Table of Contents
Many years ago Allan Greenspan testified before Congress about the dangers of Fannie and Freddie failing and their impact on the global economy. With a combined total of $5 trillion in mortgages on their books they represent a major problem if they fail. That $5 trillion in mortgages have been sliced and diced and resold into the global debt markets. Compared to the impact of the subprime crisis a failure of these government-sponsored entities could be ten times worse. However, they are "government sponsored" and that means the government would support them in some form. What form that will take remains to be seen.
S&P Financial Sector SPDR - XLF
Over the last couple weeks financial analysts have said Fannie and Freddie would have to raise another $75 billion in capital to comply with current equity guidelines. They have already had one capital raise a couple months ago but now it appears the bottom has fallen out of their valuations. Worries were rampant that the government would have to step in and guarantee the debt and convert the companies from public to governmental or at least place them into a conservatorship. Many of the possibilities would include a wipeout of stockholder equity. It would be extremely difficult for FNM/FRE to raise additional capital with worries that any capital infusion could be wiped out.
The problem continues to be the decline in housing prices and rising foreclosure rates. Every foreclosure requires FNM/FRE to raise capital to offset the non-performing mortgage. Since Paulson and crew have said the decline could last well into 2009 the news is going to get worse before it gets better. The problem with the government taking over FNM/FRE is the drain that would place on the government and the economy. Taking on another $5 trillion in debt even if only in name would cause another significant drop in the dollar and a rise in mortgage rates. However, contrary to what some analysts are saying regarding that $5 trillion in debt the government would only have to cough up about $150 billion to guarantee the current and future problem loans not all the loans. Fannie and Freddie "are" the secondary mortgage market today and without them actively buying mortgages the rates on mortgages would move higher and put additional pressure on the housing decline. To whatever extent the government had to fund mortgage defaults it would fall on the taxpayers to make up the shortfall. The combined default rate on that $5 trillion in mortgages is only 1% but that means they currently have only $50 billion in defaults. The combined companies either own or guarantee 70% of all mortgages written in the U.S. but in core capital each has less than 2-cents in capital for every dollar of liability on those mortgages.
There are multiple ways to handle this situation without a government takeover and one of them was rumored on Friday. About 12:45 on Friday Reuters said Bernanke told Freddie's CEO that they would be able to use the Fed's discount window to remove their short-term liquidity pressures. The discount window is normally only for investment banks and opening it to Fannie and Freddie would be a major change in policy and another major cash drain on the Fed. However, it would be an opportunity to ease the current crisis with a minimum of stress. The markets quickly went from down -251 on the Dow to positive territory in just a few minutes. Freddie (FRE) had been down -50% intraday and it quickly returned to positive territory. Shortly thereafter the Fed denied the report and the markets imploded again. As an example of the panic in Freddie nearly 400 million shares traded out of the 646 million outstanding. To say owners were bailing in record numbers would be an understatement. The markets closed sharply negative after the Fed declined to comment on the rumor. Late after the bell the Fed put out a press release saying there were "no" ongoing conversations regarding opening the discount window for FNM/FRE. This carefully worded press release did not say there had not been any conversations only there were no ongoing conversations. These competing press releases were probably just the beginning and I am sure there will be a lot of news over the weekend as the government tries to calm the markets and the rumors. Paulson said the primary government mission would be to support Fannie and Freddie in their current form rather than as government entities. Next week is sure to see continued volatility in these names and in the banking sector as many of the major firms report earnings.
Also late after the bell Fannie said they had raised additional capital of $7.8 billion in May and said their capital levels were substantially above statutory minimums. In fact Fannie claimed it has more core capital and capital surplus than at any time in the company's 78-year history. Fannie said they had access to ample liquidity including the debt markets. Fannie issued $24 billion in debt this week alone including a $3 billion benchmark note sale that was oversubscribed. Freddie also put out a statement after the close saying they were under no mandate to raise additional capital. If the combined companies had made these announcements during market hours the indexes would have closed substantially higher.
Friday's economic reports were not material to market movement and were completely overshadowed by the worries over Fanny and Freddie. Consumer Sentiment was unchanged in July at 56.6 despite the tax rebates. Higher gasoline prices depressed holiday driving and consumer spirits. The current level of sentiment is not only consistent with prior recessions but with severe recessions and that is not yet being seen in the economic numbers. Employment has yet to fall to recessionary norms and that would depress sentiment to even deeper lows.
Next week we will get the Producer Price Index and the Consumer Price Index and the latest inflation information. On Tuesday the FOMC minutes for June will be released on Wednesday and everyone will want to know what the Fed really thought when they met and kept rates level last month. On Thursday we will get the Philly Fed report for another look at manufacturing conditions.
Other than Fannie and Freddie the markets next week will be controlled by earnings news rather than economics. Many of the major market moving companies will report next week and their results will determine the market bias for the rest of the summer. Overall S&P earnings are expected to drop by -12.8% according to Thomson Financial. If you remove the banking sector the S&P would see a rise of +8.7%. If you remove energy the decline would be -20.3%. Nine of the top ten sectors have had their expectations cut and 60% of all the preannouncements have been negative. 10% of the S&P announces earnings next week but nearly all of the critical benchmark stocks are reporting. Those include INTC, EBAY, IBM, MSFT, GOOG, MER, JPM and Citi. Add in JNJ, UTX and HON and you will have a very good picture of Q2 and of the overall guidance for the rest of the year. After next week you could actually cancel the rest of the earnings calendar and nobody would notice. The market bias for Q3 and the year will be set in concrete by next Friday's close.
