A Revolting Development
After two weeks of trading at the resistance highs the markets sold the Intel news and have retreated back to the bottom of our current range. The positive Intel news failed to excite tech buyers and the Nasdaq remains the weakest index. The market failure to make the break higher and now the acceleration to the downside has turned into a revolting development for equity bulls.
Dow Chart - Daily
Nasdaq Chart - Daily
The markets opened higher on Friday as tech buyers bought the Intel news but it was short lived. Sellers appeared almost immediately and they never left. Helping to sour sentiment was the second largest trade deficit on record in January at -$58.3 billion. This was a +$3 billion increase from the December level at $55.7 and closing in on Novembers record high at +$59.4B. One reason given for the increase was a jump in apparel imports when the quotas expired. Oil prices were a positive impact as they fell in January but the bounce over the last month is sure to send February's deficit to a new high. The trade balance with China widened by more than $1B with Canada also growing by +$1B. The Canadian growth came mostly from imports of petroleum products.
The growing trade deficit, falling dollar and some comments from Greenspan on Thursday night all combined to weigh on bonds and sending interest rates higher. The yield on the 10-year rose to 45.35% and a seven-month high. With a Fed meeting in our near future the rise in rates could be telegraphing fears that the Fed will soon remove the measured pace comments and add a 50 point hike to punctuate the current rate hike series. While Greenspan has been taking both sides of the deficit picture in recent speeches he still cautions that there is no free lunch and the deficit will have to be brought back into reality eventually. His comments suggest the Fed will continue to push rates higher and possibly much higher. Greenspan continues to warn that anyone betting on low rates ahead will lose money. This was not good news for the markets and helped sour sentiment in spite of Intel.
Energy prices rebounded with oil gaining +89 cents to close at $54.43 and put an end to thoughts that a real bout of profit taking was in progress. Oil appears to be building a support base at $53 and is staying very close to its recent highs. The International Energy Agency revised its demand estimates upward by +290,000 barrels per day to +1.81 mbpd growth for 2005. They said robust growth in the United States and China was increasing demand at a rapid pace. Duh! Despite the increase in demand OPEC is not expected to raise production at its March 16th meeting on Wednesday. Venezuelan Energy Minister Rafael Ramirez said on Friday that OPEC had no reason to expand production and should maintain existing quotas. Other OPEC members, Iran, Qatar and Algeria have also voiced opinions that quotas should not be raised.
China's oil imports rebounded in January from a 14-month low suggesting the economic dip had passed. Weaning OPEC members from +$50 oil is going to be harder than healing a crack addict from cocaine addiction. I am still hoping to see a decent pullback at the end of March but so far there are no signs it will be soon. Lee Raymond, XOM CEO, said on Wednesday that the current price levels were not justified by fundamentals and oil fell from over $55 to $53 but the dip was very brief. I believe Raymond downplayed the story so as not to be the bearer of bad news. If XOM says oil supplies are shrinking then they could be seen as the bad guys for not exploring/discovering more. It is easier for them to stay on the sidelines and out of the battle and just keep cashing the profit checks. Why step in front of the firing squad if you don't have to? I have readers in the oil industry email me almost daily with reports that my oil scenario may have been too cautious and they see conditions accelerating to a conclusion much sooner. Time will tell but the key point is we already know how the story ends.
CRB Index Chart - Daily
SOX Chart - Daily
Intel did not make any friends with their mid-quarter update. They raised revenue guidance to the high end of their range but traders said it was simply a case of raising very conservative guidance to only mildly conservative. They raised their guidance to revenue of +$9.2B-$9.4B from prior estimates of $8.8B-$9.4B. The stock fell -65 cents on Friday after Andy Bryant said they expected a "seasonal quarter toward the better end of our forecasts." Far from exciting guidance from the largest chipmaker. They did raise their gross margin expectations to 57% from 55% but it was mostly on lower than expected startup costs for a new production line. This produced a strong sell the news event as traders hoping for signs of exploding tech demand were disappointed. Friedman Billings Ramsey lowered their outlook for the chip sector and removed AMAT from its focus list saying PC demand was simply not growing. The SOX closed at a two week low at 428 and appears to be headed for a retest of support at 420. The SOX has tried to break resistance at 445-450 for nearly a month with the first test of that level back on February 15th. The SOX was about the only support for the Nasdaq over the last three weeks and should it continue its drop the Nasdaq could easily retest its lows by weeks end.
