Table of Contents
Never underestimate the power of short covering. The financial stocks exploded out of a major low on better than expected earnings from several large banks, a lack of new bad news and a government bailout for Fannie and Freddie. One analyst called the bank rebound the biggest government backed short squeeze in history. The rebound in financials powered the broader market to gains of 1% to 3% for the week despite major earnings disappointments in the Nasdaq.
Wilshire-5000 Broad Market Index Chart - Daily
Economics were not a problem on Friday and apparently neither was option expiration. It was a calm day and there was no real attempt to sell off the gains for the week. It was a bullish day despite the implosion in the Nasdaq. The main reasons for the Nasdaq drop were Google, Microsoft and Apple.
It was extremely interesting to see traders ignore the rampant +4.9% inflation in the Consumer Price Index (CPI). The annualized headline rate is even higher at +7.9% although the core rate is only 2.4%. Energy continued to be a major component to the rising inflation and it has not changed just because oil fell -$17 from the highs for the week. $129 oil will continue to push prices higher and odds are good it won't stay at $129 for long.
The rising inflation did elicit bearish comments from some Fed officials and the Fed Funds Futures rose to a 62.2% chance of a rate hike at the August 5th meeting. Minneapolis Fed President Gary Stern told Bloomberg on Friday that "headline inflation is clearly too high and could feed through to core prices." Duh, no kidding. He said the Fed could not wait for the economy to stabilize before raising rates. He is a voting member of the FOMC. Former St. Louis Fed President William Poole warned that the Fed should act "sooner rather than later" to begin tightening interest rates. Poole said it would be better to take "a milder hit now in order to reduce the risk of a much bigger hit later." Poole stressed that we are running a "substantial risk" of inflation being more difficult next year. He also said the current data does not justify that we are in a recession. Kansas Fed President Thomas Hoenig also made some bearish comments after touring a manufacturing business in Colorado where every single component had risen sharply over the last year. Hoenig said it reinforced his concerns about needed action to combat inflation. It looks like we are definitely going to see a rate hike when the Fed meets again in two weeks.
The economic calendar for next week is rather light without any major reports. The Fed Beige Book on Wednesday afternoon is likely to be the most volatile event of the week for economics. Everything else is just a repeat of recent data and should be no surprise. We can also expect the Fed heads to be making frequent trips to the podium to warn us a rate hike is coming.
Friday was an interesting day in the markets and even more so since it was option expiration. The deluge of ugly earnings reports on Thursday sent the indexes down at the open but only the major techs stayed down. Google (GOOG) lost -$52 and closed at 481.50 after disappointing on revenue spoiled the party. Google lost -10% for it's biggest percentage loss ever. Google said the slowing economy had people clicking fewer ads and that should be a clear sign that the consumer is in trouble.
Microsoft (MSFT) fell -$1.88 or -6.8% for it's worst loss in two years after giving weak guidance about its software sales. Microsoft said spending would be higher but revenues would be lower. Acceptance of the Vista operating system continues to be slow and many companies are now planning to wait for the next Windows release before making any changes. That would be Windows 7 in 2010.
AMD posted a loss of $1.19 billion or -1.96 per share compared to a loss of $600 million in the comparison quarter. That was well over analyst's estimates for a loss of 52 cents. Revenue was also light. AMD lost -13% but at its sub $5 level that only amounted to -67 cents. Intel just needs to give AMD a monthly allowance to give the appearance there is competition in the space. Intel is so far ahead of AMD they may never catch up.
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ValueClick (VCLK) appears headed for zero with a continued drop after warning economic weakness would cause it to miss estimates. Several brokers downgraded the stock to a hold from a buy. The stock is down -50% in the last 8 weeks to close at $10 so those brokers are a little behind the curve.
Overstock.com (OSTK) was beaten like a rented mule on Friday with a -41% drop to close at $16.31. The company said it lost 28-cents per share in Q2 and its marketing costs rose +79% in the same period. Stifel Nicolaus downgraded the stock to a sell saying revenue growth could drop sharply now that OSTK has moved away from selling excess goods and into traditional retail merchandise. The analyst said OSTK may never raise margins above 2-3% at scale and well below Amazon's 8%. I dislike Overstock and will never buy from them again. They cut the return addresses off their packages and don't include invoices. If you want to send something back it is nearly impossible. Customer service is nearly non-existent. Lastly CEO Patrick Byrne has taken to spamming his customer lists with complaints about short sellers crushing his stock. What Patrick does not understand is he needs a real business model and it would help if he actually turned a profit and those short the stock would actually help push it higher in their surprise. He has been on a tirade over shorts for the last couple years in the media but resorting to spamming his customer lists is inexcusable.
Apple Chart - Daily
Apple (AAPL) crashed back to support at $165 on Friday with a -$6.66 loss ahead of earnings on Monday. Apple is expected to post strong earnings despite the recent flurry of high profile disappointments. However, their recent sales success of the 3G iPhone will not count in this earnings report. That will hit next quarter. Apple is expecting to earn about $1 per share on revenue of $7.2 billion for Q2. Analysts are a bit more optimistic with expectations for $1.08 and revenue of $7.34 billion. A problem for Apple was the decline in iPhone inventory in Q2. Since they new the 3G phone was going to be released they let their existing inventory sell down to nearly zero many weeks ago. Many stores had not had any phones for weeks or only a trickle of new inventory being shifted from other regions. How much this impacted iPhone sales is unknown. On the flip side the sales of Macintosh computers are soaring with some estimates of a 33% increase in the quarter. Apple's success with the iPhone is a strong advertising point for the simplicity of the Mac. Piper Jaffray rates Apple a buy with a price target of $250.