GE reported earnings on Friday that were inline with estimates at 54 cents per share. Revenue rose +11% to $46.89 billion. GE ended the day flat after giving guidance that many analysts thought was light. GE predicted a rough Q3 with its commercial finance profits down 10-15% and profits at GE Money flat to down 5%. Full year profits for all of GE were expected to be flat to up +5%. That is a far cry from the mid teens Jeffrey Immelt promised investors a couple years ago. GE posted a surprising drop in profits for Q1 due mostly to the Bear Stearns implosion and the impact on the credit markets. Analysts were not impressed with GE's tepid forecast saying their core business sectors were outperforming at other companies and GE was not keeping up with those other companies in their group. It appears GE simply grew too big to manage and GE is trying to narrow its focus. GE announced on Friday a sale of its Japanese consumer finance business to Shinsei Bank for $5.4 billion. GE is also going to spin off to shareholders its consumer and industrial operations in the first half of 2009 and is trying to sell its U.S. private label credit card business but is finding no takers. GE shares are down 24% YTD.
Apple shares took a $4 hit on Friday after software glitches hampered the sales of its new iPhone. After waiting in line for hours buyers were frustrated they could not activate their phones or could not access Apple services like iTunes. AT&T said the problem was too many people trying to access iTunes and the Apple software store at the same time. Since Friday sales were expected to be nearly 400,000 units I could see why the circuits would be busy. One buyer said he spent 4-hours in line and 1-hour in the Apple store and still could not activate his phone several hours later. This will pass and Apple will rise again.
The long lines at the Apple stores caused investors to sell RIMM stock but that is a misdirected trade. RIMM dropped -$7 on the idea that the new iPhone would slow BlackBerry sales. They are not the same. Forget it. Buy RIMM on dips and the Friday dip to $110 is a gift.
Cisco was pulled from the Goldman conviction list and replaced with Qualcomm. QCOM gained +16 cents, CSCO declined 31-cents. Yawn!
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Rupert Murdoch, chairman of News Corp (NWS) said on Friday he does not expect News Corp to be a part of any Yahoo buyout. He went even farther and said there will not be a Microsoft deal saying in six months Microsoft will tire of the chase and walk away. According to Murdoch Yahoo's largest shareholder Gordon Crawford of Capital Research Global Investors was upset that he did not get $33. Microsoft offered $33 in May but Jerry Yang would not budge from $37. YHOO is $23 today. Reportedly Microsoft advances to News Corp and Time Warner have come up short in trying to find a partner for a Yahoo deal. Nobody wants to touch the company in its current state of lockdown. Yahoo will eventually learn that resistance is futile and the company will either be sold to Microsoft or decline to such low levels that some lesser desirable entity comes knocking with a $10 offer.
The Wall Street Journal's Dennis Berman theorized that a deal will happen at $33 before the August 1st shareholder meeting. He believes the impending board takeover by Carl Icahn will put the fear of God in the current Yahoo management and they will take a known offer for the entire ball of string rather than risk being sliced and diced to different buyers after Icahn gets control. Several major shareholders have said they will back Icahn but there is still some indecision on whether he has enough votes. Lastly what happens to Yahoo if Icahn gets control and Microsoft lowers its offer significantly knowing there are no other suitors and Icahn went though the battle just to complete a sale to Microsoft? Congratulations Carl on your Yahoo victory, enjoy the company as it spirals down to single digits with no Microsoft deal. Reportedly despite several long phone calls between Ballmer and Icahn there is no deal and Ballmer does not like Icahn. Icahn can't talk to Yang so the trio is left playing passing cryptic notes implying possible offers and rejections. Microsoft is clearly in the drivers seat and they are in no hurry to play let's make a deal.
August Crude Oil Chart - Daily
Oil prices hit another new high on Friday at $147.27 as worries over Iran, Nigeria and Brazil hit the tape. After the -$10 drop the first two days of the week nearly every oil bear had loaded up on shorts thinking the bubble was finally bursting. Then Condelezza Rice and Iran got into a war of words on Wednesday and Iran started firing off missiles to punctuate their claims of massive retaliation for any attack. On Friday there was another round of Iran worries after the Jerusalem Post said Israeli planes were practicing in Iraq for an attack on Iran. The paper said the planes were using U.S. controlled airfields in Iraq and were establishing forward supply bases for the coming attack. Iraq, Israel and the U.S. all made strong denials saying the newspaper claims were utterly baseless. It was still enough to squeeze the shorts once again to a new high over $147. Later in the day various sources were claiming that the pictures of missiles being fired in Iran had been altered, were all the same picture from different angles and were of outdated rockets and the actual test could have occurred years ago.
Nigeria said the MEND rebels were canceling their ceasefire as of midnight Friday and to expect new rounds of violence against the oil infrastructure. Violence has kept over one-third of Nigeria's oil off the market for the last year. In Brazil Petrobras said workers were going on a 5-day strike starting on Monday. Workers said they would allow minimal production unless Petrobras tried to send in their own teams. If that happens the strikers vowed to disconnect and disable the equipment. Workers on the 42 Petrobras oil platforms in the Campos area are demanding an extra day off each month. Personally I think they already have it great with 14 consecutive days of work followed by 21 days off. The Campos area represents 80% of Petrobras daily production of 1.8 mbpd. Since the strike is limited to 5-days this should not create any impact to the market other than some news ripples.
