The Option Investor Newsletter Monday 4-3-2000 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) ****************************************************************** 4-03-2000 High Low Volume Advance Decline DOW 11221.90 + 300.00 11223.80 10863.00 1,026,501k 1,569 1,486 Nasdaq 4,223.68 - 349.15 4572.84 4193.10 1,737,386k 1,138 3,167 S&P-100 820.62 + 5.56 820.62 805.71 Totals 2,707 4,653 S&P-500 1505.97 + 7.39 1507.19 1486.96 36.8% 63.2% $RUT 516.04 - 23.05 539.02 515.56 $TRAN 2706.10 - 57.14 2765.94 2698.47 VIX 25.66 - 1.55 28.26 24.94 Put/Call Ratio .48 ****************************************************************** Tail Wags Dog? Or Dog Wags Tail? You Make the Call. As news that there would be no DOJ settlement with Microsoft hit investors like a ton of bricks prior to today's market opening, the sharp decline of MSFT on the news (-15.25, 91) was just a catalyst for choking the life out of the NASDAQ today. While it would be easy to kick sand in the face of Joel Klein, the lead prosecutor for the DOJ, and Judge Thomas Penfield Jackson for cratering our tech-heavy trade and IRA accounts, the finger could more justifiably be pointed toward the IRS and Treasury Department as tax payers are now forced to get out the checkbook in front of April 15th. While you may not like the outcome that the Judge's anticipated decision had on your account, we think the real culprit is tax bill driven. (As we write this, the condensed version of the Judge's decision is that Microsoft violated the Sherman Antitrust Act by unlawfully maintaining a monopoly on the browser market. Microsoft is expected to appeal. Neither of these actions is a surprise. However, in the meantime, the DOJ may seek injunctions preventing MSFT from continuing its behavior. Remedy hearings won't likely begin for at least six weeks, which will keep MSFT under a cloud for a while longer. As after hours trading neared an end, MSFT was trading up $2 at $92.75. Total shares traded today? 131 mln shares or 7.5% of NASDAQ volume.) Lest you think we're nuts, follow the logic for a minute. Almost anyone who made money in last year's market has a humongous tax bill due on April 15th and the money is still tied up in stocks. The original plan was to hang on as long as possible prior to tax day, then sell to cover the amount due. Now that selling has knocked the stuffing out of the NASDAQ, the prospect of further drops is scaring out yet another level of taxpayers that don't want to wait any longer. Maybe you fit into that category - certainly that thought plays out in the Denver office. Multiply that sentiment by some million number of households, and the result can be devastating to the issues with the biggest gains so far this year. Adding gasoline to the fire, maintenance margin calls are occurring with regular frequency to investors as positions further deteriorate. If you can't bring in the money, your broker has the right to sell or close anything in your account to satisfy the requirement -- more downward pressure. Now, adding some nitro so we really feel the burn, we're likely to get stopped out as prices continue to fall. It becomes a vicious circle as the once high-flyers caving in on themselves, becoming an investor black hole. Nothing escapes the gravity. Yes, MSFT makes up a big chunk of the NASDAQ 100, but it can't do today's damage alone without outside influence. If you are a buyer in this market, you are likely sitting on the sidelines awaiting MSFT's fate while hoping to get another buying opportunity tomorrow. After all, who wants to jump in with both feet while the NASDAQ puts in its largest point sell-off in history - down 349 at the close. It also qualifies as the 5th worst day percentage loss too at -7.3%. For contributing sectors, we need only look to the following: Internets fell 8.28%; computers lost 8%; chips were crunched 7.2%, while the B2B sector was bombed for an 16% loss. . .kinda conjures up scenes of Slim Pickens riding an H-bomb as its dropped from the belly of a B-52 in the movie, Dr. Stangelove. Also adding to the negative sentiment, Legato Systems (LGTO, -24.06, 20.56) lobbed its own grenade at investors, telling the street that they would have to restate sales and earnings because sales representatives of the company acted outside their authority. Parametric Technology (PMTC, -9.75, 10.81), a good sized player in the collaborative product commerce B2B solutions sector with sales of over $1bln annually, also contributed to negative sentiment by warning that they would miss revenue projections by 15% - OUCH! Anyway the good news was only as loud as a whisper and went largely unnoticed today. What good news? Shhh, lean in a little closer so you can hear it. . .Charles Schwab and Co. pre- announced blowout earnings of $0.31 vs. analysts' estimates of $0.26, which should have jumpstarted the whole on-line brokerage sector let alone SCH, which eked out only a $0.25 gain