Option Investor

Daily Newsletter, Sunday, 01/23/2005

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Table of Contents

  1. Market Wrap
  2. New Plays
  3. In Play Updates and Reviews
  4. Watch List

Market Wrap

Turn Out The Lights

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       WE 01-21        WE 01-14        WE 01-07        WE 12-31 
DOW    10392.99 -165.01 10558.0 - 45.96 10603.9 -179.34 - 43.82  
Nasdaq  2034.27 - 53.64 2087.91 -  0.70 2088.61 - 86.16 + 14.15 
S&P-100  557.32 -  7.12  564.44 -  1.94  566.38 -  8.64 -  1.04 
S&P-500 1167.87 - 16.65 1184.52 -  1.67 1186.19 - 25.46 +  1.52 
W5000  11507.29 -145.45 11652.7 +  3.85 11648.9 -323.90 + 38.98 
SOX      389.66 - 13.48  403.14 -  4.42  407.56 - 25.72 +  6.85 
RUT      611.08 -  6.40  617.48 +  4.27  613.21 - 37.87 -  1.71 
TRAN    3471.17 - 97.99 3569.16 - 67.62 3636.78 -160.56 +  9.56 
VXO       14.55           12.43           13.85           13.58 
VXN       19.37           18.57           19.15           18.37

Will the last bull out the door please turn out the lights. The party may be over if this week's market action is any guide. The major indexes secured a place in the history books with their 2005 performance. The Dow, SPX and Nasdaq have NEVER been down three consecutive weeks in January. You have to go back to 1977 for both the Dow and SPX to start the year with a three week drop. By itself the Dow was the last index to string three but it was back in 1982. This is not the way to start a happy New Year.

Dow Charts

Nasdaq Chart

Without any major news on the stock front or the world scene the indexes continued their swoon on Friday and all closed at new lows for the year. The only material economic report was Consumer Sentiment which fell slightly to 95.8 from 97.1 but that was hardly a market mover. The fear of higher rates is beginning to weigh on consumers but not enough to push the sentiment significantly lower. The falling market has become a bigger fear factor and the next revision to the sentiment survey is sure to be significantly lower.

The ECRI Weekly Leading Index stopped its multi-week drop and rebounded to 133.3 from 130.7. This is a very strong bounce that was mostly in part from the unexplained drop in jobless claims early this week. This should have been slightly positive but this is not normally an indicator that traders watch.

Bearishness abounded on Friday despite a successful conclusion to the inauguration. The major indexes all closed at their lows for the year and stock TV was full of bearish interviews suggesting that the market weakness is going to continue. Actually this could be a contrarian indicator as the number of bears has dramatically increased over the last couple of weeks.

With the market setting records for ugly performance those bears should be very happy. This is the worst January in over 20 years and the complete lack of cash inflows is really upsetting the strategy of fund managers. Normally there are withdrawals in January as some investors pull out cash once the prior tax year is over in order to use it for other reasons like taxes. The massive inflow of year end retirement contributions offsets this smaller outflow of withdrawals and gives fund managers liquidity to handle the outflows without having to close positions. The complete lack of inflows this year has upset those patterns and fund managers are having to trim positions to cover withdrawals. TrimTabs said again on Friday we are on track to see nearly -$5B of cash outflows in January and this is unprecedented in recent years. January 2004 saw inflows of +$43.8B.

There is no single reason for the lack of cash other than investors waiting for the profit taking from the Q4 rally to ease. We had a huge bounce off the October lows and most funds/investors were fully invested. With expectations for 2005 less than exciting many investors are deciding to put money in other places than the market. Bond funds are seeing huge inflows of cash and funds that invest overseas are receiving new money.

The challenge is not earnings but the guidance. 115 S&P companies have reported earnings and 65% beat estimates, 18% reported inline and only 17% missed analyst estimates. For this reporting cycle the GAAP earnings are running about +9.4% growth over 2004. Proforma earnings are about +18.2% over last year. This performance both in percentage of companies beating the street and percentage of earnings growth are both really good given the strong comparisons from 2004. Unfortunately many companies that beat the street this quarter are warning for Q2 or longer and few are raising guidance.

