Enough time has passed that current economic reports are beginning to show the results of Katrina and $3 gas prices. Major swings in economic numbers announced this week might just be the beginning of a deluge of negativity. On the surface it appeared a -1.75 drop in oil prices helped to defuse the economic numbers and allow the market to rally but the real motive power came from option and futures expiration and a rebalance in the S&P.
Dow Chart - Daily
Nasdaq Chart - Daily
SPX Chart - Weekly
The morning started off with a bang after Consumer Sentiment came in for September at only 76.9 and more than -12 points below the August final at 89.1. This was nearly -20 points below the July level at 96.5. The -12 point drop was the largest drop since December 1980 and the 76.9 level was the lowest level seen since 1992. The expectations component fell to 63.6 from 76.9 and present conditions fell to 97.7 from 108.2. The drop was three times the consensus estimate. There was only a -10 point drop after 9/11 and this shows the result of the double whammy of $3 gas and the Katrina damage. Expectations are for a substantial rebound in the next release. Wholesale gasoline prices have dropped sharply and the recovery efforts in New Orleans are moving faster than expected. This should smooth over fears by consumers as they see more positive news reports and fewer negative sound bites.
On Thursday we saw a corresponding drop in the Philly Fed Survey from 17.5 to 2.2 as the shock of the hurricane damage rippled outward from the disaster zone. In prior hurricanes Andrew and Ivan the Philly Fed number dropped -12 and -13 points respectively. The biggest component drop in this report came in New Orders from 19.8 to -0.5, a drop of more than 20 points. Back Orders fell from 7.2 to -10.9 a drop of -18 points. It is hard for me to believe that orders, especially back orders fell this much in only three weeks due to a hurricane in a southern state. This suggests a substantial portion of the downtrend was already in place before the hurricane impacted the data. The six-month outlook component fell by -26.4 points to only 7.0 and a level not seen since Jan-2001. 50% of respondents felt high energy prices would have a negative impact on business while 58% said those prices would slow production levels due to decreased demand.
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Also on Thursday new Jobless Claims spiked to 398,000 for the week from only 320,000 the prior week. That 320K number was adjusted up by +7,000 to 327K in the same release. 68,000 claims were attributed to the hurricane. Considering the number of people unemployed by the storm that 68K number is only a trickle ahead of a flood. With few locations to file claims coupled with the difficulty of just trying to find a place to live and food to eat many have undoubtedly put off filing for unemployment. Expectations are for something in the 500,000 range or even higher as the reporting infrastructure is reactivated. This was the largest jump in unemployment claims in a decade.
The Bush speech on Thursday has prompted a host of questions and worries. With estimates of the rebuilding cost now running well over $200 billion maybe as large as $400 billion the potential for inflation and higher taxes is looming large. Those taxpayers who don't live in the hurricane zone are already complaining about the potential for having taxes raised to pay for the recovery. The potential for inflation as a result of the rebuilding demand and high-energy prices pushed December gold prices to $463 and a high for the year.
December Gold Chart - Daily
Next Tuesday the Fed meets again and the Fed Funds Futures are showing an 85% chance of another 25-point hike. Initially there was a strong feeling that the disaster would push the Fed to the sidelines as the country recovered from the initial shock. With the magnitude of the rebuilding effort growing exponentially the odds of this cash inflow sparking inflation are also growing rapidly. The Prices Paid component in the Philly Fed Survey on Thursday jumped from 25.9 to 52.7, an unheard of rate of increase. The same component in the NY-Empire State Manufacturing Survey also released on Thursday jumped from 29.0 to 53.4. Obviously it was NOT a regional problem and it shows that inflation has already spiked sharply higher over the last month.
While the initial hope was a halt to the Fed rate hike cycle it now appears the Fed may have to accelerate their hikes to 50 points very soon. They may pause at next weeks meeting simply to ease sentiment but the outlook is for stronger hikes ahead.
