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Daily Newsletter, Wednesday, 03/16/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews
  4. Trader's Corner

Market Wrap

GM Skids, Slams Dow

GM Skids, Slams Dow

The day opened to a huge profit warning from GM, and was followed up by news from the Commerce Department of a new record Current Account deficit for Q4. Despite a brief upside pop for the Nasdaq, all the major indices spent the day declining to new lows, with support breaks on the daily charts.

Volume was very high across the indices, with QQQQ breaking 161M shares compared with its average daily volume of 92.9M. Declining volume swamped advancing volume 2.5:1 on the NYSE and 4.06:1 on the Nasdaq.

Daily Dow Chart



A picture tells a thousand words, and the Dow's daily chart is particularly eloquent today. The 1.04% drop could not have come at a worse time for the bulls, with today's candle gapping clean below rising trendline support in place for the past 5 months. The Dow closed lower by 111.88 at 10633. Below 10625 support, 10575 is next. The daily cycle downphase should continue below 10760.


Daily S&P 500 Chart



We see the same story on the SPX, with the index opening lower at 1197 and never looking back, with the opening print also the session high. The low came at 1186, just above daily Bollinger support at the late February low. Bulls need to regain 1206 to stop the daily cycle downphase, but 1197-98 looks like stiff resistance from here.


Daily Nasdaq Chart



The Nasdaq has been trading an entirely different chart from those of its peers, but today's break took out an important support line as well, breaking the rise off the January lows for the first time in 3 months. That low was tested by today's 2012 low, below which there's only light support below 2000 until the 1975 confluence. Interestingly, the Nasdaq's volume was below the average, despite QQQQ's impressive 161.5M shares reported by Interactive Brokers.

Daily TNX Chart



The Mortgage Bankers Association released its weekly update for the week ended March 11th. The Purchase Index rose 2.5% to 462.8, while the Refi Index rose 4.2% to 2267.5. The Market Index, which measures the overall volume of mortgage loan applications, rose 3.2% for the week, but is down 33.4% from its year-ago level. The gains for the week occurred despite the average contract interest rate for 30-year fixed-rate mortgages increasing to 5.91% from 5.69% the previous week.

Today was a good day for treasury bonds, the first day in many without a large auction of new treasury debt. It also marked the third consecutive session in which the ten year note yield (TNX) made a lower low and lower high for the day, closing lower by 2.4 bps at 4.518% after breaking below the 4.5% mark. Gap support is at 4.44%, and bond bulls/yield bears will want to see that level broken to kick off a new daily cycle downphase, confirmed by a close below 4.4%.


The day kicked off on a sour note as GM warned, citing tight North American sales and lowering its quarterly and full-year earnings outlook. The company is expecting negative EPS of $1.50 for Q1, a big change from its former breakeven-or-better target. The full year outlook was reduced from a profit of $4-$5 per share to $1-$2 before items. GM expects negative cashflow of $2B for 2005, which represents a $4B decline from its previous target. Later in the session, Merrill downgraded GM to "sell" from "neutral," following which Standard & Poor's lowered its outlook on GM's debt from "stable" to "negative." Moody's also announced that it is reviewing GM's and GMAC's debt for possible downgrades. Fitch downgraded GM's and GMAC's ratings to "BBB-" from "BBB" and warned that these ratings could be lowered further to non-investment grade if GM's negativity continues to affect production in the second half of 2005.

It was a busy day for economic data, but the massive GM warning in the premarket cast a pall over the news. At 8:30, the Commerce Department announced a record current account deficit of $187.9B for Q4, exceeding estimates for a deficit of $183B. The $187.9B figure also represents a record 6.3% of GDP. 2004's current account deficit totaled a record $665.9B, or 5.7% of GDP- also a record. Foreign-owned assets in the US grew $460.2B in Q4, completing a $1.4T rise in 2004. Q3's current account deficit was revised to -$165.9B from the previously reported -$164.7B.

Also at 8:30, the Housing Starts and Building Permits reports were released. The Commerce Department reported 2.195M housing starts in February, a .5% increase that brought the rate of new home construction to a 21 year high and blew away estimates for a 2.03M increase. January's reading was revised upward from the 2.159M initially reported, to 2.183M.

Building permits declined 2.7% to a 2.074M gain, just north of estimates for a 2.07M gain. The prior 2.132M number for January was not revised.