for the day. Here's another piece of big news from an influential analyst that couldn't escape the surrounding noise. . .DLJ's Tom Galvin announced today that he sees the NASDAQ up 20%-30% this year from current levels. Party hats and horns? A month ago when the index reached a new high of 5132, that would have been greeted with cheers from the street. Not even a tip of the hat today. Let's take a moment to examine the carnage. The NASDAQ closed down 349 points at 4222, it's largest point loss ever by a long shot. Decliners pounded advancers 3168 to 1138, while down volume was about 7.5 times greater than up volume on a total of 1.74 bln shares traded. While volume seems normal, remember MSFT, LGTO and PMTC made up about about 200 mln shares, leaving just 1.54 bln for the rest of the market. While on the surface, that may appear bullish given the numerical damage, (you know, "it has to turn around since the tech issues have been hit so hard") it raises skepticism that the sell-off has not yet run its course. The NASDAQ blew clean through points of support at 4550 (gapped under at the open), 4500, 4400, 4300, and 4200. Once under 4400, that figure acted as resistance for the next move down to 4300. While struggling for support there at mid-day, 4300 finally gave way just before the last hour of trade and final descent below 4200. We hate to contemplate it folks, but despite a mild 31- point bounce in the last five minutes, 4192 is the old high that offered resistance back on January 3rd, and today offered support. Otherwise, the NASDAQ is in no man's land. If we can't maintain that tomorrow and make a move back up over 4300, better start looking for the next level of support around 4000-4050. And if the unthinkable happens, look for support at 3750 to 3800. While we don't think it will get there, we didn't think it would get back to 4300 either. As of now, the index stands corrected 18% off its February high. 20%, the standard definition of a bear market gets us to 4100, but has no historical basis of support. Even the 50-dma of 4542 isn't going to help now. While we don't like to force a moving average to fit a chart, the 100- dma could offer support if it's embraced. Reaching back to December of 1998, and May, June, August and October of 1999, there has been empirical, support at that level, currently at 4118. Based on the above, you'd probably think the whole market collapsed today. Nope. The Dow, S&P and the NYSE held up pretty well. When was the last time you saw the Dow gain 300 points? If you weren't looking, it was today! The last time was on March 16 with a 491 point move. Particularly impressive with today's Dow gain was the extremely bullish candlestick engulfment of the five previous days. That's when a move from open to close and high to low on the candlestick exceeds the movement of the previous day or days' trade range. Engulfing five days is a major accomplishment. While the S&P wasn't nearly so powerful, it too closed with a gain -- plus five points to 820, while finding support in the 810 range.. The Dow for its part moved up exactly 300 points to finish at 11,221 on respectable volume of 1.03 mln shares. Heck, had MSFT finished flat for the day instead of down $13, the Dow might have gone to +365 for the day. Advancing issues edged out decliners 1568 to 1488. Up volume was nearly twice down volume as 69 new highs bested 51 new lows. Not all technology was bad today, especially here -- HWP finished unchanged, while IBM tacked on $3.63. Take that you little NASDAQ pipsqueeks! Begin to look for the next level of resistance at 11,300, then again in 100 point increments up to 11,700. Don't be surprised though by a little intraday breather to say 11,150 just to consolidate the gain. There you have it. . .divergence like we've never seen before. Not much on the economic front tomorrow to move things either way, though YHOO will report earnings on Wednesday (and they better be good, otherwise kiss the Internet sector goodbye). However, since jumping into a 12-lane freeway at rush hour isn't good for your physical well being, neither too is doing the financial equivalent with your trading account. Remember to trade only when it is profitable to do so. That is, make sure the market is moving in your direction, advancers beating decliners, and a positive movement of your stock. Today was a rough day for NASDAQ plays and good for Dow/NYSE plays. That could reverse at the drop of a hat since the Dow is exhibiting a bullish trend, while the NASDAQ is stochastically oversold and due for a turnaround. Remember, just when your positions are as low as they can go, they can still go lower. It would behoove all of us to review the 10 rules of trading, especially #6, #9, and #10. (see Web site, left hand column, reference section, top 10 rules) While it won't work in every gap down, a stop loss is a must in this market until the damage runs its course. It's