The high energy prices are already contributing to a steady stream of warnings as we move deeper into earnings warnings season. Dana Corp, (DCN), for instance fell -25% this week after warning that high energy prices and higher steel costs would impact future profits. This story was echoed over and over all week and we are just barely into the warnings cycle. The closer we get to the end of September the more we should expect this pace to increase.
Energy prices are not likely to drop much more anytime soon. The Minerals Management Service said on Friday that 56% of oil production and 34% of gas production is still offline. They said 46 production platforms were destroyed and 20 were seriously damaged. However, a recent survey showed that there was no significant damage to the undersea pipelines. After hurricane Ivan there was serious damage from undersea mudslides, which kept production offline for months in some cases. This good news about the pipelines helped push oil prices back for another retest of support at $63 and exactly where they closed. Should this level fail the most likely support level to hold is $60 and the 100-day average. Since the overall outlook for oil and gas has not changed I seriously doubt we will break that level. I am still recommending buying oil on any dip and a dip into the $60-$63 range is buyable in my opinion.
Crude Oil Chart - Daily
We have seen a slowing of demand due to both the end of the driving season and the removal of an entire region from the daily commute process. This is a temporary reprieve and in light of the IEA comments oil prices should recover soon. The IEA said it was not going to change the quantity of oil (60mb) or the time (30-days) it had allocated to ease the U.S. over the disaster. They refused to extend the time period or quantity and told OPEC to pump more if necessary and to increase its output capability. By closing the exit door on the chance of additional releases it puts the burden of supply back on the normal supply chains and the Gulf. With 56% of oil production still offline it will not take long for us to consume those strategic releases. Also, there will not be any natural gas supplies coming to our rescue. There are no strategic supplies of natural gas to offset the 34% of gas production still offline. We are in the lull between cooling and heating seasons but once the thermostats start creeping higher there could be a serious shortage.
Encana sold its holdings in Ecuador last week to a holding company called Andes Petroleum. The company is actually a front for China according to recent reports. Either way Encana got rid of a serious problem for more than five times cash flow. Ecuador has been a hotspot lately with protestors blowing up oil facilities in hopes of getting oil companies to give them more jobs. Somehow I don't see the logic in this. Neither did Encana and they bailed for a profit. Occidental also has property there and could be in talks with China on selling those assets as well. Wonder if China instigated the riots to make the companies more eager to sell. Enquiring minds want to know. On the other side of the world five Chinese naval ships were spotted near the Chunxiao gas feld in the East China Sea. This is the site of a long term territorial dispute between China and Japan. A Japanese plane monitored the vessels, which included four missile boats, a destroyer, two frigates and an observation support ship as they cruised near the gas field. This was the first time Chinese ships had been spotted near the gas field. Tensions between the two powers over oil and gas assets in the region are escalating and this could have been the first step towards shots being fired. Japan has recently awarded drilling rights to the field to Teikoku Oil Co. and China has already begun drilling in the disputed waters. Sounds like trouble to me and it all comes from China's increasing oil demand. China's demand has increased +40% in the last four years and +7% year to date in 2005. China appears determined to lock up all the oil assets it can well in advance of its future needs. Keep watching for more news of Chinese acquisitions as it paints a dreary picture for the rest of the global oil consumers.
