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Daily Newsletter, Thursday, 06/23/2005

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Table of Contents

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

Market Wrap

The Little Market That Couldn't

The Little Market That Couldn't

After weeks of consolidation, the market struggled higher out of the consolidation over the past week, chugging up the hill ever so slowly, only to come crashing back down today into the same range we've been in since the end of May. Today's big red candle looks bearish, no two ways about it. Now the question is what it means in the larger pattern. No surprise, we get different answers when we look at different indices. The mere fact that the DOW lost 166 points today while the SOX ended in the green causes a bit of head scratching. When people want out of stocks they usually sell the high-beta stocks, i.e., the techs and semiconductor stocks are usually the first to go. So the fact that the SOX was green today causes one to wonder whether the sell off today was real or just an over reaction to something, or worse a manipulation of the market.

By manipulation I mean there may be very large players who cause the market to swing one way while they position for another. We see this intraday when for example we get a buying spike that is immediately reversed. This is usually someone creating a buy program or two to get some buying/short-covering started, goose the liquidity so that they can then sell into it. This liquidity push enables them to sell without causing a down spike and they can get better prices in the process. The opposite happens in a selling spike where someone does their buying during the sudden selling. This maneuver can be done on a daily basis as well. That's why today's sudden selling spike may not be trustworthy yet. When the whole market participates, then consider it real selling. Or strong moves down followed by sloppy corrective bounces likely means the selling will continue. One day down does not a trend make and that's what we need to be careful about after today's hard sell off.


Other manipulation can be done by the Fed but their manipulation tends to be longer term where they're more interested in the amount of money floating through the system. We constantly hear about the Fed's concern about inflation, economic growth, etc. and how they're going to change interest rates to affect the economy. What we don't hear much about is what they're doing behind the scenes with money supply which can have a far greater impact on the market than what they're doing or saying about interest rates. In fact they're often doing just the opposite of what they're saying. They might be saying they're worried about inflation and that they're going to maintain a "measured pace" in interest rate increases, but with the other hand they're pumping huge amounts of money into the system so as to prime the economic pump. How do they do that? They print money and buy stuff from anyone not part of the Federal Reserve System. The stuff they buy may be bonds from Merrill Lynch or a basket of S&P500 stock from Morgan Stanley. If they want to pull money out of the system they buy stuff. They can also introduce money into the Federal Reserve System through foreign banks. We know after the 1987 crash that the Fed implemented a control system to thwart future crashes. That system seems to have evolved into a daily control system instead of just an emergency system. The all-knowing Fed has become a dangerous player in the market.

Money supply, as measured by M-3, can expand exponentially as banks lend out their money, and account for it as an asset. The consumer or business who borrowed the money then spend the borrowed money and it lands in another bank who then lends it out. Keep doing this and you can see how quickly it multiplies from the initial dollar the Fed may have inserted into the system. With the banks' historical low reserve requirements we have a banking system more vulnerable to a crash than we had prior to the banking collapse from the 1929 stock market crash. But back to M-3, we've had a huge increase in money supply in the past 12 weeks and it is accelerating. The Fed is stuffing the money channel at a furious rate at the moment, up almost $153B over the past 3 months and up $79B in just the last week alone, a 42.5% annualized growth rate. This is being done while the Fed is talking about inflation and the need for measured increases in interest rates. Printing money and inserting into the system is highly inflationary. The Fed knows something and doesn't want to scare the market. Perhaps they're worried about the housing market and want free money to be available longer, hoping to stave off any housing collapse. The problem is when they stop stuffing the channel--any "normal" correction that was coming, and held off, is only made worse. Look what happened in 2000 after the Fed did the same thing out of Y2K worry. So the longer term picture by the Fed's actions is actually quite worrisome. They usually make matters worse rather than better.

But that's in the future. We care more about what's going to happen tomorrow and next week. I mention it because I don't want anyone caught like a deer in the headlights in the next leg down of the bear market which could be even more violent, and hit the blue chips harder, than the first leg down. Let's take a look at today's price action and see how it fits in the larger patterns.