Matthew Simmons was interviewed on CNBC again on Friday and was again adamant that this price hike was just another step higher towards $200 oil and higher. He said as long as so many people continue to expect a return to lower prices nothing will really change. Consumers will drive less in the short term but not really change their consumption habits. He thinks the government should be worried about how to limit consumption and increase production rather than focusing on a witch-hunt for whatever demon caused the problem. He believes the U.S. is on a dangerous spiral where inventory levels continue to decline until some geopolitical event causes a severe shortfall in imports. When that happens there will be a shortage of gasoline and diesel and the country will see severe civil unrest from the lack of fuel and food. I know this sounds dire but I have been preaching this for several years. All of my predictions have come true as many of our readers know. This is just another step in the process of peak oil and while we have not seen the top in production yet it is expected to be in 2009. Once that occurs there will be a serious downward economic spiral not just in the U.S. but around the world. Peak oil does not mean the end of oil, just the end of cheap oil. Every barrel from that point forward will be fought over either by bidding or shooting or both.
On the market front the steep -251 point Dow drop at the open was just another drop in a long slide over the last two months. By any metric the market is grossly oversold. We saw the short squeeze on Tuesday get sold hard on Wednesday when the Dow hit 11400. At Friday's low the Dow fell under 11000 and a level not seen since July 2006. You may remember a couple weeks ago I was targeting 10700 for the Dow and Louise Yamata was targeting 10000. She was on TV again on Friday and she has not changed her bear coat or her predictions. Actually four high profile technicians were interviewed Friday and all four were predicting lower lows. What we are facing today is a crisis of confidence in the banking system, housing sector and the economy along with $4 gasoline, $5 diesel and rising inflation. The headline number on the Consumer Price Index next Tuesday is expected to be +0.8%. The economy appears to be headed for a severe bout of stagflation, a period of no growth and high inflation, like we saw back in the 1970s. Whether it comes to pass or not remains to be seen but we are definitely setting up for that possibility.
With that potential in focus the markets will probably be neutral next week as we await the earnings and more importantly guidance from the big firms I highlighted on the earnings list above. The earnings outlook is pessimistic so there is the potential for a positive surprise but as we saw in the GE earnings on Friday their outlook was gloomy. There is a real possibility that we could have more negative than positive news. Couple bad earnings with all those symptoms in the prior paragraph and the path of least resistance is still down. Dow 10700 is only 400 points lower and appears to be an easy target. However, in any bear market there is always the potential for multiple 3-5% rebounds and even rallies for up to 10%. I am not predicting just explaining. The average bear market peak to initial trough is nine to twelve months. This is the 9th month already so the normal bottom could be anywhere between here and October.
According to analysts the markets have plenty of firepower on the sidelines. Reportedly 23% of money normally allocated to equities is in cash on the sidelines. Think about that number. That is 23% of normally invested cash and a massive amount of money. Short interest continues to be at record highs. New lows hit their second highest level for the year on Friday at 1215. The prior high was 1381 back on March 17th. The combination of available cash, record short interest and grossly oversold conditions have the explosive force of a nuclear explosion if the all-clear signal was suddenly given in the market place. We could easily be up several thousand points over a couple weeks but nobody is even close to giving that all clear signal. There is probably a tradable bounce in our future but I thought that was possible back on Tuesday and it failed miserably. Until something significant changes in the marketplace we will continue to be in sell the rally mode. Negative internals continue to suggest more pain ahead.
It is possible that better than expected earnings next week could produce a rebound. I believe it is more likely that any bounce will be sold and we will see Dow 10700 if not Louise mata's 10000 target. The Dow has no visible support between here and 10700. It does have highly visible resistance at 11400. Any bounce should stop there until those broader market issues I mentioned above are resolved. They say the market climbs a wall of worry but this wall is still so clouded in unknowns the bulls can't find a foothold. Until greed overcomes fear the path of least resistance is down.
DoDow Chart - Daily
The Nasdaq tested 2200 again on Friday and that is current support. Under 2200 the next targets are 2050 and 2000. If we hit 2050 I would expect us to retest 2000 since it is so close. Like Dow 10700 Nasdaq 2000 is strong multiyear support. With INTC, MSFT, EBAY, GOOG and IBM reporting next week the tech stocks will become market leaders. The direction they will lead is still unknown but gloomy words from any of them could just accelerate the downtrend. Currently the tech sector is second only to the energy sector in terms of earnings expectations. If they can pull off a positive surprise it would go a long way towards healing market sentiment but I would doubt it could heal the unknowns in the financial sector.
Nasdaq Chart - Daily
S&P-500 Chart - Weekly
The S&P-500 is where technical analysis and fundamental analysis are about to do battle. The S&P hit it's two-year support low at 1225 on Friday. If it were solely up to the charts the S&P would be ready to rally. Unfortunately the financials are the largest sector in the S&P and they are nowhere near a bottom. There have been plenty of bottoms called but none have held. The financial PDR the XLF hit a historic all time low on Friday at 18.29. The unknowns in the sector are simply overpowering the indexes. Bill Gross of Pimco said on Friday he was 100% sure there will be another major bank failure in our future. Lehman, -26% this week, continues to be the one traders point to but there are dozens of others just below the radar. Wachovia (WB) fell -22% for the week.
LLiterally as I was writing the last paragraph the Federal Government announced they have closed the $32 billion IndyMac bank and transferred its assets to the FDIC. This is the largest regulated thrift to fail and the second largest financial institution to close in U.S. history. The largest was the Continental Illinois National Bank with assets of $40 billion when it failed. The Office of Thrift Supervision said IndyMac failed on Friday when it was unable to cover depositor withdrawals. The bank will reopen on Monday as the IndyMac Federal Bank FSB. The FDIC will begin the process to clean up the portfolio and sell the bank to a healthy buyer. Last Monday IndyMac quit accepting loan applications and announced plans to slash 3,800 jobs. The announcement along with a letter to regulators by Sen. Charles Schumer urging them to take action to prevent the banks collapse caused a run on the bank and depositors withdrew $1.3 billion over the last week. The bank's problems came from massive mortgage loan losses and the collapse of the real estate market.