For instance GE beat the street by a penny and said they were confident they would return to double digit growth in 2005 and the market yawned. It was really good earnings from a corporate giant and they said good things about the economy. Immelt said the breadth and depth of the economic momentum is very positive. However they only predicted +10%-15% earnings growth for 2005. That is not bad but it is not exciting enough to make investors rush into the stock. GE closed down a quarter and well off the highs of the day.

Oil also came back to haunt investors with a return to $48.95 after a one-day dip. Speculators are betting that the Iraq elections next week will see a huge spike in attacks on oil facilities. Sabotage in Iraq has completely halted exports from the northern fields since an attack more than a month ago. Barclay's Capital said Friday the inability to keep pipelines and wells operating in Iraq was a growing indication of serious reservoir damage caused by under investment, misuse and neglect. They said the outlook for Iraqi oil production is getting dimmer. Output is currently -21% under pre invasion levels.

Also, another snowstorm for this weekend is expected to deplete even further the heating oil supplies which are already -13% below last years levels.

OPEC said on Friday that demand is continuing to rise unexpectedly but they would still be able to meet that demand. It may cost us $55 or $60 but if we pay they will pump it. OPEC meets again next Sunday to discuss the next round of production cuts but it is looking less likely it will happen with oil already near $50. They said their current projections for demand show an increase of 1.65 mbpd for 2005. That would push the daily global demand to 83.64 million barrels per day. This jump in demand is more than OPEC had predicted just a month ago. OPEC expects demand from China to only grow +7.2% in 2005 to 6.9mbpd after a +15.5% jump in 2004. I would bet against that low number. With the rapid internal growth and the huge ramp in the delivery of autos it could actually exceed the 15% jump from 2004. High growth countries expand oil usage much quicker than those already stable. The Venezula Oil Minster said he would support a million barrel cut because current oil prices are just given the growing demand. Makes sense to me. Demand is growing unexpectedly fast so lets cut production and charge more. We will be hearing a lot of this in the not to distant future.

With the worst three-week start in recent history to set the stage we have some serious decisions in front of us. There are a growing list of problems and although none of them are serious they seem to take on added importance when the market is performing exactly the opposite of what analysts expect. The bears claim it is the slowing economy and we have seen several instances of that in just the last week. They also point to the rising inflation and the potential for higher rates as a wet blanket on stocks. Add in the deceleration in earnings guidance, higher oil and the coming Iraqi elections and we have a witches brew of trouble.

I thought the market would shake off all these problems with a swish of its bullish tail and continue higher on the January cash flow. That lack of cash flow now has me singing a more cautious tune. My critical market levels of SPX 1175 and Dow 10425 have failed and the next stop could be a long drop lower. As long as the market was consolidating above those critical levels there was still hope. Once broken that hope turns into despair and more traders will begin throwing in the towel until some sanity returns to the market. It is not that there is insanity now but when historical market trends are broken with no specific reason the average trader tends to panic and over react.

The Dow closed under 10400 on Friday and there was not any material driving force. It was simply a lack of buyers and steady selling across the board. Once the 10500 level was severely broken on Thursday and buyers did not appear the sentiment of the market changed drastically. We could call it an option expiration event and that could be right. We already knew this expiration cycle would produce negative market pressure but I don't believe that is the only reason. It may have been a contributing factor but not the cause. Sentiment has turned nasty in just the last two days. The lack of inflows has caused traders to question their beliefs and assumptions. What does $40 billion in retirement cash know that we don't? It is very strange that this many people would suddenly pull the plug on that much money with no warning. This has really spooked many traders.