DOW chart, Daily


Today's big red candle looks very bearish and the DOW's red candle looks worse than the others. After struggling to rally up underneath the broken uptrend line from March 2003, it finally collapsed. It dropped below its 200-dma at 10445 and stopped exactly on its 200-ema at 10421. Also, not shown on this chart, there is a trend line that runs down from January 2000 through the January 2004 currently at about 10420. The 50-dma and price level support lies in the 10375-10490 area so we could see a little more downside work tomorrow.

SPX chart, Daily


SPX broke down from its bearish ascending wedge also looks very bearish. As shown on the 120-min chart below, there may be trend line support at 1197 and then below that is price level support at 1191 which is the high in April and low in June. A parallel line to the one along the highs from April, snapped to the low in May, shows potential support at the same 1191 area. If price does drop down to that level, the bounce from there (or here for that matter) will be telling--an overlapping corrective rise will signal more downside coming whereas a strong reversal back up will signal that the move down was a false move.

SPX chart, 120-min


This closer view shows the ascending wedge that decisively broke today. These typically see a quick retracement back to the beginning of the pattern, which in this case would first be the 1191 low on June 9th. But watch to see if price finds support on the trend line along the lows from the end of May.

Nasdaq chart, Daily


As mentioned above, the SOX ended in the green today and that certainly helped the Nasdaq as compared to the DOW. It's pullback, again from 2100 resistance, looks more like it's part of the consolidation underneath firm resistance. The uptrend line from October 2002 currently sits near 2056 so we'll get to see if this acts as support. If it does, we may simply be consolidating and getting ready to bust a move above 2100. If that were to happen, it's a straight shot back up to previous highs just under 2200.

SOX index, daily chart


While the SOX gave up most of its gains today, and created a shooting star candlestick pattern (bearish), this candlestick is normally more effective at the top of a strong rally. This one is happening more as part of a potential consolidation under resistance. Like the Nasdaq, the SOX looks more bullish than the blue chips at the moment which is a change in character. It may get a further pullback with the broader market but so far I don't see anything especially bearish here yet. 

BKX banking index, daily chart


The banks got a sharp pullback and certainly contributed to the DOW's demise today. Whether this turns into something more bearish or is simply part of its consolidation, it's too early to tell. Right now the banks are bouncing between its 200-dma's. The recent break to the upside from its very corrective pullback over the past month looks bullish and I'm not ready to count this pullback as anything more bearish than just a pullback.

Before the bell we got some news from FedEx when they announced they would miss Q4 forecasts by $0.02 and lowered guidance for Q1 FY06. This kind of news only made it worse for the Transports today which was a leading sector to the downside today, beat only by the Airlines. This morning's economic numbers included unemployment claims and then Existing Home Sales and the Weekly Mortgage Application Survey for the week ending June 17. Later in the morning we got some more news from Greenspan's testimony before the Senate Finance Committee. The unemployment data showed Initial claims fell 20K to 314K, below expectations of 330K, and the lowest level since the 299K reported in mid April. This further validates a strong labor market, which should result in a good nonfarm payroll gain for the month of June. 

May existing home sales fell 0.7% to an annual rate of 7.13M (consensus 7.15M), down from April's record high 7.18M in April. The data roughly matched forecasts, and still reinforced the understanding that low mortgage rates and strong price gains continue to fuel the housing market. The median national sales price was $207,000 in May, up 12.5% from the previous year. Inventories of unsold homes rose 4.9% to 2.55 million units, representing a supply of 4.3 months. On a year-on-year basis, existing home sales were up 3.5%. "The housing market remains red hot with mortgage rates low, the economy growing and the labor market improving," said David Lereah, NAR chief economist.

But the oracle of Omaha, Warren Buffett, the billionaire chairman of Berkshire Hathaway has a different opinion. He told CNBC on Thursday that he thinks there's probably a real estate bubble in the U.S. He said lending practices, low interest rates and herd mentality are "coming together in the real estate market in a way that would lead me to believe that, certainly at the high end, people who buy houses today may have some periods when they regret it." The investing legend also said the U.S. current account deficit is a big problem and will lead to a weaker U.S. dollar, possibly in five years. He has been very public about his short position in the US dollar.

The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending June 17. The Market Composite Index--a measure of mortgage loan application volume--was 786.8, a decrease of 11.3 percent on a seasonally adjusted basis from 887.0 one week earlier. On an unadjusted basis, the Index decreased 11.7 percent compared with last week but was up 29.6 percent compared with the same week one year earlier.

