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Daily Newsletter, Monday, 04/18/2005

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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

Aftermath

Aftermath

Friday's selloff continued in international markets overnight, dragging US futures lower. But as the sun came up in North America, prices were off their lows and ticking positive with positive earnings being reported (see below). The indices retraced part of Friday's losses, holding uneasy ranges on both sides of unchanged.

Breadth was positive for most of the session and volume was above average, though lower than Friday's massive numbers. The volatility indices rose briefly above Friday's high closing levels, and then declined throughout what proved to be a slow, boring session. Volume breadth finished fractionally positive, with 1.5 advancing NYSE shares for each declining, and 1.4 advancing for each declining on the Nasdaq.

Daily Dow Chart


The Dow finished lower by 16 points, 51 points off its low but failing at a high of 10105. Extreme oversold readings on the intraday charts generated only a tired sideways bounce, and today's candle printed entirely below the lower Bollinger band at 10163. The 10000 support level has yet to be tested, and the Dow remains stretched to the downside to an extreme degree. While a technical bounce is to be expected, bulls are hoping that today's tired twitching wasn't it. To the upside, there's a big overhang in the 10330-360 area.

Daily S&P 500 Chart


The SPX eked out a 3.4 point gain, bouncing from a low of 1140 and failing at 1149, both well-worn support/resistance zones from months and years past. As with the Dow, extreme oversold conditions on the intraday cycles generated only a sideways retrace of the lower end of Friday's range, and resulted in a print below the Bollinger channel bottom at 1149.8. A break of these levels will see a retest of the confluence zone fro 1125-30, while to the upside, the 1162 area is the Dow's 11330-360 equivalent.

Daily Nasdaq Chart


The Nasdaq also closed lightly green, adding 4.77 to close at 1913 after testing a low of 1904. The bounce failed at 1922, 20 points below the lower Bollinger channel. 1970-75 is upside resistance, followed by 1996 and 2025, while 1900-05 is support from last October. While the intraday cycles are oversold and calling for a bounce, the longer daily and weekly cycles continue to point south.

Daily TNX Chart


The Treasury auctioned $30 billion of 3-month and 6-month bills today. There were 2.1 bids tendered for each accepted on the $16 billion 3-month auction, which generated a high rate of 2.805%, while the bid to cover ratio for the $14 billion 6-month bills was a stronger 2.25 with a high rate of 3.04%. Foreign central banks took just over 1/5th of the total.

Ten year treasury bonds had been very strong for the morning, with ten year note yields (TNX) gapping lower and holding their losses until a few minutes before the release of the auction results. The morning gap was nearly filled as the TNX spiked back above the 4.25% level at 1PM. Currently, a strong daily cycle downphase is reaching the lower end of its range, suggesting support at current levels. 4.2% and 4.26% are back in play, and with the 10-day stochastic looking bottomy, ten year treasury bulls/TNX bears should be tightening their stops. For the day, the TNX lost 2.4 bps to close at 4.249%.

Chart of Crude oil


May crude oil printed a new low for the move at 49.65 last night, bouncing later in the morning to break 51 briefly. OPEC President Sheikh Ahmad al-Fahd al-Sabah said that the cartel would stand by its recent output increases, but that the price drop would likely forestall any further increases until the mid-June meeting. Currently, US inventories are at their highest levels since the summer of 2002.

On the daily chart, today's failed bounce to 51.15 finished closer to the bottom of its range, leaving a doji star verging on a gravestone doji. The daily cycle oscillators continue to point lower, just approaching oversold territory. The rising support line and the confluence support at 50 are followed by less significant support in the 46-47 area, still nearly 20% off the December-January lows and well within this year's uptrend. For the day, May crude closed lower by .175 at 50.325 on the Nymex.


Today was a quiet day, with no major economic reports. There was also a relatively quiet weekend newswire, as little came out of the G7 meeting. Most notable instead was China's absence therefrom, which amounted to a strong statement in the rarified air of diplomatic relations. The attendees failed to reach an accord concerning the forgiveness of loans to developing nations, and resolved not to sell gold to pay down those debts. Speculation continues as to the outcome of the US-China dispute over the Chinese currency peg and recent threats of tariffs as high as 27.5% on Chinese imports, but WMT closed higher today by 18 cents at 47.88.

