Option Investor

Daily Newsletter, Monday, 10/27/2003

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The Option Investor Newsletter                   Monday 10-27-2003
Copyright 2003, All rights reserved.                        1 of 2
Redistribution in any form strictly prohibited.

In Section One:

Wrap: Monday's Merger Madness
Futures Wrap: Underwhelming Upside
Index Trader Wrap: Bank of America may have paid too much
Traders Corner: Reality Bites

Posted online for subscribers at http://www.OptionInvestor.com
MARKET WRAP  (view in courier font for table alignment)
     10-27-2003            High     Low     Volume Advance/Decline
DJIA     9608.16 + 25.70  9663.79  9584.54 1.64 bln   1896/ 905
NASDAQ   1882.91 + 17.32  1890.66  1873.62 1.50 bln   2017/1058
S&P 100   510.77 -  0.48   514.69   509.98   Totals   3913/1963
S&P 500  1031.13 +  2.22  1037.75  1028.91
RUS 2000  515.35 +  8.92   516.15   506.43
DJ TRANS 2841.39 + 14.14  2862.07  2823.89
VIX        18.05 +  0.34    18.18    17.74
VXO        19.10 +  0.17    19.35    18.53
VXN        26.12 +  0.67    26.81    26.00
Total Volume 3,434M
Total UpVol  2,339M
Total DnVol  1,016M
52wk Highs     440
52wk Lows       25
TRIN          1.44
PUT/CALL      0.64

Monday's Merger Madness
by James Brown

It was a very busy day on Wall Street that echoed the glory days
of the late 90's where Merger Monday's were commonplace.  The
markets were buoyed at the open on the merger news but stocks
faded from their highs by the close.  Earnings reports from three
Dow components and a better than expected home sales report were
not enough to keep the bulls focused.  Caution ahead of
tomorrow's FOMC meeting and news of four more lethal car bomb
attacks in Iraq weighed on investor confidence.

U.S. exchanges got a boost from a strong Japanese NIKKEI index,
which added 1.15% or 118 points to close at 10,454.  The Hang
Seng was also positive, up 13 points.  European exchanges joined
their Asian counterparts with the German DAX adding 1.87% or 64
points to close at 3517.  The London FTSE closed higher by 12
points.  By the end of today's session the DJIA was up almost 26
points to 9608.  The NASDAQ added 17 points or 0.92% ending at
1882 and the S&P 500 squeaked out a 2-point gain to close at

Market internals were positive with advancing stocks outnumbering
declining stocks nearly 19 to 9 on the NYSE and 20 to 10 on the
NASDAQ.  Up volume was strong on both exchanges, measuring almost
2-to-1 versus down volume on the NYSE and not quite 3-to-1 on the
NASDAQ.  Total volume was modest with 1.6 billion shares trading
on the Big Board and 1.5 billion on the NASDAQ.  Crude oil
futures closed below the $30 a barrel mark, down 24 cents on the
session while gold futures dropped $1 to $388.20 an ounce.

Chart of the DJIA:

Chart of the NASDAQ:

Mergers Aplenty

Launching the markets to an early lead was news that Bank of
America (BAC) would pay $47 billion in stock to buy FleetBoston
Financial (FBF).  Together the two would become the nation's
biggest consumer bank and their union would rank as the third
largest merger (in financial value) behind the Travelers-Citicorp
merger and Nations-BankAmerica merger, which both occurred in
1998.  The acquisition would give FBF shareholders 0.5554 shares
of BAC stock for each share of FBF owned, which equates to a
41.5% premium for FBF over Friday's close.  Together the two
banks would hold 9.8% of the nation's banking deposits, which is
just below the 10% cap set by federal regulators. However, if the
merger is approved the new entity can certainly grow their
business beyond the 10% level.  A merger of this size is going to
come under a lot of federal scrutiny but management believes it
will be completed in the first half of 2004.  As expected shares
of FBF soared today, ending higher by more than 23% while shares
of BAC dropped more than 10% as traders worried that the company
may have paid too high a price for growth.

The BAC-FBF news sent the financial sector in motion.  Several
regional banks like Coamerica Inc, KeyCorp, PNC Financial,
Soveriegn Bancorp and SunTrust Banks all rose on speculation that
further consolidation will make them takeover targets.  The
broker-dealer sector also jumped on the news.  Big Wall Street
houses Goldman Sachs, Merrill Lynch and Morgan Stanley, all with
large investment banking arms, were trading higher since
additional M&A activity means big business for them.

Speaking of big business, the two largest Blue Cross Blue Shield
providers also announced a merger today.  Anthem (ATH) announced
it would buy its larger rival WellPoint Health Network (WLP) for
more than $16 billion in cash and stock.  In a somewhat
convoluted agreement, ATH is buying WLP for nearly $24 in cash
and one share of stock for each share of WLP.  Yet WLP
shareholders will own more than 53% of the new entity and the
combined corporation will be call WellPoint Inc.  The merger will
create the nation's largest health insurer.