The rally on Friday came mostly on the back of a S&P rebalance event. The rebalance caused an extra two billion shares to be traded as Friday drew to a close. S&P has finally switched to weighting the S&P-500 based on shares available to trade rather than shares outstanding. For instance a very large number of Wal-Mart shares are held by the family and various trusts. They are not available for sale. S&P has now removed those shares from the outstanding shares to calculate market cap weighting. This has the effect of reducing market cap substantially. This meant index fund managers had to sell shares of companies like Wal-Mart and buy shares of other S&P companies to adjust their portfolios to the new S&P weighting. While there were very large sell-on-close orders for numerous large caps including WMT and MSFT those sales were not final until after the close. Meanwhile the accumulation of the smaller companies took place all afternoon. If you are selling 5-million shares of WMT or 10-million of MSFT plus dozens of others it means you have to buy shares in hundreds of companies who had their rankings raised by default. The only way for all the funds to sell those massive amounts of shares is to do it with market on close orders but buying small amounts of hundreds of replacement companies can occur all day. This buying helped push the indexes higher while the major selling was lumped into the close. Index arbitragers were also active trying to front run the funds as the imbalances were posted. What this will do to the indexes on Monday morning is still undetermined since the amount of buying/selling still undone is unknown. We also don't know how much stock the arbitragers are still holding. Still, the point is the rally was again artificially induced and does not represent real buying. Just for reference WMT traded 96 million shares, 10x daily average and 40 million of those shares came five minutes after the close. Other shares traded after the close include nearly 25M in MSFT, 3M in INTC, 6M in GE, etc. Volume across all the indexes soared to 5.9 billion and nearly two billion (+50%) above any other day this week. Volume had been heavier the prior three days but still just a fraction over 4B each day. An extra two billion shares traded will definitely skew the indexes and the bias by default was to the upside.
SPX Chart - 5 min
Despite the extra two billion shares the Dow was not able to close positive for the week. The +83 gain on Friday came close but the index still lost ground for the week as did the other indexes. The Dow rallied to 10650 before running out of steam at the close. The Nasdaq hit 2160 before the bell. The S&P, the index most likely to be erratic from the rebalancing jumped +10 to 1238 and nearly to the 1243 resistance we saw last week. Even the SOX got in on the act as it spiked +5 points to 475 just before the close. Personally I believe any artificial bounce is begging to be sold once the artificial stimulus is removed. Once any remaining portfolio rebalancing occurs at the open on Monday I would be a seller of the broader market on any weakness. This is especially true given the recent spikes in the inflation indicators and the impending Fed meeting on Tuesday.
I heard one analyst saying they expected $500 million in routers and switches to be sold into the disaster zone with Cisco, Juniper and Lucent benefiting. Another was saying over a billion in personal computers would need to be replaced. Still others were talking about massive amounts of cell phone equipment to replace an entire city of towers and bases. I completely agree that these events will come to pass but not until the pumping is over, the cleanup completed and the carpenters leave. Look for it in Q1 not Q4. Also, an extra $200-$300 million for Cisco is a drop in the bucket given their $25 billion in annual sales. Dell could get a large portion of the PC replacement cycle but with $50 billion in annual sales it will not really make a serious dent. It will also be a long-term replacement cycle as the recovery continues not a lump sum event.
the anticipated replenishment cycle is still many months away for things
other than wood, sheetrock and other building supplies, I don't see any material
reason to buy stocks ahead of the normal end of September and early October
weakness. I would much rather buy the dip than buy the top. I would continue to
watch SPX 1225 which acted as support once again on Thursday. SPX 1230 was
earlier interim support but it lasted barely more than a day. On Friday it was
intraday support once again
and a failure there should predict a failure at 1225
as well. I would short any break of those levels with an eye on lower levels for
the next couple weeks. Earnings warnings will increase and the Fed is likely to
say things the market will not like. As always, remember to enter passively and
exit aggressively and definitely don't get married to your positions or your
Apache - APA - close: 73.42 change: +1.32 stop: 69.49
Why We Like It:
BUY CALL OCT 70.00 APA-JN OI=9626 current ask $4.90
BUY CALL JAN 70.00 APA-AN OI=8878 current ask $7.80
on September 18 at $ 73.42
Cameco Corp - CCJ - close: 53.30 chg: +1.85 stop: 49.49
Why We Like It:
BUY CALL DEC 50.00 CCJ-LJ OI=8351 current ask $6.30
Picked on September 18 at $ 53.30
Altria Group - MO - close: 73.14 change: +0.89 stop: 69.90
We Like It:
BUY CALL OCT 70.00 MO-JN OI=15029 current ask $4.70
Picked on September 18 at $ 73.14
Hovnanian - HOV - close: 54.75 chg: -2.46 stp: 57.81
Why We Like It:
PUT OCT 55.00 HOV-VK OI=2884 current ask $2.80
Picked on September 18 at $ 54.75
Amer. Intl Group - AIG - cls: 61.30 chg: +0.35 stop: 58.99*new*
Insurance stocks joined the market in what turned out to be a broad-market, option expiration rally on Friday. Now shares of AIG were not exactly screaming higher but it does look like the stock has broken out from its recent (one-week) consolidation pattern (see chart). We see this as a new bullish entry point although more conservative traders may want to consider waiting for some confirmation with a move over minor resistance at the $62.00 mark. The Point & Figure chart is currently bullish and points to a $90.00 target. We are only targeting a move into the $64.75-65.00 range. We are also raising the stop loss to $58.99.