With the Dow close under 10400 it appears the next minor support level at 10350 will only be a speed bump. I don't know how many times I have said it over the years but Monday will be a key day. If the down trend confirms with post OpEx move lower then funds could begin to dump stocks in volume. Once we pass 10286 and the 50% retracement level for the October rally the next support could be 9800. Yes, 9800. Once a real correction takes hold we tend to aggressively over correct and the drop accelerates even faster. It could get really ugly if sentiment does not change almost immediately.

The Nasdaq appears much weaker than the Dow and the weak book-to-bill number on chips on Thursday has not helped. The Nasdaq closed well under 2050 at 2034 and below all material support levels with the possible exception of the 38% retracement at 2022 and the 100 day average at 2019. That is weak at best on my chart and the most likely target now would be 1900-1920 if we break that 2020 level.

The SPX closed well under my 1175 line in the sand and right on 1167 which some analysts are calling terminal support. Terminal because a break here could be deadly to the future outlook. I see that level as 1160 but that difference of opinion is what makes a market. We are already under my "get flat" level at 1175 and under 1160 I will switch to a strong short bias. Under 1160 we could see pause points at 1140 and 1100 but the next real support is not until 1060. Funny how 1300 and 1325 were all the rage last week on stock TV and this week 1060 is now the silver bullet for killing the bear. That would be the 100% retracement of the October rally and a concept I have trouble grasping at present.

SPX Chart - Daily

SPX Chart - Weekly

I am sure there are others scratching their head today and trying to figure out why we are not moving higher. As long as you are scratching your head and not buying the dips you will be ok. Once the market breaks critical support levels the best thing bulls can do is stand aside. Those who can make the mental switch to the potential plunge can don their chutes and go along for the ride.

The key point to remember is "don't fight the trend." We should be in "short the rally" mode under SPX 1175 instead of buy the dips. Until historical trends return to the market we need to remain focused on short term positions. Monday could be pivotal for sentiment but we just need to keep our eyes on the 1175 level for direction and not listen to all the analysis on stock TV. It is our red light, green light indicator and we all know what happens when we ignore red lights. The result is not pretty. Cheer up! The last time the Dow started the year with three down weeks was 1982. Actually the first three months were down for the Dow but it came back to gain +20% for the year. This is also 2005 and we have not finished negative since 1880 on a year ending in five. A 120-year trend may be just a long anomaly but it does exist. Unfortunately the first year of a second term president also has a rocky history so we are right back where we started watching 1175 for direction.

Jim Brown

"Nothing is more exhausting than searching for easy ways to make a living"


New Plays

Most Recent Plays

The bearish trading pattern in this semiconductor stock is forecasting a breakdown soon. We're going to use a trigger to catch the move.

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New Bearish Plays

Intel Corp - INTC - close: 22.42 change: -0.16 stop: 23.01

Company Description:
Intel, the world's largest chip maker, is also a leading manufacturer of computer, networking and communications products.
(source: company press release)

Why We Like It:
We like INTC as a bearish candidate due to its technical weakness pure and simple. The stock has been stuck in a bearish triangle with support near $22.30 and a consistent trend of lower highs since it peaked in November. The company reported earnings that were above estimates and guided higher going forward but even this good news couldn't spark a breakout. Now with the NASDAQ hitting new lows for the year and the NDX-100 bullish-percent rolling over into a bear-alert condition we suspect that the tech sector has more weakness ahead. We are going to use a TRIGGER to catch the breakdown in shares of INTC. The pattern "should" produce a downside breakdown pretty soon because the stock price is coiling into a tighter and tighter range. We want to use an entry point at $22.24, which would be a new three-month low and a breakdown through support. More conservative traders may want to wait for a drop under its 100-dma and the $22.00 level before considering positions. The P&F chart doesn't show any support until the $19.50 region so we're going to target a decline into the $20.50-20.00 range.

Annotated Chart:

Picked on January xx at $xx.xx <-- see TRIGGER
Gain since picked: - 0.00
Earnings Date 01/11/05 (confirmed)
Average Daily Volume: 240 thousand

Active Trader (AT) NEW LONG PLAY

Dividends and Oil

This oil trust has a huge dividend yield and a bullish chart pattern that is sure to grab the bulls' interest.