IndyMac Bank Chart - Daily
That should start the markets off on the downside on Monday. Nothing like the second largest bank failure ever to further spoil market sentiment already worried about potential bank failures. I don't know if there is any way the markets can rebound next week given the ugly financial news. Of course things are always darkest before the dawn and it is getting pretty dark on Wall Street. Sell the rallies until something changes.
THE BOTTOM LINE:
My carry over to a Sunday update, from my usual Saturday, was due to a travel day from smoky Northern California, where I was in and around Big Sur. My coastal haunts were not as fun this summer as friends were driven from their homes. Glad to say that they all got back to their homes, only with a lot of clean up involved. Here on the Rocky Mountain shores I'm blessed to be where there are no fires (except in the mountains), no tornados, floods, no humidity or hurricanes!
I would note also that I think my Thursday 'Trader's Corner' (TC) article is worth visiting (& short) if you didn't see it already. The online link to it is available by clicking here.
Back to market basics and some things I was struck by and discussed in the aforementioned TC piece is that bearish sentiment finally built up enough on Friday to suggest the possibility that a tradable bottom is at hand or near. My call to put volume ration reading for all CBOE equities was at a level that I consider bullish in a contrary opinion sense.
The S&P 500 (SPX) came within a hair's breadth of equaling its July 2006 weekly closing low: SPX closed at 1239 (intraday low equaled 1225), versus the 1236 weekly low Close (1228 intraday low). Moreover, the intraday low on Friday, at 1225, equaled SPX's June and July '06 lows.
Further notes on some of the other technicals are that the S&P 100 (OEX) exactly equaled its 2006 weekly closing low at 567. The Dow 30 (INDU) was showing signs of support at 11000, although major support could be closer to 10700. INDU is VERY oversold now on a long-term basis as measured on a 13-week week basis; the S&P is also, but when measured on a shorter-term 8-week basis.
Last but not least, the magnitude of this decline occurred because the energy
stocks were (finally) also correcting and coming down. The CBOE Oil stock Index
(OIX) has now retraced fully half of its last run up (from the week ending 1/25
to the week ending 5/23). It could retrace more of that prior advance of course,
but in a strong market or strong market sector, there is not often more than a
fibonacci 50% retracement.
The Nasdaq hardly needs help, as the relatively strong Nas 100 (NDX) Index has managed so far to close above a level that represents its 2/3rds or 66% retracement of its March-June advance which will be apparent in the NDX individual index commentary below.
MARKET NEWS and INFLUENCES:
** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **
S&P 500 (SPX); DAILY CHART:
The S&P 500 (SPX) Index still has a bearish chart and nothing has changed in that regard. However, there's the best potential seen yet for a possible interim bottom given that SPX bounced a bit after finally reaching minor technical support implied by the down trendline and significant chart support suggested by a prior 'line' of lows going back to June-July 2006.
Rounding out the potential for a reversal here is the extreme oversold suggested by the 21-day Relative Strength Index (RSI). An index or stock being at a same or similar low RSI level that has previously been associated with a bottom is never enough to suggest reversal potential. Being extremely 'oversold' AND with the potential for support and buying coming in at a prior important low IS worth paying attention to.
Near resistance in SPX is at 1277, then at 1290-1292; key resistance at the 21-day average now stands at 1299. Near SPX support we can assume lies at the 1225 intraday low made on Friday. Next support is probably at 1200, mostly due to the psychological importance of such a round 100 number; going back on the chart to late-2005, support was seen that year in the 1173-1170 area.
S&P 100 (OEX) INDEX; DAILY CHART:
The S&P 100 (OEX) Index didn't actually trade at 660 key support but got quite close this past week. There is the possibility that OEX is at or near at least a short-term or interim bottom. I talked about the extreme oversold condition seen with the SPX above. In terms of what I usually display with the OEX chart, an 'oversold' condition is seen in its chart below, given the Friday extreme in my sentiment indicator.
This most recent Friday 'CPRATIO' extreme low, unlike a prior expiration-Friday instance of it, could be assumed this time to be more purely driven by a collective bearish trader outlook. When put volume gets nearly equal to call volume, such a 1-day occurrence has a good track record in suggesting a tradable bottom is close at hand. Relying on such sentiment extremes is trickier after lengthily periods of forceful declines. However, unlike bullishness at tops, bearish sentiment extremes don't always go on and on.
Near support is in the 560 area, the low end of a downtrend channel and also the area of June 2006 lows. 542-543 is major support suggested by a significant double bottom low of March and October 2005. Near resistance is at 585, then at 591 to 595. 591 is a key resistance implied by the 21-day average.
DOW 30 (INDU) AVERAGE; DAILY CHART:
The Dow 30 (INDU) still looks like it may be headed toward the low end of its (highlighted) downtrend price channel around 10700, which was also support seen at its 2006 bottom. This technical target, however neat or 'ideal' it may seem in chart terms, is only one possibility for the NEAR-TERM. Besides being very oversold, the 21-day RSI is starting to trend higher and sets up a potentially bullish price/RSI divergence. Stay tuned on the rally potential implied by this divergence!
Near support is at 11000 to 10960, with major support in the 10700 area. Near resistance remains 11400-11435, then at 11500, with 11638 resistance implied by the 21-day average.
NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:
The Nasdaq Composite (COMP) Index has been finding support in the 2250 to 2200 price zone and appears to be resisting a further decline, so is showing better relative strength than the S&P and Dow. On the other hand COMP hasn't been able to rally much, but could if the S&P has a bounce.
Major support remains at 2155-2169. Key initial resistance first lies in the 23.2 area, at the intersection of the down trendline, with even more pivotal resistance at the 21-day average at 2350. A close above the 23.25 to 23.5 zone would be bullish and suggest potential to get back up to the 2410 area, perhaps higher.
COMP is also fully oversold now, as measured with the 13-day RSI. It has the potential to rally, is resisting a further decline, but it remains to be seen if this 'potential' will translate into a tradable rally.
NASDAQ 100 (NDX) DAILY CHART:
The Nasdaq 100 (NDX) Index on Friday retraced a bit more than 66%, but rebounded above this implied support by the close. I suggested taking profits on puts in the 1800 to 1775 area and put holders had another chance at the end of the week when NDX got to a low of 1784. As long as the index can maintain closes above 1800 I see potential for a rally, such as back to the 1900 area and higher; e.g., to around 1950.
Near resistance to be overcome to would suggest bullish near-term potential is at 1857, then at the 21-day average, which stood at 1889 at the Friday close. I've highlighted a bullish price/RSI divergence: as prices have drifted lower the RSI has drifted up. The difficulty is in knowing WHEN any such rally implied by this divergence will develop. The index could have a good-sized bounce when the S&P stops acting as an overall drag on the market. When it does, tech seems ready to rebound some.
I estimate support below 1800 to be at 1775, then in the 1760 to 1750 zone. Major support is down in the 1670 area, where NDX bottomed in early-March.
NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:
The Nasdaq 100 tracking stock (QQQQ) has seen support develop in the 44.25 to 43.7 area recently. Key resistance looks to be initially at the down trendline intersecting currently around 45.8, then at the 21-day average at 46.47.
If they can't take it down or down much more, they could take the stock up in the coming week. Conversely, a close below prior (down) swing lows at 43.7 and at 43.3 would suggest that QQQQ was headed to a retest of major lows in the 41 area.
The distinct rise in daily trading volume seen on Thursday and Friday on the QQQQ chart above could be part of a minor selling climax. I take the rise in volume bullishly in that it reinforces the idea that, on a closing basis, the Q's have been 'basing' over the past week. For a stronger bullish indication, I'd rather see a huge volume jump like at the March bottom at 41, but the same volume pattern may not repeat, at least just yet.
RUSSELL 2000 (RUT) DAILY CHART:
I'm not exactly sure what to make out of the Russell 2000 Index (RUT) pattern, but recent days formation of a minor bear 'flag' per the light blue lines drawn on the chart below, suggest potential for RUT to drop next to the low-640 area. If this is going to happen, it should happen soon.
On the other hand, a close above 680 would be a near-term bullish development, especially if the index stayed above 680 for a second day.
Near support is in the 660 area, then at 643-640. Near resistance is at 682-684 and is next anticipated in the 700 area, with fairly major resistance at 720.
GOOD TRADING SUCCESS!
NOTES ON MY TRADING GUIDELINES AND SUGGESTIONS
Trading suggestions are based on Index levels, not a specific option (month and strike price) and entry price for that option. My outlook often focuses on the intermediate-term trend (next few weeks) rather than the next several days of the short-term trend.
Having at least 3-4 weeks to expiration tends to be my guideline for trade entry choice. I attempt to pick only what I consider to be 'high-potential' trades; e.g., a defined risk point would equal in points only 1/3 or less of the index price target.
I most often favor At (ATM), In (ITM) or only slightly Out of the Money (OTM)
strike prices in order not to 'overtrade' my account. Exit or 'stop' points, as
well as projected profitable index price targets, are based on my technical
analysis of the indexes.
Last week's Trader's Corner followed up on a previous article, and I thought that trend might be a good trend to continue. When I write novels, I like to tidy up all the loose ends, and I feel that I should do the same when writing these articles.
One of those loose ends was first introduced in a Trader's Corner article back on March 20. The article theorized that it was useful for those trading the Dow, SPX and OEX to study the NYSE advance/decline line using standard technical analysis tools. The article pointed out that this study should be accomplished on intraday charts as the daily ones provided little information. The following daily chart illustrated the conclusion that, because the A/D line could move only so far in any one direction, the daily chart provided little useful information. However, something on the chart I'd used as an example piqued my interest, as the annotations on the original chart show.
Annotated Daily Chart of the A/D Line as of Mid-March:
That intriguing contraction and expansion of the A/D line on the daily chart continued to intrigue me. Although a cursory look at the chart suggested some sort of sound wave and nothing to help us with our trading, could the contraction and expansion produce signals? Had that same contraction and then expansion accompanied the recent downturn in the markets?
Annotated Daily Chart of the A/D Line as of 7/07/08:
Hmm. More and more intriguing, isn't it? Such a tendency could also make sense from a logical point of view, if big trending moves are born out of a period of consolidation. Consolidation is a period when bulls and bears are rather evenly matched, when neither can win the day. Whether or not volume contracts or expands, the even matching of the bulls and bears would mean that the swings in the A/D line would tamp down.
Questions immediately arise. Would a rally born out of a consolidation period show the same pattern? Would the contraction or the breakouts occur in a different manner? Are the triangles sometimes not neutral triangles but sometimes bullish or bearish ones with flat tops or bottoms?