The GM warning followed by the Current account data at 8:30AM delivered a one-two punch to the markets, and the equity indices broke to new lows for the week. Following the 8:30 data but before the Industrial production and Capacity utilization reports, CLX released an update based on the tax impact of various items in Q3 and Q4, which it expects to add an extra 2 cents per share in earnings for Q3. These factors should result in a reduction in Q4's earnings by 2 cents, however. The company expects earnings of 65-71 cents for Q3, and a 3%-5% increase in sales. The full year forecasted EPS is $5.95-$6.05, and profit from continuing operations of $2.72-$2.82 per share. CLX closed unchanged at 61.05.

GM closed lower by 13.97% at 29.01.

At 9:15, the Federal Reserve released the Industrial production and Capacity utilization data for February, showing a 3% increase in industrial production that missed expectations by .1%. January's unchanged result was revised up to a .1% gain. Capacity utilization rose to 79.4%, exceeding expectations for 79.2%. The January number was revised up from 79.0% to 79.2%.

The White House announced that Deputy Secretary of Defense Paul Wolfowitz will be nominated by the President to head the World Bank, replacing James Wolfensohn who has held the spot for ten years. While I don't watch CNN, I'm hoping that Wolf Blitzer will have reported on the replacement of Wolfensohn by Wolfowitz.

GM's warning was a shackle on the Dow, SPX and the Nasdaq. Its warning blamed a huge downside adjustment to their quarterly and annual targets on weakness in the North American market, and was then followed by the poor Current account report. GM weighed particularly hard on automotive parts manufacturers, with DPH (-5.06%), GNTX (-2.75%) and VC (-4.12%) getting hit along with GT (-3.31%). Combined with the new highs in commodities, with the CRB breaking to new 25 year highs today led by agricultural futures, as well as the rise in treasury yields, today's picture looked bleak for consumers as well as the companies who sell to them.

Steel manufacturer STLD also reduced its quarterly (Q1) forecast, lowering its target to $1.1-$1.2 per share citing poor market conditions and high raw material costs as well as production outages caused by equipment failures. Nevertheless, the company expects Q2's results to beat lowered Q1 forecasts by 30%-40%, and 2005's results to meet or exceed those of 2004. STLD lost 8.47% to close at 36.94.

There was no help from the energy market, with Crude oil futures spiking following the release of the Energy Department's weekly inventory update. Gasoline supplies declined 2.9 million barrels, exceeding expectations for a 1 million barrel drop. Crude oil supplies rose 2.6M barrels, compared with expectations of a 2 million barrel increase, while distillate supplies declined 1.8 million barrels. Shortly following the announcement, ticker headlines reported that front month crude hit a record all-time high of 56.20. Nymex later reported the session high at 56.70 on my feed. The API released its own numbers, which confirmed a rise in crude and distillate inventories and a decline for gasoline.


Daily chart of Crude oil



Ahead of today's OPEC meeting, an OPEC spokesman announced that production quotas will be raised by 500,000 barrels per day in April to 27.5M bpd, to be followed by an additional increase in the second quarter of 500,000 bpd should it be needed. Saudi Oil Minister Ali al-Naimi said that Saudi Arabia prefers the price of crude oil between $40-$50 per barrel, and feels that the current prices are high.

The daily chart of June crude shows today's new break above 56 and test of the 150% retracement off the 40.00 level in September. Bollinger resistance is at 57.92, and the daily cycle is either on the verge of an upside trending move or a bearish stochastic divergence should the contract break back below the 54 support level. For the day, Nymex crude gained 2.5% to close at 56.425, while the Amex Oil Index, XOI, rose .20% to 853.82.

The futures did not react to news announced just past 2PM that the US Senate has voted to maintain language in federal budget legislation to open the Alaska Artic National Wildlife Refuge to oil drilling. In a victory for the Bush administration, energy companies would be given the green light to exploit the Wildlife Refuge's estimated billions of barrels of oil. The federal budget will be voted later this week, following which it must pass the House of Representatives.

In the afternoon, F reaffirmed is Q1 and 2005 earnings projections, targeting Q1 EPS of $.25-$.35 and full year EPS of $1.75-$1.95 excluding items. Cashflow is expected to come in between $1.2B and $1.5B. Japanese automakers benefited from GM's weakness, with NSANY and HMC holding positive and TM declining fractionally. F closed lower by 2.62% at 11.91, while NSANY gained .43%, HMC rose .89% and TM lost .59% to close at 77.08.

