Table of Contents
Hanging By A Thread
After a week of mixed results and several rebound attempts the markets traded right on the edge of the cliff until 20 min before the close. A large buy program that boosted the A/D line +800 issues appeared just before the close to pull the major indexes back from the brink. The buy program was futures based with the S&P futures spiking +7 points over several minutes. The spike was just enough to close the Nasdaq and S&P with miniscule gain for the week and prevent the S&P from stretching its string of weekly declines to four weeks. Market manipulation anyone?
Friday's economic reports did not help the bullish sentiment with the GDP headline number falling to growth of only 3.1% for Q4. The consensus estimate was +3.5% and the whisper numbers were as high as +4.5%. Several analysts have speculated that the Microsoft dividend alone would have added +1% to the number. It that was the case then the real GDP number would have been closer to +2%. The factors contributing to the growth were a +4.6% rise in consumer spending and a monster +14.9% jump in capital spending. The capital spending was undoubtedly due to the one time tax credit for equipment purchased before 12/31/04. With the one time factors of Microsoft and the tax credit unable to push the GDP into a respectable range then what is the current quarter going to bring? The biggest drag on the GDP was the record trade deficit in Q4. This subtracted -1.73% from the headline number. This is the silver lining to the GDP cloud. It means our real internal GDP was something in the +4.8% range if you ignore the deficit. Economists will tell you that it can't be ignored but investors really only care that our economy is growing and the ex-deficit number suggests the growth was not as slow as the headline number indicated. Inflation did appear to rise substantially with the personal consumption expenditure (PCE) rising +2.5% in Q4 compared to only +1.3% in Q3. The core PCE also rose at +1.7% compared to +1% in Q3. With the Fed meeting next week traders will be cautious as all indications suggest the Fed is getting nervous.
The Employment Cost Index rose slower than expected with the weakest year over year growth in wage costs on record. With the employment market still soft there is competition for positions and employers do not have to pay up to get quality people. However, benefit costs continue to soar with 60% of the growth in wage costs for the quarter going to benefits. Employment costs rose +0.7% for Q4 and were relatively tame. It would be tough to get a roaring inflation fire going without wages to feed it. This is a partial offset for the Fed to the GDP mentioned above.
Proctor Gamble (PG) announced they were buying Gillette for $57 billion and made Warren Buffet even richer. Berkshire Hathaway is a major shareholder in Gillette and the spike in the stock price provided a whopping +$800 million one day gain for Warren. He said it was a dream deal and would create a company that would have over $60 billion in sales and over $200 billion in market cap. This set off a flurry of merger speculation as to who was next. One suggested combination would be Colgate (CL) and Kimberly Clark. (KMB) Both companies are nearly the same size with KMB only slightly larger. A combination of these two companies would allow the merged company to compete better with the PG/G combination.
Thursday the Dow was shredded by the Cat and today was a bone crusher hit by Merck. A federal court invalidated a patent by MRK on Fosamax, its blockbuster osteoporosis drug. Fosamax had $3.2B in sales in 2004 and with the new ruling MRK will lose the patent in 2008 instead of 2018. This knocked MRK for a -3.16 loss and another Dow drop. Teva Pharmaceuticals stands to gain the most with its generic Fosamax once the patent expires. Combine the drop in Dow components MRK, PG and Boeing and you have a loss of over -40 Dow points from just those three stocks. The Dow closed down -40.20 for the day.
The Iraq election dominated trader chatter in the afternoon and the references on stock TV seemed to increase in intensity as the day progressed. It appeared nobody wanted to take a position before the weekend with countless unknowns ahead. Over a dozen separate car bombs were detonated in Iraq and five U.S. soldiers were killed on Friday. With the election still a day away the violence is only going to get worse. We don't know if there will be dozens killed over the weekend or hundreds or even thousands. The terrorists are determined to prevent as many people from voting as possible and officials are expecting the worst.