BUY CALL OCT 60.00 AIG-JL OI=8903 current ask $2.35
Picked on September 11 at $ 61.23
Oil stocks continued to rise on Friday despite a sharp $1.75 drop in crude oil to $63.00 a barrel. It could be investors are waiting to hear if there are any surprises from the OPEC meeting this Monday. Or investors could be waiting to hear if Alan Greenspan and the FOMC has anything to say about energy prices again on Tuesday. Or Friday's strength in oil stocks could be part of the S&P rebalancing. Whatever the case is the upward trend for oil stocks and shares of NBL remains intact. We continue to target a move into the $49.00-50.00 range. More conservative traders may want to step back and wait to see if crude oil slips toward stronger support near the $60.00 a barrel level. A dip to $60/bbl could be an attractive entry point for new bullish positions in the oil stocks.
BUY CALL OCT 40.00 NBL-JH OI=1270 current ask $4.70
Picked on September 11 at $ 44.90 *post-split price
Noble Corp - NE - close: 70.15 change: -0.92 stop: 67.85*new*
The sell-off in crude oil on Friday seemed to hit shares of NE harder than the rest of the oil sector. The OSX oil services index added 0.18% while NE lost 1.29%. Despite the loss shares of NE are still trading in a pattern of higher lows. Unfortunately the stock's multi-week consolidation has rendered many of its daily technical useless. We continue to have an upward bias for NE but traders may want to wait for the stock to breakout over resistance at the $72.00 mark before buying calls. More conservative traders can wait for a new high over $72.50. Our target is the $78-80 range, compared to the P&F chart, which points to a $94 target. We are raising the stop loss to $67.85, just under the simple 50-dma.
Picked on August 31 at $ 71.30
Adobe Sys. - ADBE - close: 29.43 chg: +2.53 stop: n/a
So far so good. ADBE soared on Friday with a 9.4% gain on huge volume following its better than expected earnings report on Thursday afternoon. This is a bullish breakout over resistance at its 50-dma and resistance near $28.00. Friday's gain also breaks through ADBE's three-month trendline of lower highs and additional resistance at its exponential 200-dma and its simple 100-dma. The next question is how far will this rally go? How much follow through will there be on the earnings news? The more important question for our readers is where do I exit? One of our readers emailed us and asked about potential resistance at the $30.00 level. Not only is $30.00 round-number, psychological resistance but it is also bolstered by the simple 200-dma. The $30.00 region may be a good spot to consider exiting for a profit. We suggested that readers buy the October $27.50 call (which was trading around $1.05) and the October $25.00 put (which was about $0.55). Our cost in the play should be in the $1.50-1.60 range. Following today's breakout the October $25 put is virtually worthless but the $27.50 call is now trading around $2.30. Thus $2.30 minus $1.60 is a 70-cent gain or about +43%. Our initial plan was to try and get a $1.00 or $1.50 profit out of the play. However, when faced with an opportunity to exit quickly (like Monday or Tuesday next week) for a decent gain or to wait and see if ADBE might continue to rally through the rest of September in order to hit our target we would probably choose the early exit. It's up to you when you exit. We would not be surprised at all to see ADBE rally toward the $32 level. However, we are going to adjust our target. If ADBE trades in the $29.90-30.00 range we'll close this play.