Greenspan's testimony included discussion on China and he warned lawmakers against a "step back into protectionism," saying that imposing punitive tariffs on Chinese imports would harm U.S. consumers, protect "few if any American jobs" and put the U.S. economy "at risk." While the Treasury market shrugged off the text, as much of what has been said is nothing new (e.g. yuan revaluation would not narrow trade deficit and protectionist efforts are "misguided"), arguments that proposals for anti-China tariffs would do little to protect U.S. jobs and may undercut U.S. living standards amplified an already broad-based sense of nervousness in stocks. His remarks citing "no credible evidence" that U.S. manufacturing activity or jobs would be helped by China revamping its currency system did not help alleviate the concerns of many who are hoping that such revaluation would provide support to the U.S. economy.

As already mentioned, the Transports took a beating today. The Industrial sector was weak across the board, with huge losses coming from Construction & Farming to Transportation, as the Dow Jones Transportation Average closed at its worst level since mid May. Of the nine economic sectors that lost ground, Materials paced the way lower, led by a drubbing in Steel--the worst performing S&P group--as well as Diversified Materials & Mining and Diversified Chemicals. Steel was under pressure after Steel Technologies (STTX 17.31 -3.39) issued downside Q3 earnings and revenue guidance, citing increased margin pressure amid continued price declines. This may be only the start of such warnings.

Other leading sector losers included the retail index, computer hardware and internet and financials. Green sectors today included the energy indexes, gold and silver index, the SOX and brokers. It's interesting that the brokers were green when the financials took a big hit. Usually the brokers selling off is a clue behind real selling and this is just another piece of the puzzle that makes me wonder about what today's selling was all about. With oil's price rising, it was no surprise the oil indices did well. Their charts continue to look very bullish.

Oil chart, August contract, Daily


After a very brief consolidation, oil continues to drive higher, making a new high above April's. It might consolidate at current levels for a couple of days, which would be natural at this level, but it looks like it will head higher--the top of the parallel up-channel near $63.50, and rising, makes for a good target.

Oil Index chart, Daily


The oil index and oil continue to track closely. After breaking to a new high above the March high, price is pulling back a little to that high. Like oil this index may consolidate a little around the current level. But after the beating the rest of the market took today, this one only gave us a doji day. Like oil, this index looks to be headed to the top of its parallel up-channel. If this index begins to roll over to any significant degree, it could be forecasting a topping in oil. For now there's no such signal.

Transportation Index chart, TRAN, Daily


The Trannies, hurt by the Airlines today, which were hurt by the news of record oil prices, continues to look like one of the more bearish indexes. The blow this index took today contributed to the DOW's hard decline. But watch to see if support is found at the uptrend line from May 2004. It's likely to at least give the index a bounce which will help the DOW bounce and for that reason this index is a good one to watch.

U.S. Home Construction Index chart, DJUSHB, Daily


This index gave us a throw-over above the top of its parallel up-channel and has now fallen back inside the channel. This is a bearish heads up for something more significant that may happen here. The larger pattern looks like it needs a consolidation here that will be followed by one more push back up. If we get that, watch for negative divergence at any new/equal high since it would be a signal to take profits in this sector and prepare for a more significant pullback. Right now it's firing off warning flares (including the latest negative divergence at the new high), but it may only be a small pullback here. The other warning, as discussed at the beginning, is what the Fed is doing with money supply. It makes me wonder what they see coming down the pike in the housing market and by their actions they don't like what they see and it should have you on guard if you're invested in this market.

U.S. Dollar chart, Daily


The US dollar looks like it's consolidating which could be bullish. The dollar may consolidate further with an additional pullback or it may start to drop hard from here after a corrective looking bounce so far. At the present time I do not see the dollar rallying to new highs, yet.

Gold chart, June contract, Daily


After practically no hesitation in getting back above its broken uptrend line, there was only a minor consolidation at its downtrend line before breaking above it. The yellow metal is on fire and I don't see any evidence yet of it slowing down. If the dollar pulls back again it will probably ignite some more buying.