There was just no excitement in the market. We are in that period of the quarter where there is really no reason to buy other than hopes for a new bull market to appear. So far that hope has been dashed several times in 2005. The resistance highs continue to hold despite the Dow and S&P actually touching new highs before rolling over. On the bright side the selling was slow and on light volume. The A/D line was only slightly in favor of decliners but A/D volume was 2:1 to the downside. One point of interest was a sudden spike in the new 52-week lows to 142 and the high for the year. In fact new lows have been over 120 for three straight days with new highs falling into the 150 range after being as high as 650 back in early March. The 124 new highs posted on Thursday was the lowest level since January 6th. So, while the volume was light the internals have taken a sudden turn for the worst.
Mutual funds saw inflows for the sixth consecutive week with $2.96 billion hitting fund accounts last week. 88% of that went into overseas funds leaving only a trickle for U.S. stocks. According to TrimTabs since Jan-1st more than three times the amount of cash inflows have gone overseas that that staying in U.S. funds. Last week emerging market funds saw their largest inflows since 1994. Tech funds saw their 16th consecutive week of outflows so it is no surprise that the Nasdaq finished at its lows. CSFB published a study this week showing that retail traders were mostly absent from the market with hedge funds accounting for 50% of the volume on the NYSE and the London Stock Exchange. They also said 70% of ETF volume was directly attributed to hedge funds. The bottom line to this paragraph is that individual investors are unsure about the future of the market and are waiting on the sidelines for better visibility ahead. With the hedge funds controlling the majority of trades the volatility could continue to increase. It is still a bull market in commodities and that has mixed implications for equities. The biggest of which is a serious cash drain as funds play the commodity momentum and avoid stocks.
Next week is a minefield of economics with 23 reports mostly clustered in the Wednesday-Friday period. We also have a reweighting of the S&P to a new structure. The S&P is going from a market cap weighting of "shares outstanding" to a "shares available to trade" method. This should produce a negative bias to the market for the week. For instance, 40% of Wal-Mart shares are held by insiders and are not available for trading. By changing the weighting to value only the 60% currently in circulation it reduces the weight of WMT on the S&P by a considerable amount and index fund managers will be forced to sell it. Multiply this by the entire S&P and it could be a significant impact. Standard and Poors will change one-half of the S&P this month and the second half in September. Still, since the odds are good that most large companies will drop in weighting there should be selling on the larger companies and light buying on the smaller companies to bring everything back into parity. I believe this should provide a negative bias that could be accentuated by option expiration.
The Dow lost -166 last week and closed right at the bottom of its two week range. If the negative bias on the S&P is correct then the same S&P selling should hit the Dow since all 30 Dow stocks are major components in the S&P. This suggests we could see a return to 10650 and the support from late February. The SPX closed right on 1200 and its two-week low. It also has risk to 1190 or lower. The Nasdaq appears hell bent to retest the 2025 level we saw in late January and it appears conventional wisdom was right after all. I mentioned on Tuesday that the rejection at 2100 could be the beginning of another market cycle and conventional wisdom suggested we short the Nasdaq again for the current cycle. Unfortunately I lacked the faith to make it a firm recommendation with the Dow and S&P at three-year highs. Fear not there is always another entry just ahead.
I believe we are going to retest the lows but I don't yet believe they will be broken. Until the pattern changes I would be a dip buyer at Nasdaq 2020, SPX 1085. We have what should be a strong earnings cycle just ahead and there have not been any indications that earnings will disappoint. I still believe oil will ease as we move into spring and that should give the equity markets a positive bias. The wild card here is the S&P reweighting and whatever impact it has on the indexes. As long as those levels mentioned above do not break we are still in an uptrend with just a bit of normal consolidation. Should the Nasdaq break 2020 then 2000 becomes a critical psychological support level and a break there could see 1900 very quickly. As I said I don't see that happening yet and I am still looking for a trading bounce from 2020. Buy the dip to 2020/1185 if oil is under $53 and look to exit stocks if oil moves over $56. If you don't have a strong reason to trade this week it might be a good idea to watch and wait. This could be a pivotal week and we should know by Tuesday night how the bias is going to impact option expiration. I will revisit this conversation on Tuesday and hopefully from those support levels mentioned above.