As expected following Friday's market declines, foreign bourses sold off Sunday night but were recovering by the time US traders returned to their terminals. US futures had been down hard overnight, but the SPX futures were back to unchanged before 8AM. There was even chipper news to greet them, courtesy of Bank of America. BAC, the 3rd largest US bank, reported a 75% jump in Q1 profit from the previous year, citing growth in consumer banking and its acquisition of FBF. Quarterly net income climbed from 91 cents per share or $2.68 billion to $1.14 per share or $4.7 billion, which results included a charge of $112 million or 2 cents per share for merger and restructuring costs. These results blew away estimates for EPS of 97 cents. BAC closed higher by 1.02% at 44.73 following a gap up open, trading 16.8 million shares compared with its 9.6 million average.

This good news was supported by SunTrust (STI), the #7 bank in the US, which reported a 36% jump in profits for the quarter on growth in loan and deposit activity, a decline in bad loans and its acquisition of National Commerce Financial. Net income rose from $1.28 per share or $361.8 million to $1.36 or $492.3 million. The prior results were restate to correct entries for some of the reported bad loans. Excluding items, the quarterly EPS was $1.37, beating estimates by a nickel. STI rose throughout the day to close 1.44% at 71.17 on stronger than average volume.

First State Bancorp (FSNM) chimed in with a 19% rise in earnings from 23 cents or $3.6 million to 28 cents or $4.3 million for the quarter, beating estimates by a penny. PrivateBancorp (PVTB) came in with a 31% increase, earning $7.8 million or 37 cents a share, beating estimates by a penny and citing narrowing loan-loss provisions. FSNM gained 2.02% to close at 17.19 on light volume, while PVTB added 1.55% to close at 31.18. The PHLX Bank Index (BKX) closed higher by 1.26% at 95.73.

MMM reported before the bell as well, announcing earnings of $809 million or $1.03 per share, up from 90 cents or $722 million the year earlier. Estimates were for $1.01 per share, but revenue came in light, rising 4.06% from $4.94 billion to $5.17 billion. Analysts were looking for $5.26 billion. The company said that improved efficiency, pricing and sales growth helped it to weather slow economic conditions in Western Europe and Japan, as well as high input material prices. MMM got clocked for a 6.13% loss, gapping lower at the open and declining all morning to flatline in the afternoon, closing lower by 4.96 at 75.90.

The lone bright splash of green on Friday, aside from the volatility indices and the US Dollar Index charts, was in the health- and drug-related stocks. LLY reported before the bell, announcing a big jump in Q1 earnings from 37 cents or $400.4 million to 68 cents or $736.6 million on revenue of $3.497 billion, topping estimates for 66 cents but missing the $3.564 billion expected revenue. LLY gained 1.6% to close at 59.

The Nasdaq futures went green as Corning (GLW) announced that Q1 earnings would come in higher than expected on stronger demand for hardware and equipment, lower than expected taxes and strength at its Dow Corning unit. Estimates are for earnings between 16-17 cents compared with the prior 11-13 cent guidance. Expected revenues are now $1.04-$1.05 billion from a previously expected $.98-$1.03 billion. Software security maker CheckPoint (CHKP) reported good news as well, announcing a 76% rise in Q1 net profit y-o-y, which, excluding items, beat estimates for 29 cents per share by a penny. GLW rose 4.14% to close at 11.56 on double its average volume, while CHKP lost 1.97% to close at 21.37.

