The Option Investor Newsletter Monday 1-24-2000 Copyright 2000, All rights reserved. Redistribution in any form strictly prohibited. Posted online for subscribers at http://www.OptionInvestor.com Also provided as a service to The Online Investor Advantage ****************************************************************** MARKET WRAP (view in courier font for table alignment) ****************************************************************** 1-24-2000 High Low Volume Advance Decline DOW 11008.20 - 243.50 11366.50 10917.30 1,115,890k 1,028 2,029 Nasdaq 4096.08 - 139.32 4303.15 4095.31 1,980,657k 1,802 2,399 S&P-100 758.74 - 21.04 787.90 754.86 Totals 2,830 4,428 S&P-500 1401.91 - 39.45 1454.09 1395.42 38.9% 61.1% $RUT 522.95 - 10.99 540.60 522.27 $TRAN 2702.95 - 48.54 2761.45 2700.14 VIX 26.32 + 3.66 27.54 22.50 Put/Call Ratio .49 ****************************************************************** Who Moved My Cheese? No, this isn't a Book-of-the-month club best read. However Yours Truly zipped through this one in about an hour over the weekend. It was written by Spencer Johnson, M.D., co-author of The One- Minute Manager and other One-Minute_____ (fill in the blank) books that fill the bookshelves of entrepreneurs and corporate managers around the world. It uses two mice and two "little people" that live in the same maze to illustrate a good way and an undesirable way we deal with changes in our lives. Their sole purpose of existence was to find and eat plentiful cheese stashes of different types found in various places in the maze. Those of you that may have already read this gem know that the mice are always ready to put on their running shoes and search the maze to find a new stash of cheese the instant they run out of "old cheese". The little people however didn't fare as well once they had consumed their entire cheese stash because they analyzed themselves nearly to death trying to figure out "who moved their cheese", when it was really their own complacency and lack of preparedness for the inevitable. They got so used to eating the same stash because it was plentiful, that they failed to notice a decrease in its quantity and to make a plan for when they ran out. Is this starting to sound like a metaphor for your trading style since the October lows? Were you used to playing profitable tech stocks that you thought would never go down? Maybe you are thinking that the good market (cheese) must be around here somewhere and that you'll just hang around for it to come back. Get your running shoes on folks. It's time to think like a mouse, prepare yourself again for change and be a cheese seeker! Other editors and contributors have noted that with earnings season ending next week, the FED likely to raise rates on February 1st and 2nd, not to mention over-extended tech stocks that needed some consolidation, it is time to think again of bracing for a top in the markets. I fully support that position, but have been more optimistic and willing to play the volatility figuring that earnings and liquidity would keep us afloat nicely until the end of this week. I knew the day would come, I just didn't know when and was willing to push it to the limit. Today was the limit, as the selloff in both the DJIA and NASDAQ markets accelerated with greater volume. The DJIA spiked open this morning to 11,366 and began its descent that would carry it through the rest of the day (a great reason not to buy during amateur hour). While finding support in late morning around 11,200 and bouncing to 11,250 over a two-hour lunch, it couldn't hold. The selling intensified and carried the DOW below 11,200 all the way to 10,917 before a 91-point recovery 30 minutes before the bell to close at 11,008. Notice on the 6- month chart the strong support at 11,000 and be thankful for the decent recovery off the low. We can't say for sure if this represents a "V" bottom selloff. It happened a little to late in the day to define a trend. However, in the past with such a steep selloff, it's been a signal of a temporary bottom from which we get a bounce. One thing in particular that plagues the technical wizards is the selloff in GE, which lost $6 today and has been down for each of the last five days. Because it represents such a broad cross section of the market, traders assume that what happens to GE happens to the market. Today, it closed below its 50-dma ($145) for the first time since October of 1999. Ominous, perhaps, but with sentiment negative, contrarians may start to nibble. Liquidity is still there and this could be just a bump in the road. Internals, though ugly, are something we've seen before. Decliners outpaced advancers by 2:1. Only 95 new highs could stack up to the bigger weight of 163 new lows, with only 38% of the volume