Picked on September 13 at $ 26.82
Black & Decker - BDK - close: 83.20 chg: +0.25 stop: 87.75
BDK is a relative weakness/technical breakdown play. The stock peaked back in July, managed an oversold bounce in September, which failed under its simple 50-dma near the $88 level. Now the stock's technicals are pointing lower and shares have broken through support at its simple 200-dma and its exponential 200-dma in addition to support at the $84 level. The P&F chart points to a $74 target. We think BDK can trade into the $78-77 range before its October earnings report. Readers can watch for a failed rally under $84 or $85 as a new bearish entry point.
BUY PUT NOV 85.00 BDK-WQ OI=724 current ask $4.40
Picked on September 14 at $ 83.31
Fedex Corp - FDX - close: 80.19 chg: +0.47 stop: 82.01 *new*
Transport stocks bounced on Friday following a $1.75 decline in crude oil prices. The one-percent gain in the Dow transportation index pushed the index toward the top of its descending channel and technical resistance at its simple 200-dma. A breakout from here would suggest a trend change higher. That's why we're lowering the stop loss on FDX to $82.01. The stock bounced back above the $80 level and will probably challenge the $80.50 region. What concerns us is how the technical indicators on FDX are suggesting a new short-term bottom is being formed. We're not going to suggest new plays at the moment and more conservative traders may want to take some money off the table.
Picked on August 23 at $ 82.99
Hershey Co. - HSY - close: 57.96 change: +0.09 stop: 59.51
Volume on Friday for HSY was massive due to the S&P rebalancing. The stock managed to rally toward resistance near $59 but couldn't breakout. This looks like a new bearish entry point that traders can use but more conservative types may want to wait for a new relative low under $57.70 before initiating positions. Our target is the $54.00-53.50 range. Currently the P&F chart points to a $51 target.
BUY PUT NOV 60.00 HSY-WL OI=1348 current ask $2.80
Picked on September 14 at $ 57.90
MBIA Inc. - MBI - close: 58.20 chg: +0.84 stop: 59.01
Put holders may need to turn their toes toward the exits. The massive rally in financials on Friday helped push MBI back toward resistance near the top of its descending channel. So far the bearish trend in MBI remains intact but if shares breakout over the top of its channel and its 200-dma we expect to be stopped out at $59.01. It will be very interesting to see if Friday's rally was a one-day rally inspired by the S&P rebalancing or whether it will have any legs to it.
Picked on September 13 at $ 57.75
KB Home - KBH - close: 75.00 chg: -2.05 stop: 71.50
We've been somewhat cautious on the homebuilders the last few days but KBH had been out performing the group until Friday. Suddenly KBH went from setting new relative highs to trying to catch up to weakness in the homebuilding sector. The RLX retail index and the DJUSHB Home construction index were the only two major indices to close in the red on Friday. The DJUSHB lost strong 2.88% and looks poised for more weakness. Now we can't tell how much, if any, this was due to the S&P rebalancing but we have to react to what the market shows us and right now KBH is displaying a short-term bearish reversal. We're going to exit early here and watch to see if KBH will bounce from its rising 100-dma again.
Picked on September 07 at $ 75.89
MDC Holdings - MDC - close: 77.15 change: -1.82 stop: 74.45
We are going to jump out of MDC too. The stock has been struggling a bit under technical resistance at its simple 50-dma. The new weakness in the DJUSHB home construction index doesn't help matters. We'd rather exit early and watch to see if MDC retests support near its 200-dma again, which bulls can try and use as a new entry point.
Picked on September 01 at $ 77.01
Ishares DJ Fin. Serv. - IYF - cls: 96.87 chg: +1.24 stop: 96.75
Friday produced some huge rallies in the financial sector that pushed both the BKX and BIX banking indices through significant trendlines of resistance. The IYF spiders were no different and the IYF broke out over resistance at the $96.50 mark and hit our stop loss at $96.75.
