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Daily Newsletter, Tuesday, 09/16/2003

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The Option Investor Newsletter                 Tuesday 09-16-2003
Copyright 2003, All rights reserved.                       1 of 3
Redistribution in any form strictly prohibited.


In Section One:

Wrap: Unchanged But Changed
Futures Markets: Bear Flambi
Index Trader Wrap: See Note
Market Sentiment: All Aboard!


Posted online for subscribers at http://www.OptionInvestor.com
************************************************************
MARKET WRAP  (view in courier font for table alignment)
************************************************************
      09-16-2003           High     Low     Volume Advance/Decline
DJIA     9567.34 +118.50  9571.13  9449.16 1.72 bln   2312/ 902
NASDAQ   1887.26 + 41.60  1887.87  1848.41 1.80 bln   2186/1067
S&P 100   517.36 +  7.40   517.59   509.96   Totals   4498/1969
S&P 500  1029.32 + 14.51  1029.66  1014.81
W5000    9979.05 +136.10  9980.60  9842.92
RUS 2000  515.66 +  9.02   515.91   507.64
DJ TRANS 2773.38 + 40.40  2775.43  2732.06
VIX        19.31 -  0.94    20.85    19.25
VXN        31.66 -  1.27    33.44    31.24
Total Volume 3,800M
Total UpVol  3,145M
Total DnVol    582M
52wk Highs  552
52wk Lows    21
TRIN       0.53
NAZTRIN    0.40
PUT/CALL   0.66
************************************************************

Unchanged But Changed

The Fed left rates unchanged today but there was a change in
the statement. It was very subtle and just enough to tilt the
scales but traders completely ignored it. Tuesday was governed
by several large program trades that caught the market by
surprise and left many shorts running for cover at the close.

Dow Chart



Nasdaq Chart




The day started off negative with the Retail Sales report and
a decline of -0.3%. Wal-Mart and Target held up the sector or
it would have been much worse. Back to school sales continued
to provide the majority of their gains. The 9/11 anniversary
did not really impact sales and life continued as normal. The
numbers were also boosted by heavy sales of building supplies
on the east coast in preparation for the hurricane. This
was the first negative week after three consecutive weeks of
gains. The Bank of Tokyo is now projecting gains for September
of only +3.5% to +4% which is down from their +5% earlier
estimate. It is going to be harder for retail sales to grow
over the next month because the tax checks are over and the
refinancing boom has bust. Consumers should be in conservation
mode for the holiday purchases in December.

The NAHB Housing Index fell to 68 in September from 71 in
August. This is a minor decline and 68 is still the second
highest number since early 2002. The outlook by the builders
may be eroding but it is still high. The components showed
that buyer traffic dropped to 20 from 55 and single family
sales dropped to 73 from 77. The only component that did not
drop was the six-month outlook which remained at 78 and the
same as the prior month. With the drop in buyer traffic from
55 to 20 I am amazed the headline number did not drop any
more. Builders are still hoping the rising economy will
offset rising rates and keep the momentum moving. They are
shifting their marketing to adjustable rate mortgages in an
attempt to diffuse the impact of the rate increase.

The Consumer Price Index rose only +0.3% for August and the
majority of that increase was due to energy prices. The core
rate showed only a +0.1% gain and emphasizes the lack of
pricing power for corporations and the potential for an
"unwelcome fall in inflation". The lack of inflation will
do nothing to prevent the Fed from taking stronger action
if needed to fuel the economy. The core rate at only +0.1%
was so low that it pushed the 12 month inflation rate down
to only +1.3%. This is the lowest rate since 1966. At only
+0.1% there is very little room before we start seeing
negative numbers and true signs of deflation. The economy
needs to put in a floor here, draw line in the sand or make
goal line stand. Choose your metaphor.

The FOMC meeting ended with no change in interest rates as
expected. The statement was a carbon copy of last months
statement with one small but important exception. Today's
release specifically said labor conditions were weakening
instead of labor conditions are mixed. Other than that
they repeated the same comments from the last two meetings
of risks are basically balanced between inflation and an
"unwelcome fall in inflation" but all things considered
there is still a minor risk of the latter. They still do
not trust us with the "D" word. Still the mere mention,
regardless of how minor, of the D phrase kept the bond
market to only a minor loss. The key point here is that
the Feds are either cautiously optimistic that the economy
is still recovering or they are still behind the curve or
they just have their heads buried in the sand. They did
realize that after seven months of jobs losses and
increasing jobless claims that the labor market was
weakening instead of mixed.

The Fed also issued the coded sentence that there were no
rate changes coming any time soon to keep the market from
worrying that any economic bounce could jumpstart the
rate hike cycle. This is critical considering the real
funds rate is already negative and has been for most of
the last 2 years. Also, this is one of the longest periods
of low rates over the last 50 years. The M2 money supply
has expanded more quickly in the last three year period
than any other period in history. Many analysts think the
"labor market weakening" statement was a clue that the
Fed could actually cut rates again if the Oct jobs report
was negative. The markets had a mixed reaction to the
announcement at first but then rallied strongly into the
close on a monster buy program. Conspiracy theorists were
flocking to the theory that the Fed was pumping money into
the market to make it appear the market was excited about
the Feds decision.

The Fed announcement was actually preempted by another
news event on the west coast. Two of the top three pension
funds in California with assets of nearly $300 billion in
stocks, called for the resignation of Richard Grasso and
a reduction in his announced pay package. They were quickly
followed the North Carolina Treasurer, claiming he represented
700,000 pensioners, and the New York State Controller who
claimed he represented 960,000 fund holders. This brings
to about a dozen the number of major players calling for
his resignation and in some cases the resignation of the
board. Now that the top players in the country have gone
on the offensive and pledged an aggressive fight using all
the methods at their disposal, Richard's days are numbered.
The reluctance to release details of the pay package until
pressed by authorities and then the bits and pieces release
already make the board and management look guilty. The
pressure is rising and although they did not do anything
legally wrong the appearance of abuse and cover up will
probably lead to a big announcement soon. Grasso has
refused all interview requests since the resignation
demands began to increase. Expect this to take center
stage on Wednesday right behind the hurricane.

After the bell MCHP affirmed a lower range of estimates for
earnings. Prior estimates were for sales to increase from
+1% to +6% and they narrowed the range to +2% to +5%.
Earnings were still expected to be 17 cents. Dell's CFO,
Kevin Rollins, was interviewed on CNBC and he was not as
upbeat as Michael Dell. He tried to carefully express both
caution and confidence without stepping on his boss's toes.
He said demand was stable but there was no real growth. He
also said they were seeing growth in performance but not
in price. The interviewer asked him specifically again if
that meant that revenue would not increase and Kevin tried
to dodge the bullet by repeating that they were seeing
growth in performance and launched a sales pitch for Dell.
Interesting interview where they actually discussed the
fact that Michael Dell may be more bullish about expectations
than facts would allow but it was very carefully worded.
I think Michael must hold training classes on how to speak
to the media to turn every interview into a sales pitch and
how to divert pointed questions.