Another health insurance merger was announced today with
UnitedHealth (UNH) declaring its intent to purchase Mid Atlantic
Medical Services (MME).  The agreement has UNH spending $18 in
cash and 0.82 shares of its stock for each share of MME, which
gives MME shareholders a 16% premium over Friday's closing price.
All told the deal will measure about $3 billion.  The two health
insurance mergers today had shares of Oxford Health (OHP) trading
higher on takeover speculation.

Monday's merger news wasn't confined to financials and
healthcare.  Technology companies also got into the act.
Symantec (SYMC) has agreed to buy On Technology (ONTC) in a deal
worth $100 million in cash.  Meanwhile Ciber (CBR) announced it
is buying SCB Computer Technology (SCBI) for $90 million in cash
and stock.  Plus, the Internet empire built by Barry Diller
expands to France as InterActive Corp (IACI) declares plans to
buy Anyway.com, a French subsidiary of Canadian tour operator
Transat for almost $63 million.

As if that wasn't enough merger news R.J. Reynolds Tobacco (RJR)
announced after the closing bell today their plans to buy rival
cigarette maker Brown & Williamson, a division of British
American Tobacco (BTI).  RJR plans to spend $2.6 billion in cash
and stock for a 58% ownership in the new company to be named
Reynolds American.  The new entity will have 30% slice of the
U.S. cigarette market with $10 billion in sales a year under
their combined brands American Spirit, Camel, Kool, Lucky Strike,
Pall Mall and Winston.

Earnings News

The breakout of merger news overshadowed earnings announcements
from three Dow components.  American Express (AXP) turned in Q3
earnings that beat estimates by a penny with 59 cents a share.
Revenues were strong and the company guided to the high end of
previous forecasts for the full year but investors seemed
disappointed that results weren't stronger.  Shares lost 1.82%.

Fellow Dow component International Paper (IP) fared poorly as
well.  Shares lost more than 1% after reporting Q3 earnings that
were worse than year-ago levels and missed current estimates by a
penny.  IP's net income of 24 cents a share was hurt by weak
demand and pricing for its paper and packaging products.
Management was quoted as saying the fourth-quarter "looks tough".

The third Dow component to announce today was consumer products
giant Procter & Gamble (PG).  The company reported Q3 earnings
that rose 20% over a year-ago period but only managed to beat
current estimates by a penny.  Net income came out to be $1.26 a
share with revenues up 12.9% to $12.2 billion, which was above
analyst estimates.  PG said its third quarter was boosted by
strong demand for its heartburn drug Prilosec and cost cutting.

Housing Market Hot

Counter balancing the lackluster earnings news was a better than
expected existing home sales report.  Home sales in September
were on fire as sales rose an unexpected 3.6% to a record-setting
6.69 million annual pace.  New home sales were flat at $1.145
million, but remained at a very strong pace.  Analysts had been
estimating small declines in September home sales.  Mortgage
rates are up off their 40-year lows from June but homebuyers are
taking advantage of rates that remain near historically low
levels.  It is a common train of thought that home sales create
demand for appliances, home furnishings and furniture.  Thus, the
high pace of home sales is yet another clue to the improving
economic picture and strong consumer demand.

Terrorist Threat

It may have been a positive Monday on Wall Street but it was a
bloody one in Iraq.  The media is reporting that four attacks/car
bombs have hit three Iraqi police stations and one Red Cross
building in Baghdad.  The violence claimed another 30 to 35 lives
and wounding more than 230, mostly Iraqis.  The Iraq situation
may no longer be a factor influencing the markets but if
conditions continue to heat up it is unclear how it may affect
the future of American consumer confidence and investor
sentiment.  Crossing the wires this evening is another warning
from the U.S. government urging citizens to avoid all non-
essential travel to Saudi Arabia due to "credible" information
regarding terrorist activities.  This in and of itself should not
affect trading in the U.S. exchanges but should extremists strike
down a passenger plane entering or leaving Saudi then we could
see a sharp reaction in the markets.


Hopefully we'll see some follow through on the rebound from
Friday's low but a lot may depend on earnings news and economic
reports out tomorrow.  The Durable Goods Order report will be out
before the opening bell.  Shortly after the open should be the
Consumer Confidence report.  Later in the afternoon will be the
FOMC meeting on interest rates.  Everyone is expecting the Fed to
leave rates unchanged at the 41-year low of 1% but all eyes and
ears will be focused on what they have to say about the economy,
the recent signs of improvement and any new concerns over the d-
word (deflation).  Overall the rash of merger news today is a
healthy sign of stronger investor confidence.  These big
corporations would not be making these kinds of acquisitions if
they didn't think the economy wasn't improving.