Qualcomm (QCOM) is an unexpected beneficiary from the surge in 3G iPhones. QCOM licenses the technology to every 3G manufacturer except Nokia and they are in a nasty royalty suit against them as well. With the popularity of the iPhones it will cause more 3G phones by other makers to be sold as well. Qualcomm confirmed last week that the average selling price of smart phones would climb from their last $203 estimate to more than $217 by year end. Qualcomm also has a new Snapdragon processor that will power two classes of devices from pocket PCs with 4-7 inch screens to mobile computing devices with 7-10 inch screens. Think oversized iPhones on one end and small laptops on the other. Intel has a competing chip but it requires four times power of the SnapDragon. QCOM earnings are on Wednesday.
IBM Chart - Daily
Outside the financial sector IBM was the earnings hero for the week. IBM posted a 22% rise in profits and well over street estimates. They also raised their guidance for 2008 to $8.75 per share, a gain of 25 cents over prior guidance. They earned $1.98 for the second quarter compared to $1.55 in the comparison quarter. More than half of IBM's gains came from their services component. It appears nearly immune to the current economic downturn. IBM said it was concerned about the weak global economy but their current guidance upgrade accounted for that. In other words, times are tough but we are still increasing our earnings. When economic conditions improve they are going to knock the cover off the ball. IBM closed at $129.89 with a gain of +3.37. However, if IBM was given Google's forward PE of 24X they would be a $210 stock. Using Google's price to sales ratio of 6.8x rather than their current 1.6x they would be a $525 stock. Personally I think IBM is a much better company than Google but they are hindered by being an old-line blue chip bought by value funds rather than aggressive portfolio managers. I think we will see IBM at $200 not long after Apple hits $225. Quality growth has a place in today's questionable environment.
Fannie and Freddie have gotten so much press this week I am going to pass on spending too much time on them. Investors feel the Fed will backstop them in some form and guarantee the debt but that is where the feeling ends. Freddie is contemplating selling $5 to $10 billion in equity to avoid additional government oversight. One analyst questions this concept. Freddie is currently yielding 13% on their preferred stock. For them to basically pay 13% for money and turn around and lend it on 7% mortgages does not make any sense. Many analysts feel there is still more rocks in the road ahead for Fannie and Freddie.
Wells Fargo (WFC) was the turning point for the financial sector on Wednesday. WFC beat the street and raised its dividend at a time that others are cutting them. WFC has a large mortgage component and their great results were a serious shock to the sector. WFC posted earnings that fell -22% on higher loan losses but still beat the street. Wells Fargo stock surged +35% to close at $28 on Friday. Their results helped several other major banks gain even more ground after their own earnings. Even Citigroup and their less than exciting earnings on Friday saw a +21% gain for the week.
You know from my prior commentary that the financials were locked in a downward spiral with an all time low on the XLF on Tuesday. The implied government backing of Fannie and Freddie, the elimination of the naked short capability and the earnings surprise from Wells Fargo started a short covering sprint that was nothing short of amazing. The XLF rebounded +25% from its low to Friday's high. The $64 question is will it stick? There is no doubt this was short covering and some asset allocation moves from commodities back into equities. There is a considerable debate underway on whether this rebound has legs or will we roll over again. There are several regional banks that report earnings next week that could upset this euphoria. Wachovia reports on Tuesday and the pessimism is very high. Washington Mutual also reports on Tuesday and their subprime credit portfolio could be a strong negative.
Also reporting next week is Yahoo on Tuesday and Carl Icahn received a blow to his board election campaign on Friday when Legg Mason Capital said it would back Yahoo instead of Icahn. Legg Mason owns 4% of Yahoo stock. It is not a large position but the defection of a high profile play to Yahoo's side is sure to rock some conviction by other large holders. They are the largest independent shareholder to announce in favor of Yahoo. Legg Mason Chairman Miller said he met several times with Jerry Yang before making the decision. Miller feels Yahoo should not be sold for less than $33 and Icahn cannot get that from Microsoft. Icahn owns a 5% stake. According to Yahoo they have 14% of the major shareholders on their side of course Yang and co-founder David Filo have 10% between them so that completes the 14%. Yahoo's earnings on Tuesday could also impact votes. If Yahoo disappoints it would help Icahn garner the necessary votes. If Yahoo somehow pulls a rabbit out of the hat with some miraculous performance that could help Yang garner votes. Yahoo has taken the fight to their webpage with a big banner poking fun at Icahn and a link to a page with all the reasons shareholders should back Yahoo. On that page is a list of companies Icahn has attacked/joined and the results in the stock price after that involvement. The list appears to be rather damning but I don't know how it was produced other than you can bet it was biased. The list would not make me want to vote for Icahn so I guess it served Yahoo's purpose.