The recall election is not off. At least according to the
ninth circuit court. Instead of waiting to see if the parties
to the recall suit would appeal the three judge ruling the
9th circuit gave the parties a limited amount of time to
file a 15 page position paper from which the court would
decide to take the case or pass. The court stayed the order
from the lower court halting the election and told everyone
to consider the election as back on until they ruled on the
appeal. The court can pass and open the door for a supreme
court appeal.

Spitzer is on the prowl again and they woke up the mutual
fund community today by filing not only civil charges but
criminal charges against Theodore Sihpol a broker for BAC
until he was fired last week. They are claiming that traders
"stole" money from fund holders by allowing late trading.
He faces up to 25 years in prison. Spitzer and colleagues
claim there will be many more charges against dozens if not
hundreds of fund personnel. The wake up call has caused some
real grief from people expecting a hand slap and a fine.
Real jail time on multiple charges with minimum sentencing
provisions will cause some sleepless nights tonight.

There will be more sleeplessness tonight for those that
were caught off guard by the strong rally today. There was
a strong move up at the open accompanied by a buy program
at 9:50. This produced some short covering that pushed the
Dow to strong resistance at 9500 where it traded sideways
in a ten point range until the Fed announcement. After the
announcement the Dow dropped only to the bottom of that
range and another buy program triggered to push the Dow
to the 9525 range where it held on strong but declining
volume for 30 minutes only to blast off on yet another
apparent buy program to 9560. When the 9525 buying began
the shorts began covering in earnest and pushed the Dow
and the Nasdaq to six day highs. Almost the entire drop
for the last six days since the September 8th closing high
was recovered in one day on negative news. There are quite
a few bears still short and scratching their heads tonight.
The S&P Emini came to a dead stop at 1028 with very strong
resistance at the 1030 level and the contract high. The
Dow closed at 9563 and only a very short 37 points away
from very strong resistance at 9600. 9607 was the recent
52-week high. The Nasdaq rallied +41 points and came to
rest only one point below the recent 52-week high. This
very bullish day completely surprised almost everyone.
However, if you look at the candles on the charts above
I am sure you will agree it was not normal buying patterns.

Let's reconstruct. Retail Sales declined and the Bank
of Tokyo lower their estimates for September. The core rate
of the CPI rose only +0.1% and could not get any closer to
an unwelcome fall in inflation. The NAHB Housing Index
showed buyer traffic fell to 20 from 55. The Fed said the
labor market was weakening and deflation was still a greater
threat than inflation. We are in the most dangerous six
weeks of the year. If all of this is bullish then I am
missing the boat. So what prompted the markets to retest
the current highs? What prompted the strong program buys
that triggered the massive short covering? Maybe I should
start believing the conspiracy theorists. It was certainly
not excitement that Grasso may be on his way out or that
Spitzer could file charges against hundreds of traders.

Ok, let's assume the economy is in a stealth recovery. We
are getting cautious comments from quite a few companies
that are affirming estimates but not specifically raising
them. Earnings warnings are very low on a historical basis.
We have analysts quoting +7% GDP for the 3Q with no evidence
to support it. Great, I hope we get it. The problem I see
that this is already priced into the market. Literally every
major analyst agrees with this concept. Also, almost all
analysts agree that a rally over the traditional Sept/Oct
period would be strongly bullish. Unfortunately nobody can
explain why it would happen. Nobody can explain why we are
not seeing any real profit taking.

The only scenario that makes sense is the new bull market
scenario. Scrap the concept of waiting for valuation because
stocks are always over valued at this stage of a market
cycle. Forget the normal historical market cycles because
they are only serving to produce dips to buy. Stocks are
going up because people want to buy them. They want them to
go up. After three years of a bear market they are tired of
the bearishness. They have bought the recovery scenario lock
stock and barrel. 2004 will be a banner year according to
the rising six month sentiment expectations. That is the
bullish view, buy the dip. The bearish view sees all the
negatives I mentioned above and keeps trying to short the
resistance. Been there, done that, today. Many are scared
of shorting the tops now because of the numerous breakouts.
They are waiting for the dips to gain speed and after 2-3
days of a downtrend they finally get suckered back into a
short position. Just as they get comfortable with the trend
the trend changes but just slow enough to keep them short
until the last minute.

We had five days of weakness on the Dow totaling about -220
points. No big deal but enough to make traders think that
Dow 9000 was possible again. This was especially true when
we were trading in the high 9300s last week. Shorts are like
that frog in a pan of cold water. Just as they are getting
comfortable and adding to their positions the price begins
to rise little by little but always with a hint of a continued
down trend. These represent the bearish equivalent of buying
opportunities or shorting opportunities. After a couple days
of sideways movement to lull them to sleep we got the big
morning bounce on bad news. Their fear factor rises but
surely this is temporary. We always get a sell off just
before the Fed announcement. What, no sell off? That is ok
we will see a monster sell the news event because the Fed
cannot say anything positive for fear of spooking the bond
market. The news is out, the market drops slightly and maybe
they add to their positions thinking the crash is about to
occur. Suddenly a massive buy program kicks the Dow up +60
points and their pain threshold increases exponentially.
Short covering begins on heavy volume but the majority are
still locked into that final lie. Don't worry the Dow will
fail again at 9600, Nasdaq 1890, S&P 1030. That was the prior
highs and very strong resistance. Shucks, I am going to
average down and add to my positions if we hit that level.

Replay that scenario every week for the last six months and
just change the economic reports and the prices and you will
see why we are threatening to break out again. All the
indications for the bear point to a failure in the economy,
a failure on price and a failure based on the calendar. None
of which has yet to come true. Most retail bulls are oblivious
to the complicated forces in the market. They have a winning
plan and they are following it carefully. Buy the dip. It
worked for years and it is back. Martha, take the funds out
of the money market we are going to make it all back. Actually
the Fed is supporting this plan. If they can keep talking the
market up and not scare anybody with the D word then investors
will feel prosperous again and they will spend money and pay
taxes with those profits. The only problem with this scenario
is that it will only work until it quits and nobody knows
when that will be. Eventually institutions will decide they
have ridden the bull long enough and start taking profits.

Actually, the activity over the last several days had looked
an awfully lot like some institutions were taking profits.
It looked like we were in a distribution phase. Distribution
occurs when institutions want to exit a large position
without tanking the market. If they think the market is near
a top they will start feeding each bounce with a fraction of
their position. Say they wanted to sell 20 million shares of
MSFT or GE. Just placing an order for 20 million shares would
knock us back to July in a heartbeat and they would end up
getting far less than current value. Instead they start
dumping smaller blocks of 5, 10, 20, 50,000 shares into the
market at a slow enough rate to keep the market from tanking
but fast enough to get them out as high as possible. By
distributing these multimillion share positions to the retail
investors in thousands of smaller chunks they get out quietly.

The signs of distribution are heavy volume and no movement.
This is exactly what we have been seeing over the last several
days. Today especially. There were several periods of huge
volume for a prolonged time with no movement. The bulls were
buying hard but somebody was feeding them in volume. The
bounce in the late afternoon was on very heavy volume and
it appeared as though the 9525 and 9550 pause levels were
particularly heavy. Of course this is all speculation on my
part because nobody knows what it powering the market. We
could have just been seeing some asset allocation programs
coupled with short covering triggered by those programs. The
key to the puzzle is still tomorrow.