OPEC meets on Sunday but the outcome is already known. The OPEC president again said there would be no cut in production. This produced another drop in oil prices to $47.18 after spending most of the week near $50. A weather forecast for the northeast suggested there would be a warming trend and this also relieved demand concerns. The OPEC president again said they would look at the demand again in March to determine if they should cut production to maintain the price. Last year they cut production too much in the spring and then spent the rest of the year trying to catch up to demand shortages. In separate news the Russian oil company Yukos said it would not export any oil in February because it lacked enough cash to pay the export duties. There are no estimates for the drop in total exports because other Russian companies are expected to pick up the slack.
If you are an active trader and live on the west coast then get ready to set your alarm an hour earlier each day. The NYSE is considering opening at 8:00 or 8:30 ET each day and very few traders are happy about it. The traders on the floor are negative about the change saying it will not increase their profits and only increase their costs. The NYSE is hoping to capitalize on the current premarket trading from news events, earnings, etc. The electronic markets open for trading at 8:AM and the NYSE wants part of this volume. On days were there are significant developments many millions of shares are traded on the electronic exchanges. The current betting line on the time change is an 8:30 open and it will start on May-1st.
It was announced after the bell on Friday that Lockheed Martin won the $1.7B contract to build the next generation of presidential helicopters. LMT beat out Sikorsky on the deal and breaks with tradition by using a foreign-designed aircraft. The aircraft will be assembled in Texas but about a third of the work will be done in Europe. The first helicopter will be ready by 2009 and will eventually be a fleet of 23. Just how many helicopters can one person use at a time?
The markets swooned on Friday despite a flurry of decent earnings on Thursday night. The bulls can't get any traction and money is still flowing out of funds. AMG Data confirmed on Friday what TrimTabs has been saying for two weeks that January will end with negative flows for the month. With the average inflows over $20 billion since 1990 and recent years over $40 billion the complete absence of any flows is a major market negative. Several recent reports suggest that large investors are moving to defensive positions ahead of looming uncertainty. With $900 billion in hedge funds the rising bearish sentiment is shifting much of that money to the sell side as well.
The Dow is only off -4% for the year despite the strong decline. It seems stronger because of the extreme bullishness as we entered 2005. A -4% drop is just a blip in the long run but there is increasing worry that this could turn into a real correction instead of just minor profit taking. For the Dow to experience a normal -10% correction it would need to trade down to 9800. Friday's close at 10427 was right on the neckline of that head and shoulders I mentioned on Thursday. Were it not for the last 15 min buy program that added +35 points it would have closed under 10400. It literally was hanging on by the slimmest of threads to that 10400 level and the market manipulation at the close was the only saving grace.
The challenge now is determining if the weakness was due to the impending Iraqi elections or just another bout of the defensive selling we have seen since January began. Fortunately we will have that election answer very soon but that is not the last word. The Fed meets on Tuesday for a two-day session and there is come real confusion over what direction they will take. There was considerable speculation about three weeks ago that the Fed would make one more cut and then pause. However, over the last two weeks the comments have been running more towards removing the measured pace language in anticipation of larger rate hikes to head off inflation. This uncertainty has the bond groupies in a tizzy and traders unsure of where to place bets. This, along with the Iraq elections could be the major reason for the lack of buyers. Those who want to be long the market are slowly ticking off the January events and earnings guidance and waiting for the all clear signal before jumping into the game. That all clear may not be until after the Jobs numbers next Friday.
Dow Chart - 180 min
With the Dow clinging to the 10425 neckline by the slimmest of margins we could be looking at another leg down if the Iraq news is worse than expected. Most expect dozens if not hundreds of attacks over the weekend. We might actually find that much worse projections were already priced into the market and a low death toll actually positive for Monday. Should the Dow lose its grip on 10400 there is light support at 10370 and the 100-day average. The 200-day average is slightly lower at 10279, which corresponds with the 50% retracement of the October rally. If the bears are fixated on forcing a full -10% correction neither of those support levels will matter for long. If the market weakness was due to the election cloud then Monday's open should see a move back to retest 10500 resistance while we wait on the Fed.