Allergan - AGN - close: 73.09 chg: -2.30 stop: 76.05
Why We Like It:
BUY PUT APR 75 AGN-PO OI=2211 current ask $3.20
Picked on March 13 at $ 73.09
MicroStrategy - MSTR - close: 64.89 chg: -1.25 stop: 68.51
Why We Like It:
BUY PUT APR 65.00 EOU-PM OI= 880 current ask $4.40
Picked on March xx at $ xx.xx <-- see TRIGGER
Barr Pharma - BRL - close: 50.12 chg: +0.35 stop: 45.99
BRL continues its slow and steady pace higher. On Friday the stock rebounded again from the rising, simple 10-dma and broke out over round-number, psychological resistance at the $50.00 mark. This is the first time BRL has traded over $50 since March 2004. It's also bullish to see BRL closing above this key level on above average volume. BRL is actually climbing faster than we expected. Our strategy's time line still gives BRL a couple of months to hit our target in the $54-55 range. Readers can choose to go long with Friday's breakout or look for another dip to the 10-dma as an entry point.
BUY CALL MAY 45.00 BRL-EI OI=1704 current ask $6.30
Picked on March 01 at $ 48.53
Hartford Financial - HIG - cls: 70.98 chg: -0.77 stop: 69.95
Once again HIG is nearing pivotal support at the $70.00 level. The market weakness has pulled HIG lower this past week and sucked most of its momentum out of the rally. The longer-term up trend in still intact and its P&F chart is still very bullish but if HIG breaks down under the $70 level and its 50-dma it could be bad news. At this time we are growing more and more concerned that the markets may be due for a stronger pull back. Thus we are not suggesting new bullish entries in HIG. Conservative traders may seriously want to consider exiting now to minimize any losses and wait for HIG to produce a new relative high.
Picked on February 06 at $ 71.17
Ingersoll-Rand - IR - cls: 84.25 chg: -0.22 stop: 82.49
IR, like many stocks in the manufacturing sector, has a bullish up trend over the last couple of months but shares have pulled back from their highs. On Thursday IR bounced where we expected it to in the $83-84 range but there was no follow through on Friday. At this point, given the lackluster performance by the broader indices and the fading/bearish technicals on IR we are expecting IR to test the $83 level and its 21-dma again. We would not suggest new bullish positions unless IR produced another big bounce from $83 and/or traded above $85.26 (Friday's high and 10-dma).
Picked on February 27 at $ 83.00
Nova Chemicals - NCX - close: 48.96 chg: -0.13 stop: 47.95
This past week NCX came close to hitting the bottom of our target range (52.50-54.00) but couldn't quite muster enough momentum to breakout over the $52 level. Then suddenly on Thursday the stock dropped sharply under support at its 10-dma and the 50.00 mark with big volume behind the decline. That should immediately put bulls on the defensive. We remain defensive now. The longer-term trend is still bullish and its P&F chart is still bullish but the short-term technical oscillators have turned bearish. At this point we would expect NCX to pull back more and test support in the $48.00-48.50 range. Traders can use a bounce above $48.00 as a new entry point but confirm market direction first. That means if the Industrials or S&P 500 are heading south then you may want to wait on initiating new bullish positions.
Picked on February 22 at $ 48.01
Parker-Hannifin - PH - close: 68.04 change: -0.22 stop: 63.99
The rebound in PH still looks tempting especially if you view the new bullish signal on its P&F chart. Unfortunately, weakness in the major indices has been affecting PH the last few days. At this point we would expect PH to probably dip again Monday-Tuesday before bouncing and that would turn its MACD indicator dangerously close to a new sell signal. We would suggest that readers looking for a new bullish entry point wait for PH to trade back above $69.00 or better yet wait for a move over $70.00.
