Option Investor
Market Wrap

Climbing the Wall of Worry

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The market soared at the open today as the proverbial fog began to lift on what has been a tumultuous year. A lot of the added volatility can be attributed to the unusual amount of unknowns. The most recent bout of volatility and new 12 year lows can be blamed on the concern that Citigroup (C) would be the next "too big to fail" bank to fail. The SPX climbed up 8.1% intraday to close up 6.5% on news that the Treasury will buy $20 billion in Citigroup preferred stock using TARP funds, which brings the Treasury's total investment in Citi to $45 billion. In addition, the Treasury, Fed and FDIC will provide guarantees for up to $306 billion of troubled assets in exchange for $7 billion in preferred stock and warrants for 254 million shares of common stock at a strike price of $10.61. Citi will absorb the first $29 billion in losses on the troubled assets and then 10% on any remaining losses, while the government will cover the remaining 90% in losses.

President Elect Obama provided some additional clarity to the speculation of who his cabinet would be made of with the most attention being focused toward the Treasury Secretary. As you already know, that job is going to the current New York Federal Reserve President, Tim Geithner. Rather than going with someone experienced like Larry Sommers, President Elect Obama kept with the change theme and hired someone untested. However, Larry Sommers is slated to be the Head of Economic Council and is rumored to be in line to be the next Federal Reserve Chairman after Ben Bernanke's term expires. President Elect Obama spoke at a press conference today to confirm his recent cabinet choices and also suggest that a "big" economic stimulus package is needed. Obama did not say he would postpone raising taxes on the richest Americans as some had hoped for, but will listen to what his economic team says about letting the Bush tax cuts expire. While he clarified one question, he a few others to fill its place. As is the same with people, the markets don't like uncertainty. But the markets are capable of climbing higher on worry. In fact, bottoms are set at points when it seems that zero is a viable price target for the DOW JONES. It is at times that people become familiar with the constant turmoil and just accept that volatility is normal when the markets begin to climb higher when all else is going wrong.

The European Markets closed decidedly higher today on the Citigroup news and the follow through from the U.S. markets on Friday. The British FTSE closed 371.7 points higher to 4152.7 while the German DAX closed up an astonishing 10.6% (439.1 points) at 4566.5. Finally, the French CAC closed up 290.9 at 3172.1. The Nikkei was closed due to a holiday and the Hang Seng closed down 201.3 to 12,457.

The only big name to report after the close, Hewlett-Packard (HPQ) beat their earnings estimates by $0.02 and reported revenues in line. But HPQ pre-announced this last week so the positive affect will be reduced. Revenues rose 19% year/year to $33.6 billion versus the consensus of $33.3 billion. In addition, HPQ reaffirmed its first quarter EPS guidance of $0.93-0.95 vs. a $0.91 consensus.

I was mistaken by excluding Analog Devices(ADI) from the big name companies. ADI reported earnings tonight that beat EPS estimates by $0.05 per share for the fourth quarter. The results came in at $0.49 per share. Revenues increased 76.7% year over year to $660 million versus the $655 million consensus. The company said, "We are planning to take steps to avoid a large inventory buildup by significantly reducing manufacturing output, which we expect will temporarily impact our gross margin by ~3 to 4 percentage points. We are therefore planning for gross margin to be ~57% to 58% in the first quarter, depending on the actual product mix and level of sales we achieve."

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Tomorrow has a few companies worth watching for signs of consumer tendencies. For instance, American Eagle Outfitters (AEO), Talbots (TLB) and Chicos (CHS) should provide some insight into consumer discretionary spending while Dollar Tree (DLTR) may provide some guidance whether consumers are becoming discount shoppers. DR Horton, a builder, reports earnings tomorrow. Pulte Homes (PHM) announced today, after the close, that the company would suspend dividend payments due to the slowing economic times. It makes you wonder why they didn't reduce the dividend a while ago when there were obvious signs of slowing.

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The big economic news from today was that of the Existing Homes Sales. The results came in at 4.98 million versus the 5.07 forecast. Some how the market felt that this was a positive and pushed the markets up after stalling a bit around 10:00 AM EST. This is a holiday shortened week due to Thanksgiving on Thursday. The preliminary 3rd Quarter GDP is due out tomorrow morning at 8:30 AM. The forecast is expected to be negative 0.5% from the prior -0.3%. Consumer Confidence is expected to be 40 for November from October's reading of 38, which was the lowest level in recent history. On Wednesday, Durable orders are expected to contract further as demand from manufacturers retracts. Manufacturers are reducing inventories as a result of reduced consumer demand and availability of recurring credit. Basically, businesses want to keep cash.