The Nasdaq is holding on slightly better than the Dow to the weeks gains. After +10 point buy program at the close the Nasdaq ended just above the middle of its range for the week at 2035. Since the Nasdaq is compromised of more than 30 stocks it is less reactive to a major drop in a single stock than the Dow. Resistance remains 2055 and support at 2020. The Nasdaq was helped by a firming SOX this week. The flood of positive chip earnings had pushed the SOX back over 405 by Friday morning despite the somewhat cautious earnings guidance for the sector. The morning sell program at 10:40 knocked it back to 397 but it clung to that level and refused to go lower despite some decent volume in chips. The closing buy program pushed it back to 400 and nearly +20 points over last Monday's lows. I was impressed by the SOX strength over the last three days and I believe it is suggesting tech sellers are running out of ammo.
SOX Chart - Daily
SOX Chart - 15 min
The Russell is lost and can't find its way home. For three weeks the Russell has shown some very uncharacteristic intraday volatility. Conflicting fund money flows are whipping it around like a butterfly in a windstorm. The range of movement has been from 605-625 and we closed right in the middle at 613. January is normally a small cap month but the tide has turned. Funds are being forced to sell the small caps to raise money for withdrawals. Any excess cash is being invested in highly liquid large caps where it can be extracted on a moments notice. That strategy is also failing with numerous large cap favorites seeing sudden news related drops. There appears to be no safe port in this storm.
I think cash is still a position while the SPX remains in neutral territory between 1160-1175. For five days we have been unable to hold over 1175 resistance and the rebound attempts were lifeless at best on the S&P. There appears to be an effort to hold the S&P over 1167 but baring an Iraqi relief rally on Monday that effort may fail. The January downtrend is still intact and critical support at 1160 could be the next causality.
While we wait on Iraq, the Fed and Friday's Jobs Report I am still recommending only small long positions over 1175 and remaining flat between 1160-1175 with a strong short under 1160. This takes the worry out of picking a market direction and eliminates getting chopped to pieces with the numerous range bound head fakes.
Enter Very Passively, Exit Very Aggressively!
Goldman Sachs - GS - close: 106.12 chg: +2.12 stop: 102.00
Why We Like It:
BUY CALL MAR 100 GS-CT OI= 56 current ask $7.40
BUY CALL APR 105 GS-DA OI=16336 current ask $4.50
Picked on January 30 at $106.12
Eli Lilly - LLY - close: 53.58 change: -1.99 stop: 56.01
Why We Like It:
BUY PUT MAR 55 LLY-OK OI= 4629 current ask $3.60
BUY PUT APR 55 LLY-PK OI=13433 current ask $4.10
Picked on January 30 at $ 53.58
Call Play Updates
Aetna Inc - AET - close: 125.97 change: -0.78 stop: 123.75*new*
Why We Like It:
Picked on January 13 at $127.61
Alliance Resource - ARLP - close: 69.66 chg: -1.67 stop: 69.00
Why We Like It:
Picked on January 10 at $ 69.80
Invitrogen - IVGN - close: 68.39 chg: -1.20 stop: 66.00
Why We Like It:
Picked on January 27 at $ 70.05
KB Home - KBH - close: 107.69 change: +1.92 stop: 99.50
Why We Like It:
BUY CALL APR 100 KBH-DT OI=1023 current ask $11.90
Picked on January 13 at $106.00
Pulte Homes - PHM - close: 64.99 chg: +0.60 stop: 62.49*new*
Why We Like It:
Picked on January 16 at $ 65.99
Pixar - PIXR - close: 86.65 change: -1.43 stop: 84.90*new*
Why We Like It:
Picked on January 18 at $ 88.24