Picked on September 13 at $ 95.76
United Parcel Svc - UPS - cls: 68.98 chg: +0.52 stop: 70.11
UPS, like most of the transports on Friday, rallied higher following the $1.75 decline in crude oil but not before UPS dipped under the $68.00 level and into our target range of $68.00-67.00. We are closing the play per our game plan. If you failed to exit on Friday (or last Monday) we would expect UPS to rally back towards the $70 level and maybe higher if oil prices continue to drop and the Dow Transportation index breaks out of its current bearish channel.
Picked on August 17 at $ 71.99
A trading friend mentioned that Monday was often a difficult trading day. In contrast, Friday often sees my least successful plays. Why do some days prove more successful or treacherous for traders than other days?
The reason may relate to situations particular to traders. By Friday, I'm tired. I may also have participated in a number of profitable trades by Friday, and may be overconfident and entering riskier trades. That's what happened this Friday, even though I know my own trading record.
The reason may not be as important as recognizing one's own trading record and then making appropriate trading plans. And sticking to them. Since I've documented my record, I know that I should limit the size of any trades entered on a Friday, and should pay particular attention to the setup. Is that setup sound or am I anticipating a setup, entering before I have enough confirmation?
Some days might be more difficult than others because of patterns related to days of the week. Martin Pring refers to such a day-of-the-week effect in TECHNICAL ANALYSIS EXPLAINED. The term "blue Monday" proves applicable, Pring explains, with Monday's weak performance seen in equities, non-U.S. equity markets, debt instruments, and even in commodities. My trading friend might find the reason for that less-profitable Monday trading record anchored in this effect. The study Pring quotes, a somewhat dated one, pegs Monday as the only day to see a negative return over a period of time. A cursory glance at more recent studies and thesis papers corroborates this effect across many equity markets across the globe, however, continuing into the present.
Moreover, many of these studies mention that Mondays see the most volatility or deviation from the mean return for a Monday. Middle-of-the-week days tend to have less volatility. Although more recent studies conducted on other markets show some variability, Friday tends to be less volatile than other days, and, according to the chart Pring includes, it tends to be the most positive day on average.
Why would this day-of-the-week effect exist? In a 2003 article in APPLIED FINANCIAL ECONOMICS, "Stability of the day of the week effect in return and in volatility at the Indian capital market: a GARCH approach with proper mean specification," authors Kaushik Bhattacharya, Nityananda Sarkar and Debabrata Mukhopadhyay proposed a theory. "These findings on the day of the week [sic] effects . . . suggest that stock exchange regulations and the nature of interaction between the banking sector with the capital market could possibly throw valuable insights on the origin of the day of the week" effect. Authors Dan Galai and Haim Kedar-Levy draw a different conclusion in "Day-of-the-Week Effect in High Moments," published in FINANCIAL MARKETS, INSTITUTIONS & INSTRUMENTS. They report, as do many others in studies performed across the globe, greater volatility in the first trading day of the week. They theorize that the "probable explanation of the phenomenon appears to be information dissemination: corporate announcements released after closing of the last trading day of the week spill-over [sic] to the opening of the first trading day, increasing its variability."
Gauging likely spillover effects and monitoring the interactions of the banking sector with the capital markets might prove difficult at best each Monday. Jonathan Levinson helps those of us reading the Market Monitor to anticipate some of those interactions. Still, Monday's general weakness but volatility or deviation from the mean certainly give my trading friend an excuse for those less-profitable days. I have another explanation for the aggregate less successful results I have on Friday: the fact that once a month, option expiration occurs on a Friday.
Consider including a day-of-the-week column in your trading journal. Do some
quick calculations and discover
whether a particular day of the week often
proves less profitable than others. Then limit your risks on those days, avoid
trading those days at all, or ensure that your setups are stellar to help
improve that trading pattern.
Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda
and all other plays and content by the Option Investor staff.
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