Underwhelming Upside
Jonathan Levinson

Equity bulls managed to hold Friday's end-of-session gains, but
could not build on them, with the opening bounce setting the day
high and kicking off a downside slide into the cash close.
Treasuries and gold declined, the dollar and commodities moved

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

Note regarding pivot matrix:  The support, pivot and resistance
levels above are derived from the high, low and closing price
levels by a simple mathematical formula.  They are not intended
to be predictive of market turning points or to serve as targets,
but rather represent the range retracement levels as generated by
the pivot algorithm.  Do not think of them as market "calls"
or predictions.  Like any technically-derived indicator or price
level, the pivot matrix values should be regarded as decision
points at which to evaluate current market conditions.  Visit us
in the Futures Monitor for our realtime views of the various
markets covered here.

15 minute chart of the US Dollar Index

The US Dollar Index moved sideways all night and all day, but did
so with sufficiently wide swings to create a dangerous intraday
trading environment.  The whippy action in the dollar saw
December gold negative, with the CRB breaking 250 but closing
unchanged at 249.34, and mining equities trading mixed throughout
the session.

Daily chart of December gold

December gold could not crack 390 today, trading a session high
of 389 below Friday's close of 389.20, low of 385.60.  It's
either a consolidation of last week's considerable gains, or a
distribution top.  The daily chart oscillators are pointed north,
but with heavy resistance beginning in the 390 area, bulls have
their work cut out for them at current levels.  That said, with
the CRB and silver remaining firm, it would be premature and
imprudent to write off the bullish technical case for gold.  At
current levels, however, with the oscillator upphase looking
tentative, it looks risky to the upside as well.

This is a good area at which to evaluate your risk tolerance and
timeframe, because while I believe that ultimately gold and
silver are headed much higher, I'd be surprised to see it occur
without a pullback first.  As discussed last week, 390-420 is a
significant resistance area dating back to the mid-1980's and
mid-1990's, and there are plenty of hot-money profits currently
on the table from this year's big runup.  It may require some
profit-taking and shaking of weak-hands into stronger hands to
propel gold to the next level.  While the higher low at 365 could
have been it, it didn't look like the kind of solid base of
buyers from which I'd expect the next big wave up to launch.

Daily chart of the ten year note yield

Ten year treasury notes gave back some of their recent gains
today, with the yield adding 5.3 bps to close at 4.265%.  The
move was more of a consolidation of the recent losses in the TNX
than anything else, but the higher low could be indicating the
start of a more meaningful bounce.  Unfortunately, we won't know
without more data points, but for the moment, the trend remains
down on the TNX / up on ten year treasuries.

Daily NQ candles

NQ was negative at the cash close and had made it back to
unchanged territory as of this writing.  It was a tense session,
with sharp, brief bounces fighting a general drift lower from the
10AM high.  We can expect more of the same tomorrow, with the
FOMC meeting in the afternoon.  The move was bullish insofar as
the market did not give back Friday afternoon's gains, but the
inability to break 1387 was bad news in light of the 30 minute
chart upphase (below) powering the doji bounce from Friday's
lows.  The current daily downphase continues, and 1340-50 is
setting up as a key level to watch this week.

30 minute 20 day chart of the NQ

The NQ was deeply oversold on an intraday basis as of Friday's
lows, was due for bounce and delivered.  Unfortunately, it
delivered most of its punch on the closing ramp of Friday's
session, with the remainder of its energy expended uselessly in
the opening minutes of today's session.  More impressive,
however, was the lack of downside price traction on the
oscillator downphase that followed, with 1370 holding for
multiple tests.  If the lows do not break on this move, I expect
another attempt on the 1387-90 resistance level.

Daily ES candles

The ES also created some grey hair today, chopping and bouncing
its way lower from the 10 AM high.  1036.75 held and was not
subsequently challenged, and the pattern of lower lows and mostly
lower highs throughout the remainder of the session coincided
with the 30 minute oscillator downphase below.  The daily
oscillators remain in a downtrend, and the dominance of this
cycle over its shorter peers is reflected in the fact that the 30
minute chart oscillator (below) failed at a lower high, not even
close to the 1040 area.

20 day 30 minute chart of the ES

On this basis, the bearish scenario is working as expected,
except for the lack of downside price traction for the 30 minute
oscillator downphase that kicked off this morning.  It's either
reflecting a buildup in  bullish pressure or, more likely to my
mind, a dwindling in activity ahead of the FOMC announcement
tomorrow.  Volume was lighter today, with 1.53B Nasdaq shares and
1.36B NYSE shares changing hands.  If I'm correct, we can expect
a nothing end to the current downphase and a nothing end to the
upphase to follow, with the real action kicking off tomorrow
afternoon.  1036-1042 remains the critical resistance level

Daily YM candles

Same setup on the YM.

20 day 30 minute chart of the YM

The oscillators that have served us so well recently added to the
confusion today, and I'm expecting more of the same tomorrow.
All day, we watched the intraday oscillators fighting amongst
themselves, resulting in a rangebound drift that was difficult to
trade for more than scalps.  If this is just pre-FOMC noise, then
we'll find out by the end of tomorrow.  With the daily and weekly
oscillators bearish, I expect uncertainty to be resolved to the
downside, as it was today.  See you at the bell!