Unless you live in a cave you probably heard about the $17 drop in oil prices from Tuesday's high of nearly $147. Crude closed at $128.88 on Friday for the biggest weekly drop in history. Various support levels were crushed and Friday's close suggests a possible test of $122 on a purely technical basis. The reasons for the drop were as varied as there were investors but several stood out specifically. Options on crude futures expired on Thursday. August crude futures themselves cease trading on Tuesday. Oil was grossly overextended with a nice double top at $147. Demand is dropping almost daily. There were a dozen reasons why crude could have dropped but expiration and an asset swap back into equities were probably the most important. Another prominent reason was the "apparent" cooling of Iranian tensions. On Tuesday comments were being made about a meeting with Iran's nuclear negotiator this weekend. An Iranian spokesman denied it saying it was "psychological warfare." On Wednesday they admitted they were meeting with the UN group in Geneva. On Thursday the U.S. said they were sending an official envoy, William Burns. This will be the first official meeting between the U.S. and Iran since the hostage crisis in 1979. On Friday Condoleezza Rice said the U.S. has no "permanent enemies" and is open to negotiations with anyone. She said Iran was "a difficult and dangerous state" but "We have been very clear that any country can change course." Many analysts have claimed over the past months that the growing tensions between the Israel, Iran and the U.S. were responsible for as much as $40 in the price of oil. Unbelievably, the U.S. also suggested it might consider opening a diplomatic mission in Tehran. I can't even believe the words I just typed given the rhetoric of the past several weeks.
August Crude Oil Futures Chart - Daily
While all of this may seem like Iran is just going to walk in and layout their nuclear plans to be blessed by the participants this is not the case. On Thursday Iran has made broad claims about the meeting in an effort to boost their credibility in the Middle Eastern region. The great satan has come to bow at our feet or something like that. The press has been eating this up and oil prices were falling like a rock. Now as of late Friday night Iran has changed its tune. They will not allow any influence by the Zionist state, referring to Israel. No power on earth can deny us of our nuclear rights. And, the combined proposal from the six nations (China, Russia, France, Britain, Germany and U.S.) is not acceptable. They basked in the glow of U.S. recognition late in the week and now appear prepared to disagree with everything. Analysts believed nothing will come from this meeting because Iran hopes to find a more agreeable ear when a new president is elected. This is just a stalling tactic on the side if Iran and a desperation move on the U.S. side in hoping to get something done before Bush leaves office. I believe the meeting was destined to fail and next week Iran will be as forceful as always in claiming its nuclear right. The six nation U.N. group will try to enact stronger sanctions in order to get something done before Israel does something stupid. To the extent any Iran premium was subtracted from oil prices in advance of the meeting they could rebound just as easily. After meeting for six hours on Saturday the diplomats said they were still deadlocked on Iran's refusal to halt their nuclear program. The six countries said after the meeting "Iran has been given two more weeks to give us a clear decision or face stronger sanctions. The U.S. State Dept said, "Iran has been given a choice to make: negotiation or further isolation." The British official said, "They can take our warning back with them to Iran but if they don't agree with the proposals, we will have to start imposing sanctions." It does not appear to me that it went well for Iran.
You may remember a week ago when Iran showed pictures of a missile test with four missiles streaking skyward out of the desert. A couple days later that picture was pulled and replaced with one with three missiles streaking and one dud still on the trailer. They had modified the original to erase the dud but got caught. A reader claims that was still not the correct picture and sent me a copy of the actual missile shoot. (grin)
Iranian Missile Test
Last Tuesday I showed a table of the comparison of the January 22nd market bottom and the internals on Tuesday. I updated the table and you can see below that the volume reversed after the opening drop on Wednesday to sharply overpower the declining shares. Volume was strong with a strong imbalance. This was a perfect example of a short covering rebound. Volume slowed on Friday even though it was option expiration. That suggests that either the short covering has run its course or traders were just leery of buying the steep bounce ahead of the weekend. I vote for both.
I reported in past commentaries that a bear market typically has at least two 5% rebounds and one rebound of as much as 8-10%. The Dow rebounded +6% off its Tuesday lows and the S&P +5%. Technically we have fulfilled the criteria for a bear market bounce. Can we go higher? Absolutely. The Dow could easily run to 11700 and a Fibonacci retracement of 38% from the May high to the July low. That would also be an 8% rebound. Nobody can tell you with any certainty if that will happen or not but it is always possible.
The only thing we can be sure of is continued weakness in the banking sector. Their problems did not go away just because a couple banks had less than catastrophic results. Despite the government backed short squeeze the economy is still in the tank and sentiment is still falling. Fuel prices are still going to be pushing inflation higher even if oil falls to $122. The Fed is going to raise rates at the August 5th meeting and they will have to talk tough on inflation for the hike to have any impact. August and September are the two worst months of the year for the markets with bottoms normally made in October. The presidential candidates will be calling names and telling us how bad it is for the next two months as they position themselves ahead of their conventions. This is always bad for sentiment. September is known as cleanup month because fund managers clean house after the Labor Day holiday in preparation for buying October bottoms.
Just because the next two months are typically bearish and we are already in a bear market does not mean it will continue. It does not mean we will just rocket higher either. The focus for next week will be more earnings and especially the regional banks. The earnings scorecard will be helped by a lot of energy companies reporting. Analysts still claim oil companies are valued at $80 oil and we have not been there in a long time and I doubt we will ever be there again. That suggests the energy sector still has room to grow. With the oil implosion last week this could be a good entry point for some oil plays.
Dow Chart - Daily
The Dow closed above resistance at 11400 and could run to 11700 as I indicated above. Support levels are 11200 and 11000. The Nasdaq has resistance at 2325 and closed at 2283 after the Google/Apple/Microsoft decline. Support is 2200. There will be a flurry of semiconductor stocks reporting next week including TXN and QCOM. Good news could overcome the negative big tech sentiment and bad news could add to it. According to one analyst somebody bought 140,000 QQQQ Sept-$42 puts on Friday with the QQQQ at $44.50. Having a lot of money does not make you right but it is interesting to note that people are making big bets. I believe this is probably a portfolio protection play rather than a bet the QQQQ is going lower.
