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Daily Newsletter, Tuesday, 06/21/2005

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Table of Contents

  1. Market Wrap
  2. New Option Plays
  3. In Play Updates and Reviews

Market Wrap

Inchworm Losing Its Grip?

Lackluster trading, minimal volume, rising oil prices and weak economics have failed to stop the markets from moving steadily higher over the last week. The ten steps forward, nine steps backward I mentioned last week is still in play with every strong spurt of buying followed with an almost identical spurt of selling. Despite the advances the markets are having trouble creeping higher as we approach major resistance levels just overhead. Social Security news late in the day helped grease the skids and the inchworm began to lose traction. 

Dow Chart - Daily

Nasdaq Chart - Daily

The morning started off with a negligible +0.1% gain in the weekly retail sales but it was the third straight week of gains. Warmer weather has helped boost sales of seasonal goods but rising gas prices could slow future consumption. On Monday the Conference Board Leading Indicators fell again by -0.5% with nine of the ten components leading the index lower. April was revised up +0.2% to unchanged technically breaking the five-month string of losses. The index is showing a rising risk of recession due mostly to the rising energy prices. The indicators are being adjusted beginning in June to "bring the index more inline with growth in the economy." A simple case of "if you don't like the answer just change the question" by those that manipulate these things. 

The markets were inching slowly higher as the day progressed until news broke at 3:PM that Republican Senator Bob Bennett was prepared to introduce a Social Security plan that does NOT include private accounts. This would be a reversal to the Bush plan and the markets did not take the news well. When the news broke the Dow lost -30, Nasdaq -10 and both fell into negative territory. Traders bought the dip and rescued the indexes from a potentially stronger bout of profit taking. There has been no real profit taking since early May and the closer we get to Q2 earnings the more likely traders will want to lock in some profits. 

SPX Chart - Daily

The SPX gained +7% since April and is trading only about 1% below its highs for the year at 1229. There is a clear triple top retest in progress and there have been no signs of failure despite the lackluster gains. The VXO fell to a lows not seen since 1994 at 10.08 and is VERY close to single digit levels. This puts the VXO at extremely risky levels for the bulls. The low volume advances and constant dip buying have removed nearly all the volatility from the market despite numerous challenges ahead. Traders have decided to buy bad news and good news alike and there is little fear of the future. 

Considering the falling Q2 guidance this constant dip buying is even more amazing. Q2 guidance began as strongly positive with one negative announcement for every positive one. Historically the average is 2:1, two negative for every positive. 2-3 weeks ago that 1:1 ratio changed with an acceleration of negative releases to a 2:1 ratio. This week we saw negative guidance from MWD, ITW, AET, NUE, NYT, KRI and others that pushed the ratio to 2.7:1 negative to positive. This is not a good sign but traders continue to buy the dips ahead of the normal late summer weakness. After the close today Ford slashed its earnings outlook by -20% for the rest of the year and announced they were going to cut -5% of salaried positions. Contributions to 401K and bonuses for remaining workers were also eliminated. 

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This Friday we will see the Russell indexes rebalanced at the close and next week is quarter end. This has got to be hell week for fund managers as they try to adjust portfolios to match the new Russell weightings as well as window dress for the end of quarter close. This should increase volatility as the week draws to a close, especially with a Fed meeting approaching. 

The interest rate discussions are accelerating with the June FOMC meeting only a week away. Record oil prices are being overshadowed by the almost daily Fedspeak and the coming two-day meeting. Fed funds futures are showing nearly a 100% chance of a quarter point hike at both the June and August meetings and better than a 50% chance of another hike in September. Just when the bond groupies were nearing agreement on the future of rates, Pimco's Bill Gross suggested today that the Fed could be cutting rates by year end. Confused? So are the markets and we are likely to trade sideways until we hear what the Fed says next Wednesday when their meeting closes. We do have another Greenspan speech this Thursday but I doubt he will say anything contrary to his prior appearances with that Fed meeting just ahead. 