Bank of America may have paid too much

In what is said to be the 13th largest acquisition in corporate
America history, and create the nations largest consumer bank,
Bank of America (NYSE:BAC) $73.57 -10.12% said it was willing to
pay $47 billion, a 42% premium over Friday's close for
FleetBoston (NYSE:FBF) $39.20 +23.2% in a stock-for-stock deal.

While the news had many regional banks share prices moving higher
on speculation that they too might be rewarded with premiums
attached to FBF by BAC, market participants questioned the
premium being paid by Bank of America (BAC) as it lost just over
$12 billion in market capitalization.  Meanwhile, FBF, which has
a large footprint in the Northeaster part of the U.S. increased
its shareholder's value by just over $7.7 billion.

All told, the market seemed to think BAC may have paid roughly
$4.3 billion too much by day's end.

Today's 10% decline in Bank of America (BAC) single-handedly
wiped out gains in the more regional S&P Banks Index (BIX.X)
325.29 -0.17%, while the larger money center banks as depicted by
the KBW Bank Index (BKX.X) 923.64 -0.4% edged lower as investors
pondered what premiums might be paid by other money center banks
looking to grow the size of their footprint.

S&P Bank Index (BIX.X) Components - Sorted by Market Cap

A quick look inside the BIX.X shows some of the money center
components weighing on the BIX.X in today's session, while the
"smaller" regional banks all posted gains.

The AMEX-listed Regional Bank HOLDRs (AMEX:RKH) $123.85 +2.3%
benefited from today's gains in FBF.  According to the American
Stock Exchange and data provided by Merrill Lynch, the top 5
weighted components in the RKH as of 10/17/03 were USB (56.8%),
WB (41.0%), ONE (33.0%), FBF (25.0%) and WFC (24.0%).

The RKX is comprised of (ASO, ONE, BBT, CMA, FITB, FBF, KEY, MI,

An analysts note I'll make tonight is that on July 17, 2003,
Friedman Billings Ramsey upgraded FleetBoston (FBF) to
"outperform" from "market perform" at approximately $30 citing
the progress the company was making in repairing its retail and
wealth management operations, as well as their belief that the
company's exposure in Latin America and loans to troubled
corporations had been adequately addressed and no longer posed a
threat to future earnings.  Just last week, 10/24/03, Friedman
Billings Ramsey upgraded Mellon Financial (MEL) to "outperform"
from "market perform" saying they feel there has been a
disconnect between the extent of the "bad" Q4 news contained in
MEL's Q3 earnings release and the then seen 13% decline in MEL's
stock price.  FBR says MEL still boasts a diverse mix of asset
mgmt, wealth mgmt, and securities processing business units, each
of which possesses double-digit annual growth potential and
warrants a premium valuation.  FBR placed a $33 target price on
MEL's shares, which has MEL's stock trading at a 10.7% discount
to FBR's price target.

While today's banking merger news had little net effect on the
banking sectors, the HMO Index (HMO.X) 785.89 +2.46% grabbed
today's top spot among sector winners with two of its components
making merger-related headlines.  Anthem Inc. (NYSE:ATH) $71.05
-8.03% saying it would buy HMO Index component WellPoint Health
(NYSE:WLP) $91.09 +8.53% for $16.4 billion in a stock and cash
deal.  If fully consummated, the deal will create the nations
largest health benefits company.

Also seeing gains were HMO Index component Mid Atlantic Medical
(NYSE:MME) $59.62 +10.65% being acquired by UnitedHealth
(NYSE:UNH) $52.40 -3.41%.  Under the terms of the agreement, MME
shareholders will receive UNH stock at a fixed ratio of 0.82
shares for each MME share, plus $18.00 per share in cash, which
value the deal at approximately $62.49 per MME share.

The news helped lift Oxford Health (NYSE:OHP) $45.99 +3.46% to an
intra-day high of $46.60 and challenge a 52-week high set on July
29, 2003 of $46.67.  I think tomorrow morning's before the bell
earnings and comments from OHP should be closely monitored by SPX
and OEX traders when analysts expect the company to report
quarterly earnings of $1.15 per share.  The reason I say this is
that on August 5, 2003, OHP reported EPS of $0.85 per share,
which was 5 cents better than analysts' estimates, but the stock
fell from $42.32 to $35.38 in following sessions on concerns that
a weaker jobs market had enrollments falling by 23,500 during
that quarter and the sell-off in OHP may have been a near-term
negative reaction to a weak jobs market and future enrollments
not only for OHP, but other HMO's.  Tomorrow we might monitor OHP
for any divergence or similarity to August 5, as a pulse from the
market on future prospects for jobs growth.

Other HMO Index (HMO.X) components (SIE +5.3%, PHS +3.7%, CVH
+1.96%, HNT +1.06%, CI +0.72%, FHCC -0.32%, HUM -0.6%, AET
-2.76%) finished mixed to higher in today's trade.