trading up and 62% trading down. Yes, it's bad, but we've seen worse. With volume clocking in at 1.2 bln shares on the NYSE, lots of investors were feeling pain, but there was no blood in the streets. Just so you know though, 40% (12) of the DJIA are trading under their 200-dma, while 30% (9) trade below their 50-dma. Only five of the thirty DOW stocks finished the day with a gain - three of those five reported earnings today. DIS finished up $0.56 at $53.31; AXP finished up just $0.31 at $132, despite announcing a stock split; and EK posted a $1.31 gain to $62.06 after beating street estimates by three cents. Are we scared? Maybe. We'd sure like to see the rebound continue back over 11,000. Otherwise we might soon be staring at 10,850 for support, then 10,600, though we really don't expect to go that low. If there is a consolation prize, it's that the last time 70% of DJIA members traded that far under their averages, we were at a bottom. Having not helped matters at all during the last week, PG finally admitted they had discussions about acquiring Warner Lambert and American Home Products, but also said they would not pursue that course of action. You'd think investors would show their relief by raising the share price by the 17% they lopped from it last week. Nope, they also disclosed that they had discussions to buy Gillette, which got the street thinking that they maybe PG needed a merger to juice what might be their stagnant revenue growth rate, sending PG down another $6 today. Dang if you do; dang if you don't. As for the NASDAQ, you'd think from the celebration of market bears that we haven't seen a market this low since last year. Not so. Try last Monday, when with a gain for the day, the index was still lower by 30 points. It's amazing how a few good record-setting days can spoil us. While today was in fact the 10th highest point drop on the NASDAQ, it doesn't even make the top 50 list in percentage terms. Nonetheless, traders took some profits off the table in a big way, though liquidity remains alive and well. The NASDAQ popped out of the chute reaching just over 4300 in the first few minutes of trading, but plodded along lower until the final two hours of trading. Like lettuce on a hot summer day, it quickly wilted under interest rate fears, oil prices, FED meeting next week with rate increase anticipated, FED meeting with rate increases again in March, earnings winding down (pick your favorite reason) sending, the index down sharply to just under 4100, still above its 10-dma of 4064, its nearest support. For the chart watchers, 4050 is the next level historically. After that, start looking for 3850. The 50-dma is at 3714, but we don't expect the index to reach that far. In the end, any way you slice, investors saw fit to take some chips off the table. By the looks of the volume at 1.99 bln shares (a new record by a long shot), there was a whole lotta sellin' goin' on. Frankly, we're a bit gratified to see some fear return to the market. Decliners beat advancers 3:2. New highs amazingly outstripped new lows by a whopping 452 to 92 (maybe some faulty data there), while down volume of 1.1 bln shares traded down compared to almost 900 mln trading up. So let's wrap it up for tomorrow and the rest of the week. The negative - A FED rate increase in February is all but certain and priced in. What isn't certain is that the FED could act to raise rates again in March, which is keeping interest rate pressure on equities. The price of oil isn't helping, but it's a sideshow with fewer on-lookers right now. While earnings reports have been fairly good, the season is coming to an end. Wage cost reports on Thursday are fanning the inflation flames. The positive - There has been a resurgence of fear indicated by selling volume, building a nice wall of worry for investors to scale. We are at near-term support levels too. All math and charts aside, sentiment is pointing to the downside, but you'll have to draw your own conclusion based on tomorrow's action. The important part is to recognize that the market is changing. As option traders, we need to change with it if need be. You may be better off on the put side. Don't be paralyzed by fear of not finding "new cheese" if your "old cheese" gets moved. Get your running shoes on, hit the maze, and go find the new cheese supply. As always, sell too soon. Buzz Lynn Research Analyst *********** STOCK NEWS *********** Don't Blame the Trade Deficit By S.P. Brown In a recent Reuters news article, Japanese Finance Minister Kiichi Miyazawa reported that Federal Reserve Chairman Alan Greenspan had confided in him that the U.S. lust for imports could not go on forever. According to Miyazawa, Greenspan reasoned that money was not being made from producing goods