Regardless of the reasons we did close at or near the highs.
If the gains today were based on program trades of some sort
then tomorrow could see a reversal. If it was really a flood
of new money into the market then tomorrow could see a break
to a new high once again. Shorts will be sitting with their
finger on the trigger at the open. They are in a very dangerous
position this close to a breakout. Let one major buy program
hit at the open and it could be off to the races. The economic
news tomorrow is light with only Residential Construction and
Mortgage Applications and the Semi Book-to-Bill after the close.
We are on our own for direction and the futures are perfectly
flat at 9:PM. It could be an exciting day if you are on the
right side of the market. It could be painful if you are on
the wrong side. The Nikkei rose +179 points at the open tonight
to break 11,000 for the first time in 14 months. This could be
our first clue. Dow 9600 is the key at the open. Once broken
the next stop could be 10,000. The key word there is "broken".

Enter Very Passively, Exit Very Aggressively!

Jim Brown
Editor


***************
FUTURES MARKETS
***************

Bear Flambi
Jonathan Levinson

Treasuries pulled back, with a brief reversal following the FOMC
announcement at 2:15.  Gold inched lower, miners inched higher,
and equities punched through resistance with brief pauses.

Daily Pivots (generated with a pivot algorithm and unverified):


150 tick chart of the ES




15 minute chart of the US Dollar Index




The chart of the US Dollar Index looks incredibly similar to my
chart of the S&P futures, but I'd be shocked if it was merely
Yasuo Fukuda and the BOJ behind the buying.  The move found
resistance in the 96.70 area, but set a higher low on the
pullback.  The action was bearish for gold and commidities,
bearish for bonds, and bullish for equities.  The CRB dropped
2.75 to 237.67, with strength in sugar, silver, platinum and
gold, weakness in crude oil, cocoa and coffee futures.


Daily chart of December gold




December gold dropped 1.10 to 374.50, consolidating its failure
below the rising wedge trendline while finding support at 372.50,
right on the 78.6% Fibonacci line.  The daily chart oscillators
are on sell signals but have yet to violate their rising
uptrends, although the failure looks likely from here.  Despite
the weakness in the metal, the HUI was up .88 to 196.90, and the
XAU gained .48 to 92.43.  Dec silver was up .022 to 5.232 as of
this writing.


Daily chart of the ten year note yield




The TNX had a relatively narrow-range day, closing higher by 4.6
basis points to 4.291%, right on the bull wedge descending
resistance line on the daily chart.  This pullback in ten year
notes came on the heels of the FOMC's widely expected
announcement.  If lower rates is the Fed's goal, then it failed
today.  The real action was in equities, however, which reversed
almost 1 week's worth of weakness in a single bullish engulfing
candle.


Daily NQ candles




There's not much to say about a bearish engulfing daily candle
that launches from a higher low.  It's a bullish print, within
the confines of a bearish ascending wedge formation.  The
oscillators are on sell signals, and that did not change in
today's trading.  Volume on the Nasdaq was respectable at 1.78B
shares, exceeding yesterday's volume.  The bulk of the advance
today came following the FOMC meeting, and the sheer velocity of
the gain and the absence of more than very shallow pullbacks felt
like a short squeeze.  Nevertheless, further upside is to be
expected.

The real test will come at the rally highs at NQ 1392. As
discussed in this weekend's newsletter, the longer daily and
weekly cycle oscillators appear to have topped out and are in the
beginning stages of a fresh downphase.  A move to the rally highs
does not change that cyclical picture, as the shorter cycles
bounce from overbought to oversold and back again, as seen on the
30 minute chart below.  A move beyond the rally high and through
upper resistance on the bear wedge would cause the daily chart
oscillators to begin trending, which is entirely possible but
less likely.

30 minute 20 day chart of the NQ




The vertical move brought the 300 minute stochastic to the top of
its range.  After some residual upside tomorrow morning, bulls
will be faced with the task of moving this cycle into a trending
upphase.   As discussed with reference to the daily cycle
oscillator, such is entirely possible, but less likely than a
reversal.  When oscillators of different timeframes are lined up,
in this case overbought, the odds of a reversal increase
accordingly.

Above the highs of the year, shorts will lose their reference
range and become defensive, which could result in the kind of
vertical launch that we witnessed this afternoon above 1021 ES.
A lower low will embolden the bears and discourage the bulls, and
fulfill the prophecy of those overbought oscillators.


Daily ES candles




We have the same picture and the same setup on the ES, both daily
and on the 30 minute chart below.  The NQ led to the upside
today, but the cyclical picture on the ES is identical.  Again,
it will take a decisive break of the rally highs to reverse the
sell signals printed on the daily chart oscillators, with the
upper wedge trendline providing a useful boundary to cap a
possible stoprunning throwover above it.


20 day 30 minute chart of the ES




The ES respected the trend of higher lows on its 30 minute chart
oscillators, and appears to be playing out the bear wedge
breakout targeting the rally highs.  If memory serves, the
overnight high on ES was 1035.  Keep in mind that the secondary
interpretation on the bullish formation was of a bull flag.  If
this latter is the case, any break above the rally highs could
potentially kick off Rally II.

Daily YM candles




Nothing to add on YM.  9500 was key resistance, and its failure
powered what appeared to be the final round of short covering of
the afternoon.

20 day 30 minute chart of the YM




The Fed's 3B repo drain explains some of the weakness in the bond
market, but the strength in equities alongside strength in the US
Dollar Index remains puzzling.  Unless it was genuine foreign
buying of US equities, it's a countertrend coincidence, as the
lower dollar/ higher equity relationship was present throughout
the spring 2003 rally.

In any event, tomorrow is setting up to be an important day,
particularly with op-ex uncertainty added into the mix.  Bulls
need to keep their stops in place, and bears need to keep their
wits about them.  Use stops whatever your bias, and let them
protect your account.  A sudden move in either direction would
not surprise me at this point, although I favor the downside so
long as the previous highs are intact.


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********************
INDEX TRADER SUMMARY
********************

Check the Site Later Tonight For Jeff's Index Trader Article
http://members.OptionInvestor.com/itrader/marketwrap/iw_091603_1.asp


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****************
MARKET SENTIMENT
****************

All Aboard!
- J. Brown

Investor sentiment is getting pretty simple these days.  If it
goes up, buy it!  If it pulls back, buy it!  If it goes sideways,
wait for it to go up or pull back.  I say this tongue in cheek
but any veteran trader knows this can't last for very long but
until it changes, enjoy the ride.

The FOMC's decision to hold interest rates at 1 percent was no
surprise and the markets cheered with a 118-point rally in the
DJIA and a 2.2 percent rally in the NASDAQ.  Analysts continue to
harp on their positive expectations for strong corporate profits
the next two quarters and beyond so money keeps flowing into
stocks.