Picked on March 03 at $ 68.11
PACCAR - PCAR - close: 75.23 chg: -0.92 stop: 71.99
We're starting to sound like a broken record but the mild weakness in the major indices is weighing on the markets, which is of course completely normal. In PCAR's case that means the stock has pulled back and is testing support at the $75.00 level. Fortunately, PCAR has additional support near the $74.00 mark. Another bounce from $74.00 would be a bullish entry point but we'd wait for the bounce back over the $75 level.
Picked on February 28 at $ 75.25
Progressive - PGR - close: 88.54 change: -0.75 stop: 85.80
The very long-term trend in PGR and its Point & Figure chart is still very bullish. Short-term the five-week trend is bullish too but we're starting to see the momentum fade as PGR tries to breakout over the $90.00 level. Given the recent weakness in the major indices and the breakdown in the IUX insurance index PGR could have a tough time logging any gains next week. Readers looking for new positions might do best to wait for a breakout over the $90.00 mark. At this point we're expecting PGR to retest the $87.50 level before moving higher.
Picked on March 07 at $ 89.20
Red Robin Burger - RRGB - close: 48.03 chg: +0.03 stop: 43.99
RRGB is a new play from Thursday night's newsletter. The stock hasn't changed much and neither has the strategy although we would suggest looking for some follow through on Thursday's breakout. A reprint of the Thursday play description follows:
We like RRGB for its relative strength and technical breakout. The relative strength is shown today with a 3.89 percent rally while the rest of the market went sideways (or worse). RRGB's technical breakout looks very bullish with a move over its two-month trendline of resistance, its 50-dma, and its 100-dma on volume that is over twice the average (see chart). The stock also has bullish breakouts in the MACD indicator and RSI oscillator. The P&F chart is currently bearish but RRGB is obviously bouncing and appears to have put in a double-bottom near the $44. There is a risk that RRGB could be channeling sideways but most of the signs above say otherwise. The median analyst target is $54 and we agree. Our eight-week target is also $54. Look for news next week when RRGB presents at the Bank of America conference on March 16th.
BUY CALL JUN 45.00 QZR-FI OI= 16 current ask $5.30
Picked on March 10 at $ 48.00
Texas Industries - TXI - cls: 64.08 chg: +0.03 stop: 63.49
Fasten those seat belts! TXI is trading at a pivotal level of support. The pull back in the past few days has erased the late February breakout and TXI is resting on long-term support at the rising 50-dma. The good news is that TXI has tested this technical support several times and we would expect the stock to bounce from here. The bad news is that if TXI breaks down instead it could hit a crowd of stop losses and there could be a rapid amount of profit taking. Readers need to double-check and make sure they are happy with where their stop losses are set. At this point we would look for a move over $65.50 or 65.85 before considering new bullish positions. Until then we're not suggesting new plays.
Picked on January 09 at $ 60.18
Wellpoint - WLP - close: 122.81 chg: -1.54 stop: 119.99
We do not have much new to report on for WLP. The stock has failed to produce any follow through on the breakout to new highs six days ago. Technical oscillators are starting to look negative. Fortunately, WLP still has a rising trend of higher lows, which has built a trendline of support for us to watch. Readers can watch for a bounce above the $120.00 level as a new bullish entry point. However, we would want to see that bounce push past the $124 or $125 levels before initiating new positions. Until then we are not suggesting new positions.
Picked on March 06 at $126.88
Apollo Group - APOL - close: 74.00 chg: -1.95 stop: 78.01
The bears did it again. A few days ago APOL was in danger of breakout over three-month old resistance in its descending trendline of lower highs. Yet the stock couldn't push past the $78 level and declines in the major averages helped sap any investors buying interest in APOL. Friday's 2.5 percent decline did a lot to help re-establish the bearish pattern but we still see short-term support near the $73 region. This is a challenge for us since our initial target was the $72-70 range. Considering the lack of strength in the major indices we're going to stick to our target and plan an exit at $72.00. However, this close to our target we're not suggesting new plays.
Picked on January 23 at $ 77.61
Career Education - CECO - close: 33.22 chg: -0.40 stop: 37.51
So far so good. CECO continues to wither and the stock closed at a new relative low on Friday. Shares are now approaching the next challenge for the bears and that is potential support near the $32.50 level. Fortunately, when you consider the lackluster major indices, weakness in CECO's peers, the bearish triangle breakdown sell signal in CECO's P&F chart we feel confident the stock will continue sinking. Currently the P&F chart points to a $24 target. Our short-term target is the $30.00 area.