December Crude Oil Chart 

Oil prices cooled slightly from their record levels but only slightly. Inventory levels are expected to drop substantially when announced on Wednesday and only a few traders took profits ahead of the news. The current month contract closed at $58.90 with the December contract at $60.23, slightly below its $61.15 high from yesterday. The August contract becomes the current contract on Wednesday. (CL05Q) I won't repeat all the news moving oil higher but there is one elephant in the room. China Oil (CNOOC) has been rumored to be preparing a rival bid for Unocal. Today the price of that bid was rumored to be $71.50 a share, all cash. Chevron issued a statement saying they were committed to the acquisition as though warning CNOOC that they were ready to raise their bid to complete the deal. In other words, don't waste your time, we already have FTC approval and we are not going to withdraw peacefully. If CNOOC, a government sponsored entity, does bid higher then that revalues oil properties on a global scale. China is currently importing 3.2mbpd of oil over and above their current production and that demand is rising quickly according to BP. With construction accelerating on infrastructure ahead of the coming 2008 Olympics this demand could consume all excess global production by year-end. 

It was also announced today that China's Q1 GDP was +9.4% and the same record rate of 2004. If China's economy paused it was only briefly and several analysts expressed concern that is was actually accelerating from that Q1 rate. China did make a bid for Maytag today as the dominoes continue to fall in their direction. In 2002 China bought 18 U.S. companies, 15 in 2003 and a whopping 26 in 2004. They are rapidly buying or attempting to buy assets that will allow them to broaden their global reach and market share in many areas. With 1.3B people moving rapidly into a consumer economy China will eventually be a global force and a powerful economic force. This should be sending chills through the current administration. 

Those chills probably turned into real fear on Monday when the Washington Times reported yet another intelligence failure on China. Reportedly U.S. spy agencies failed to recognize several key military developments over the past decade. Among the biggest were the development of a new long-range cruise missile and deployment of a new warship using stolen U.S. Aegis battle management technology. They also missed the deployment of a new class of attack submarine known as the Yuan class until photos appeared on the Internet. They also developed new precision guided munitions, air to ground missiles and more accurate warheads. They also developed new surface-to-surface missiles for targeting U.S. aircraft carrier battle groups. Last but not least were imports of advanced weaponry including Russian submarines, warships and fighter-bombers. China is not going to be the sleeping bear much longer and is rapidly growing teeth and claws to backup its acquisition goals. I have said numerous times that we will be in a shooting war with China over oil within the next ten years and it is not one that will be easy to win. If we do go to war with China over oil how will that impact our imports of Chinese goods and those made by the 60+ U.S. companies China has bought in the last three years?

Over the last week the Dow has climbed slightly above 10600 to three month highs and has raised the high side of our recent range. 10635 has turned into current resistance and has held solid for three days. Despite that overhead resistance there has been very little pullback and 10575 is acting like support. Traders continue to maintain a bid under the Dow stocks and that bid has finally translated into a bid under the Nasdaq. 

The Nasdaq finally pulled out of its slump to 2060 and has returned to overhead resistance at 2095. Real resistance is 2100 but the 2095 level appears to be where the overly eager sellers have taken a stand. Despite the social security news dip the Nasdaq rebounded to close with another gain at 2091 and just under those resistance levels. Now that techs stocks have found buyers all we need is a strong catalyst to catapult us over 2100 to produce a real short squeeze. 

I still believe we have a strong bout of profit taking before the summer is over but my bias on the short term is still slightly to the upside. I say slightly because the gains are minimal, volume is very low and internals are barely breakeven. The VXO is screaming a warning and every bear in the market is camped at Nasda1 2100. It appears we have the makings of an explosion and all we need is a spark. Investors Business Daily is comparing the current market with the 1994-1995 beginning of the Y2K bull market. The Fed is 2-3 moves away from being done and it could come as soon as the August meeting. When the Fed stopped raising rates in Feb-1995 the market exploded with the S&P jumping +50% by Q2-1996. Talk like this is energizing retail traders and creating the underlying bid. Any apparent flinch by the Fed next Wednesday could create a monster move higher. Should that move appear it will run headfirst into Q2 earnings and with warnings accelerating it could be a spectacular impact. 

The S&P appears to have triple topped at 1220 and this could be the stalling point ahead of next Wednesday's Fed announcement. A breakout over 1220 could be very powerful with a sprint to 1250 very quickly. I just have a problem seeing a summer rally that is not followed by a strong retracement in the August-October period. That retracement could erase the gains all the way back to 1160. This keeps me from being too bullish on anything but energy stocks until fall. The imploding VXO confirms my hesitancy to be long the market. Conversely I don't want to be short it either until we get past the end of the quarter and into July. This is summer trading at its finest with low volume and minimal direction. I believe it will change over the next three weeks and I suggest everyone be ready. Definitely enter longs passively and be ready to exit aggressively. Above all do not leave positions open without stops if you go on vacation! 


New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

New Calls

None today.

New Puts

None today.

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