Market internals were very bullish with advancing stocks
punishing losers 20 to 7 on the NYSE and 21 to 9 on the NASDAQ.
Up volume was 6 times down volume on the NYSE and almost as
strong on the NASDAQ.

Volatility indices, which are supposed to measure investor fear
fell lower today as the markets rallied.  From the looks of it,
investors are pretty fearless and again this is a warning signal
that veteran traders will recognize as a clue to be careful.

Play the trend but don't get caught when the trend changes.
Fortunately for the bulls, it feels like the current trend still
has some legs underneath it.

A couple of items to be aware of tomorrow:  The homebuilders have
been strong with interest rates still near historical relative
low.  We're going to see the housing starts and building permit
numbers tomorrow before the opening bell.  Plus, nearly everyone
has jumped on the bullish bandwagon for semiconductors.  We're
going to see the latest book-to-bill ratio tomorrow night after
the bell.  Let's hope they're good.  Many believe the chips tend
to lead the markets either higher or lower.



-----------------------------------------------------------------

Market Averages

DJIA ($INDU)

52-week High:  9609
52-week Low :  7197
Current     :  9567

Moving Averages:
(Simple)

 10-dma: 9512
 50-dma: 9291
200-dma: 8660

S&P 500 ($SPX)

52-week High: 1032
52-week Low :  768
Current     : 1029

Moving Averages:
(Simple)

 10-dma: 1022
 50-dma:  997
200-dma:  926

Nasdaq-100 ($NDX)

52-week High: 1387
52-week Low :  795
Current     : 1382

Moving Averages:
(Simple)

 10-dma: 1362
 50-dma: 1292
200-dma: 1132


-----------------------------------------------------------------

No surprises here.  The volatility indices both took a dive with
the markets in rally mode.  These are suppose to measure investor
fear and right now the markets are pretty much fearless.

CBOE Market Volatility Index (VIX) = 19.31 -0.94
Nasdaq Volatility Index (VXN)      = 31.66 -1.27

-----------------------------------------------------------------

          Put/Call Ratio  Call Volume   Put Volume

Total          0.66        705,925       464,376
Equity Only    0.50        555,642       276,726
OEX            1.20         34,893        41,948
QQQ            0.98         71,870        70,308


-----------------------------------------------------------------

Bullish Percent Data

           Current   Change   Status
NYSE          73.1    + 0     Bull Confirmed
NASDAQ-100    78.0    + 0     Bear Correction
Dow Indust.   83.3    + 0     Bull Confirmed
S&P 500       81.8    + 0     Bull Confirmed
S&P 100       88.0    + 0     Bull Confirmed


Bullish percent measures the number of stocks in an index
currently trading on a buy signal on their point and figure
chart.  Readings above 70 are considered overbought, and readings
below 30 are considered oversold.

Bull Confirmed  - Aggressively long
Bull Alert      - Cautiously long
Bull Correction - Pause or pullback in upward trend
Bear Alert      - Take defensive action if long
Bear Confirmed  - High risk if long, good conditions for shorting
Bear Correction - Pause or rebound in downtrend

-----------------------------------------------------------------

 5-Day Arms Index  1.19
10-Day Arms Index  1.17
21-Day Arms Index  1.02
55-Day Arms Index  1.02


Extreme readings above 1.5 are bullish, and readings below .85
are bearish.  These signals don't occur often and tend be early,
but when they do, they can signal significant market turning
points.

-----------------------------------------------------------------

Market Internals

            -NYSE-   -NASDAQ-
Advancers    2051      2134
Decliners     779       968

New Highs     180       309
New Lows       10         4

Up Volume   1441M     1476M
Down Vol.    240M      250M

Total Vol.  1693M     1779M
M = millions


-----------------------------------------------------------------

Commitments Of Traders Report: 09/09/03

Weekly COT report discloses positions held by small specs
and commercial traders of index futures contracts at the
Chicago Mercantile Exchange and Chicago Board of Trade. COT data
can be found at www.cftc.gov.

Small specs are the general trading public with commercials being
financial institutions. Commercials are historically on the
correct side of future trend changes while small specs tend
to be wrong.

S&P 500

No change in sentiment for the commercial traders here.  Meanwhile
small traders forked out a little more cash to increase both
their long and short positions.


Commercials   Long      Short      Net     % Of OI
08/19/03      404,665   455,381   (50,716)   (5.9%)
08/26/03      410,378   472,987   (62,609)   (7.1%)
09/02/03      417,973   482,392   (64,419)   (7.2%)
09/09/03      418,958   486,209   (67,251)   (7.4%)

Most bearish reading of the year: (111,956) -  3/06/02
Most bullish reading of the year:   18,486  -  6/17/03

Small Traders Long      Short      Net     % of OI
08/19/03      162,034    87,064    74,970    30.1%
08/26/03      170,424    76,967    93,457    37.8%
09/02/03      169,030    75,748    93,282    38.1%
09/09/03      176,401    81,444    94,957    36.8%

Most bearish reading of the year:  (1,657)- 5/27/03
Most bullish reading of the year: 114,510 - 3/26/02


E-MINI S&P 500

Commercial traders in the e-minis continue to pump up their
long positions.  The last numbers show the most bullish
posture in quote sometime.  Meanwhile the small trader has
rotated a little bit of money from short back to long.


Commercials   Long      Short      Net     % Of OI
08/19/03      296,971   235,779     61,192    11.5%
08/26/03      338,766   234,841    103,925    18.1%
09/02/03      347,724   224,011    123,713    21.6%
09/09/03      370,909   237,610    133,299    21.9%

Most bearish reading of the year: (354,835)  - 06/17/03
Most bullish reading of the year:  133,299   - 09/02/03

Small Traders Long      Short      Net     % of OI
08/19/03       90,428   125,980   (35,552)  (16.4%)
08/26/03       52,131   120,853   (68,722)  (39.3%)
09/02/03       56,709   134,094   (77,385)  (40.6%)
09/09/03       59,692   130,270   (70,578)  (37.1%)

Most bearish reading of the year: (77,385)  - 09/02/03
Most bullish reading of the year: 449,310   - 06/10/03


NASDAQ-100

Commercial traders are increasing their bets on the NDX
but they're still beating more heavily on a move lower.
Small Traders are also active with larger net positions
but they're still beating on the bulls.


Commercials   Long      Short      Net     % of OI
08/19/03       32,107     53,665   (21,558) (25.1%)
08/26/03       33,991     55,849   (21,858) (24.3%)
09/02/03       37,002     55,379   (18,377) (19.9%)
09/09/03       44,677     62,369   (17,692) (16.5%)

Most bearish reading of the year: (21,858)  - 08/26/03
Most bullish reading of the year:   9,068   - 06/11/02

Small Traders  Long     Short      Net     % of OI
08/19/03       25,607    10,134    15,473    43.3%
08/26/03       26,108     8,864    17,244    49.3%
09/02/03       23,168    10,561    12,607    37.4%
09/09/03       28,788    13,370    15,418    36.6%

Most bearish reading of the year: (10,769) - 06/11/02
Most bullish reading of the year:  19,088  - 01/21/02

DOW JONES INDUSTRIAL

No change in investor sentiment for the professional traders
here.  There is little change for the small trader but they
have bumped up their long positions a tad.