and services, but was being made through stock market appreciation. "At this point what's troubling him (Greenspan) is that the money is going into imports, and this may be good for the people of the world but for the American economy this cannot continue for long," Miyazawa said. To the uninitiated, the Commerce Department numbers are indeed disconcerting (Greenspan, of course, is not among the uninitiated). The trade deficit swelled 3.7 percent in November to $26.5 billion from October's deficit of $25.6 billion, a second straight monthly record. What's more, over the past year, the U.S. trade deficit has increased by 60 percent. If more folks understood trade and it's concurring benefits, the short response to the Commerce Department's report would be, big deal. Fact is, the trade deficit is really much ado about nothing. Unfortunately, though, trade and trade deficits are two of the most misunderstood economic concepts in this country. The majority seems too indifferent to economic theory to bother learning trade's importance, making it easy fodder for populist politicians. One of the most enduring misconceptions of trade is that the U.S. is exporting jobs when it incurs a trade deficit. This simply is not the case. Yes, open competition will cause some people to lose their jobs, but in the aggregate, the U.S. gains more than it loses. In a study undertaken by Daniel Griswold of the Cato Institute, during years of expanding trade deficits, the unemployment rate has fallen by an average 0.4 percentage points. But during years of improving deficits, the unemployment rate has risen on average of 0.4 percentage points. Another popular misconception is that trade is paid for with blue-collar jobs. Griswold has found that in the manufacturing sector, the trade deficit proves to be a friend not foe. During years of rising deficits, manufacturing output grew an average of 4.5 percent a year. During years of shrinking deficits, the average growth rate of manufacturing output was 1.4 percent. In fact, Griswold found that manufacturing jobs increased an average of 13,100 workers a year in those years trade deficits grew, while those years of shrinking deficits were accompanied by an average annual loss of 116,700 manufacturing jobs. Griswold goes on to report that during years of rising deficits, the growth of real gross domestic product averaged 3.2 percent per year, compared to 2.3 percent during years of shrinking deficits. In other words, the U.S. economy typically grows about 40 percent faster in years in which the trade deficit grows compared to years in which it shrinks. Another popular concern is that nations with trade surpluses are wealthier than those with deficits. This concern stems from the old mercantilist belief that the larger the trade surplus, the wealthier the nation. This belief originated in 18th-century England where it was believed that if a country exported more than it imported, the national treasury would swell with gold, meaning a net exporting country would become wealthier than its neighbors. This simply isn't the case. While a country may indeed have been accumulating gold, and in our day, paper currency, that country was foregoing the consumption of its own goods and services, which actually means a country can be made poorer if those goods and services are valued more than the currency exchanged for them. Here's a modern day example to prove this point: It's no secret that the U.S. has been running trade deficits with Japan for decades. Billions more in goods and services flow from Japan to the U.S. than vice versa. But does that mean that Japan is better off then the U.S.? According to the mercantilist view, it is. In reality, though, the answer is no. Just on anecdotal evidence alone, it's easy to discern that the U.S. has the higher standard of living. Nevertheless, many economists will laud Japan for its high savings rates and trade surpluses and chastise the U.S. for its low savings rates and deficits. But the reason savings rates are so high in Japan is that there are far fewer goods and services to purchase than in the U.S. What's more, those goods and services that are available have been bid up to much higher prices than those in the U.S. because of the lack of competition that imports would bring. Further supporting the notion of trade as a non-issue is the fact Americans pay for Japanese goods and services with dollars. Dollars, though, aren't used for barter within Japan's borders. So Japanese firms must do something with this currency to realize any utility. The options are limited. A Japanese firm can trade the dollars for yen in the open market, they can invested them in the U.S., or they can purchase U.S. goods and services. Regardless of the course of