Texas Industries - TXI - close: 62.83 change: +1.28 stop: 59.95*new*
Why We Like It:
BUY CALL APR 60 TXI-DL OI= 78 current ask $5.40
Picked on January 09 at $ 60.18
Put Play Updates
Apollo Group - APOL - close: 76.98 chg: -0.04 stop: 81.01
Why We Like It:
BUY PUT MAR 80 OAQ-OP OI= 54 current ask $5.50
BUY PUT MAY 80 OAQ-QP OI= 418 current ask $7.00
Picked on January 23 at $ 77.61
Black & Decker - BDK - close: 80.91 chg: +1.35 stop: 82.61*new*
Why We Like It:
BUY PUT FEB 80 BDK-NP OI= 2264 current ask $1.40
BUY PUT MAR 80 BDK-OP OI= 179 current ask $2.60
Picked on January 26 at $ 79.47
Nike Inc - NKE - close: 86.49 chg: +0.04 stop: 87.01
Why We Like It:
BUY PUT MAR 85 NKE-OQ OI= 292 current ask $2.00
BUY PUT APR 85 NKE-PQ OI=1086 current ask $2.50
Picked on January xx at $ xx.xx <-- see TRIGGER
Adobe Systems - ADBE - close: 55.48 change: -0.69 stop: 57.11
A minor sell-off in the software sector and another pull back in the NASDAQ helped push ADBE to a new three-month low on Friday. Shares bypassed our recently adjusted target at $55.35 and dipped under our old target at $55.00 to hit $54.80 before a late day bounce in the last 30 minutes. We are closing the play per our guidelines at $55.35. Traders still short the stock should note that ADBE is very short-term oversold and testing support at the $55 level, which happens to be its 38.2 percent Fibonacci retracement of the July-December rally. The stock is overdue for a bounce.
Picked on January 06 at $ 58.99
VNO $69.05 -0.18 - We strongly considered adding VNO to the play list as a put this weekend. The breakdown under round-number support at $70.00 and its 100-dma looks like a bearish entry point. Volume has been way above average on the recent sell-off suggesting more weakness ahead. The 38.2 percent retracement level of its May to December rally would be the $65 mark, which looks like a good target for short-term bearish plays. Plus, the P&F chart has produced a new sell signal with a $63 target. We hesitate because VNO looks short-term oversold so we'll watch for a bounce and a failed rally under $72.
HSIC $65.99 -0.00 - HSIC closed unchanged on Friday after dipping to support at the $65.00 mark bolstered by its 200-dma. The stock has sold off sharply following the recent breakout over $70.00 and thus looks short-term oversold. We would watch for a breakdown under $65.00 as a new bearish entry point.
AZO $88.55 -1.15 - AZO appears to have topped with the peak near $93 at the first of the year. Now the stock is fading under a trend of lower highs and just broke down under $89 and its 50-dma. This looks like an entry point for bearish plays with a target near $85.00.
GCI $79.53 -0.55 - GCI continues to sink under a trend of lower highs and is in danger of breaking down under support in the $78.50-78.00 level. Watch for the breakdown and target a move toward $75. The P&F chart points to a $72 target.
FLIR $59.84 -0.14 - FLIR appears to be channeling higher in a series of short-term peaks and valleys with support at the 200-dma. We see similar action in the MACD with a bullish up trend. We would consider going long on a move over $60.55 with a short-term target of $65.00. Yet we suggest waiting until after its February 2nd earnings report.
CI $78.60 -1.95 - The IUX insurance index broke down under its 200-dma on Friday undermining any strength in the individual stocks in the group. CI may have topped in its current sideways trading range. Look for a drop under $78 as a potential entry point for shorts. The $72.50 level should be support.
ACL $78.90 -0.15 - The consolidation in ACL is narrowing and we should see a breakout up or down soon.