Commercials   Long      Short      Net     % of OI
08/19/03       21,088    18,984    2,104       5.3%
08/26/03       24,586    10,386   14,200      40.6%
09/02/03       25,462    10,447   15,015      41.8%
09/09/03       25,807    10,756   15,051      41.2%

Most bearish reading of the year: (8,322) -  1/16/01
Most bullish reading of the year: 15,135  - 10/16/01

Small Traders  Long      Short     Net     % of OI
08/19/03       15,717     9,143    6,574     26.4%
08/26/03       14,115     5,592    8,523     43.2%
09/02/03        6,629    13,402   (6,773)   (33.8%)
09/09/03        7,429    13,796   (6,367)   (30.0%)

Most bearish reading of the year:  (8,777) - 10/12/01
Most bullish reading of the year:   8,523  -  8/26/03

-----------------------------------------------------------------


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The Option Investor Newsletter                  Tuesday 09-16-2003
Copyright 2003, All rights reserved.                        2 of 3
Redistribution in any form strictly prohibited.


In Section Two:

Dropped Calls: GILD
Dropped Puts: KSS
Call Play Updates: AU, ERTS, GS, LEA, LUV, MERQ, UTX
New Calls Plays: AMGN, APOL
Put Play Updates: KKD
New Put Plays: None


****************
PICKS WE DROPPED
****************

When we drop a pick it doesn't mean we are recommending a sell
on that play. Many dropped picks go on to be very profitable.
We drop a pick because something happened to change its
profile. News, price, direction, etc. We drop it because we
don't want anyone else starting a new play at that time.
We have hundreds of new readers with each issue who are
unfamiliar with the previous history for that pick and we
want them to look at any current pick as a valid play.


CALLS:
*****

Gilead Sciences - GILD - cls: 61.86 chg: -4.15 stop: 64.75

It was a rough day for GILD, losing 6.28 percent on the heels of
a downgrade from J.P. Morgan.  JPM cut the stock from
"overweight" to "neutral" on their belief that GILD will have a
tough time meeting revenue forecasts and any price appreciation
will be "difficult".  The stock gapped down to $63.64 at the open
and fell from there towards the $60 level.  Volume was huge at
14.2 million shares.  Merrill Lynch later tried to defend the
stock and reiterated their own "buy" and Focus 1 ratings for
GILD.  This may have helped lift GILD off the lows for the day
but it was too late for our call play.

Picked on August 19 at $65.32
Change since picked:    -3.46
Earnings Date        07/31/03 (confirmed)
Average Daily Volume:    3.31 million
Chart =



PUTS:
*****

Kohl's Corp - KSS - close: 59.91 change: +1.37 stop: 61.01

Okay, now it's time to start waving the white flag.  Bears should
be VERY cautious.  The market just does not want to go down and
unless the bearish story is extremely compelling most stocks are
going to drift higher.  That's what we are seeing in shares of
KSS.  The big rally today helped KSS add another 2.3 percent and
close above its simple 50-dma.  Psychological resistance at
$60.00 held but we really don't expect it to hold tomorrow.  The
recent affirmation by Wal-Mart that weekly sales are strong has
brought new interest to the retail sector despite the weakness in
the U.S. retail sales numbers.  We're going to call it quits
before we get hurt.  It could be we're just chicken but we'd
rather preserve our capital and live to play another day.

Picked on September 9 at $59.35
Change since picked:     + 0.56
Earnings Date          08/14/03 (confirmed)
Average Daily Volume:       2.9 million
Chart =



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PLAY UPDATES - CALLS
********************

Anglogold Ltd. - AU - close: 38.78 change: +0.19 stop: 37.50

It hasn't been a very positive week for the Gold sector, with the
price of gold continuing its gradual retreat over the past couple
days.  To its credit though, the Gold & Silver index (XAU.X) has
actually held up fairly well and seems to be solidifying above the
$90 level.  Our AU play is behaving much the same, drifting lower
after a failure to hold its breakout over $40, but still above its
most recent breakout level ($38.50).  With volume declining
throughout the drift lower, this looks like nothing more than
orderly profit-taking ahead of the next upward leg.  We've felt
all along that entries on pullbacks were the way to go on this
play, and we got a really solid opportunity today, as AU dipped to
the 20-dma ($38.22) and rebounded to close fractionally positive.
Intraday dips above $38 can still be used for new entries, as we
wait for the daily oscillators to turn positive again, signaling
returning strength to both the stock and the sector.  Maintain
stops at $37.50.

Picked on September 2nd at  $39.51
Change since picked:         -0.73
Earnings Date             10/30/03 (unconfirmed)
Average Daily Volume =       841 K
Chart =


---

Electronic Arts - ERTS - close: 93.14 chg: +4.34 stop: 87.44*new*

Hi-ho silver!  The markets charged ahead after the FOMC confirmed
what the markets were expecting and technology stocks led the
way.  The GSO software index added 2.75%, which fell behind ERTS'
4.8% gain today.  Today's move was also boosted by a positive
report out showing video game sales in August were 4% higher than
last year thanks to ERTS's "Madden NFL" games.  ERTS also had
some positive news with the launch of their EA SPORTS Nation for
Sony PlayStation2 users.  We would be careful chasing shares of
ERTS right here but the stock did breakout over the $92 mark,
which was previous resistance.  The lows on Friday-Monday were a
nice bounce from the bottom of the rising trend and simple 30-
dma.  Bulls can also cheer the decent volume of 4.1 million
shares.  We are going to raise our stop loss to Friday's low near
$87.44.  Our short-term target of $95 is almost in reach and some
traders may want to plan taking some profits off the table.  If
the markets keep up the positive atmosphere momentum bulls might
push ERTS to $100.  FYI: point-and-figure chart readers will
notice that today's breakout produced a fresh spread-triple-top
bullish buy signal for ERTS.

Picked on August 28 at $89.06
Change since picked:    +4.08
Earnings Date        07/23/03 (confirmed)
Average Daily Volume:     3.3 million
Chart =


---

Goldman Sachs Grp. - GS - close: 90.93 change: +1.73 stop: 88.00

Is anyone else getting tired of this?  GS has been churning around
in the $89-92 area ever since we initiated coverage on 9/02 and
has been unable to sustain either a breakout or a breakdown from
that range.  The bulls keep propping it up at critical support and
the bears keep knocking it back at key resistance, with neither
faction able to sustain an advantage.  But it looks like that
stalemate may be about to break in favor of the bulls, with
strength building in the Broker/Dealer index (XBD.X).  The index
blasted higher with a 2.73% gain on Tuesday, ending at its highest
point since February or 2001.  We're betting that GS will catch
fire and go along for the ride, and soon.  As we've been advising,
intraday dips into the $89-90 area look favorable for new entries
and there have been numerous opportunities for that in the past
several days.  Traders waiting for a breakout before playing will
want to wait for a trade above $92.25, with continued strength in
the XBD before playing.  Until this range breaks, maintain stops
at $88.