Tomorrow's economic reports include Durable Goods Orders at 8:30 for May with a forecast of +3.0%, while the market expects +1.5% and the prior number was +1.9%. At 10:00 we get New Home Sales for May and the forecast, expectations and prior numbers are 1325K, 1320K and 1216K, respectively, so it doesnt look like there should be any surprises there. The big question for tomorrow is how it will react to today's big sell off, at least in the blue chips. As discussed above, don't take this one-day sell off as meaning anything more bearish than a heads up that something worse might happen because it may not. This market has been struggling to climb and has/had a lot of nervous longs. If there is some manipulation going on, they will want to shake out the weak longs to prepare the market for a strong thrust higher. By creating a large sell off over a day or two, they also accomplish the task of loading the rocket with fuel, otherwise known as weak shorts. These are the traders who will give a shrill scream as they run for cover on the next rally and provide the short covering fuel needed to propel the market over resistance. I have no idea if this will happen or we instead start a sell off through the summer. I just think it's too early to make any big bets. Trade carefully, take profits (or losses) quickly and watch for the next setup. This market has not been kind to buy/sell and hold. It has been more kind to fast traders so be one and good trading. 

 
 




New Plays

New Option Plays

Call Options Plays
Put Options Plays
None None

Editor's note:

Thursday proved to be a rough day in the markets if you are bullish. Yet despite the sell-off the DJIA, S&P 500 and the NASDAQ Composite are all still above support. We are considering a number of new bearish candidates but hesitate to jump in without more confirmation that the markets are reversing. Look for new plays in the weekend newsletter. 

New Calls

None today.

New Puts

None today.


Play Updates

In Play Updates and Reviews

Call Updates

AmerisourceBergen - ABC - close: 66.95 change: -0.40 stop: 63.85

ABC held up pretty well considering the market sell-off today. We're not changing our strategy here but we'd hesitate to consider new long plays. Watch for a bounce from the $66.00 level if the markets continue to slide. Actually, if the DJIA breaks down below the 10,400 level or its 50-dma near 10,375 then readers may want to consider exiting their bullish positions. 

Picked on June 13 at $ 65.57
Change since picked: + 1.38
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 1.3 million 

---

Ashland Inc - ASH - close: 71.13 chg: +0.64 stop: 66.99

ASH continues to show lots of relative strength and the stock hit another new high today despite the market sell-off. We're certainly encouraged by its gain. Our target is the $74.75-75.25 range but we do not plan on holding over ASH's July earnings report.

Picked on June 16 at $ 70.05
Change since picked: + 1.08
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 1.1 million 

---

Chubb Corp - CB - close: 83.65 change: -1.60 stop: 82.49

Uh-oh! Today's decline in CB does not look healthy. Shares have broken down through the bottom of its narrow, rising channel over the last few weeks. The selling did pause near its 40-dma but we suspect that CB will continue to fall toward its 50-dma near $82.50. Conservative traders may want to seriously consider exiting now to avoid further losses. Our stop loss is at $82.49.

Picked on June 10 at $ 85.05 
Change since picked: - 1.40
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 1.2 million 

---

Rockwell Collins - COL - close: 47.60 chg: -0.76 stop: 44.95

The defense sector was hit with some profit taking today as the DFI index lost 1.65 percent. We suspect the selling will continue tomorrow and in this case that may be a good thing. We're still waiting for COL to dip toward its 100-dma currently near $47.00. However, since the markets tend to overreact we're going to keep our suggested bullish entry point at $46.75-46.50. More conservative traders may feel better if they wait for the dip and then bounce back above the $47.50 level before initiating new positions. After the closing bell it looks like COL announced it had one a $350 million deal from the Air Force. 

Picked on May xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 800 thousand 

---

Cummins Inc - CMI - close: 72.98 change: -1.90 stop: 70.95

CMI was not immune from the profit taking today and lost 2.5 percent to close back under its 200-dma and its 10-dma. At this time we'd probably watch for CMI to dip toward the $72-71 region. We would not suggest new bullish positions until we see a rebound. Our stop at 70.95 might be too tight as the $70.00 level should be stronger support. However, we don't want to lower our stop only to see CMI continue to fall. 

Picked on June 19 at $ 74.03
Change since picked: - 1.05
Earnings Date 07/21/05 (unconfirmed)
Average Daily Volume = 970 thousand 

---

Eagle Materials - EXP - close: 90.91 chg: -2.49 stop: 89.49 

Whoa! Looks like traders did a little bit of panicking and tried to lock in some profits in EXP today. The $90.00 level should be the next level of support. We would not suggest new bullish positions until we see a significant bounce from the $90.00 region. 