never too late to sell too soon Buzz Lynn Research analyst *********** STOCK NEWS *********** Investing Style By S.P. Brown Momentum or value, which is the better investing style? That's been an easy question to answer over the past two years. If momentum investing is represented by the Nasdaq Composite Index (COMPX) and value investing by the Dow Jones Industrial Average (INDU), momentum has trumped value by a mile. During that period, the COMPX has increased 150 percent while the INDU has increased only 25 percent. On an annualized compounding basis, that translates to an 11.80 percent annual return for the INDU and 58.11 percent annual return for COMPX. Money managers and investors who have foresaken the momentum strategy have paid dearly for their transgression. In fact, some of the biggest names in money management have seen there reputations sullied and investment acumen questioned. Over the past two years, value investing has caused Warren Buffett to suffered his worst investing returns ever. Buffett's investment vehicle, Berkshire Hathaway (BRKa), has seen its price drop by nearly 25 percent over the past two years. Another value victim is Robert Sanborn, who was removed last week as the manager of the Oakmark Fund after the value mutual fund plunged 24 percent in a year. And, of course, who can forget Julian Robertson's mea culpa last week. Robertson closed his famed Tiger Hedge Fund after finding himself in a hole created by two consecutive years of double-digit losses. It's easy to deride these guys for sticking to their philosophy and eschewing momentum-driven stocks like Qualcomm (QCOM) and Puma Technology (PUMA), which have been far more enriching than the likes of Proctor & Gamble (PG) and General Motors (GM). Still, market watchers need to remember that Buffett, Sanborn and Robertson had posted an average of 25 percent annual return over the past two decade. To get an idea of what that kind of compounding will do to a portfolio, a thousand bucks invested 20 years ago would be worth nearly $87,000 today. But let's face it, we live in a world of "what have you done for me lately?" Admittedly, value investing has done little for anybody over the past two years - momentum investing has been the successful modus operandi. The reason momentum investing has worked so well is that in a market with a strong and stable trend, momentum works best; whereas, in flat or volatile market, value investing works best. To that end, regardless of what market commentators have said about market volatility, over the past two we've had a market that has trended up with virtually no correction (today's 349 point sell-off in the Nasdaq not withstanding). The reason momentum works well in a trend market is that it literally becomes a self-fulfilling prophesy, for a trend market is essentially a "buy high/buy higher" strategy. If equities raise in price, more equities will be bought. Value investing, on the other hand, doesn't work nearly as well in a trend market, which is why the strategy has performed so miserably over the past two years. Value investing is basically a "buy low/sell high" strategy. As the market rises, value investors usually sell at a pre-determined price, so they forfeit additional upside gains by selling out too early. For example, let's say the S&P 500 Index (SPX) is trading at 600 and sells at a P/E ratio of 10. A value investor will set a target at which to sell. In this example, well say a price of 900, or a P/E of 15, which ever comes first. Obviously, once the S&P 500 reached 900, the value investor would have sold, and he would have missed the additional gains that would have been realized from the index moving higher to 1,500. The momentum investor, however, will ride the market to the top. In this example, let's say the momentum investor started buying the S&P 500 in equal increments starting at 700. If the momentum investors bought at 800, 900, 1,000 etc. up to 1,500, he would have realized a gain of 1,100 compared to only 300 for the value investor. Additionally, momentum investing beats value investing when the market is in a down trend, too. Again, referring to the example, the momentum investor will start to sell his positions as the S&P 500 falls. As the index goes from 1,500 to 1,400 to 1,300 etc. the momentum investor will be lightening his exposure. The value investor, though, will be increasing his exposure; thereby, incurring a loss in portfolio value because his cost basis will likely be below his portfolio value. So, when is value investing the preferred strategy? Believe it or not, in a volatile market. The reason being, when the markets are volatile, value investors can buy and sell repeatedly, while momentum investors usually find themselves buying high but selling low because there isn't enough movement for them to profit. And now, the times may be a changin' from trend to volatility. Over the past three