Picked on September 2nd at  $90.45
Change since picked:         +0.48
Earnings Date              9/24/03 (unconfirmed)
Average Daily Volume =    3.80 mln
Chart =


---

Lear Corp - LEA - close: 54.83 change: +0.97 stop: 52.49*new*

The bulls weren't about to let the rally pass by shares of LEA.
The stock tacked on another 1.8 percent and traded through our
trigger of $54.05 to open the play for us.  This definitely looks
like an entry point for new longs but we would have liked to have
seen more volume on the move.  LEA's technical indicators
(stochastics, momentum, and RSI) are all strongly bullish while
its MACD should produce a new bullish signal in a couple of days.
Short-term traders can aim for the old highs near $57 but we're
going to shoot for a move to $60.  We're also going to raise our
stop loss to $52.49, just under the recent lows near the 50-dma.
There was no new news for LEA other than a new executive officer.

Picked on September 16 at $54.05
Change since picked:      + 0.78
Earnings Date           10/17/03 (confirmed)
Average Daily Volume:        694 thousand
Chart =



---

Southwest Airlines - LUV - cls: 18.72 chng: -0.06 stop: 17.50*new*

It was bound to happen eventually and it looks like our LUV play
may be stalling out just a bit.  After the run its had over the
past couple weeks, a bit of profit taking is overdue and with
price action beginning to weaken, we should now expect the
pullback to confirm that old resistance in the $18.00-18.25 area
is new support.  Cautious traders may want to consider harvesting
some minor gains at current levels and look for a re-entry on a
successful test of that support.  Our confidence in the play
remains strong, especially with the Airline index (XAL.X) closing
at another new high today.  Another measure of the stock needing
to rest a bit is the fact that today was the first close BELOW the
upper Bollinger band since last Wednesday.  Look to initiate new
positions on a successful rebound from above the $18 level, which
should now be strong support.  Note that we've raised our stop to
$17.50, which is still just under the 20-dma ($17.60).

Picked on September 11th at  $18.36
Change since picked:          +0.36
Earnings Date              10/20/03 (unconfirmed)
Average Daily Volume =     2.45 mln
Chart =


---

Mercury Inter. - MERQ - cls: 50.00 chng: +2.01 stop: 45.90*new*

Now that's not a bad start for this bullish Software play.
Investors didn't seem to know what to do ahead of the FOMC
meeting, so they did a lot of nothing on Monday.  But once the
unknown became known, the bulls made their move and propelled
shares of MERQ to a 4.18% advance on Tuesday, with the Software
index (GSO.X) tallying up a 2.75% gain.  Closing right on the $50
level, the stock is right at the edge of a breakout.  While this
is a new 2-year closing high for the stock, it is just below the
early September intraday high of $50.22.  An intraday pullback to
the $49 or even $48 levels can be used for a fresh entry, while
momentum traders will want to take a position on a breakout over
$50.25.  If entering on the breakout, look for continued strength
from the GSO index, which will soon have to contend with solid
resistance in the $145-146 area.  Raise stops to $45.90, which is
just below the 20-dma ($45.95) that provided support on last
week's pullback.

Picked on September 14th at  $48.26
Change since picked:          +1.74
Earnings Date              10/15/03 (unconfirmed)
Average Daily Volume =     3.14 mln
Chart =


---

United Technologies - UTX - cls: 79.84 chg: +1.64 stop: 77.20

The excitement over the improving economy, the Fed's
accommodative stance on monetary policy, and the 118-point rally
in the DJIA had a lot to do with UTX's breakout today.  The 2%
gain broke the short-term two-week trend of lower highs for UTX
and gave bulls some signs of new hope.  More conservative traders
may want to wait for UTX to trade above or close above the
$80.00-80.50 levels.  UTX also has some defense sector exposure
and the surge in defense stocks didn't hurt today.  There is no
significant news.

Picked on August 29 at $80.05
Change since picked:    -0.21
Earnings Date        07/17/03 (confirmed)
Average Daily Volume:     2.1 million
Chart =



**************
NEW CALL PLAYS
**************

Amgen, Inc. - AMGN - close: 69.81 change: +1.31 stop: 66.75

Company Description:
The biggest of the Biotech big guns, AMGN makes and markets
therapeutic products for hematology, oncology, bone and
inflammatory disorders, as well as neuroendocrine and
neurodegenerative diseases.  Anti-anemia drug Epogen and immune
system stimulator Neupogen account for about 95% of sales.  Its
Infergen has been commercialized as a treatment for hepatitis C,
and Stemgen is approved for stem cell therapy in Australia,
Canada, and New Zealand.  The company has a strong pipeline of new
drugs in various stages of development as well as research and
marketing alliances with Hoffman-La-Roche and Johnson & Johnson.

Why we like it:
AMGN appeared to be Teflon-coated throughout the rise from last
fall, right through tagging its most recent high near $72 in the
middle of July, as nothing seemed able to drag the stock back very
far or for very long.  Finally, after hitting that $72 level
(exactly reaching its PnF bullish price target), AMGN pulled back
and has spent the past two months consolidating in a very healthy
manner, and in the past few weeks has been finding support at the
long-term ascending trendline that was established between late-
September and mid-February.  That trendline has been gradually
lifting AMGN higher and last Friday the bulls pushed it back above
its 50-dma ($68.32) and we've seen some nice follow-through
already this week.  Looking at the PnF chart, we can see that it
is right on the verge of giving a new PnF Buy signal and all it
needs to do is trade the $70 level.  Since AMGN is currently on a
mild PnF Sell signal right now (which looks a bit like a bear
trap), that allows us to get a new vertical count from this Buy
signal if we can get it.  Just trading $70 will give us a bullish
vertical count of $81 and that's ample upside potential to keep
everybody happy.

While momentum traders may be content to enter on a trade at $70
and with that new PnF Buy signal, we would advise caution due to
the fact that price is pressing right up against the upper
Bollinger band, which is currently flat.  This likely means a
couple tests will be required for AMGN to push and hold above the
$70 level.  So our preferred strategy would be to wait for the
trade at $70 to give the PnF Buy signal and then look to enter on
an intraday pullback in the $68-69 area, with the 50-dma serving
as key support.  Note that the ascending trendline and the 20-dma
currently line up in the $67.25-67.50 area and that should be very
strong support if this bullish move has any life at all.  We're
initially placing our stop at $66.75, which is also just under
last Wednesday's intraday low.  Since AMGN trades so much in
sympathy with the overall Biotechnology index (BTK.X) look for
confirming strength from the BTK before playing.

Suggested Options:
Shorter Term: The October 70 Call will offer short-term traders
the best return on an immediate move, as it is currently at the
money.

Longer Term: Aggressive traders looking to capitalize on an
extended rally will want to look to the January 75 Call.  This
option is currently out of the money, but should provide
sufficient time for the stock to move higher without time decay
becoming a dominant factor over the short run.  More conservative
long-term traders will want to use the January 70 Call.