New Bullish Plays

BP Prudhoe Bay - BPT - close: 50.21 chg: +0.75 stop: 46.39

Company Description:
BP Prudhoe Bay Royalty Trust holds royalty interest for The Standard Oil Company, BP Exploration Inc, The Bank of New York and F. James Hutchinson. The Trust distributes royalties on approximately 16 percent of the first 90,000 barrels of the average daily net production of oil and condensate per quarter from the company's working interest in the Prudhoe Bay Field. (source: Reuters Business Summary)

Why We Like It:
BPT has two things going for it. First and foremost is the rising demand for oil and crude oil prices. Second is the growing interest in dividend paying stocks. When asked where they planned to put their money to work in 2005 many fund managers said they were looking toward dividend paying equities. BPT should have a growing crowd of supporters with its 12.3 percent annual yield. The high-yield dividend and its bullish chart pattern make BPT look like a great relative strength play in the current market. We want to use a TRIGGER at $50.51 to go long and target a run towards the $55.00 region. Investors may actually want to consider this a longer-term holding considering the dividend payout and the strong possibility that rising oil prices are here to stay. FYI: The P&F chart has an ascending triple-top breakout buy signal with an $82 long-term target.

Annotated chart:

Picked on January xx at $xx.xx <-- see TRIGGER
Gain since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume: 240 thousand

High Risk/Reward (HR) NEW SHORT PLAY

Too Extended

This investment services company looks way overbought and suddenly teetering on the edge of a big breakdown.

New Bearish Plays

Nuveen Investments - JNC - cls: 37.35 chg: -1.07 stop: 39.01

Company Description:
Nuveen Investments provides high-quality investment services designed to secure long-term client goals. The Company serves institutional clients, financial advisors and high-net-worth investors. The firm's asset management capabilities are marketed through four distinct brands, each with an independent investment team and area of expertise: Nuveen, focused on fixed-income investments; NWQ, specializing in value-style equities; Rittenhouse, dedicated to conservative growth-style equities; and Symphony, with expertise in alternative investment portfolios. In total, the Company manages over $115 billion in assets. Nuveen Investments, Inc. is an affiliate of The St. Paul Travelers Companies, Inc. (source: company press release)

Why We Like It:
Before we begin let us remind our readers that this is a high-risk/reward play. Normally we strongly suggest picking a top in stocks because it can be hazardous to your financial health. We're willing to speculate on some short-term weakness in spite of JNC's current up trend based on the following observations. First the XBD broker-dealer index began to roll over a few weeks ago and the recent bounce failed with what looks like a tweezer top. The XBD's weekly chart also shows its MACD indicator rolling over towards a new sell signal from overbought levels. If the sector index looks poised for more declines then JNC could easily see some profit taking. The company just recently reported its Q4 earnings that were very strong but the reaction in the stock price was an intraday spike. It seems the strong performance has already been baked into the stock after a huge run from $25 in August to almost $40 in December. The recent high-volume drop has also produced a breakdown below the 21-dma, where shares had found support during the last couple of months. In spite of these bearish developments we're still going to use a TRIGGER to try and confirm the breakdown. There is minor support near $37.00 and we want to open shorts only if JNC trades at $36.90 or below. Our initial target is a 38.2 percent Fibonacci retracement to the $34.00 level, which happens to be underpinned by the 100-dma. Our stop is a little wide to begin with but we'll adjust it after the play is triggered.

Annotated Chart:

Picked on January xx at $xx.xx <-- see TRIGGER
Gain since picked: + 0.00
Earnings Date 00/00/00 (unconfirmed)
Average Daily Volume: 65 thousand

Play Updates

In Play Updates and Reviews

Tech Stocks (TS) SHORT play Updates

Software Sinks

Our bearish software play has broken support and its 100-dma.