RCL $52.40 -0.49 - RCL is testing the bottom of its rising channel and technical support at the 50-dma. Readers may want to consider bearish plays on a drop under $52.00 or bullish plays on a move over $54.00.
Show Me the Money
The major stock averages just barely avoided their fourth down week in a row. The NASDAQ escaped by just one point. I would not call this past week a victory for the bulls. The mid-week rally failed and most believe it to be nothing more than an oversold bounce in the current short-term downtrend.
Economic data continues to be mixed and Wall Street was not impressed with the latest GDP numbers out on Friday. Everyone seemed to be more focused on Sunday's voting process in Iraq than anything else. Even the bullish Microsoft earnings news on Thursday failed to spark a rally in the software sector.
Market internals continue to weaken. Decliners outpaced advancing issues again and down volume was about 30-to-40 percent stronger than up volume on Friday. The bullish percent data is also starting to sour. In the last two days the Industrials bullish percent has turned into a "bear alert" and the S&P 500 and S&P 100 have faded into a "bull correction". The NYSE and NASDAQ 100 were already in a "bear correction" and "bear alert", respectively.
If the Iraqi vote turns out better than expected we might see a relief rally on Monday but trading could just as easily be stagnant with the two-day FOMC meeting on Tuesday-Wednesday next week. Traders should be careful. The major averages remain short-term oversold and due for a bounce but bullish catalysts continue to go missing. Furthermore Wall Street remains perplexed by the missing inflows to stock funds. Normally January is a huge month for stock inflows and this month could actually turn out to be negative leaving fund managers wondering where all that cash went.
52-week High: 10868
S&P 500 ($SPX)
52-week High: 1217
52-week High: 1635
CBOE Market Volatility Index (VIX) = 13.24 +0.00
Bullish Percent Data
Bullish percent measures the number of stocks in an indexcurrently trading on a buy signal on their point and figurechart. Readings above 70 are considered overbought, and readings below 30 are considered oversold.
Bull Confirmed - Aggressively long
Extreme readings above 1.5 are bullish, and readings below .85are bearish. These signals don't occur often and tend be early,but when they do, they can signal significant market turning points.
Traders sometime ask that question. My answer? That depends.
Trending, range-bound and volatile markets require different approaches. Indicators that work for one type market will lighten trading account balances in another.
Take a look at a range-bound market first. A monthly chart of Dupont (DD) shows that since 2000, DD has remained range-bound between $35.00-50.00, with most prices encapsulated in a narrower range between $40.00-50.00.
Monthly Chart of Dupont:
Clearly, DD qualified as range-bound during that period. In range-bound markets, oscillators such as stochastics tend to work well as predictors of market behavior. On the following daily chart of Dupont from late December 2003 to mid-July 2004, stochastics tops and bottoms demonstrated some congruence with price swing highs and lows. Bullish stochastics crosses up through the lower signal line tended to be good signals for long positions, and bearish crosses down through the upper signal line tended to be good signals for bearish positions. On the chart, bullish entries appear in green, and bearish, in red.
Daily Chart of Dupont:
No signal proves infallible, even if matched to the right type of market. Using oscillators in a range-bound market doesn't either. Depending on exit signals used, bullish signal 2 would likely have resulted in a losing or breakeven play, as would bullish signal 7 and bearish signal 9.
Technicians warn, however, that oscillators such as stochastics prove less useful when markets trend. One example of a trending market was TASR's climb from January through April, 2004.
Annotated Daily Chart of TASR:
In the case of a trending market, some technicians watch the behavior of prices with relationship to key moving averages. In a bullish trend, bounces from an appropriate moving average, perhaps confirmed by another indicator, help pinpoint new entries. Take a look at the same period for TASR, but with the inclusion of the 21-ema.