BUY CALL OCT-65 YAA-JM OI=15944 at $5.60 SL=3.75
BUY CALL OCT-70 YAA-JN OI=34866 at $2.20 SL=1.00
BUY CALL JAN-70 RQB-AN OI=21517 at $4.50 SL=2.50
BUY CALL JAN-75 RQB-AO OI= 9887 at $2.25 SL=1.10

Annotated Chart of AMGN:



Picked on September 16th at  $69.81
Change since picked:          +0.00
Earnings Date              10/21/03 (unconfirmed)
Average Daily Volume =     8.26 mln
Chart =


---

Apollo Group - APOL - close: 68.45 chg: +2.55 stop: 62.50

Company Description:
Apollo Group Inc. has been providing higher education programs to
working adults for more than 25 years. Apollo Group Inc. operates
through its subsidiaries The University of Phoenix Inc.,
Institute for Professional Development, The College for Financial
Planning Institutes Corp., and Western International University
Inc. The consolidated enrollment in its educational programs
makes it the largest private institution of higher education in
the United States. It offers educational programs and services at
67 campuses and 118 learning centers in 37 states, Puerto Rico
and Vancouver, British Columbia. (source: company press release)

Why We Like It:
One of the major beneficiaries of the economic slow down are the
purveyors of higher education.  Stocks like EDMC, CECO, COCO and
APOL have all done extremely well for investors this year based
on higher enrollment numbers.  Out work employees have decided to
go back to school and make themselves more attractive and
marketable to employers when the recovery finally does start
hiring again.

We like APOL out of the bunch because shares have been
consolidating its gains for the last couple of months.  The
recent breakout to a new all-time high has much stronger legs to
stand on than some of the other stocks.  The company actually
raised its guidance in late August telling Wall Street it expects
fiscal 2004 to beat estimates fueled by higher enrollment and new
campus openings.  APOL forecasts that its University of Phoenix
division (with its own tracking stock) should see enrollment grow
from 12 to 14 percent just in the first quarter.  APOL raised its
Q1 revenue numbers to $392 - 395 million compared to estimates of
$389 million.

The upside breakout today is bolstered by an oversold MACD
curving higher into a bullish signal, while all of its daily
oscillators are pointing skyward.  The move today also produced a
fresh double-top breakout on its point-and-figure chart.  Volume
readers will also notice that volume has been climbing the last
few days.  Our short-term target is $75 while longer-term traders
might hold out for $80.  We'll begin the play with a stop at
$62.50.  More conservative trader might want to consider placing
their stop under $65.

Suggested Options:
Short-term traders should probably look at the November strikes
while longer-term traders may want to look over the February
strikes.  We'll probably see a November 75 issued if APOL trades
above $70.

BUY CALL NOV 65 OAQ-KM OI=1039 at $6.00 SL=4.00
BUY CALL NOV 70 OAQ-KN OI= 694 at $2.90 SL=1.50
BUY CALL FEB 65 OAQ-BM OI= 390 at $7.90 SL=5.25
BUY CALL FEB 70 OAQ-BN OI= 227 at $5.00 SL=3.25
BUY CALL FEB 75 OAQ-BO OI= 302 at $3.00 SL=1.65

Annotated Chart:
Chart =




Picked on September 16 at $68.45
Change since picked:      + 0.00
Earnings Date           10/07/03 (confirmed)
Average Daily Volume:        1.9 million
Chart =



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*******************
PLAY UPDATES - PUTS
*******************

Krispy Kreme Doughnut - KKD - cls: 41.96 chg: -0.74 stop: 44.01

Krispy Kreme teases the bears once again with a painfully fast
drop at the open towards the $40 level before eventually bouncing
back down just 74 cents.  What caused the early morning weakness?
It was a Wall Street Journal column that suggested things are not
as sweet as they seem to be at Krispy Kreme.  The WSJ article
highlighted that average-store sales were down to about $35K a
week, which is significantly less than the $64K they're used to.
Not only are average sales down but its biggest franchisee, Great
Circle Family Foods LLC, has seen even its wholesale shipments
drop 10% and their visitor traffic drop 20%.  Great Circle
actually put themselves up for sale earlier this year but have
not yet announced a buyer.  Wall Street knows that KKD is richly
valued at 62 times earnings compared to the S&P's average of 28
so any stumble in KKD's execution will likely be paid for by the
shareholders.  The close under $42 is still encouraging for bears
but we're cautious.  The big intraday bounce is worrisome on such
big volume of 3.75 million shares.

Picked on September 8 at $41.69
Change since picked:     + 0.27
Earnings Date          08/21/03 (confirmed)
Average Daily Volume:       1.0 million
Chart =



*************
NEW PUT PLAYS
*************

None


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**********

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Contact Support

The Option Investor Newsletter                  Tuesday 09-16-2003
Copyright 2003, All rights reserved.                        3 of 3
Redistribution in any form strictly prohibited.


In Section Three:

Play of the Day: CALL - APOL
Traders Corner: Monthly Reports That Give a Heads Up On Inflation


**********************
PLAY OF THE DAY - CALL
**********************

Apollo Group - APOL - close: 68.45 chg: +2.55 stop: 62.50

Company Description:
Apollo Group Inc. has been providing higher education programs to
working adults for more than 25 years. Apollo Group Inc. operates
through its subsidiaries The University of Phoenix Inc.,
Institute for Professional Development, The College for Financial
Planning Institutes Corp., and Western International University
Inc. The consolidated enrollment in its educational programs
makes it the largest private institution of higher education in
the United States. It offers educational programs and services at
67 campuses and 118 learning centers in 37 states, Puerto Rico
and Vancouver, British Columbia. (source: company press release)

Why We Like It:
One of the major beneficiaries of the economic slow down are the
purveyors of higher education.  Stocks like EDMC, CECO, COCO and
APOL have all done extremely well for investors this year based
on higher enrollment numbers.  Out work employees have decided to
go back to school and make themselves more attractive and
marketable to employers when the recovery finally does start
hiring again.

We like APOL out of the bunch because shares have been
consolidating its gains for the last couple of months.  The
recent breakout to a new all-time high has much stronger legs to
stand on than some of the other stocks.  The company actually
raised its guidance in late August telling Wall Street it expects
fiscal 2004 to beat estimates fueled by higher enrollment and new
campus openings.  APOL forecasts that its University of Phoenix
division (with its own tracking stock) should see enrollment grow
from 12 to 14 percent just in the first quarter.  APOL raised its
Q1 revenue numbers to $392 - 395 million compared to estimates of
$389 million.

The upside breakout today is bolstered by an oversold MACD
curving higher into a bullish signal, while all of its daily
oscillators are pointing skyward.  The move today also produced a
fresh double-top breakout on its point-and-figure chart.  Volume
readers will also notice that volume has been climbing the last
few days.  Our short-term target is $75 while longer-term traders
might hold out for $80.  We'll begin the play with a stop at
$62.50.  More conservative trader might want to consider placing
their stop under $65.

Suggested Options:
Short-term traders should probably look at the November strikes
while longer-term traders may want to look over the February
strikes.  We'll probably see a November 75 issued if APOL trades
above $70.