In other news, JPM announced its agreement to pay $2B in settlement of a class action arising from the Worldcom debacle. JPM closed higher by 1 cent at 36.26 The FDA warned that BIIB's Avonex drug for multiple sclerosis can cause severe liver damage, and issued an advisory to physicians about the drug. BIIB closed lower by 2.31% at 37.19.

There will be less economic data tomorrow, with Initial claims to be released at 8:30, then Leading economic indicators at 10AM and at noon, the Philadelphia Fed. The picture is, predictably, mixed, with bears focusing on the significant support breaks on the daily charts and the utter lack of support or strength on the intraday charts. Bulls will point to heavy volume for the day for QQQQ and the deviation of today's decline from upside options expiration "maximum pain" prices. As often happens during op-ex week, strong directional moves and breakouts occur and suddenly reverse as market makers who may be short expiring contracts attempt to shake the corresponding long positions loose. Today's move, with its trendline breaks and absence of bounces, no doubt separated a great many call holders from their positions. While the damage done to the daily charts is very suggestive of more downside to come, it would not be out of character for an op-ex bounce tomorrow. As well, the intraday cycles are deeply oversold. A significant bounce would surprise me as I'm more persuaded by the message of the daily charts, and in any event, such a bounce should be corrective within the context of the declining daily cycle. But caution is the rule, particularly as op-ex Friday approaches.
 

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

New Calls

None today.

New Puts

None today.


Play Updates

In Play Updates and Reviews

Call Updates

Barr Pharma - BRL - close: 48.92 chg: -1.04 stop: 45.99

BRL did pull back today but given the decline but it seems to be market related. Look for a bounce from the $48.00 level.

Picked on March 01 at $ 48.53
Change since picked: + 0.39
Earnings Date 02/02/05 (confirmed)
Average Daily Volume = 800 thousand

---

Hartford Financial - HIG - cls: 70.99 chg: -0.26 stop: 69.95

No change from previous update.

Picked on February 06 at $ 71.17
Change since picked: - 0.18
Earnings Date 01/26/05 (confirmed)
Average Daily Volume = 1.2 million


---

Parker-Hannifin - PH - close: 67.80 change: -0.80 stop: 63.99

No change from previous update.

Picked on March 03 at $ 68.11
Change since picked: - 0.31
Earnings Date 01/18/05 (confirmed)
Average Daily Volume = 1.0 million

---

PACCAR - PCAR - close: 73.90 chg: -1.89 stop: 73.25

Danger! Danger! PCAR has broken down under support at the round-number, psychological $75.00 level. The MACD indicator has produced a new sell signal with today's decline. The close under the $74.00 level is also bearish since this was resistance back in early February. Conservative traders may want to consider exiting here if they have not done so already. It would not take much for PCAR to tag our stop at $73.25.

Picked on February 28 at $ 75.25
Change since picked: - 1.35
Earnings Date 02/01/05 (confirmed)
Average Daily Volume = 1.0 million


---

Progressive - PGR - close: 90.08 change: -0.54 stop: 87.49

No change from previous update.

Picked on March 07 at $ 89.20
Change since picked: + 0.88
Earnings Date 04/21/05 (unconfirmed)
Average Daily Volume = 770 thousand


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Red Robin Burger - RRGB - close: 49.74 chg: +0.50 stop: 43.99

No change from previous update.

Picked on March 10 at $ 48.00
Change since picked: + 1.74
Earnings Date 02/14/05 (confirmed)
Average Daily Volume = 199 thousand


---


Texas Industries - TXI - cls: 65.15 chg: -0.16 stop: 63.49

No change from previous update.

Picked on January 09 at $ 60.18
Change since picked: + 4.97
Earnings Date 12/16/04 (confirmed)
Average Daily Volume = 238 thousand

Put Updates

Allergan - AGN - close: 72.31 chg: -0.43 stop: 76.05

No change from previous update.

Picked on March 13 at $ 73.09
Change since picked: - 0.78
Earnings Date 04/29/05 (unconfirmed)
Average Daily Volume = 777 thousand

---

Apollo Group - APOL - close: 74.33 chg: +1.24 stop: 78.01

An overly bullish reaction to a 10-K filing by CECO helped spur all the education stocks higher. Thus on a day when APOL should have been breaking down to new lows and hitting our target the stock shot higher only to fail again at its descending trendline of resistance.

Picked on January 23 at $ 77.61
Change since picked: - 3.28
Earnings Date 12/16/04 (confirmed)
Average Daily Volume = 2.4 million

---

Google Inc - GOOG - close: 175.60 chg: -3.01 stop: 185.01

No change from previous update.