BUY PUT APR 35.00 CUY-PG OI=11638 current ask $2.95
Picked on February 22 at $ 34.90
Genentech - DNA - close: 44.08 chg: -0.12 stop: 47.11
DNA is a new put candidate we listed in Thursday's newsletter. There has been little change in the stock and no change in our strategy. A reprint of the original play description follows:
This is simply a technical breakdown play. The BTK biotech sector index is in decline and now DNA has broken down below significant support at the $45.00 level on volume almost twice the average. The MACD has produced a new sell signal and its P&F chart points to a $38.00 target. We want to target a quick drop into the 41.00-40.00 range. Traders need to know there a couple of significant risks here. Normally when playing a biotech stock there is always risk of a failed clinical trial or a successful cure vaulting the stock one way or the other. For option traders that can mean the difference between a massive windfall or a total loss. However, this time we know what some of the risks are. DNA has a few significant clinical trials coming to an end or potential FDA filings that could move the stock expected to occur sometime in 2005. The company expects at least one sometime in the second quarter of this year. The second major risk for the bears is the upcoming ASCO conference in mid-May. Biotech stocks tend to rally the month before this conference and then they sell-off (a classic sell the news move). That means we, as short-term bears, only have about four weeks for DNA to hit our target.
BUY PUT APR 45.00 DNA-PI OI=7590 current ask $2.90
Picked on March 10 at $ 44.20
Google Inc - GOOG - close: 177.80 chg: -2.18 stop: 185.01
On your mark. Get set. Go! GOOG is our recently added high-risk aggressive play. We added the stock on Wednesday with a trigger to buy puts when shares traded at $179.49. Our plan is to catch the next breakdown with a target in the $165.00 region. The good news is that GOOD has broken below technical support at its 100-dma and its three-month trendline of support of higher lows. GOOG has also broken round-number support at the $180.00 level and its recent drop has produced a fresh P&F chart sell signal with a $156 price target. Potentially adding to GOOG's weakness was a recent article in Barron's highlighting another case of insider selling of GOOG shares. Friday's drop looks like another bearish entry point.
BUY PUT APR 185 GOU-PQ OI=2374 current ask $12.00
Picked on March 10 at $179.49
Ishares Dow Jones US Energy - IYE - cls 75.40 chg: +0.55 stop: 80.01
The oil sector managed a very meager bounce on Friday but that's to be expected after the Wednesday-Thursday decline. We remain short-term bearish but long-term bullish on the group. We added IYE on Wednesday given the very clear bearish engulfing candlestick reversal pattern and the massive volume on the breakdown. We are only looking for a quick drop to the $72.00-71.00 range, which is where we expect investors will attempt to buy the dip. A drop to this level would be between the 38.2 percent and 50.00 percent retracement levels.
BUY PUT APR 80 IYE-PP OI= 14 current ask $5.70
Picked on March 09 at $ 76.25
Cheniere Energy - LNG - close: 70.68 chg: +0.54 stop: 75.01
LNG is a new put candidate we listed in Thursday's newsletter. We had a trigger to buy puts on a breakdown below $69.49. The stock hit our trigger on Friday afternoon after fading from its early morning highs. We remain bearish and our strategy remains unchanged. However, more conservative traders might want to wait for LNG to now trade under $69.00 before initiating positions. A reprint of Thursday's play description follows:
We normally do not like to play a stock this close to its earnings date but given the current sell-off underway in the oil sector we couldn't help but take the bait. LNG reported earnings today that were worse than expected. On top of disappointing earnings news the oil sector confirmed yesterday's reversal. The result was a 7.4 percent decline in LNG on volume more than three times the average. The stock has broken its simple 50-dma but is desperately holding on the $70.00 level. Given the massive run up in the stock price LNG is a huge target for profit taking. We will use a TRIGGER under today's low to open the play. Wait for LNG to trade at $69.49 before buying puts. Our target is the $60.00-62.00 range.