Nasdaq Chart - Daily
S&P-500 Chart - Daily
The S&P recovered to resistance at 1260 and stalled. The rebound was completely driven by financial stocks and it will be up to that trend to continue if the S&P is going higher. There are several resistance levels on the S&P at 1275 and 1285 and just getting over the 1260 hurdle won't give them a lot of room to run.
I cautioned everyone last week about the potential for a short covering bounce and not to get married to it. Trade it but don't back up the truck thinking the only direction is up. Now that we have had a 6% rebound it is time to start looking for a failure. Hopefully it won't happen but if you are watching for it you won't get hurt. Next week should be interesting regardless of which direction the markets move.
THE BOTTOM LINE:
Index Traders last week will recall that I suggested that the market was near at least an interim bottom and enough of a rebound could follow to suggest that holders of puts be on ALERT to cover.
I followed up on Thursday with my Trader's Corner (TC) piece about 'bellwether' stocks, indexes, indicators and patterns that were key in forecasting the recent rebound. Of course, fundamentally it was news on oil price declines and some other factors, but the market also always has bellwethers that tip us off ahead of time to a possible CHANGE in the fundamentals.
Bellwethers I discussed in the aforementioned Thursday TC article included:
For more on 'bellwethers', see my aforementioned Thursday Trader's Corner article by clicking here.
There are 3 weekly charts that I find of interest that I'll finish up my 'bottom line' commentary with that show patterns suggesting that the market may have made a significant or tradable bottom here and that the major indexes could gain some further upside traction ahead.
The S&P 500 (SPX) made an approximate double bottom this past week at 1200; this relative to its June '06 low at 1219. The S&P 100 (OEX) made an EXACT double bottom low potentially as measured on a weekly close basis and highlighted on the OEX weekly line chart below.
The recent weekly closing low was accompanied by a fully oversold reading on a 13-week (quarterly) basis per the RSI indicator. OEX has the potential to rally some more no doubt. It may look too 'easy' or too 'obvious' but sometimes technical patterns ARE picture perfect textbook examples. Stay tuned on that!
The Dow 30 (INDU) also traced out a 'classic' chart pattern, that of a key (2-week) upside reversal as there was a new low, followed by a weekly close above the prior week(s) HIGH. The close above the prior high is what makes it a 'key' upside reversal, versus a close simply above the prior Close, which is a garden variety 'upside reversal'.
This kind of bottom is also sometimes called a selling climax or volatility bottom. It also could be termed a 'bear-trap' reversal; the bears were gunning for 10700 and instead may have wound up still short on a weekly close near 11500!
The unusual thing about the Nasdaq Composite (COMP) and Nasdaq 100 (NDX) is that both remain within their long-term UPTREND channels. NDX still is holding above it's long-term up trendline, whereas COMP has held its lower support trendline on a CLOSING basis to date. A couple of dips below such a trendline isn't a big deal, especially if held to 2-3 such dips. COMP has held above its 2155 low of this year, showing a very different chart picture relative to SPX.
MARKET NEWS and INFLUENCES:
** MAJOR STOCK INDEX TECHNICAL COMMENTARIES **
S&P 500 (SPX); DAILY CHART:
The S&P 500 (SPX) Index may have turned the corner from the 1-way downtrend and achieve further upside progress ahead. The chart remains bearish on an intermediate-term basis. It's a favorable sign that buying interest came in around and not far under June 2006 lows in the 1217 area in SPX.
1200 was a 'natural' support area and the S&P stocks did see some short covering around this index level. 1200 could be the bottom for awhile if not a 'final' low (seems doubtful). Next key support is at 1170.
A close under 1200 not reversed in the following 1-2 days would maintain a bearish chart, whereas currently short-term momentum has turned up. An hourly close above 1260, then a daily close above 1273-1277 would reverse the short-term trend from down to up. Next resistance (above 1273-1277) is at 1312. 1320 is resistance implied by a fibonacci 50% retracement (of the last downswing) and 1350 is resistance suggested by the fibonacci 62% retracement level.
S&P 100 (OEX) INDEX; DAILY CHART:
I like trading the S&P 100 (OEX) Index when it has periods of acting fairly 'technically'; a recent example being the rebound from the low end of the trendline highlighted on the daily chart below, which was also in the area of its summer '06 lows, which was then a key bottom.
555 is near support, then down at 542. Near resistance implied by the 21-day moving average is around 581 and just a hair's breadth above the Friday close. I've noted next resistance at 608-609 on the chart.
A key indicator got bullish a week ago when daily equities put volume on the CBOE was approximately equal to that day's call volume as seen in the most recent green up arrow on the 'CPRATIO' portion of the chart. Seems too simple to be true, yes? However, it doesn't happen all the much and it's quite a good forecasting tool and gets me tuning in closely for price action that ALSO suggests formation of a bottom.
Favorable signals from technical indicators come most reliably when there is a price pattern (e.g., a rebound from the area of a prior low) and other indicators that also point toward trend reversal potential such as I noted already with the very 'oversold' RSI readings seen recently.
Maybe this most recent rally will fall apart, but as long as bullishness doesn't also shoot up a lot in terms of the CBOE equities call to put volume ratio I use, I'm along for the ride with a few light call purchases bought on the recent dip below 559 in OEX.
DOW 30 (INDU) AVERAGE; DAILY CHART:
The Dow 30 (INDU) had a key upside reversal in terms of the weekly chart (noted in my initial 'bottom line' comments) and the daily chart had some favorables also, especially the upside breakout above INDU's down trendline and the close above resistance implied by the 21-day average. A bullish backdrop to this recent rebound was the bullish price/RSI divergence that set up.