Obviously, those questions can't be answered by a cursory look at a few charts. Also obviously, someone else has probably studied this in depth, although I haven't found the studies yet. However, to further explore these questions in an anecdotal way, I scrolled back through the SPX's daily chart, without looking first at the A/D chart, until I noticed the rally off the October 2005 low. Only then did I look at the A/D chart. I hadn't wanted to cherry pick a point in which I could already see a contraction in the A/D line.
Annotated Daily Chart of the SPX:
Annotated Chart of the A/D Line in late 2005:
On 12/14 and 12/15 of that year, the SPX was hitting a lower high and began a consolidation period that would eventually carve out a broadening formation, an unusual formation that's not always seen at the top of a climb. Such formations are typically emotion-based and are considered potentially bearish formations, although this one broke to the upside. A glance at the A/D chart above shows us that the A/D line was actually broadening during the formation of that broadening formation, as might be expected if it was an emotion-based formation.
While breakouts might attend the end of a consolidation period, that action during the broadening formation proves that not all consolidation or reversal formations produce a narrowing A/D line pattern. A broadening formation did not.
Neither does the A/D line always narrow into a triangle. The period from 5/17/07 to 9/06/07 was characterized by a rising channel on the A/D line. On 5/17/07, the SPX began chopping out an inverse or reverse head and shoulders.
Annotated Daily Chart of the SPX:
What's the conclusion to all these charts and suppositions? The conclusion should be that perhaps those sound waves on the daily A/D chart do mean something after all. Perhaps we should watch for a narrowing and then a breakout of that narrowing as confirmation that a new trend has begun. Perhaps we should watch the shape of any triangles or rising channels or broadening formations on the A/D line for clues as to what's happening with the markets, too.
But does it mean something in particular if the break out of a narrowing triangle is first to the downside or first to the upside? The initial studies suggest that both rallies and declines can begin with a break to the downside, so it seems to matter more that the narrowing formation is violated on a daily close than that it break one direction or another, at least on first glance. Does it mean anything if the topside is flat and the bottom rising, or vice versa? It's easy to notice the breakdown out of a narrowing formation, but what about the beginning of a rising channel? It's not so easy to identify those until a number of touches have occurred and trendlines can be established.
Unfortunately, the few charts available here provide enough information to
intrigue traders and pose further questions but not enough information to
warrant too strong a belief in the predictive power of any one pattern on the
daily A/D chart. They intrigue me enough that I'll keep watching, however, and
I'll certainly pay attention if I see a narrowing formation set up, watching for
CurrencyShares Euro - FXE - cls: 159.44 chg: +1.45 stop: 156.75
Why We Like It:
BUY CALL AUG 160.00 FLN-HD open interest= 65 current ask $1.75
BUY CALL SEP 165.00 FLN-II open interest= 95 current ask $0.95
Picked on July xx at $ xx.xx <-- see TRIGGER
Eaton - ETN - close: 80.93 change: -0.50 stop: n/a
Why We Like It:
These prices will change tomorrow. We want to open positions as close to $80.00 as possible. However we would use the $81.00-79.00 zone as an range to launch strangle positions.
Estimated cost with August options is $x.xx (to be filled in on Monday). We want to sell if either option hits $x.xx (TBD).
BUY CALL AUG 85.00 ETN-HQ open interest= 183 current ask $2.55
- Or if you want to be really aggressive try the July options, which expire in five days.
Estimated cost with July options is $x.xx (to be filled in on Monday). We want to sell if either option hits $x.xx (TBD).
BUY CALL JUL 85.00 ETN-GQ open interest=2731 current ask $1.15
Picked on July 13 at $ 80.93
UBS Ag - UBS - close: 19.49 change: -0.41 stop: 20.75
Why We Like It:
We are listing two different strangles. Pick the one that best suits your trading style and risk.
UBS Strangle #1) This uses the August $22.50 calls and $17.50 puts. Our estimated cost is $1.90. We want to sell if either option hits $3.00.
BUY CALL AUG 22.50 UBS-HX open interest= 931 current ask $0.80
UBS Strangle #2) This uses the August $25.00 calls and $15.00 puts. Our estimated cost is $0.90. We want to sell if either option hits $1.90.
BUY CALL AUG 25.00 UBS-HE open interest=1793 current ask $0.35
Picked on July 13 at $19.49
FinancialSector SPDR - XLF - cls: 18.68 chg: -0.54 stop: n/a
Why We Like It:
I am guessing that the XLF may open on Monday morning around $18.00, give or take 25 cents. We're suggesting the following options: the August $20.00 calls and the August $16.00 puts. If the XLF opens at $19.00 then adjust the strikes up $1.00. If the XLF opens at $17.00 then adjust the strikes down $1.00, etc.
We will fill in the estimated prices based on where the XLF opens on Monday morning. Our estimated cost for this play is $(TBD). We want to sell if either option hits $(TBD). Try and keep your investment balanced on both sides of this play.
BUY CALL AUG 20.00 XLF-HT open interest=41,562 current ask $0.95
Picked on July xx at $ xx.xx <-- Monday morning
CF Inds. - CF - close: 159.05 chg: +2.20 stop: 147.45 *new*
Target exceeded! CF continued to rally as expected but it was another volatile session with CF trading in a $7.00 range. Bulls bought the dip at $153.00. Our first target was $159.00 and CF hit $160.50 intraday. Our secondary, more aggressive target is the $164.50 mark. We are raising the stop loss to $147.45. We strongly suggest you take some profit off the table if you have not done so already. We're not suggesting new plays at these levels. FYI: More aggressive traders may want to aim for the $170 region or even aim for the top of the channel closer to $180.