Annotated Daily Chart of TASR:
The same technique can be applied in downtrends and across different time frames:
Three-Minute Chart of the ES Futures Contract:
Trending and range-bound markets aren't the only types of markets, of course. Choppy markets shouldn't be traded except by adept scalpers, using any indicators. Choppy conditions sometimes show up after an extended move, when markets begin a consolidation and before they've settled into a particular consolidation pattern. Be aware that markets could chop around after such a move, then step aside until you see a pattern develop.
Annotated Five-Minute Chart of the OEX:
Stochastics and other such oscillators might have proven helpful once the rectangular shape of the formation was determined, but the OEX's tight range prevented all but the most adept scalpers from benefiting.
Choppy markets are sometimes volatile, but volatile markets are not always choppy. Periods of expanding volatility sometimes result in a trending play, but the trick lies in catching the moment when volatility expands after a period of consolidation.
Annotated Five-Minute Chart of the OEX:
Most traders would have recognized the choppy trading conditions, but still wanted a way to identify a breakout when it occurred. That breakdown did occur with a trendline break (not shown), but traders might have been too convinced of choppy trading conditions to trust that event. Other tools used to identify expanding volatility include Donchian channels, Keltner channels and thrusts, among others.
One technician defines a thrust as a gap followed by a candle larger than the candle before the gap, with a close near the top of the thrusting candle on an upside breakout and near the bottom on a downside breakout. This technician believes upside breakouts to be more reliable than downside. No such thrust occurred in concurrence with the beginning of this breakdown, whether trustworthy or not.
The creators of both Donchian channels and Keltner channels crafted these channels to identify breakout plays. That's their original purpose, although some traders have since adapted them for other uses. Both types of channels deserve more commentary than can be included in this article, but archived articles discussing these channels in some depth will soon be available.
A couple of charts serve to introduce these channels, however. Note this example of the same five-minute period on the OEX as in the last chart, showing a breakout below a Donchian channel with a period of 20 and an offset of 2.
Annotated Five-Minute Donchian Channel Chart for the OEX:
The Donchian channel identified the breakout. They always catch breakouts. However, a careful examination of the chart reveals false upside breakouts, too, and hones in on one of the pitfalls of trading breakout plays.
Many who study markets suggest that breakout plays provide the most profit over the long run as compared to other types of plays. They sometimes catch big moves. Those big moves amass profit that more than makes up for the unprofitable plays entered while markets chop around as long as losses are kept minimal. Most breakout plays lose money.
Capturing those big moves requires entering on each breakout, however, as it's difficult to identify those that will ultimately prove false and those that would continue to move in the breakout direction. A study of the Donchian channel breakouts above shows that several of those false upside breakouts would have trapped bulls, ending in unprofitable plays. Donchian channels confer no special protection from those traps or from the pitfalls of a trading style that consists of or encompasses playing breakouts.
Exit decisions sometimes prove difficult to make, too. My previous study of Donchian channel breakouts shows that an almost irrational faith in one's abilities and a deep-enough pocketbook to weather long periods of draw-downs are necessary attributes for the trader playing breakout plays using this tool. That investigation also demonstrated that plays are profitable over the long run, corroborating evidence of others.
Keltner channels display similar strengths and weaknesses.
Annotated Five-Minute Keltner channel for the OEX:
Nested Keltner channels may confer a few more benefits than either single Keltner channels or Donchian channels, however. Nesting several channels of different widths inside each other helps set profit targets and identify clusters of support and resistance, perhaps refining entries, too. When examining the following chart, note that it's composed of three separate channels--blue, black and purple. Don't get too caught up in the tangle of lines and what they mean. That's a subject for another article, and one that will soon be available through the archives. For now, you're looking for a break outside one channel, headed to the outer boundary of the next widest.
Annotated 60-Minute Keltner Chart for the OEX:
If I had to choose a favorite tool, that would be the nested Keltner charts because of their versatility. However, these examples confirm that different market conditions dictate the use of different indicators to pinpoint effective trades. Be flexible.
What's my real favorite? The one that works with current market conditions.
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