In other news, ADBE announced its plan to buy Macromedia (MACR) in a deal estimated at $3.4 billion, pursuant to which MACR share would be exchanged for .69 shares of ADBE. The price represents a 25% premium to Friday's MACR closing price. MACR shareholders would end up owning 18% of Adobe upon completion. The deal is pending shareholder approval from both companies and by federal regulators. ADBE's CEO stressed that the deal is a growth play, and not a consolidation. ADBE got hit hard on the announcement gapping down to the low 53 area and advancing slowly throughout the session, while MACR gapped up. Keybanc analyst Marc Schappel ruled the selloff in ADBE to be an over-reaction, saying that it provides a good entry point, presumably from the long side, upgrading the stock to a "buy" rating and setting a $70 price target. ADBE closed lower by 9.71% at 54.77, while MACR gained 9.78% to close at 36.72.

After the bell, NVLS reported net earnings of 22 cents or $30.5 million on $339.7 million revenue, meeting estimates on EPS and coming in $300 000 light on revenue but well up from last year's Q1 11 cents or $16.7 million earnings. The stock has risen 2.19% to close at 24.30 during the regular session, but was down to 23.92 as of this writing.

Texas Instruments got a lift afterhours, beating net EPS earnings estimates by a penny at 24 cents or $411 million on revenue of $2.97 billion, compared with 21 cents and $2.94 billion in last year's Q1. Estimates were for revenue of $2.99 billion, and the company cited not strong demand but rather lower manufacturing and operating costs. Nevertheless, the stock was up 5.45% at 24.00 as of this writing.

The economic calendar heats up starting tomorrow, with Housing Starts and Building Permits, as well as the Producer Price Index, all before the opening bell. Wednesday we get the CPI and Core CPI data. As well as the Fed's Beige Book. Added to the mix is a heavy slate of Fed speeches and appearances, with Chairman Greenspan testifying on budget process reforms to the Senate Budget Committee on Thursday. With the indices short term oversold, even after today's consolidation, and ten year treasury yields becoming oversold and approaching strong support, the stage is set for a strong move on the release of either the PPI or CPI data. With earnings season in full swing and a full slate of reports for tomorrow (including GM and PFE reporting before the open and INTC reporting after the close), there's even more potential than usual for wild swings and violent chop.
 

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
ETN None
IYE  

New Calls

Eaton Corp - ETN - close: 58.51 chg: +0.96 stop: 56.99

Company Description:
Eaton Corporation is a diversified industrial manufacturer with 2004 sales of $9.8 billion. Eaton is a global leader in electrical systems and components for power quality, distribution and control; fluid power systems and services for industrial, mobile and aircraft equipment; intelligent truck drivetrain systems for safety and fuel economy; and automotive engine air management systems, powertrain solutions and specialty controls for performance, fuel economy and safety. Eaton has 56,000 employees and sells products to customers in more than 125 countries. (source: company press release)

Why We Like It:
We like ETN for a couple of reasons but readers should know this is a speculative, more aggressive play. Car and truck-related stocks have not been doing well the last few weeks with bad news coming out of Ford and GM affecting the whole group. ETN is no exception. The stock was hit hard last week when they announced earnings and guided lower for the second quarter. Shares of ETN crashed through several levels of support on very big volume. The move last week looks like a definite trend-changing event. However, there are a few clues to suggest we can play ETN for a short-term oversold bounce back toward the $62.00-63.00 range. First and foremost the stock is very short-term oversold and due for a bounce. Combine that with an oversold market that is also due for a bounce and odds of a rebound are in our favor. Now add to the mix the P&F chart that shows ETN testing P&F support, which can normally produce a decent bounce. Plus, the weekly chart shows a long-term trendline (see below) that ETN is bouncing from. Now add today's press release that ETN's Board of Directors has approved a stock buy back program of up to 10 million shares with $200 million worth of shares to be purchased "near term". The rest of the press release was pretty vague on when ETN would repurchase the rest of these shares but it remains a positive for the stock. It might be tempting to think that most of the bad news is already calculated into the stock but we're not making any long-term forecasts. This is just a short-term play looking for a quick pop back toward potential resistance. Our stop loss will be $56.99, just under the recent lows.

Suggested Options:
We are going to suggest the July calls although we do see that May and June strikes are available.