months, the COMPX has appeared to have lost some of its upward thrust. In fact, the index has become downright volatile, particularly over the last half of March where it bounced up and down over 10 percent twice. Meanwhile, during the same period, the INDU has had a steady 10 percent rise. Obviously, hindsight is 20/20, but if we are moving to a more volatile market and away from a trend market, we are again going to see market divergence, except this time, the divergence will likely favor the INDU over the COMPX. Keep this in mind, though, it should be clear that no single strategy is inherently superior to another. A value-oriented buy low/sell high strategy will produce superior results when the volatility of the market dominates the market's trend over, while a momentum strategy will produce superior results if the the trend of the market dominates volatility. Finally, if you're unsure which way the market is headed, a buy-and-hold strategy offers a compromise. Buy-and-hold will produce average returns between momentum and value regardless of market conditions. *************** PLAY OF THE DAY *************** CALL **** BAC - Bank of America, $55.50 +3.06 (+3.06) Bank of America is one of the largest holding companies in the U.S. and offers a wide array of banking and financial services. They have over 11,500 branches in 47 states and almost 40 countries. BAC is the nations first coast-to-coast bank. They provide services throughout the Mid-Atlantic, the Mid-west and the South. BAC offers consumer, commercial, and global corporate banking, which include commercial real-estate investment and brokerage services, insurance and mutual funds. Most Recent Write-up Investors began to shop for bargains late Thursday and BAC was on their shopping list. At this point it appears as though another near term bottom may have been put it. Profit taking during the week drove shares of BAC down to $50.44. Why do we think that level produced a bottom? Thursday in the last hour of trading, BAC saw about 1.8 million shares change hands. As BAC made its low, almost 700K shares were traded in a 15 minute period. About 200K would be average for that time frame, depending on the volatility of the day. Traders continued nibbling on BAC Friday morning, and by the end of the day, the holding company had added another $1.63 to the price of its stock. So we've bounced off the $50 area and find BAC heading higher. The volume on the move back up has been nothing to write home about, but at this point we will take what we can get. The $52 area should be the tell tale sign, as it provided good support during the session on Friday. A break below that level and we could see another trip south. A bounce off that level and BAC may be back on track. Speaking of on track, money manager Elaine Garzarelli, said in an interview this week, she disagreed a bit with Abby Joseph Cohen's comments on moving 5% out of stock portfolio's into cash. Rather raising that kind of cash, Garzarelli said she would be putting money into beaten-down groups, that are significantly down from their highs. Any guesses as to what was included in her group of picks? Yep, BAC. Garzarelli said BAC and several of the financials are an "extremely good value." We couldn't agree more, and that's why we would look for opportunities next week to buy calls in BAC. A federal appeals court gave Bank of America a shot in the arm on Friday. The court said BAC, Wells Fargo & Co. and other banks can continue to charge non-customers to use automated teller machines in San Francisco and Santa Monica, California. The appeals court upheld a preliminary injunction granted in November, which temporarily bars cities from enforcing ordinances banning the fees. Comments You couldn't ask for a nicer chart than what BAC gave us today. After a $2 pop in the first 30 minutes of trading, buyers steadily pushed the price higher. The only perturbation to the near-perfect trend was a surge higher in the last 15 minutes of trading. Benefiting from a broad-based surge in Financial stocks, BAC managed to add over $3 on volume 25% over the ADV. If investors keep their appetite for "old economy" stocks, look for BAC to remain in favor. BUY CALL APR-45 BAC-DI OI= 2138 at $10.88 SL=8.25 BUY CALL APR-50*BAC-DJ OI= 4949 at $ 5.88 SL=3.75 BUY CALL APR-55 BAC-DK OI= 5344 at $ 2.25 SL=1.00 BUY CALL MAY-50 BAC-EJ OI=20302 at $ 7.00 SL=5.00 BUY CALL MAY-55 BAC-EK OI=10241 at $ 3.75 SL=2.25 Picked on Mar 23rd at $54.19 PE = 12 Change since picked +1.31 52 week high=$76.38 Analysts Ratings 13-11-5-0-0 52 week low =$42.31 Last earnings 01/00 est= 1.24 actual= 1.23 Next earnings 04-17 est= 1.24 versus= 1.08 Average daily volume = 6.54 mln /charts/charts.asp?symbol=BAC ************************Advertisement************************* Tired of waiting on trades to execute? Does your broker offer Stop Losses on Options? 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