Bearish Play Updates

Synopsys - SNPS - close: 16.99 change: -0.15 stop: 17.90

Continued weakness in the NASDAQ and the GSO software index helped push shares of SNPS lower on Friday. The stock broke support at the $17.00 mark and its simple 100-dma to hit a low of $16.81. Our trigger to go short was at $16.95 thus opening the play. As expected the drop under the $17.00 mark has produced a new point and figure chart sell signal that now points to a $14.00 target. Remember that we're only targeting a decline toward support in the $15.50 region.

Annotated chart:

Picked on January 21 at $16.95
Gain since picked: + 0.04
Earnings Date 02/17/05 (confirmed)
Average Daily Volume: 1.5 million

Active Trader (AT) LONG play Updates

Coal, Aerospace and Natural Gas

Our non-tech bullish candidates have been narrowed to more defensive candidates given the pull back in the market.

Bullish Play Updates

Arch Coal - ACI - close: 34.52 change: +0.11 stop: 32.49

Coal producer ACI continues to churn sideways between resistance at the $36.00 mark and slowly rising support at its 200-dma near $33.00. While the stock's long-term trend remains bullish and its P&F chart points to a $40.00 target we are growing weary of ACI's slow progress. We'll give the stock another week to see if shares can mount a breakout over the $36 mark. Otherwise we'll close the play for lack of performance. The latest data suggests that ACI is due to report earnings on February 8th not January 29th as previously thought.

Annotated Chart:

Picked on December 13 at $34.71
Gain since picked: - 0.19
Earnings Date 02/08/05 (unconfirmed)
Average Daily Volume: 951 thousand

Boeing - BA - close: 50.07 change: -0.83 stop: 49.95

Exit alert! New comments out from Boeing's defense operations management said that defense cuts coming from the Pentagon are expected to hit all large weapon makers including BA. This news came out on Friday and sent the stock to a 1.6 percent decline. Shares managed to stall the descent near round-number support at the $50.00 mark but it doesn't look good. The MACD indicator has rolled over and the short-term oscillators also look bearish. Our stop loss is only 12 cents from here so we opted to hold the play on the small chance of a bounce this Monday. In reality we expected to be stopped out for a 3.6 percent loss. Aggressive traders may actually want to switch sides and consider short plays on a break below the 200-dma's near $49.00.

Annotated chart:

Picked on January 12 at $51.94
Gain since picked: - 1.87
Earnings Date 02/02/05 (confirmed)
Average Daily Volume: 3.2 million

El Paso Corp - EP - close: 10.89 change: +0.14 stop: 9.99

We have good news for energy traders. Shares of EP, the largest natural gas company in the U.S., have continued to out perform the market this past week. Traders bought the dip toward its simple 10-dma on Thursday and the stock is now poised to challenge what could be resistance at the $11.00 mark. The rising trend in EP appears to be based on EP's continuing debt reduction and growing expectations for stronger demand for natural gas in 2005 and beyond. Please note that we are changing the earnings date. There appears to be some confusion over when EP's next earnings report will be but most sources point to its Q4 report in March, not January 29th as previously expected.

Annotated Chart:

Picked on January 13 at $10.61
Gain since picked: + 0.28
Earnings Date 03/20/05 (unconfirmed)
Average Daily Volume: 3.9 million

Raytheon Co - RTN - close: 36.76 change: -0.14 stop: 36.25

RTN remains stuck in its sideways trading range between $37.50 and $36.35. If you're feeling optimistic one could say RTN is displaying relative strength considering it failed to turn lower with the rest of the market. Yet positive comments from Bear Stearns on Thursday were not enough to spark any sort of rally in the stock. Currently we remain cautious. The overall market environment is bearish and RTN is likely to test the bottom of its trading range again soon. Readers may be better off waiting for RTN to breakout over the $37.50 level before initiating new bullish positions.