The Dow Jones Home Construction Index (DJUSHB) 548.86 +2.13%
finished a close 2nd to the HMO.X for today's sector winner to
close at an all-time high.  While September new home sales edged
back from August's 1.147 million unit pace at 1,145 million
units, September's pace was well ahead of economists' forecasts
for a 1.125 million unit annual rate.

Small to mid caps as depicted by the Russell-2000 Index (RUT.X)
515.35 +1.76% clearly outperformed the major indices in today's
trade.  Some trading desks mentioned that small caps were
benefiting from some mutual fund end of quarter window dressing.
In Sunday's Market Wrap
we took a look at the Russell-2000 Index (RUT.X) where today's
gains come at an upward trend and rising 50-day SMA.

Pivot Matrix

A late session rally on Friday did have the major indices
reclaiming last week's WEEKLY S2s by the close, and this week
started out with the major indices below their WEEKLY Pivots,
where intra-day trade did find moves higher seeing trade at the
WEEKLY Pivots, but traders seemed tentative to push the major
market averages higher ahead of tomorrow's FOMC meeting.

My only negative thoughts at this point would be related to a Fed
rate hike, where I do think WEEKLY S2s could be traded again this
week, should the Fed decide to raise its Fed funds rate by 0.25
points or more.

One observation I make tonight as it relates to an August 31,
2003 Ask the Analyst column
is that the Continuous Gold Contract ($GOLD) $388.10 fell $1.10
today and trades under the $400 level and based on that article
and comments/observations made by Steve Forbes, has the gold
market telling the Fed they are correctly doing their job.  After
tomorrow's 02:00 PM EST update, I will monitor the December Gold
futures contract (gc03z) $388.40 +0.05%, where its contract high
of $394.80 was found on September 25, 2003, but has yet to see
trade at or above the $400.00.  Still, the price of gold getting
closer to $400.00 than further away does hint the Fed rate hikes
may not be far off, but it may still be early in the scope of
"signs of sustainable economic growth" that the Fed has said it
wanted to see before it started raising rates, or moving from its
current stance of an accommodative monetary policy.

Dow Industrials ($INDU) Chart - Daily Intervals

The INDU traded strong for the bulk of this morning's session,
but gave back early gains after American Express (NYSE:AXP)
$46.75 -1.82%, which reported earnings during today's trade gave
full year 2003 guidance of between $2.26-$2.29 per share, which
was at the low end of consensus estimates of $2.29 per share.
International Paper (NYSE:IP) $38.00 -1.14% fell as higher energy
prices hurt results and had the company reporting quarterly
earnings of $0.24 per share, which was a penny below Wall
Street's consensus estimates.  Procter & Gamble (NYSE:PG) $96.80
+0.77%, which is the highest priced stock in the price-weighted
Dow beat estimates with quarterly earnings of $1.26, compared to
consensus estimates of $1.25.

In the theme of "the market giveth and market taketh away," I
make note that analysts have revised 3M's (NYSE:MMM) $75.74
+0.07% next quarter EPS estimates up a penny to $0.75 from $0.74,
but revised SBC Communication's (NYSE:SBC) $23.48 +2.35% EPS
estimates for next quarter down a penny to $0.34 per share.

Today's trade saw no net change in the very narrow Dow
Industrials Bullish % ($BPINDU).  Still "bull correction" status
at 83.33%.

S&P 500 Index (SPX.X) Chart - Daily Interval

Rules are rules and a stop placed as profiled in the S&P
Depository Receipts (AMEX:SPY) $103.63 at $102.20 would have been
stopped out on Friday when the SPY traded a session low of
$102.18.  The SPX and SPY does lend itself to a bullish test back
into the 1,045-1,050 area this week, but tough new bull entry
with that type of bullish target parameter, but would rather get
another shot at pullback instead of looking long in today's
trade.  Looking for 1,015 support this week, with rally potential
to WKLY R1.  Need technology to firm and start showing some
strength to happen.

Today's trade saw the broader S&P 500 Bullish % ($BPSPX) see a
net loss of 1 stock to a point and figure sell signal.  Still
"bull confirmed" at 78.4%, where a reversal lower at 76% would be
"bull correction" status.

The narrower S&P 100 Bullish % ($BPOEX) saw a net loss of 1 stock
to a point and figure sell signal today as the bullish % slips
another 1% to 77%.  Still "bull correction" status and shows the
large caps seeing some supply outstripping demand.

NASDAQ-100 Tracking Stock (QQQ) Chart - Daily Intervals

The QQQ rallied late on Friday to close right at its WEEKLY S1 of
$36.20, but sputtered throughout today's session.  I'd look for a
short-covering rally to trigger on a move above today's highs.
Would wait for that break as the QQQ may still want to try and
fully fill its gap from the October 2nd high of $33.43, which it
didn't quite do on Friday with a session low of $33.49.  Similar
to this weekend's Market Wrap where it seemed like old bears may
have been a bulls best friend on Friday, with WEEKLY R1 at
$33.31, complacent bears that may not have taken the opportunity
to cover some short positions on Friday should be doing buying on
weakness at this week's WEEKLY R1, which is just below the
October 2nd high of $33.43.