The S&P 500 (SPX) closed up 51 points on above average volume on the NYSE. There were 3,261 net advancing issues versus 489 declining issues. Only two stocks hit a new 52 week high while 153 stocks hit new 52 week lows. The SPX appears to have hit a short term bottom at 741.02 (see chart below) and has accomplished the difficult feat of closing above the 8 day Exponential Moving Average (EMA). The 8 day EMA is at 836 while the 21 day EMA is at 881. The SPX closed at 851, in between the two moving averages. I am not calling for a new trend until the SPX closes above the 21 day EMA and holds above it. For instance, it may be conceivable to see the SPX break above the 21 day EMA and then run up to the upper Bollinger band and the 11/4 price resistance at around 1007. The Slow Stochastics re-emerged from oversold territory and closed above the 3 bar MA (green line) today. In addition, the 5 bar RSI re-emerged on Friday's close and continued to higher 53 today. If the 8 day EMA crosses above the 21 day EMA and holds, the trend can be considered upward. We will have to look for that to happen. Usually, the market moves higher after a holiday. Since the SPX closed a little above the sharp downtrend line drawn on the chart below, I think that the SPX could move higher up to the 21 day EMA and then sell off from short term profit taking on Wednesday.

Daily SPX Chart [Image 4]

As the chart below shows, the SPX almost went to lows not seen since 1996. But the good news is that the monthly chart still shows higher lows over a ten year period. However, the bad news is that the SPX broke through the 2002 lows that I have been watching for as a target. The SPX has risen over 110 points from its Friday low.

Monthly SPX Chart [Image 5]

As the lower chart shows, the 50 day Simple Moving Average (SMA) is quickly declining and is currently at 990.5. As I have mentioned before, moving averages provide dynamic support and resistance levels. If you are looking for simple price support and resistance, you may want to look into Point and Figure charting. The chart also has the Fibonacci Retracement levels from the 11/4 high to the 11/21 low. The SPX closed above the 38.2% retracement level and almost got to the 50% retracement level at today's high. A potential short entry, since we are still in a sharp downtrend, would be at or lower than the 61.8% retracement level at 906 but above the 50% retracement level at 875. With the advance over the last two days, the ADX has lost the signal for the downtrend. Our MoneyFlow Index indicator peaked near 70 on 11/14 and as broken below 50 to 43.11. An uptick in the money flow may help determine if this bounce has legs.

Daily SPX Chart [Image 6]

The United States Oil Fund (USO) moved 3.13 higher to 44.13 along with the Crude Oil commodity's 7.5% advance. I have been waiting for oil to bounce from what seems to be a grossly oversold price level. It is almost inconceivable that Crude was at 147 a few months ago. On Friday, Crude hit an intraday low of $48.35 a barrel. While oil is cheep and I love that it only cost $40 to gas up the Denali XL, there has been a world wide demand destruction due to the oil rich countries greed. Consumers were pushed a little too far and actually changed their habits a little. The economies across the world are shrinking and aren't demanding as many goods and services to be transported. Therefore, while $50 a barrel seems cheep, don't forget to account for the strength in the US dollar. When the barrel was at $147, the Eurodollar spot currency pair was at about $1.59 per euro. Now the Eurodollar is at 1.29 or 20% less. In a fixed currency, the price of oil is at about $66 per barrel. One way to play the weakening dollar is to buy crude oil futures or USO or DIG. DIG is the Ultra Long Oil and Gas Proshares ETF that moves according to the stocks in the Dow Jones Oil and Gas Sector. Therefore, a bad day in the overall markets could outweigh an upside move in the energy commodity markets. Both USO and DIG have options. So one can trade the volatility while also the positive or negative deltas. I prefer to sell premium. For instance, I will be sending out some Option Writer positions tomorrow and Wednesday on one or both of these ETFs. A taste of what I might sell is the December 41 Call on DIG in anticipation that DIG will decline a little before then selling the 19 or 20 December Puts. Risk management is easily set at a break of the short strike price. As for USO, I might sell the 39 Puts for December since the recent low is at 39.16. That means that a break of price support is reason to close out the bullish position.

USO Chart [Image 7]

If you are like me and believe that the Treasury will be printing money to pay for the once called "buy out" and now the banking bailout, then you may agree that increasing the float of the dollar will devalue it. If the dollar weakens again, buying the Australian or Canadian Dollar or Swiss Franc or Euro and selling the dollar may be a viable strategy. There are some new ETFs that trade the currencies. I have mentioned the CurrencyShares briefly in other articles. For instance, if you choose to buy the Swiss Franc you would buy the FXF. These are also optionable so you can buy the ETF and sell calls as a hedge. For me, currency trading is more of a trend or momentum game. But there are traders that can scalp the volatility around economic events. Since there are options, one can sell out of the money puts to essentially target shoot for a long entry or sell in the money puts and create a synthetic covered call position. See the chart below of the Swiss Franc. Of you aren't comfortable with the currency trading idea, you may want to look at simply buying an ETF that focuses on international markets. For instance, you can buy the iShare MSCI ETF (EFA) or the iShare Emerging Markets ETF (EEM). I still like consumer staples and utilities for the U.S. sectors. For all of our US readers, have a nice Thanksgiving. And for those of you that are overseas, have a great week with lots of success!

FXF Daily Chart [Image 8]

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