Along with too many others, I was anticipating a possible test of major support in the 10700 area. So, of course, it didn't happen! Well the Dow was VERY oversold when it got to 11000, which was also seen as a support and which put INDU very far under its 200-day average at 1395. The Dow was due for a rally and the major index that had gotten stretched the furthest snapped back the fastest and farthest.
Near resistance is at prior low seen at 11732; support, once pierced, often 'becoming' resistance later on. Next resistance is at 12000 and that's about the highest upside potential I see currently for the Dow and is in the area of a 50% retracement of the mid-May to mid-July decline.
NASDAQ COMPOSITE (COMP) INDEX, DAILY CHART:
The Nasdaq Composite (COMP) Index bounced strongly from the area of prior earlier year lows as highlighted on the daily chart below. The rebound was also deflected initially at resistance implied by the 21-day moving average, putting COMP back down near the top of its recent trading range.
I anticipate that the index will work higher after some backing and filling and maybe a pullback to near support in the 2250 area. Near resistance is at 2315-2325. Next resistance is in the 2365 area and then extends up to 2390-2420, a zone highlighted on the daily chart below.
Some tech earnings disappointments with Microsoft and saint Google (GOOG) led to a divergent trend on Friday, which was the way I had been seeing it with oversold extremes in the S&P and Dow leading to a good-sized rally in that market when oil had its inevitable (downside) correction.
Key support in COMP begins in the 2200 area and extends down to the 2170-2155 zone. I pointed out already that the Composite had a bullish price/RSI divergence that was a backdrop to the recent rally, as highlighted in the recent price and RSI trendlines sloping in opposite directions. A reading in the 30 area in the 13-day RSI suggested that COMP was quite oversold also.
NASDAQ 100 (NDX) DAILY CHART:
The Nasdaq 100 (NDX) Index in terms of its bounce from a prior low, then a minor pullback from resistance at the key 21-day average, is pretty much a copy of the recent pattern in the broader COMP index. The key difference, in a show of stronger Nas 100 relative strength, is that NDX hasn't retraced its entire prior advance; the index has mostly managed to stay above 1800, a retracement of 2/3rds of its March-May run up.
I noted last week: "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." There were two consecutive closes below 1800, with the first such close leading to a next day sell off to 1760. However, the index came back relatively strongly by the end of that day, with Wednesday then bringing a minor breakout above NDX's down trendline.
Where to next? I anticipate that NDX can climb above 1856, to above its 21-day average. A close above the next resistance at 1900 may be tougher; tougher still to make it back to 1950.
Support is in the 1800 to 1790 area, then around 1785 and is next noted at the recent 1761 low. Major support begins at 1700 and extends to 1670, at the early-March bottom.
NASDAQ 100 TRACKING STOCK (QQQQ); DAILY CHART:
The Nasdaq 100 tracking stock (QQQQ) has rallied from support in the 43.70 area, with the one break to an intraday low at 43.3. Resistance has come in on rallies toward 45.7-46, the top end of the recent trading range. A close above 45.65, then 46.0 is needed to turn the short-term trend higher. Next resistance is at 46.7-46.9.
Near support lies in the 44 area, then at 43.7 and 43.3. Major support begins at 42.0
There could be some backing and filling, but the recent sideways trend in the Nasdaq 100 tracking stock, as with the underlying NDX index of course, looks to me more like 'basing' action for another rally attempt. I don't currently see potential to much more than back up to around 47 however.
RUSSELL 2000 (RUT) DAILY CHART:
The Russell 2000 Index (RUT) in follow the leader fashion did manage to break out above congestion/resistance at 680-684 and head up toward pivotal next resistance at 700. Above 700, a significant amount of stock should be for sale in the 717-720 area.
A close above 717-720, not reversed the next day, would be bullish for RUT, suggesting potential back to the 741 to 747 area which would be a more bullish outcome than I see in the current chart pattern.
Near support is in the 680, with next support at 660 and very key support at the prior lows and the low end of the multimonth trading range, at 647 to 643.
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.
I'm on roll the last couple of weeks, following up on topics brought up in previous Trader's Corner articles. The purpose is to encourage you to check up on the topics introduced, the charts pondered or the theories proposed. Did those topics or theories make sense? Have they since been disproved?
One of those topics from an April 26, 2008 article concerned the corrective fan principle. The article examined whether that principle would help traders determine whether the downturn that had begun in October had ended and, if not, when it would end. We of course know the answer to that question now, but at the end of April, the SPX had bounced so strongly off the March low that some pundits were claiming that the bottom was in. I wasn't one of those who believed it was, although I wouldn't claim "pundit" status anyway.
That March article had itself been a follow-up to previous articles in November and December, all discussing the corrective fan principle and how it related to the decline off October's highs. For those who haven't read the previous articles, the corrective fan principle is a principle discussed by market guru Martin J. Pring in TECHNICAL ANALYSIS EXPLAINED.
As Pring explains and many traders will have noticed, the first trending move after markets break out of a consolidation pattern often proves to be explosive. Prices climb or decline almost straight up or straight down. Either bears or bulls have been suddenly overwhelmed. They rush to cover or sell, helping to fuel that explosion. The slope of the descending or ascending trendline can be steep.
In fact, it's usually too steep to be sustained. Eventually, that first trendline is broken. Many market watchers assume at that point that the trend has ended. Not so. Usually, after a bit of chopping around, the movement continues, but this time along a less steep trendline.