Picked on July 08 at $145.06 *gap open entry/1st target hit
Fording Candn.Trust - FDG - cls: 81.38 chg: +1.72 stop: 74.45*new*
Many of the coal stocks continue to bounce and FDG hit an intraday high of $83.00 on Friday. Our target is the $84.00 level. More conservative traders may want to start doing some profit taking now. We're upping our stop loss to $74.45 and we're not suggesting new bullish positions at this time. More aggressive traders may want to aim for the $86-90 zone but we suspect the $85 region might offer some resistance.
Picked on July 08 at $ 75.35
Gold ETF - GLD - cls: 95.16 chg: +1.63 stop: 89.45
Gold surged to a new three-month high on Friday. The combination of geopolitical concerns with Iran, a new high in oil, another big drop in the U.S. dollar, and increasing worries over the U.S. financial sector all contributed to gold's strength. The GLD closed above potential resistance at $95.00, which is bullish. The intraday high was $95.50. Our target is the $97.00 level. More aggressive traders may want to aim for the $99.50-100.00 zone instead.
Picked on July 09 at $ 91.50
Hess Corp. - HES - close: 111.76 chg: -1.22 stop: 107.24
HES did not deliver much of a performance when you consider that crude oil hit another new record high. The stock temporarily traded above potential resistance at $115.00 and then dipped back to its 100-dma again. The afternoon bounce could be used as a new bullish entry point but more conservative traders may want to tighten their stops. We're leaving our stop at $107.24 for now. We have two targets. Our first target is $119.75. Our second target, if HES can breakthrough resistance near $120.00, is the $124.50 mark. We do not want to hold over the late July earnings report.
BUY CALL AUG 110.00 IGG-HB open interest=2110 current ask $9.10
Picked on July 10 at $112.98
Mosaic - MOS - cls: 141.81 chg: +1.72 stop: 133.45 *new*
Traders bought the intraday swoon at $136.77 on Friday. The bounce back over $140 is bullish. If there is any follow through on Monday then MOS could hit our first target at $144.00. If you are looking for a new entry point you could use this bounce but consider a tighter stop in the $134-135 zone. We're raising our stop loss to $133.45. Our second target is the $158.00 mark. More aggressive traders may want to aim for the top of the bullish channel in the $175-180 region. Remember, we do not want to hold over the July 28th earnings report.
Picked on July 08 at $133.57 *gap open entry
CBOE Volatility Index - VIX - close: 27.49 chg: +1.90 stop:
It's been a wild ride thus far in the VIX. Concerns over FRE/FNM and the financial sector sent the VIX to an intraday high of 29.44 on Friday. It was only 6 cents short of our first target at 29.50. Readers may want to consider taking some money off the table if the VIX trades over 29.00 again. We were suggesting the August options. We were listing two targets. One target is 29.50 and a second one at 34.00.
Picked on June 30 at $ 23.95
Apple Inc. - AAPL - close: 172.58 chg: -4.05 stop: 181.01
If you read tonight's market wrap then you already know that AAPL's 3G iPhone launch did not go quite as planned. The network and activation servers were overloaded and failed. It's a temporary problem but didn't help shares of AAPL on Friday. The stock traded lower and still looks poised to drip toward its 200-dma. Today that 200-dma is at 164.38. Our target is the $165.00 mark. If AAPL does trade lower we'll be considering bullish trading ideas in the $164-160 zone.
Picked on July 09 at $174.25
Amazon.com - AMZN - close: 68.54 chg: -2.09 stop: 72.65 *new*
AMZN's afternoon rebound toward $70.00 failed and this looks like another entry point to buy puts. We are adjusting our stop loss to $72.65. It could be a volatile week with the onset of earnings season and news out of the tech sector could influence AMZN's share price. The new trend is down but be careful. Our target is $62.50.
Picked on July 10 at $ 69.75 *triggered
(What is a strangle? It's when a trader buys an out-of-the-money (OTM) call and an OTM put on the same stock. The strategy is neutral. You do not care what direction the stock moves as long as the move is big enough to make your investment profitable.)
Alpha Nat. Res. - ANR - close: 96.80 chg: + 4.96 stop: n/a
It was another strong day for ANR and shares bounced sharply from their dip near $90.00 on Friday. Unfortunately, we are very quickly running out of time for this strangle play. Thus we're going to reduce our exit target to breakeven at $9.40. We're not suggesting new strangle positions at this time. This is a higher-risk strangle play with the options so expensive. The options we suggested were the July $105 calls (ANR-GA) and the July $85 puts (ANR-SQ). Our estimated cost was $9.40.
Picked on June 15 at $ 94.25
Chevron - CVX - close: 92.25 chg: -4.00 stop: n/a
CVX plunged on Friday but managed to pare its losses to just -4% after bouncing from the 200-dma. The August $90 puts spike to $3.20. We are not suggesting new strangle positions at this time. The options we suggested were the August $110 calls (CVX-HB) and the August $90 puts (CVX-TR). Our estimated cost is $2.20 (based on June 30th prices we needed 2 calls per 1 put). We want to sell if the puts $3.85 or if the calls hit $1.90. More aggressive traders may want to aim higher.
Picked on June 30 at $ 99.13
DIAMONDS - DIA - close: 111.00 chg: -1.22 stop: n/a
The DJIA tagged another new 52-week low. Volume is rising as stocks keep falling. We are not suggesting new strangle positions on the DIA at this time. The options we suggested were the August $115 calls (DIA-HK) and the August $109 puts (DIA-TE). Our estimated cost is $4.35. We want to sell if either option hits $6.90 or more.