BUY CALL JUL 55.00 ETN-GK OI= 0 current ask $5.30
BUY CALL JUL 60.00 ETN-GL OI=2579 current ask $2.45

Picked on April 18 at $ 58.51
Change since picked: + 0.00
Earnings Date 04/14/05 (confirmed)
Average Daily Volume = 1.1 million

---

Ishares Dow Jones Energy - IYE - cls: 70.78 chg: +1.25 stop: 68.84

Company Description:
Ishares for the Dow Jones U.S. Energy Sector index fund. Companies represented come from the oil production, oil equipment, oil services and oil pipelines.

Why We Like It:
This looks like a short-term bottom in many of the oil stocks. The IYE ishares have been channeling lower in what looks like a bear-flag pattern. Investors bought the dip toward the 100-dma this morning. It's no coincidence that the bottom today was at the bottom edge of its channel. We believe that this looks like a good spot for a speculative bullish play to catch a bounce in the oil sector. We can play the ishares without having to risk holding over any one company's earnings report. We are only targeting a bounce back toward the top of the descending channel in the $74.00-75.00 range. Traders might want to consider this as a longer-term entry point but it wouldn't surprise us to see the bounce to $75 fail and have the IYE retest the $70 level as support again.

Suggested Options:
We are suggesting the July calls.

BUY CALL JUL 65 IYE-GM OI= 0 current ask $7.00
BUY CALL JUL 70 IYE-GN OI=149 current ask $3.50
BUY CALL JUL 75 IYE-GO OI= 82 current ask $1.65

Picked on April 18 at $ 70.78
Change since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 170 thousand
 

New Puts

None today.


Play Updates

In Play Updates and Reviews

Call Updates

Patterson Cos. - PDCO - close: 50.51 chg: -1.17 stop: 49.45

We have been triggered in PDCO and the play is now open. PDCO is a relative strength play with a strong bullish trend but we suspected the stock could trade lower this week and pull back toward support near $50.00 and its simple 50-dma. Our strategy was to go long (buy calls) on a pull back to $50.75 or lower. That's exactly what happened today. Shares slipped to $50.39 this afternoon and the play was triggered at $50.75. Technically speaking we're a little concerned over the big volume on today's decline and the MACD indicator doesn't look so good. Conservative traders may want to wait for signs of a bounce back over $51.00 or $51.50 before initiating new long positions. Our short-term target is the $55 level.

Picked on April 18 at $ 50.75
Change since picked: - 0.24
Earnings Date 05/19/05 (unconfirmed)
Average Daily Volume = 789 million

---

Red Robin Burger - RRGBE - cls: 52.11 chg: +0.11 stop: 49.49

No change from previous update on 04/17/05.

Picked on March 10 at $ 48.00
Change since picked: + 4.11
Earnings Date 02/14/05 (confirmed)
Average Daily Volume = 199 thousand
 

Put Updates

Expeditors Intl Was. - EXPD - cls: 48.63 chg: +0.46 stop: 52.51

No change from previous update on 04/17/05.

Picked on April 14 at $ 49.31
Change since picked: - 0.68
Earnings Date 05/04/05 (unconfirmed)
Average Daily Volume = 748 thousand

---

Ishares Russ 2000 Val - IWN - cls: 176.11 chg: +0.98 stop: 183.51

No change from previous update on 04/17/05.

Picked on April 14 at $178.04
Change since picked: - 1.93
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 324 thousand

---

Starbucks - SBUX - close: 47.00 chg: -0.34 stop: 51.75

No change from previous update on 04/17/05.

Picked on April 10 at $ 48.62
Change since picked: - 1.62
Earnings Date 04/27/05 (confirmed)
Average Daily Volume = 4.3 million
 

Dropped Calls

None
 

Dropped Puts

None


Trader's Corner

Point & Figure - Finishing It All Off

Continuing on in our series on Point and Figure charts I would like to quickly do a recap of what we have learned so far.

P&F Basics - here we started with the history of P&F and explained:
1. Box size and 3 point reversal
2. How to make a column Xs or Os

P&F Support and Resistance - we built on the basics and learned how to draw and use the:
1. Bearish Support Line
2. Bearish Resistance line
3. Bullish Support Line
4. Bullish Resistance Line.