Today's trade saw no net change in the NASDAQ-100 Bullish %
($BPNDX) and status remains "bear correction" status at 75.00%.

Jeff Bailey


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Reality Bites
by Mark Phillips

I'm starting to feel like old Ebeneezer, with my consistent
highlighting of the problems facing our current market, but like
the leopard, I can't change my spots.  I'm not one that will trade
only fundamental information, but neither can I ignore it when it
is sending such a clear message.

The actions of the Federal Reserve have been at the forefront of
investors' minds since Alan Greenspan uttered his first comments
about irrational exuberance back in 1996.  While that comment
turned out to be a bit premature, it was nonetheless eerily
accurate, as that exuberance reached its zenith in early 2000
prior to a painful 2 1/2 year bear market decline that reached its
nadir just over one year ago.

Ironically, it was the Federal Reserve that exacerbated the size
of the bubble before it finally popped, through its easy money and
credit policies leading up to the Y2K non-event.  When it became
clear that there would be no catastrophic computer bug to contend
with, the Fed began tightening monetary policy, too aggressively
in my never-to-be-humble opinion, helping to intensify the
downward slide that got underway in March of 2000.  Greenspan was
tardy in recognizing the error of his ways and the actions of the
Fed were clearly reactionary throughout 2001-2002, trying to build
some traction in the economy by priming the money pump.

By the end of last year, short-term interest rates (and bond
yields) had been driven to multi-decade lows and money creation
(read: printing) was running at a frightening pace.  All the
while, the domestic economy showed no signs of improvement.  This
is in stark contrast to how the economy had responded to every
other similar bout of monetary stimulation in the post-war period.
What changed?  Between the last economic downturn and the one we
are currently dealing with, the economy made the successful
transition to a truly global economy with all the attendant
benefits and of course, the darker side.

You see, the reason monetary stimulation (low interest rates and
plentiful supply) has worked in the past is that it has coerced
businesses to expand and consumers to spend.  Consumers are
willing to take on additional debt to finance expenditures because
employment is rising and they feel better about their future
financial condition.  With consumers spending more, businesses can
ramp up production, taking advantage of the cheaper money supply
to finance the expansion, as they know it will pay for itself in
the long run as the overall economy expands.  Part of that
expansion is increased hiring, which further fuels consumption.
It's a simple equation and one that has worked on numerous
occasions before.

But this time, even driving interest rates to 40+ year lows really
hasn't been able to get the growth engine humming again and
employment still looks dismal.  Don't be confused by the marginal
improvement in the weekly Jobless Claims, the real key is total
unemployment, which really hasn't moved very far from its peak for
this cycle.  And let's not forget about the people that have
already dropped off the unemployment rolls during the past 2-3
years -- they effectively don't show up in the official government
statistics anymore, but I'll bet they would argue that they do
count very much!

Money creation has been running at historical highs and the cost
of money (interest rates) have been at historical lows, yet the
employment picture isn't improving?  Why not?  Well, it's all in
how you define the equation.  Mathematicians and engineers call
them boundary conditions.  We know that monetary stimulus creates
jobs, right?  The big difference this time around is that all
those jobs and all the economic growth is OUTSIDE of the U.S.,
primarily in places like China and India.  Business leaders aren't
stupid, they've been actively moving production and service jobs
overseas, where the cost to the bottom line can be as little as 5-
10% of what it is here.

Where that becomes a problem is in looking at the end market.  The
U.S. is still the consumer to the world, or put another way, the
engine of growth for the global economy.  The rest of the world
produces and we consume.  But wait a minute.  Consumers need an
income stream to consume, right?  If we aren't increasing our
employment rate domestically, how long can consumers (which make
up roughly 70% of GDP) continue to provide the necessary stream of
dollars to be distributed through the global economy?

There's another serious issue to contend with, which is ironically
traceable right back to the Alan Greenspan and his minions.  As
the money supply has been stimulated (arguably with strong
psychotropics!) we have seen twin deficits mount in the U.S. --
the budget deficit and the current account deficit.  We all know
what the budget deficit is -- the difference between revenues and
expenditures.  The current account deficit is the difference
between imports and exports.  Both of these measures are running
near $500 billion annually and are not showing any signs of
imminent shrinkage.

It is the mechanism through which these deficits are funded that
keeps me up at night.  If the government is running a budget
deficit, it is funded by issuing government debt (i.e. bonds), and
to a greater and greater degree, these bonds are being purchased
by foreigners.  To the largest degree in our nation's history, our
debt is owned not by domestic investors but by foreigners.  What
would happen if these foreigners decided that the current rate of
money creation here in the U.S. was unhealthy and decided to
unload a portion (let's say 20%) of their exposure to the
weakening U.S. dollar?  I can't quantify the result, but I can
tell you it wouldn't be pretty for any dollar-based paper assets.