Picked on March 10 at $179.49
Change since picked: - 3.89
Earnings Date 02/01/05 (confirmed)
Average Daily Volume = 10.9 million

---

Ishares Dow Jones US Energy - IYE - cls 74.60 chg: -0.28 stop: 80.01

No change from previous update.

Picked on March 09 at $ 76.25
Change since picked: - 1.65
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 124 thousand

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Cheniere Energy - LNG - close: 71.01 chg: -0.89 stop: 75.01

No change from previous update.

Picked on March 11 at $ 69.49
Change since picked: + 1.52
Earnings Date 03/10/05 (confirmed)
Average Daily Volume = 517 thousand


---

Mcgraw Hill Cos - MHP - close: 88.16 chg: -0.24 stop: 90.21

No change from previous update.

Picked on March 15 at $ 88.40
Change since picked: - 0.24
Earnings Date 04/26/05 (unconfirmed)
Average Daily Volume = 751 thousand


---

Millipore - MIL - close: 43.73 chg: -0.69 stop: 46.05

Wednesday's market sell-off was enough to push MIL through the $44.00 level and below the short-term trend line of support. This looks like a confirmation of the bear-flag pattern. MIL has traded below our entry point at $43.95 so the play is now open.

Picked on March 16 at $ 43.95
Change since picked: - 0.22
Earnings Date 04/19/05 (unconfirmed)
Average Daily Volume = 358 thousand


---

Oil Service Holders - OIH - close: 94.25 chg: -0.20 stop: 100.01

No change from previous update.

Picked on March 09 at $ 96.10
Change since picked: - 1.85
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 3.1 million

Dropped Calls

Ingersoll-Rand - IR - cls: 83.02 chg: -0.76 stop: 82.49

A triple-digit loss in the Dow Industrials is bad enough but IR also announced that the SEC is asking for information on IR's involvement in any U.N. oil-for-food programs. Investors did not respond well and the stock dipped early after the opening bell. Shares traded below our stop loss at $82.49 before bouncing. While IR is currently still above minor support at the $82 level we would avoid any bullish positions until IR traded back above the $85.25 level.

Picked on February 27 at $ 83.00
Change since picked: + 0.02
Earnings Date 02/01/05 (confirmed)
Average Daily Volume = 1.1 million

---

Wellpoint - WLP - close: 119.57 chg: -1.18 stop: 119.99

Another down day in the markets was not what WLP needed and the stock broke down through its 50-dma and the $120 level. We have been stopped out at $119.99.

Picked on March 06 at $126.88
Change since picked: - 7.31
Earnings Date 04/20/05 (unconfirmed)
Average Daily Volume = 2.1 million

Dropped Puts

Career Education - CECO - close: 36.35 chg: +3.61 stop: 37.51

Whoa! Maybe it was a short squeeze or someone got excited about the company's comments at the Credit Suisse First Boston conference today. One Reuters article suggested that investors are responding to comments in CECO's 10-K filing it issued today stating that the government's investigation into its accounting and business practices was nearing an end. Whatever the case the stock soared and pierced technical resistance at its 100-dma and 200-dma on an intraday basis. This was enough to hit our stop loss at $37.51.

Picked on February 22 at $ 34.90
Change since picked: + 1.45
Earnings Date 02/15/05 (confirmed)
Average Daily Volume = 2.1 million
 


Trader's Corner

WEDGE Patterns and the recent Dow retreat

The wedge chart pattern is the topic at hand today, but first I wanted to share a reply made to an e-mail from an OIN Subscriber:

SUBSCRIBER QUESTION:
When you suggest buying calls or puts at certain support and resistance levels, what month and strike do you like to buy?Do you buy front month options and do you go into ITM-OTM or ATM?

RESPONSE:
The way I trade, tending to buy markets at their more infrequent extremes, such as when the index in question is quite oversold or overbought, I usually want to go out beyond the lead month options if there is only a 2-3 weeks left to expiration. I prefer to have 4-6 weeks left to expiration and be able to stay with a trend, if one develops in the direction I anticipated.

If I think we're at a bottom, I tend to buy At The Money (ATM) or slightly Out of The Money (OTM) calls. If I think the market is at a top, it becomes a bit trickier.

Bottoms are "easier" in a sense. Selling tends to be more of a once or twice decision among the sellers. Whereas there is piecemeal buying of stocks on the way up, selling tends to be more emotional and investors/traders exit frequently all at once - sell everything, get me out of the market kind of thing. This dynamic creates a bottom that is often a one-time spike low - of course, sometimes you get a retest of the low and get a double bottom or a slightly lower low, then it rallies.