Picked on June 09 at $ 90.45
Change since picked: + 0.46
Earnings Date 08/03/05 (unconfirmed)
Average Daily Volume = 134 thousand 

---

Fording Candn Coal - FDG - cls: 93.83 chg: +0.56 stop: 87.49 

FDG out performed the market with another gain today but we suspect that shares might pull back tomorrow. We would not be surprised to see a dip back toward the $91-92 level before FDG continues higher. 

Picked on June 19 at $ 90.30
Change since picked: + 3.63
Earnings Date 07/25/05 (unconfirmed)
Average Daily Volume = 384 thousand 

---

Intl Bus. Mach. - IBM - cls: 75.41 chg: -1.82 stop: 74.99

And that's why we suggest triggers on a lot of our plays. IBM followed the DJIA lower and never got close to our suggested entry point above resistance at the $78.00 level. We'll keep IBM on the list as a candidate for now but if the stock trades under $74.00 it may be time to start looking at put options. Our current trigger is $78.25.

Picked on June xx at $ xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 07/14/05 (unconfirmed)
Average Daily Volume = 7.4 million 

---

St Joe Co - JOE - close: 80.43 change: -0.97 stop: 79.45

JOE held up reasonably well considering the pull back in the market today. The 80.00 level is still acting as support but if the selling continues then chances will certainly rise on JOE stopping us out at $79.45. Watch for a bounce back over $81.50 before considering new bullish positions. FYI: if we do get stopped out we'll watch the $75.00 level as the next region of support and potential bullish entry point.

Picked on June 20 at $ 82.56
Change since picked: - 2.13
Earnings Date 07/20/05 (unconfirmed)
Average Daily Volume = 507 thousand 

---

Netease.com - NTES - close: 59.44 chg: -1.61 stop: 55.95 

All we can say about NTES is that volume was pretty light during today's profit taking. The trend remains bullish for now. 

Picked on June 13 at $ 57.29
Change since picked: + 2.15
Earnings Date 07/26/05 (unconfirmed)
Average Daily Volume = 752 thousand 

---

SLM Corp - SLM - close: 50.66 change: -0.29 stop: 48.95

Watch for a bounce from the $50.00 level as a new bullish entry point.

Picked on June 20 at $ 50.92
Change since picked: - 0.26
Earnings Date 07/14/05 (unconfirmed)
Average Daily Volume = 1.8 million 

---

Wellpoint Inc - WLP - close: 68.74 chg: -1.24 stop: 65.90 

Healthcare and insurance stocks were not immune from the profit taking today and WLP appears to be headed for a retest of the $68.00 level. We are not suggesting new bullish plays at this time. Wait to see where it rebounds. 

Picked on June 05 at $ 68.40
Change since picked: + 0.34 
Earnings Date 07/27/05 (unconfirmed)
Average Daily Volume = 3.5 million 

Put Updates

Quality Systems - QSII - cls: 45.97 chg: -0.40 stop: 50.01 

No change from our previous update on 06/21/05. Our target is the exponential 200-dma near $41-40.

Picked on June 15 at $ 47.75
Change since picked: - 1.80
Earnings Date 06/13/05 (confirmed)
Average Daily Volume = 330 thousand

Dropped Calls

United Technologies - UTX - cls: 52.37 chg: -0.59 stop: 51.80 

We are calling it quits on UTX. The stock remains above what should be support near the $52.00 level and its 50-dma but we're just not seeing the sort of upward momentum we need. 

Picked on May 23 at $ 53.12
Change since picked: - 0.75
Earnings Date 07/20/05 (unconfirmed)
Average Daily Volume = 4.0 million

Dropped Puts

Semiconductor Holders - SMH - cls: 34.66 chg: -0.12 stop: 35.05

Now there is a surprise. The semiconductor sector rallied this morning moving the opposite direction of the markets today. The rally did fail but not before the SMH hit an intraday high of $35.62. We have been stopped out at $35.05. 

Picked on June 15 at $ 33.95
Change since picked: + 0.71
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume = 26.3 million

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