Picked on July 07 at $112.21
iShares Brazil - EWZ - cls: 81.64 chg: -0.51 stop: n/a
The EWZ tried to bounce on Friday but failed at its 200-dma. The trend remains lower. We are not suggesting new strangle positions. The options we suggested were the August $90 calls (EWZ-HR) and the August $75 puts (EWQ-TO). Our estimated cost is $3.95. We want to sell if either option hits $5.90.
Picked on July 03 at $ 83.06
Corning Inc. - GLW - close: 20.28 chg: +0.12 stop: n/a
GLW bounced around the $20.00 region on Friday providing us an opportunity to open strangle positions. Lehman Brothers came out with some positive comments suggesting the pull back to $20.00 was a buying opportunity in GLW. Aggressive traders will be tempted to buy calls here with a stop loss under $19.69 (Friday's low). Even though GLW is overdue for a big bounce we don't want to bet on it so we're suggesting a strangle. Earnings are late July and we do plan on holding over the report unless the stock hits our target first. Try and open strangle positions as close to $20.00 as possible but we would use the $20.25-19.75 zone. The options we suggested were the August $22.50 calls (GLW-HX) and the August $17.50 puts (GLW-TW). Our estimated cost is $0.75. We want to sell if either option hits $1.50. Try and keep your investment balanced on both sides of the trade.
Picked on July 10 at $ 20.16
Garmin Ltd. - GRMN - close: 42.66 chg: -1.01 stop: n/a
This is it. We're down to our last week with GRMN before July options expire. Due to our dwindling time frame we're adjusting our exit target to breakeven at $2.55. The options we listed were the July $50 calls (GQR-GJ) and the July $40 puts (GQR-SH). Our estimated cost was $2.55.
Picked on June 15 at $ 44.91
Internet Holders - HHH - cls: 50.63 change: -0.25 stop: n/a
We're still not seeing a lot of movement yet in the HHH. The chart is showing a lot of contrasting signals with a bearish failed rally last week and yet Friday's bounce could be the second part to a bullish double bottom. We were suggesting strangle positions in the $50.50-49.50 zone. The options we suggested were the August $55 calls (HHH-HK) and the August $45 puts (HHH-TI). Our estimated cost is $1.65. We want to sell if either option hits $2.45.
Picked on July 03 at $ 50.50
KLA-Tencor - KLAC - close: 37.79 chg: -0.95 stop: n/a
We are down to our last five days with these strangles on KLAC. Please note that we're adjusting our exit targets. For strangle #1 we're moving the exit target from $3.00 to $2.25. For strangle #2 we're moving the target from $1.50 to $1.15. More conservative traders may want to move their targets to breakeven. We are not suggesting new positions at this time. We listed two different strangles on KLAC.
KLAC Strangle #2) The options we listed were the July $45.00 calls (KCQ-GI) and the July $35.00 puts (KCQ-SG). Our estimated cost is $0.70. We want to sell if either option hits $1.50.
Picked on June 22 at $ 40.07
MarketVectors Agribusiness- MOO - close: 57.65 chg: +0.25 stop: n/a
We're still not seeing any movement yet in the MOO. The recent oscillation sideways has certainly provided some entry points for us to open strangle positions. We were suggesting readers open strangle positions in the $57.00-58.00 zone. The options we suggested were the August $62 calls (MYV-HJ) and the August $50 puts (MOO-TX). Our estimated cost is $2.10. We want to sell if either option hits $3.15.
Picked on July 03 at $ 57.25
PowerShares QQQ - QQQQ - cls: 44.56 chg: -0.72 stop: n/a
The Qs continued to drift lower inside their bearish channel. Our suggested entry zone was the $45.25-44.75 region. The options we suggested were the August $47 calls (QQQ-HU) and the August $43 puts (QQQ-TQ). Our estimated cost is $1.80. We want to sell if either option hits $2.75 or more.
Picked on July 07 at $ 44.90
United States Oil - USO - cls: 117.39 chg: +3.05 stop: n/a
The combination of a plunging dollar, fears over an escalation with Iran, and general market uncertainty helped send crude oil to another record high on Friday. The USO hit $119.17. We're down to our last five days before July options expire. We're adjusting our exit for USO strangle #1 to $9.00. We're adjusting our exit for USO strangle #2 to breakeven at $4.10. We are not suggesting new positions at this time. We suggested two different strangles. The strangle with the wider strikes costs less but has higher risk.
USO Strangle #2) The options we listed were the July $120 calls (QSO-GP) and the July $100 puts (IYS-SV). Our estimated cost is $4.10. We want to sell if either option hits $6.50.
Picked on June 22 at $109.14
Lehman Brothers - LEH - cls: 14.43 chg: -2.87 stop: n/a
Target exceeded! Concerns over the financial sector and anything with mortgage exposure is really heating up again. LEH got pummeled (again) for a 16.5% loss. Shares hit $13.29 intraday on Friday. That sent the August $15 puts to a high of $5.20. Our target to exit was $4.25. If you have not exited yet then consider jumping out on Monday morning. The IndyMac bank closure news over the weekend could send financials gapping lower on Monday. The options we suggested were the August $25 calls (LYH-HE) and the August $15 puts (LYH-TC). Our estimated cost is $2.54.
Picked on July 07 at $ 20.84
Today's Newsletter Notes: Market Wrap by Jim Brown, Trader's Corner by Linda
Piazza, Index Trader by Leigh Stevens, The Contrarian by Robert Ogilvie and all other plays and content by the Option Investor staff.
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