Tops can take longer to form and in an advancing trend a rally can keep going for some time - this is where you see rolling tops. The indexes tend to "hang" up there and it makes timing of put purchases a bit different. Because of this I may buy half the number of puts I want to end up with and have room to buy more, so I end up with an average price for the whole lot. I am more inclined to buy ATM or In The Money (ITM) puts. Again, I will tend to go out a month or so.

I have begged you lately to please e-mail with questions and feedback about anything I write about in my Wednesday Trader's Corner article or in my Sunday Index Trader!? Please do let me know what you're thinking!!

WEDGE PATTERNS -

I described in my most recent Index Trader article (3/13/05), relative to the Dow 30 (INDU), what I saw as a rising "wedge" pattern on its daily price chart. There are two converging trendlines involved in a wedge pattern, either rising or falling rising in this case.

The wedge pattern often signals a trend reversal ahead and there has been a significant correction since INDU hit the topmost trendline see chart below.


The validation to the RISING wedge as a significant top comes when the lower trendline is pierced, especially on a closing basis.

I will detail what the wedge formation is and how it might predict future market action - click here to see the recent Index Trader article where I used the fact of the above pattern as a key indicator for a likely top.  

The Dow had led the market up and the bearish rising wedge was well formed. The move to a new high in the Dow around 11,000 lulled many into thinking that the market was beginning a second up leg.

Wedge patterns are usually "reversal" patterns, meaning the existing trend is susceptible to a trend reversal. One such pattern - while not seen all that often - which tends to be predictive for a bottom or top, is called a "wedge".

The wedge pattern of a "rising" bearish type is usually seen after an uptrend has been underway for a while, say for a few months.

BULLISH FALLING WEDGES AND BEARISH RISING WEDGES -

In a rising wedge, prices move gradually higher and form converging trendlines and a "narrowing in" pattern of higher highs and lower lows, such as seen on the left in the Dow chart below from earlier a few months back -


The upward sloping or bearish wedge is normally bearish in
its implications for future price action.

There is a "measuring" rule of thumb for a price objective also - above, in the case of the bearish rising wedge, prices should decline to the start of the formation, or at least to the lowest prior low - this is only a "minimum" downside objective.

The wedge pattern should have at least 2-3 upswing highs and downswing lows that comprise the points through which the trendlines are drawn the more points than this minimum number the better, in terms of drawing two well-defined converging
lines.

What is being suggested in the rising, bearish wedge is that buying is being met with stronger and stronger selling as prices edge higher. When prices fall below the lower up trendline that of a rising wedge pattern, a trend reversal is suggested prices may rebound to the trendline again, but will typically not get back above it.

A declining or falling wedge is typically a bullish pattern as it suggests that selling is being met with increasing buying. Eventually, this sets the stage for an upside reversal as can be seen by the second wedge formation in the Dow chart shown above, and again here -


ANOTHER EXAMPLE ...
Again, from a few months back: a Bearish Falling Wedge

On the chart below, I applied the measuring rule of thumb for a price objective, where the prices should at least advance to the start of the formation, or to the highest prior top at the START of the wedge formation - this is only a "minimum" upside objective.


Back in the September December period, the S&P 500 Index (SPX) traced out a rising wedge pattern, suggesting a possible fall ahead -


Breaking of the lower trendline of the wedge pattern highlighted in the S&P 500 above was useful for buying puts for a short-term trade - but formation of a rising wedge pattern as seen above, did not lead to a MAJOR reversal, although SPX seems to be having a real struggle to get much above where it got to at the top (apex) of the prior wedge. So, the pattern may have signaled a top, but not in the way that I would have expected.

Sometimes a pattern that could be a wedge, but doesn't yet have many "touches" to either or both trendlines (to give better definition) but that you think MIGHT be a developing wedge, will prove not to be it will be "negated" so to speak, by prices breaking out in a direction opposite the expectation, as was the case in the Dow back in the fall


NOTE -
To Option Investor Subscribers - Please send any technical and Index-related questions for possible use in my next Trader's Corner article to support@optioninvestor.com with 'Leigh Stevens' in the Subject line.

Good Trading Success!!

Today's Newsletter Notes: Market Wrap by Jonathan Levinson, Trader's Corner by Leigh Stevens and all other plays and content by the Option Investor staff.

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