That second trendline also proves too steep to be sustained. Eventually prices break through that one, too, establishing a third trendline, this one with a much more manageable and less steep slope. Usually, the corrective fan principle claims, it's when that third trendline is broken that the trend has ended. A period of disorganization or a new trend begins.
I've seen the principle work in uptrends and downtrends, on intraday and longer-term charts.
Annotated Two-Minute Chart of the SPY:
Traders often observe a steep decline such as SPY's after the violation of a third rising trendline. Conversely, in the case of a third declining corrective fanline that's broken, they might observe a steep rise. Sometimes, however, the ending of one trend does not result in the immediate beginning of another. It may instead result in a period of disorganization.
Identifying the three trendlines does not always prove as easy as it was on the SPY's intraday chart, especially when the action is underway. Sometimes, RSI establishes its own three trendlines that corroborate the price trendlines, helping to validate them. That was true of some times during 2006 and 2007 when previous articles about the corrective fan principle were written, examining trends that were underway at that time.
The trend that began in October 2007 was to prove more difficult, however. In late April, establishing the three trendlines was proving particularly difficult. The annotations on a chart from that the Trader's Corner article written at that time pinpoint some of the difficulties. Those annotations reference previous articles attempting to establish the trendlines.
Annotated Daily Chart of the SPX as of April 24, 2008:
I concluded the April article by saying that I was not fully convinced that the second, blue trendline was a valid trendline. I was stumped, but related what I knew for sure. "At least two trendlines have been or may be in the process of being established. The green trendline has only two touchpoints, so may not be in the final form. If the green line were drawn through the upper candle shadow on December 11's high, cutting off that shadow, the April 14 high was a third touchpoint for the green trendline, so it's possible that we'll decide that version works best at some point in the future."
The purpose of this follow-up article is to determine whether there was another decline to and bounce from the blue trendline. Such an action would give it more validity than it seemed to have at the time of the previous articles. The conclusion was that, whether the blue trendline was valid or not, whether the green trendline was the second or third of the fanlines, it had not yet been violated. As of April 24, I thought that "the corrective fan principle says that the trend that began last fall has not yet concluded." My best guess was that "the green trendline may well be only the second and not the third of the three corrective fanlines."
So, what's happened? Quite a lot.
Annotated Daily SPX Chart as of July 18:
If I'd written this article a week ago, I still would have concluded that this pattern wasn't a clean one, but this week's near touch of the blue trendline and bounce from it confirmed its validity, at least in my mind. That April article proves that this wasn't a conclusion reached only in retrospect, either, as that article had spoken to the validation of that trendline that such action would provide.
Another difficulty has arisen, perhaps clarifying some confusion about the green trendline. The fact that the SPX popped above that first green trendline but then didn't act in the expected manner--either a steep zoom higher or else a settling into a longer period of consolidation than it did--suggests that the original green trendline was not the final or third of the three fanlines. I've redrawn a higher trendline, but it, like the original green trendline has only two touchpoints so far, so it remains somewhat questionable.
Those reading the article may decide that I'm just redrawing trendlines in retrospect to fit what happened. To some degree, I am, although I had noted all along what would validate that blue trendline and my concern about the "only two touchpoints" establishing the green one. Those who have read previous articles about the corrective fan line's use through past years know that there's not often this much uncertainty. We've heard a lot since last August about the strange conditions, the "not since" conditions with some far-away year or period ending that phrase, and I'm seeing some strangeness here, too, that defies an easy interpretation.
Here's what I would do now. If the SPX should continue its bounce, I would be particularly wary of rollover potential at both green trendlines, so currently at about 1320 and then again near 1400-1410. Keep in mind that both of those are descending, of course, so will be lower as time passes.
If the SPX should break through that top, new green trendline, bears should be aware of the potential for either a new trend to be established or for a long period of disorganization before any new trend--either up or down--is established.
With that top green trendline not broken and with the second one broken only
temporarily and the failure of its support leading to another steep decline, all
market participants must be aware that rallies, as sharp as they might be, can
still be prone to failure. Unfortunately, these charts suggest that the SPX
remains susceptible to further retests of that newly validated blue trendline.
Play Editor's Note: Don't get married to this bounce. We expect it to fail. The only question is when and where. I'm watching the DJIA 11,700 to 12,000 zone as overhead resistance and the probable area this bounce will fail. Obviously there are no guarantees but be ready. Until then be very selective and cautious on new positions.
Intl. Bus. Mach. - IBM - cls: 129.89 chg: +3.37 stop: 124.45
Why We Like It:
BUY CALL AUG 125.00 IBM-HE open interest=9530 current ask $6.50
Picked on July xx at $ xx.xx <-- see TRIGGER
United States Oil - USO - close: 104.44 chg: -1.09 stop: *
Why We Like It:
BUY CALL AUG 105.00 IYS-HA open interest=581 current ask $5.60
Picked on July xx at $ xx.xx
Freddie Mac - FRE - close: 9.18 change: +0.85 stop: n/a
Why We Like It:
BUY PUT OCT 7.50 FRE-VU open interest=2419 current ask $2.55
Picked on July 20 at $ 9.18
Apple Inc. - AAPL - close: 165.15 chg: -6.66 stop: n/a
Why We Like It:
We are suggesting the August options below. Our estimated cost is $8.90. We want to sell if either option hits $14.50 or more.