Coming back to the Federal Reserve, it is now clear that this gang
of central bankers ran out of ammunition when interest rates fell
below 1.5%.  They knew it, but didn't want to admit it in the open
market.  As long as the investing public was willing to pretend
the emperor had a nice new set of clothes, the Fed decided to play
along.  Then the past spring, knowing they were running out of
options, the Fed decided to see how much mileage they could get
out of a free ploy, that of jawboning the market.  Greenspan and
his cronies put a lot of effort into convincing the markets that
interest rates would remain low for a "long time" and that the Fed
could take "extraordinary measures" to ensure they stayed low.  It
was an empty threat and the bond traders (astute bunch that they
are), called the Fed's bluff back in June and we saw a
staggeringly rapid rise in bond yields.  Essentially, bond traders
(whether foreign or domestic) sent the Fed a vote of "no
confidence" and while the bond market seems to have reached a new
level of equilibrium, we're by no means out of the woods yet.

In terms of lowering interest rates, the Fed ran out of ammunition
long ago.  Their next weapon was to hold interest rates low
through the THREAT of directly intervening in the bond market and
buying Treasuries.  That threat has now been neutralized.  Ben
"Printing Press" Bernanke has been running the printing presses at
full tilt, trying to avert the dreaded Deflation that nobody is
really willing to talk about, and the net result has been monetary
inflation.  That's right -- the Fed has managed to avert the
specter of deflation for now, but all one has to do is look at the
prices of commodities and it is clear that inflation is coming
back.  How do we normally deal with inflation?  Why, we raise
interest rates to cool off the expanding economy, that's how.

But here's the rub.  From where I sit, the economic expansion is
all taking place outside the confines of the U.S., even though all
the inflation is very much felt here at home.  In terms of
domestic businesses, they're really caught between a rock and a
hard place, as the cost for their raw materials is rising due to
inflationary effects.  But they can't afford to recoup those costs
through increased prices, because they have to remain competitive
with foreign manufacturers, which are essentially importing
DEFLATION into the U.S.!  So what happens if the Fed determines
that inflation is heating up a bit too much and decides to raise
interest rates?  It just places another burden on U.S.-based
businesses that are still struggling just to maintain market share
and cost-effectiveness by applying cost cutting.

Wal-Mart is a perfect microcosm of this effect.  The company is
either the 5th or 6th largest trading partner with China.  WMT is
also the king of the discount retailers.  Can you see the
connection?  The company is continuing to expand, providing an
outlet for Chinese manufacturers, but it creates a strong flow of
dollars from the U.S. to China.  Sure, WMT is a profitable
enterprise and a perfect example of the American Dream.  But how
much does the volume of products that move through the chain
benefit domestic manufacturers?  Very little.  Most of the benefit
is going overseas.  Should the Fed actually raise interest rates,
wouldn't that diminish the amount indebted consumers are willing
to purchase?  Both companies like WMT and their foreign suppliers
would suffer, as the volume of sales would drop.  So there is a
very clear incentive to keep the party going, which is what the
Fed has been doing through its money creation (printing) and
holding interest rates at multi-decade lows.  But they are failing
to get the desired benefit, not due to the supply of money
(there's more than enough), but due to the insufficient VELOCITY
of money.  I'll have more to say on this topic on Wednesday.

This is I think the great illusion that has been foisted upon the
investing public, particularly in the past two earnings periods.
Earnings are improving to be sure, but not nearly enough to
justify the sharp increases in stock prices over the past 12
months.  More to the point though, these earnings improvements are
not coming from actual business growth -- they are coming from
trimming the fat in the corporate structure.  Until there is real
business expansion, we're looking at a house of cards built on wet
sand -- very unstable.  The business expansion that is taking
place, is doing so overseas, not in the U.S.-based manufacturing
or services sectors.

I know we've covered a lot of different issues here this afternoon
and I haven't come anywhere near tying anything together.
Hopefully I'll be able to do that with Wednesday's installment.
The key point I hope I have conveyed is that the Fed truly is
impotent at this point, having exhausted their ability to
stimulate the economy without doing more harm than good.  No
matter what transpires at 2:15pm ET tomorrow, there is really
nothing the Fed can do to change the underlying economy.  We've
seen this from recent FOMC meetings, where the post-announcement
volatility in the major indices has been growing smaller and

At some point in the future, the competing forces of monetary
inflation and imported deflation are going to butt heads and
sparks will fly.  It is at that point in time that the true nature
of the U.S. and potentially global economies will be tested.  Tune
in on Wednesday, and we'll pick up where we left off, before
moving forward to an analysis of where we are in the grand scheme
of the overall bear market and this rather mature bullish

See You Then!



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Contact Support
The Option Investor Newsletter                   Monday 10-27-2003
Copyright 2003, All rights reserved.                        2 of 2
Redistribution in any form strictly prohibited.