P&F Formations - we investigated when a P&F chart gives a buy or sell signal using:
1. Double Tops and Bottoms
2. Triple Tops and Bottoms
3. Bullish and Bearish Catapult
4. Bullish and Bearish Triangle

P&F Price Projections - gave us an idea of how to calculate the number of points a P&F buy or sell could go with the caveat that price objectives should only be used as a guide for how much you could make out of a trade or a place where you should be thinking about taking profits. Frequently stocks will trade past these projections and also frequently not make it all the way to the projection. P&F charts are not crystal balls they are just very handy tools. The tools we learned were called:
1. Bullish and Bearish Vertical Count
2. Bullish and Bearish Horizontal Count

P&F Relative Strength - getting a little more sophisticated now we learned how to compare a stock to an index and:
1. How to use Relative Strength P&F charts.
2. The four states of a RS chart.

P&F Bullish Percent Index (BPI) - was the granddaddy of all P&F charts and all analysis should start here. In this article we learned:
1. How to determine if the market is bullish or bearish.
2. When risk is high or low?
3. How do I time the market and know when to go long, short or stay flat.

Now we will try and put this altogether and see if can make some sense of this thing they call the stock market.

We will begin with the BPI because that tells us if we should be concentrating on shorts, longs or flat.

We start with the BPI to determine the overall state of the market and, using the same image I showed in the in the BPI article, I would be short this market. (This is also a good time to move your 401(k) money to a money market). That was simple wasn't it? But does that not beg the question short what? How do I find the best short candidates? This is where the things get a little more difficult. Let's start with looking at which of the indexes are the weakest.

If you have read any of my market wraps lately you probably have seen that the SPX is the strongest. Let's see if that is still the case.

In the March 31st Market Wrap I stated "The bad news is that if SPX were to trade to 1160 and give what I consider a weak P&F sell signal, it would translate into a nasty break of a double bottom on the bar chart. Then add the fact that the double bottom was met with a lower low on the MACD and you can see that the sell signal on the P&F chart becomes a little more ominous." The reason I said it would be a weak P&F signal was because the P&F chart is still above its blue support line and as you can see it still is.

Now let's look at the DOW. Here is what I said in the March 31st Market Wrap, "The DOW has added a few Os to the last column but not enough to break the blue support line. This chart gave a sell signal back at 10600 so it is weaker than the SPX, which has not yet given a sell signal."

Here is how the DOW looks now.

As you can see, it has now broken the blue support line and then some. The support line break back at 10350 was also a triple bottom break so this index gave you two reasons to be short.

Let's now look at the Nasdaq composite. Here is what I said in the March 31st Market Wrap, "the red resistance line as started to form and the blue support line has been broken. It has even had its required bounce and made a small column of Xs setting up a picture perfect short entry below 1970."

Did you short this market when it broke 1970 back on April 14th? That's Ok neither did I and what a shame.

So looking at the above P&F charts your short candidate would not be the S&P, it should have been either the DOW or the Nasdaq.

But what if you didnt want to short an index? What if you are more comfortable shorting individual stocks because you feel there is more potential for profit with one stock than with a group of stocks. How do you find those individual stocks? This is where your Relative Strength charts become extremely useful.

Let's use the DOW because there are only 30 stocks to look at. To find the weakest stock in the DOW Industrials, I will look for Relative Strength charts that have broken their blue support line, have formed a red resistance line and on P&F sell signals.

I went through all the Dow charts and found the strongest (for comparison) and the weakest. Which one of the following stocks would you pick for short candidates?

Here is Boeing (BA) compared to the Dow Industrials.

Would you short this stock even thought the market as a whole is bearish? This Relative Strength chart is above the support line and on a P&F buy signal.

How about Altria Group (MO)?

This Relative Strength chart is also above the support line and on a P&F buy signal. Not a good candidate for shorts.

Now look at Walmart (WMT).