BUY CALL AUG 180.00 APV-HP open interest=9178 current ask $4.60
Picked on July 20 at $165.15
Wachovia - WB - close: 12.97 change: -0.47 stop: n/a
Why We Like It:
BUY CALL AUG 15.00 WB-HC open interest=18278 current ask $1.00
Picked on July 20 at $ 12.97
Washington Mutual - WM - close: 5.92 chg: +0.92 stop: n/a
Why We Like It:
BUY CALL AUG 8.00 WM-HV open interest= 3014 current ask $0.30
Picked on July 20 at $ 5.92
CurrencyShares Euro - FXE - cls: 158.69 chg: +0.08 stop: 156.75
Friday did not see any action in either the dollar or the Euro. We're still sitting on the sidelines with two different entry points to buy calls on the FXE. One is a dip to $158.00. The other entry point is a rise past $160.55. We are no longer suggesting August options. The FXE can move slowly so we're only suggesting the September or longer calls at this point. If you are bullish on the dollar or bearish on the Euro then you could wait for a bearish breakdown under technical support at the Euro's 100-dma and use it as an entry to buy puts instead. If we are triggered our ten-week target is the $169.50 mark.
Picked on July xx at $ xx.xx <-- see TRIGGER
CBOE Volatility Index - VIX - close: 24.05 chg: -0.96 stop:
The VIX could be in for a rough week. The market has produced a pretty good bounce from oversold levels and I doubt the bounce is over yet. We expect the market to hit new relative lows this year but the question is whether or not that will happen before August options expire? The VIX has already exceeded our first target at 29.50 but will it trade back above 30 before our options expire? We listed this as a lottery ticket play as a bet on whether or not the market has an extreme sell-off. There is no way to know if the VIX will spike toward 30 or 35 again in the next four weeks. My short-term bias for the VIX would be down, probably toward the 50-dma around 21.75. We don't have a stop loss on this play as it was very speculative to begin with. However, if the VIX closes under 24.00 or its 200-dma (near 23) we'll drop this play and wait for another entry point, which could appear in the next couple of weeks. We would strongly consider just closing this play at current levels. Our secondary, aggressive target was 34.00.
Picked on June 30 at $ 23.95 /1st target hit 29.50
(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.)
Popular Inc. - BPOP - close: 6.89 change: +0.23 stop: n/a
We really didn't see a very big post-earnings move in BPOP. Due to the lack of movement following the report more conservative traders may want to give some serious thought to exiting early right here. You could still sell both options and recoup about $0.50 of our initial cost. We're going to stick with the play for now since there is still four weeks left before August options expire. We're no longer suggesting new plays. The options we listed were the August $7.50 calls (BQW-HU) and the August $5.00 puts (BQW-TA). Our estimated cost was $0.65. We want to sell if either option hits $1.45 or more.
Picked on July 16 at $ 5.82
DIAMONDS - DIA - close: 114.95 chg: +0.98 stop: n/a
The Dow Jones Industrial Average managed to edge past the early July resistance with Friday's afternoon gains. The DIA continues to look bullish with a close near its highs for the day. We are not suggesting new strangles. 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: 80.92 chg: +0.12 stop: n/a
The EWZ has spent almost two weeks consolidating sideways. It should see a breakout relatively soon through the top or bottom of its $84-79 trading range. If we don't see some significant movement by the end of next week (July 25th) we'll consider abandoning this play. 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
FosterWheeler - FWLT - close: 57.94 chg: -1.06 stop: n/a
The crushing sell-off in oil futures this past week has been tough on the energy sector and tough on FWLT. The stock hit new two-month lows on Friday. We are not suggesting new strangle positions in FWLT at this time. The options we suggested were the August $70 calls (UFB-HN) and the August $50 puts (UFB-TJ). Our estimated cost was $2.60. We want to sell if either option hits $4.00.
Picked on July 15 at $ 61.24
Corning Inc. - GLW - close: 20.20 chg: -0.48 stop: n/a
Friday turned out to be an ugly day for GLW. The oversold bounce is already struggling and GLW produced a bearish engulfing candlestick. We had previously suggested readers open strangle positions in the $20.25-19.75 zone. If you opened new positions today it would only cost about $0.65. 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
Google Inc. - GOOG - close: 481.32 chg: -52.12 stop: n/a
Bingo! Investors were a little disappointed with GOOG's earnings report on Thursday night. Friday morning saw GOOG gap down to $498 and post its biggest one-day loss ($52) in years. The stock closed near its lows for the day, which is bearish for Monday. I'm surprised that the put options did not rise further. The August $480 puts (GOP-TI) hit $19.70 intraday and are currently trading around $17.70big/$18.50ask. Readers have a decision to make. Do you sell now on the post-earnings pop? Or do you hold on and see if there is any follow through? We're going to hold on. Given this disappointment shares of GOOG could drift toward the $450 region. We're not suggesting new strangle positions in GOOG at this time. The options we listed were the August $590 calls (GOO-HR) and the August $480 puts (GOP-TI). Our estimated cost was $19.10. We want to sell if either option hits $30.00 or more.
Picked on July 16 at $535.60
Internet Holders - HHH - cls: 48.60 change: -0.82 stop: n/a
I was a little surprised to see the HHH only post a 1.6% loss. Then I remembered that GOOG is not part of the HHH Internet HOLDRs. GOOG didn't IPO until after the HHH had already been created. HHH's top four holdings are AMZN, EBAY, YHOO, and TWX which account for about 84% of the ETF. Thus far the trend in the HHH is still down. If we don't see another big move by the end of next week we're going to be considering an early exit! We are not suggesting new positions. 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
iShares Rus.2000 - IWM - cls: 68.88 chg: +0.48 stop: n/a
The IWM broke out from its two-week trading range a few days ago. One could argue the index has produced a bullish double-bottom in the past three weeks. Yet the rally the last couple of days seems to be struggling! We are not suggesting new strangle positions at this time. The options we suggested were the August $70 calls (DIW-HR) and the August $61 puts (DIW-TI). Our estimated cost is $1.84. We want to sell if either option hits $2.75. More aggressive traders may want to aim for more.