BUY CALL NOV 65 OAQ-KM OI=1039 at $6.00 SL=4.00
BUY CALL NOV 70 OAQ-KN OI= 694 at $2.90 SL=1.50
BUY CALL FEB 65 OAQ-BM OI= 390 at $7.90 SL=5.25
BUY CALL FEB 70 OAQ-BN OI= 227 at $5.00 SL=3.25
BUY CALL FEB 75 OAQ-BO OI= 302 at $3.00 SL=1.65

Annotated Chart:
Chart =




Picked on September 16 at $68.45
Change since picked:      + 0.00
Earnings Date           10/07/03 (confirmed)
Average Daily Volume:        1.9 million
Chart =



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Monthly Reports That Give a Heads Up On Inflation

Seems like almost every day there is a release of an economic
report giving us one more piece of information about the state of
the economy. Some reports move the market so much it is foolhardy
to be in a position before the release and others give us a big
yawn. But there some we should watch a little closer for they can
give us a heads up on the state of inflation. We know the Fed is
constantly watching inflation so maybe we should be also.

Inflation is defined as a sustained increase in the general level
of prices for goods and services. We measure it as an annual
percentage increase. As inflation rises, every dollar you own
buys a smaller percentage of a good or service.

There are three types of inflation - demand-pull, cost-push and
wage. Traders who are able to distinguish between the three will
have a better understanding of the real message some of the
monthly releases reveal.

Demand-pull inflation comes with economic booms and too much
money chasing too few goods and is readily curable using fiscal
or monetary policy to contract the money supply.

First lets visit Fiscal and Monetary policy:

Fiscal Policy - in a recession consists of either government
spending or tax cuts to stimulate the economy. Whereas, in an
inflationary economy, fiscal policy consists of reducing
government spending or raising taxes.

Monetary Policy - expands the money supply and lowers interest
rates to stimulate a recessionary economy, or shrinks the money
supply and hikes rates to contract an overheated inflationary
economy. The best example of this was the overheated economy of
2000 and the number of times the Fed lowered interest rates to
cool it down.

To maintain current monetary policy the Fed has two main tools.
The first is the open market operations where the Fed buys
government securities (i.e. Treasury Bills, Notes and bonds) in
the open market to expand the money supply and sells government
securities to contract it. The second tool, which has emerged as
the tool of choice for Alan Greenspan, is the rising or lowering
of the discount and Fed funds rate.

Now let's visit the Fed Funds Rate and the discount rate:

Federal-Funds Rate is the interest rate banks charge each other
for overnight loans. The FOMC sets a target level for the
federal-funds rate and then guides the rate near that target by
its activities in the open market.

Discount Rate -- On Jan. 9, 2003, the Federal Reserve adopted a
new system for lending directly to banks and other depositary
institutions. Three new credit rates are now in place: primary,
secondary and seasonal. The central bank often will refer to the
primary credit rate as the discount rate, which is available to
banks that are in sound financial condition.

Cost-Push Inflation - is the result of supply shocks such as oil
price hikes or drought induced food-price spikes. Cost-push
inflation is more troublesome because supply shocks can create
simultaneous inflation and recession called stagflation. Here is
how it works. Price of crude oil takes an unexpected jump because
OPEC cuts back supply. Initially this move will cause inflation
but at the same time energy costs rise for energy dependent
businesses and they, in turn, have to raise prices to offset the
rising costs of doing business.  The consumer ends up paying more
for goods, and sometimes services, just as if a tax were levied
on him.

This is why the Fed is likely to raise interest rates swiftly in
demand-pull inflation but is likely to be more cautious in cost-
push inflation. The reason for the cost-push inflation can by
itself put the recessionary pressures needed and any Fed action
may overdo it.

Two monthly reports can help us distinguish between demand-pull
and cost-push inflation. They are the Department of Labor's Core
(excluding food and energy) Consumer Price Index (CPI) and
Producer Price Index (PPI). The core numbers are generally the
best measures for demand-pull inflation because most of the cost-
push inflation supply shocks happen in the food or energy
sectors.

The Consumer Price Index (CPI) is considered the most widely used
measure of inflation and is regarded as an indicator of the
effectiveness of government policy. The CPI is a basket of
consumer goods (and services) tracked from month to month
(excluding taxes). These goods include everything from the price
of diapers and milk to funeral expenses. CPI figures are
collected in 87 areas throughout the U.S. from over 22,000 retail
and service establishments.

CPI measures inflation at the retail level with the core CPI the
most closely watched major inflation indicators. A rising CPI
indicates inflation.

The Producer Price Index is not as widely used as the CPI, but it
is still considered to be a good indicator of inflation. Formerly
known as the "Wholesale Price Index", the PPI is a basket of
various indexes covering a wide range of areas affecting domestic
producers. The PPI includes industries such as goods
manufacturing, fishing, agriculture, and other commodities. PPI
measures inflation at the wholesale level, before goods are sold
through retailers, therefore can sometimes predict movement in
the CPI.

Wage Inflation - can be triggered by demand-pull or cost-push
inflation pressures late in an expansionary economic cycle when
labor markets are tight and union bargaining power is at its
peak. Wage inflation signs can be found in the following reports:

Average Hourly Earnings (AHE) - is an early indicator of wage
growth in the previous month. However, compared to the Employment
Cost Index (ECI) the AHE has several weaknesses. First, the AHE
is not as broad as the ECI in that it does not include benefits
costs (fringe benefits such as medical benefits). Secondly unlike
the ECI, AHE increases may be due to transitory increases in wage
costs that are not causes of permanent higher wage costs. For
example, increased use of overtime will lead to an increase in
AHE but not in the ECI. For these reasons, Greenspan gives more
weight to the quarterly ECI report rather than the monthly AHE
report in deciding whether wage inflation and wage costs are
increasing or not.

Employment Cost Index (ECI) is reported quarterly and probably
the most valuable wage inflation indicator because it counts both
wages and fringe benefits and not subject to the same measurement
problems as the Average Hourly Earnings. It is considered
inflationary when the ECI increases more than expected for a
given period, or if the ECI has an increasing trend. This ECI
performance causes bond prices to drop, and yields and interest
rates to rise.

While these indicators directly measure inflation and are very
useful to make nascent decisions about inflation, a trader needs
to take heed of what the Fed is looking at also. Right now we
have no inflation, or no inflation worries, but the Fed is
concerned about deflation, a much worse scenario, so any signs of
inflation are good. Go figure!

Most Fed officials agree inflation is unlikely to rise, but
cannot agree on the likelihood of it falling and how much of a
problem that would be. Fed governor Ben Bernanke recently said he
expected some uptick in inflation later this year for technical
reasons, but "disinflation risk will remain a concern for some
time." The remarks, along with similar comments from the Federal
Reserve Bank of San Francisco's Robert Parry, helped spark a drop
in long-term interest rates in recent weeks. But Messrs. Bernanke
and Parry are probably the Fed's leading "disinflation hawks,"
and many of their colleagues aren't as concerned about the risk
of inflation going lower.

Now you can keep an eye on inflation also.

Remember plan your trade and trade your plan

Jane Fox


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