In Section Two:

Stop Loss Updates: AZO
Dropped Calls: None
Dropped Puts: None
Play of the Day: Call - BBY
Watch List: Entry Points and Earnings

Updated on the site tonight:
Market Posture: Support found at the 50-DMA

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Best Buy Company - BBY - close: 53.64 change: -1.17 stop: 52.50

Company Description:
Best Buy a specialty retailer of name-brand consumer electronics,
home office equipment, entertainment software and appliances.  The
company provides a broad selection of models within each product
line in order to provide the customer with a meaningful
assortment, offering more than 5800 products, not counting
entertainment software titles.  Growing its store count by 15% in
fiscal year 2000, brought the grand total to more than 4000 in 41
states by year end.

Why we like it:
Without Dramamine, the past couple weeks of trading in shares of
BBY have been enough to induce motion sickness.  The stock has
been bouncing between firm resistance at $55 and equally firm
support at $52.50.  While Thursday's rally had us expecting an
imminent breakout, the early action on Friday induced thoughts of
a potential breakdown.  Fortunately, the bulls arrived just in
time and bought that dip just above our $52.50 stop and lifted the
stock into the middle of that consolidation range by the close.
Until this range breaks, we're stuck with two potential
strategies.  The first is to buy rebounds near the $53 level and
the second is to wait for a breakout over $55 before playing.  Our
target for the play remains a run to $57, at which point we'd
recommend exiting open positions with a tidy gain.  Should the
bears win the current tug-of-war, our $52.50 stop will still
result in a small gain from our picked price of $51.

Why This is our Play of the Day
Our BBY play has been stuck in consolidation mode for the past
couple weeks, continually rejected from the $55 resistance level.
Monday's 1.4% rally in the Retail sector (RLX.X) was enough to
change that dynamic though, as BBY pushed as high as $55.26 before
settling just slightly off that mark, it's first close over the
"double nickel" since early 2000.  BBY has been trading in a broad
ascending channel for nearly a year, and it is encouraging to see
how the stock has rebounded again, using the center of the channel
as support.  Our next upside target is the strong resistance in
the $57-58 area, and that's where we'd suggest harvesting gains.
Not only does that coincide with the all-time highs, but it is
also near the top of the rising channel, currently $59.00.
Aggressive traders can continue to hold, looking for the $60 level
to be reached, but should understand the additional risk that
comes with such a move.  With the proximity of that upside target,
we're hesitant to suggest new entries, except on a solid rebound
from above $53.50, which is the midline of that rising channel.
Strong support has been building just above $52.50, so that's
where we'll leave our stop for now.

Suggested Options:
Shorter Term: The November 55 Call will offer short-term traders
the best return on an immediate move, as it is currently at the

Longer Term: Aggressive traders looking to capitalize on an
extended rally will want to look to the December 60 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 December 55 Call.

BUY CALL NOV-50 BBY-KJ OI= 2410 at $5.70 SL=3.75
BUY CALL NOV-55 BBY-KK OI= 6944 at $2.00 SL=1.00
BUY CALL DEC-55 BBY-LK OI= 6571 at $3.20 SL=1.50
BUY CALL DEC-60 BBY-LL OI= 2146 at $1.40 SL=0.75

Annotated Chart of BBY:

Picked on October 5th at     $51.00
Change since picked:          +4.19
Earnings Date              12/17/03 (unconfirmed)
Average Daily Volume =     3.96 mln


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Watch List

Entry Points and Earnings

American Standard Company - ASD - close: 91.21 change: +1.31

WHAT TO WATCH: That flushing noise isn't coming from ASD but any
bears still trying to short this winner.  The stock has traded
sideways for a week, which is no surprise since the recent
pattern is full of stair-step consolidations.  After finding
support at its 10-dma again ASD is shooting higher.  Traders
could aim for the $100 level with a stop under Friday's low.



Starwood Hotels - HOT - close: 35.55 change: +0.58

WHAT TO WATCH: This looks like an entry point for bulls brave
enough to buy the bounce from the 50-dma.  HOT has not closed
below this technical support since last March.  Keep in mind that
HOT is due to report earnings on Oct. 30th and we don't like to
hold over an announcement.



Omnicom Group Inc - OMC - close: 73.33 change: +0.84

WHAT TO WATCH: This advertising company is due to report earnings
tomorrow and we're curious to see what direction investors take
it.  Will OMC break support just under $72.00 or will it spring
higher towards resistance at $78.00.  The announcement should be
before the opening bell.  Estimates are for 71 cents a share.



Amgen Inc - AMGN - close: 60.83 change: -0.64

WHAT TO WATCH: We're keeping our eye on biotech giant AMGN.  The
company reported earnings last week and we've seen a steep sell
off from its 50-dma two weeks ago.  The recent bounce appears to
be failing now at its 200-dma near $62.00.  Volume was pretty
strong on the sell off so we have a bearish bias but the stock
should find support near $57.50.


RADAR SCREEN - more stocks to watch

SPG $44.91 +0.74 - Here's another stock with a very strong upward
trend and currently bouncing from support near its rising 50-dma.


Support found at the 50-DMA

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