Picked on July 14 at $ 66.16
MarketVectors Agribusiness- MOO - close: 54.75 chg: -0.58 stop: n/a
After two weeks of consolidating sideways in the $54-58 range it looks like the MOO might finally be ready to move. Shares closed under the $55.00 level and its 200-dma, both of which have been support. We're not suggesting new positions at this time. 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: 44.59 chg: -1.05 stop: n/a
The NASDAQ 100 index broke from its five-week bearish channel on Thursday and then on Friday is gapped down back into the channel thanks to negative earnings reports from MSFT and GOOG. We're not suggesting new positions at this time. 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
Starbucks - SBUX - close: 14.34 change: -0.05 stop: n/a
SBUX is still trying to bounce from its trendline of lower lows but the bulls are having trouble with the 10-dma. Don't forget that earnings are coming up at the end of July and we will hold over the report. We are not suggesting new strangle positions at this time. The options we suggested for the strangle were the August $14.00 calls (SQX-HK) and the August $13.00 puts (SQX-TJ). Our estimated cost was $1.38. We want to sell if either option hits $3.50 or more.
Picked on July 15 at $ 13.58
UBS Ag - UBS - close: 21.48 change: +0.96 stop: n/a
Shares of UBS continued to rally and this time they out did their American rivals. The stock posted a 4.6% gain although most of it was in the morning gap higher. We're not suggesting new positions at this time. We listed two different strangles.
UBS Strangle #1) This uses the August $22.50 calls (UBS-HX) and $17.50 puts (UBS-TW). Our estimated cost was $1.90. We want to sell if either option hits $3.00.
UBS Strangle #2) This uses the August $25.00 calls (UBS-HE) and $15.00 puts (UBS-TC). Our estimated cost was $0.90. We want to sell if either option hits $1.90.
Picked on July 13 at $19.49
Ultra Financials - UYG - close: 20.40 chg: +0.84 stop: n/a
Readers may want to think about doing some profit taking now with the August $20 calls currently trading around $2.30big/$2.55ask. The UYG rallied again and closed above potential round-number resistance at $20.00. We are no longer suggesting new strangle positions at this time. The options we suggested were the August $20.00 calls (UYG-HD) and the Augsut $11.00 puts (UUF-TM). Our estimated cost was $1.45. We want to sell if either option hits $3.50 or more.
Picked on July 15 at $ 14.75
The XLF is another way to play the financials. It rallied again on Friday adding another 2%. It might be time for a minor correction in the rebound. We are not suggesting new positions at this time. The options we ended up with given the Monday, July 14th, morning open on the XLF were the August $21 calls (XLF-HU) and the August $17 puts (XJZ-TQ). Our estimated cost was $1.22. We want to sell if either option hits $2.85.
Picked on July 14 at $ 19.12
Apple Inc. - AAPL - close: 165.15 chg: -6.66 stop: 181.01
Target exceeded! As expected the big weakness in MSFT and GOOG weighed on most of the major tech stocks and AAPL, which had already been acting weak, plunged toward its 200-dma. The intraday low was $165.00. Our recently adjusted target was $166.50, previously we had been aiming for $165.00. I suspect that AAPL will bounce in the $165-160 zone and the $165 region has additional support with its rising 200-dma and 100-dma. Keep in mind that the short-term trend is bearish until it breaks out past the $180 area. FYI: We are adding a strangle on AAPL to try and capture any post-earnings volatility following its report on Monday, July 21st.
Picked on July 09 at $174.25 /target exceeded 166.50
Garmin Ltd. - GRMN - close: 45.04 chg: -1.59 stop: n/a
GRMN has done nothing for a month. It should not be a surprise to see the stock pinned to the $45.00 strike price at Friday's closing bell. We warned readers that might happen a week ago. Unfortunately, our strangle has expired. 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
KLA-Tencor - KLAC - close: 39.95 chg: -0.27 stop: n/a
It's been almost a month and KLAC has gone sideways almost the whole time. Quite honestly this was a terrible strangle play. Every time it looked like the stock might breakout it reversed the other direction. Our strangles have expired. KLAC Strangle #1) The options we listed were the July $42.50 calls (KCQ-GV) and the July $37.50 puts (KCQ-SU). Our estimated cost was $1.65. 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 was $0.70.
Picked on June 22 at $ 40.07
United States Oil - USO - cls: 104.44 chg: -1.09 stop: n/a
Crude oil and the USO produced some record setting moves in the last few weeks. Unfortunately, they were followed by record setting moves the opposite direction. Oil has actually broken its multi-month bullish channel but is the breakdown for real? Our strangles used July options so they have expired. USO Strangle #1) The options we listed were the July $115 calls (IYS-GK) and the July $105 puts (IYS-SA). Our estimated cost was $7.10. USO Strangle #2) The options we listed were the July $120 calls (QSO-GP) and the July $100 puts (IYS-SV). Our estimated cost was $4.10.
Picked on June 22 at $109.14
Today's Newsletter Notes: Market Wrap by Jim Brown, Index Trader by Leigh
Stevens, Trader's Corner by Linda
Piazza, and all other plays and content by the Option Investor staff.
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