The Relative Strength P&F chart for WMT is below the Red Resistance line and on a P&F sell signal.

Here is International Business Machines (IBM).

The Relative Strength P&F chart for IBM is also below the Red Resistance line and on a P&F sell signal.

One last RS chart - here is Coca Cola (KO).

This chart is also below the Red Resistance line and on a P&F sell signal.

Now that we have three short candidates the next step in our analysis is to see how these three compare to their sectors.

First of all WMT is in the Retail sector so lets look at how well it is doing in comparison to its sector. I have used the AMEX Retail Holders Index $IRH for this comparison.

Sometime in October 2005 (red A) this Relative Strength chart gave a double bottom sell signal and it is now well below the resistance line. So far WMT is holding up as a short candidate.

Next let's look at IBM compared to the Hardware Sector represented by the GSTI Computer Hardware Index $GHA.

Between September 2004 and October 2005 this Relative Strength chart gave a double bottom sell signal and it is now well below the resistance line. So far IBM is holding up as a short candidate. .

Next let's look at KO compared to the Consumer Staples index represented by Morgan Stanley Consumer Index - $CMR.

Back in September of 2004 this Relative Strength chart gave a double bottom sell signal then another double bottom sell between November 2004 and February 2005. It is also well below the resistance line. So far KO is holding up as a short candidate as well.

All three of our short candidates are weak in comparison to the market and to their respective sectors. Now it is time to drill down even further and see if we can nail a good entry. For that we will use the plain old basic P&F charts.

Here is the P&F chart for WMT.

WMT has broken its support line and has formed a resistance line. But the thing that jumps out at me is the triple bottom break at $50, which would have been a good entry however; there are other things we need to consider. Firstly of we cant come up with a price projection yet because we dont know when the column of Os ends, we have to wait for the next column of Xs to start. Here is how we do price projection:

1. Find a buy signal. That was in November of 2004 (the B in the last column of Xs.)
2. Move to the right and find the first sell signal using a column of O's (triple bottom break at $50).
3. Then count the number of Os in it after the stock as retraced enough to build a column of X's.
4. Multiply this number by 2.
5. Then multiply that product by the value per box.
6. Then subtract this result to the top O.

The second item we need to consider if your stop loss. If you were to short WMT here, or even at the triple bottom sell signal, your stop loss is a print above $58, which is a wide stop. Therefore, you may want to wait for WMT to retrace, build a column of Xs and sell at your next sell signal. This would serve two purposes; you will be able to calculate your price objective and hopefully give you a lower stop loss.

Here is the P&F chart for IBM.

IBM is in a similar situation as WMT. It gave a sell signal below 85 but has not retraced so we can calculate the price projection. Also if you were to short here your stop is all the way up at $100, too far for my pocket book. So you will need to be patient, wait for IBM to retrace and build a column of Xs so you can calculate your price objective and lower your stop loss.

Here is your basic P&F chart for KO.

KO gave a sell signal back at $48 in July 2004 but it was above the support line so it was a weak signal. However, since then KO has broken its support line and has retraced into a column of Xs giving us a very clear entry below $39 and a price objective:

1. Count the number of Os in the last O column = 13.
2. Multiply this number by 2 (13*2 = 26)
3. Then multiply that product by the value per box (26*1 = 26)
4. Then subtract this result to the top O (51 - 26 = 25)

When/if KO prints below $39 short KO and look for a price projection of $25. Place your stop at the next buy signal.

Did you see how we started at the top and used the BPI charts to determine if you should be positioning yourself short, long or flat? Then you drilled down to the RS charts to find your individual stocks to buy or sell. Then used the RS charts to see if they were exhibiting any kind of strength/weakness compared to their sector - remember 80% of a stocks movement is related to the market and its sector.

Then once we assure ourselves that the stocks were indeed good short candidates we use the basic P&F charts to nail a good entry.

When I first heard about Point and Figure charts I thought they were called Point Your Finger charts. You just point your finger and the chart will tell you where to buy and where to sell. Maybe P&F charts arent quite that easy but darn near.
 

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

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