Annotated chart:

Picked on January 12 at $37.25
Gain since picked: - 0.49
Earnings Date 02/03/05 (confirmed)
Average Daily Volume: 1.7 million

Active Trader (AT) SHORT play Updates


Our bearish media play has shown a surprising lack of weakness the last couple of sessions and we remain untriggered.

Bearish Play Updates

Emmis Corp - EMMS - close: 17.60 change: +0.10 stop: 17.85

The outlook for EMMS remains bearish. The breakdown under the $18 level and its bearish P&F chart with its $6.00 target are enough to inspire shorts to consider EMMS. Yet the stock has shown surprising strength this past week by not trading lower. Fortunately, we remain untriggered in this play as we wait for EMMS to breakdown under the $17.00 level and hit our entry point at $16.99. More aggressive players may want to watch for a failed rally under $18.00 as an alternative entry point instead.

Annotated chart:

Picked on January xx at $xx.xx <-- see TRIGGER
Gain since picked: + 0.00
Earnings Date 01/06/05 (confirmed)
Average Daily Volume: 478 thousand

Active Trader (AT) CLOSED LONG play

Earnings are approaching

It's our policy to avoid holding over an earnings report and this play ran out of time.

Closed Bullish Plays

Bemis Co - BMS - close: 28.80 change: -0.21 stop: 27.99

The general up trend in BMS remains intact and its P&F chart continues to point to a $45 target but we're going to call it quits. The overall market environment has turned sour and with BMS' earnings report due out on Wednesday, January 26th we're choosing to close this play early.

Picked on December 22 at $29.22
Gain since picked: - 0.42
Earnings Date 01/26/05 (confirmed)
Average Daily Volume: 411 thousand


Watch List

We have a very mixed list of candidates to watch tonight.


Sanderson Farms - SAFM - close: 43.80 change: +0.78

WHAT TO WATCH: If you're looking for a bullish candidate in this weak market environment consider SAFM. The stock has been strong the last two weeks while the rest of the market has declined. Shares are currently testing resistance near the $44.00 level but its technical picture is bullish. The P&F chart's buy signal points to a $68 target. We would consider longs on a move over $44.25 (a new five-month high) or a move over $45, which is potential round-number resistance.


Broadcom - BRCM - close: 30.49 change: -1.38

WHAT TO WATCH: The semiconductor sector doesn't look very healthy and shares of BRCM could join it on the way down. BRCM has been consolidating sideways in a trading range between $30.50 and $33.50 for about seven weeks now. Currently shares are testing the bottom of this range after breaking its 50-dma. We would watch for a drop under the $30.00 mark and its 100-dma before considering bearish positions. Plus, we'd wait until after the January 27th earnings report.


Millennium Pharma - MLNM - close: 9.42 change: -0.22

WHAT TO WATCH: MLNM doesn't look very health either. The stock has been suffering under a trend of lower highs for months. The sell-off really gained some velocity during the January market pull back and now MLNM is trading under round-number, psychological support at the $10.00 mark. The P&F chart shows a bearish triangle breakdown with a $7.50 target. A P&F triangle breakdown is one of the most successful patterns to trade in a decline market. We would consider new bearish positions under $9.30 with a short-term target near $8.00. Unfortunately, we would wait until after MLNM's January 27th earnings report.

RADAR SCREEN - more stocks to watch

NXTL $28.59 -0.33 - NXTL's bullish trend has been broken after four weeks of failing to breakout over the $30.50 level. The next level of support looks like the $27.50 region near the 100-dma.

AMAT $15.59 -0.32 - AMAT is another semiconductor stock that doesn't look very healthy. Shares have broken two-week old support a the $16.00 mark and are now testing support near $15.50. We would consider bearish positions on a break below $15.50.

CSCO $18.01 -0.31 - CSCO has been suffering under a trend of lower highs for almost two months. We might consider bearish plays on a breakdown under $17.50 (the August low).

KWD $30.18 -1.06 - KWD is breaking down after two weeks of trading between $31 and $32. We might consider shorting it under $30.00.



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