BUY PUT APR 75.00 LNG-PO OI= 27 current ask $7.40
Picked on March 11 at $ 69.49
Oil Service Holders - OIH - close: 94.71 chg: +0.48 stop: 100.01
This OIH play is using the same strategy as the IYE play above. The holders have broken its bullish up trend and reversed on huge volume. Friday's bounce is no surprise considering the sell-off. We remain bearish but we're only targeting a drop to the $91.00-90.00 range, which is where we expect investors to attempt to buy the dip.
BUY PUT APR 100 OIH-PT OI= 5916 current ask $6.80
Picked on March 09 at $ 96.10
Loews Corp - LTR - close: 71.80 chg: -1.29 stop: 69.95
We are choosing an early exit in LTR. Friday's 1.7 percent decline broke down through the stock's four-week trendline of support and helped produced a new MACD sell signal. The stock should still have support near the $70.00 level but we would prefer to exit now and minimize our losses.
Picked on February 15 at $ 74.15
Market guru Martin J. Pring suggests using logarithmic charts for long-term charts or those that encompass big market movements. What are logarithmic charts and how do they differ from the standard arithmetic chart?
Most charting services use arithmetic charts as the default setup. Unless you've changed your setup, the charts you study each day are probably arithmetic charts. On an arithmetic chart, the distance between 50 and 100 is five times the distance between 10 and 20. The chart plots each 10-point increment on the same scale.
Logarithmic--or more properly in most cases, semi-log--charts plot prices on a ratio scale. The ratio of 10 to 20 is the same as the ratio of 50 to 100. In each pair, the first number is half the value of the second. On a log chart, the distance from 10 to 20 would be the same as the distance from 50 to 100. The ratio is the same. As prices move higher on a semi-log chart, the distances between each 10-point range decrease. These charts are deemed semi-log charts because only the prices are plotted proportionately. The time scale along the bottom of the chart continues to use an arithmetic scale.
The easiest way to understand the difference is to look at a couple of charts. First is a traditional arithmetic chart, followed by the same chart employing a semi-log scale.
Annotated Weekly Chart of CSCO, Arithmetic Scale
Annotated Weekly Chart of CSCO, Log Scale
Why bother to use log charts? Pring feels that market moves tend to happen proportionately. He uses the example of a rectangular consolidation pattern that forms between 50 and 100. It's possible to set targets with breakouts from a rectangular pattern. The breakout predicts a move that travels the same distance as the width of the rectangle. Obviously, though, a downside break would be unlikely to result in a drop to zero, a 50-point move from the breakdown point. A decline to 25 might be possible, however, with 25 being half of 50, just as 50 is half of 100. The proportionate move would be the same.
This becomes clear when looking at big rallies. Movements that seem exaggerated and overdone, sometimes even parabolic, look less so on a log chart.
Annotated Weekly Chart of the TRAN, Arithmetic Scale
Annotated Weekly Chart of the TRAN, Log Scale
The disparity in behavior near trendlines is even more apparent in a monthly chart of the DJUSHB, the Dow Jones US Home Builders.
Annotated Monthly Chart of the DJUSHB, Arithmetic Scale
Annotated Monthly Chart of the DJUSHB, Log Scale
Many traders have watched that almost parabolic climb on the $DJUSHB's arithmetic chart, attempting to pick tops in the housing stocks, when the climb looked much healthier and less parabolic on a log chart. Some individual homebuilders boasted similar charts. A bull might have felt more comfortable buying on trendline tests with the log chart if studying a semi-log chart, and a bear might have been less likely to start trying to pick a top quite so soon.
Annotated Monthly Chart of TOL, Arithmetic Scale
Annotated Monthly Chart of TOL, Log Scale
Would a log chart have kept traders from shorting the homebuilders quite so readily? You bet. Although even the semi-log charts now show parabolic moves that begin to scary, those semi-log charts might have convinced a few traders to participate in gains made after homebuilders as a group and individually appeared to go parabolic in mid-2003 on arithmetic charts.
For a balanced long-term look at trends, both ascending and descending, take a look at charts on a log scale. You might like what you see a little better.
Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda Piazza, and all other plays and content by the Option Investor staff.
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