action, the dollars will eventually get recycled back to the U.S. But since the U.S. is the largest free-market economy in the world, many foreigners - the Japanese included - decide just to leave their money here. The Cato Institute reports that since 1992, annual foreign investment in plant and equipment in the U.S. has risen 81 percent, from $557.9 billion to an annual rate of slightly more than $1 trillion in 1999. For the U.S., this means access to capital at lower costs. Finally, contrary to popular belief, trade does not occur between countries; it occurs between individuals. And it's only because of free trade between individuals that wealth is created. Trade creates wealth by creating surplus value. For example, a seller offers a widget to a prospective buyer. To the buyer, the widget is worth $1.10. The seller, on the other hand, values the widget at $0.90. The $0.20 difference allows for trade and wealth creation. If the buyer and seller agree to a price of $1.00, each is made better off by a dime. It's these accumulations of surplus values through the years that has created the wealth we see today. What's more, it doesn't matter if the individuals are 12 or 12,000 miles apart, the results are the same. Compared to the other developed economies, the U.S. economy is growing at a faster rate, despite the fact the U.S. persistently runs large and growing trade deficits. So if Greenspan believes that a growing trade deficit warrants higher interest rates, he's got it all wrong. Yes, the wealth effect may be driving consumer demand, but the trade deficit can go on indefinitely producing no ill effects. If the good Chairman wants to raise interest rates, he would be better served to leave trade deficits out of the explanation. ********************** PLAY OF THE DAY - PUT ********************** SLR - Solectron $77.00 -1.38 (-1.38) Solectron is a premier global provider of customized manufacturing services rendering electronic solutions for original equipment manufacturers (OEM's). They have won the Malcolm Baldrige Award twice for their manufacturing excellence. Solectron has a wide range of clients including Cisco, Hewlett- Packard, and Mitsubishi. While we don't have anything specifically in the news that would explain the negative chart pattern, we do know that investors have moved on to the sex appeal of high-flying companies offering a lick and a promise. Having predictable, nonetheless growing, earnings seems to be the kiss of death that brings wild price gyrations back to earth. With nothing left to argue about, it's pretty tough for an analyst to raise a price target from $350 to $600 just because he/she can spin the story. The fact is SLR is an excellent company with excellent (and growing) earnings. Only the stock is in a slump now. As opportunists, our job is to capitalize on the sentiment. Looking at the technical chart, SLR was doing its best imitation of a yo-yo, having encountered resistance at $95 only to regain support at $80. SLR fell through support at mid-day and couldn't get back over $79 (new resistance?). The crowning blow was the selling of over 635K shares in a block trade at $78 after the bell on Friday. Ouch! That's rough on a stock with 1.6 mln as its ADV. Needless to say, RSI, stochastic and MACD are deep in negative territory. The next level of support is around $72 and could easily move to that level in an overall southerly market move (not out of the question with Fed meetings in the offing). To be sure the move south is for real, look for a mild recovery say to $79, then another bounce south on increasing volume. That will be the key. News that may account for the recent downtrend is that IBM awarded Celestica its server business, and SLR apparently had some Q1 inventory issues. Nonetheless, Lehman Bros. upgraded the stock to Outperform from Neutral. That didn't save SLR. Not even an earnings run will save this stock since they won't announce until March 13, according to Zack's BUY PUT FEB-80 SLR-NP OI=730 at $6.75 SL=5.00 BUY PUT FEB-75 SLR-NO OI=166 at $4.25 SL=2.50 Average Daily Volume = 1.6 mln Chart = http://quote.yahoo.com/q?s=SLR&d=3m ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? Trade instantly with Stop Losses at Preferred Capital Markets Stop Losses based on the option price or the stock price. Move your trading into the next millennium with Preferred Capital Anything else is too slow! http://www.PreferredTrade.com/CF/Home.CFM?ID=OIN ************************************************************** ******************* FREE TRIAL READERS ******************* If you like the results you have been receiving we would welcome you as a permanent subscriber. The monthly subscription price is 39.95. 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