option expiration period? Let's take a look at some intraday charts, but first I have some cautions.

You've surely noted the spooky action without my needing to point it out. You've noted that indices have sometimes moved as much in a few hours or even minutes as they typically move in several days or a week, and then they reverse the whole thing in a short period, too. You've noticed that neither my predictions nor anyone else's have been totally accurate. If you'd asked me yesterday at the close whether I thought the day was bearish or bullish, I'd have said bearish. In fact, I did say that in an email to another writer on the site. However, even I didn't imagine the overnight action or where futures would be at the open, and that's because this uncertain atmosphere has contributed to volatility. Markets overreact to each fact, rumor and refutation of a rumor with exaggerated moves. It's impossible to predict.

So, let's do our best anyway to predict.

Annotated 15-Minute chart of the SPX:

To summarize, this chart brings alive the possibility of a decline to the 1429-1430 zone. That could happen right away tomorrow morning if sentiment is bad enough. However, a bounce beginning somewhere near 1449 up to the current closing level could first bounce prices up to test the aqua-colored mid-channel zone. By that time, these Keltner charts may have realigned and support may have converged beneath the SPX prices, but that mid-channel level needs to be maintained on 15-minute closes before the SPX even begins to erase that downside target. In this environment, spooky action could make it happen.

The Dow's chart looks similar.

Annotated 15-Minute Chart of the Dow:

Because the techs held up so much better for so long, I didn't expect to see the Nasdaq's intraday chart look similar, but it did.

Annotated 15-Minute Chart of the Nasdaq:

The RUT, however, did not set a new downside target similar to that set by other indices.

Annotated 15-Minute Chart of the RUT:

The RUT's action is worth watching. I would keep it and the USD/yen on the radar tomorrow.

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