Option Investor

Daily Newsletter, Wednesday, 04/27/2005

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Table of Contents

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

Market Wrap

Follow the Bouncing Ball

Follow the Bouncing Ball

If you feel like you're watching a professional ping pong match from front row seats as you watch this market gyrate up and down over the past week, you're not alone. There's a major battle going on between the Big Bears and the Big Bulls, between those who believe we're starting the next bear market leg down and those who believe this year ending in '05 will be another bull market year. And these players have huge sums of money with which they're placing their bets. We little people are caught in the crossfire trying to eek out an existence in this market. It's a time to trade cautiously while we wait for the Big Kahunas to duke it so that we can then see who's left standing. My take on the fight so far? The bears are winning and I think they'll soon be serving steak tartar (personally I prefer mine with just Kosher salt and pepper--nice and juicy that way, but I digress).

We started the early morning with the March Durable Goods orders numbers and they weren't pretty. They showed the largest drop in 2-1/2 years (since September 2002), dropping -2.8% after economists were expecting a rise of +0.3%. This makes for three straight months of drops in durable goods orders after February was revised lower to a -0.2% decline from its previously reported +0.3% increase. Inventories rose +0.4% so a bit of a double whammy for producers. In order to reduce inventory they'll likely mark down prices which will only further depress sales, and margins. Core orders (capitial equipment used by businesses) dropped -4.7% after falling -2.5% in February, making it the largest drop since November 2003. Shipments of core capital goods also dropped and Transportation represented the largest drop in March's orders, down -7.8%. From a DOW Theory standpoint, as go the Trannies, so goes the market. The Transportation index reacted to this news and dropped hard in the morning before recovering to a little better than breakeven by the end of the day (another reflection of the bull vs. bear battle).

The weakening in the durable goods orders this year is sparking debate as to whether or not the manufacturing sector has been hurt by the December 31, 2004 expiration of a special tax break for business investment goods. Regional reports for the manufacturing sector have been mixed for April. There's also lots of debate about how this will affect the FOMC and its decision on interest rate increases. The consensus seems to be that the FOMC will not be dissuaded from raising interest rates at its meeting next week, May 3rd. There's still unanimous agreement that we'll see a +0.25% increase next week. It's after that increase that the real debate is raging. Looking inside the durable goods numbers, orders for civilian aircraft dropped -22.7%, military aircraft dropped -35.0%, motor vehicles dropped -2.4% (3rd straight month for a drop in vehicle orders), and all orders excluding transportation dropped -1.0%, the 2nd straight decline. Orders for computers dropped -7.8% and machinery dropped -7.6%. Orders for electronics increased +2.2% (communications equipment rose by +5.1%) and orders for primary metals increased by +1.0%--these were the only major categories to see increases. And lastly orders for defense capital goods increased by +5.2%, thanks to the military requirements.

So with the negative durable goods numbers, the market predictably reacted negatively in the morning, pulling the DOW down by a little over 70 points in the first 30 minutes of trading. And then the bulls couldn't stand it any longer and decided there were some good deals to be had. The rest of the day was spent in rally mode. This rally looks like it should continue into tomorrow.

Let's review some of today's charts, starting with the DOW:

DOW chart, Daily

The DOW went into freefall after bouncing from and then breaking below its 200-dma and the January low. It found support at the bottom of a parallel up-channel from last October's low, after briefly breaking below it, and has been attempting to rally back up. I say attempting because the bounce looks choppy and corrective which leads me to believe that once this bounce is completed, the DOW will break to new lows. We will likely see a continuation of today's rally into tomorrow and it could get above 10,300 so I would not be anxious to get short tomorrow, at least not in the morning. But once this leg up is finished, the larger correction from last week's low looks like it will be finished. There is a downtrend line from the March high sitting near 10,320 that I would watch carefully for resistance--it could be a good area to protect profits on longs and consider playing the short side from there.

SPX chart, Daily

SPX dropped below its uptrend line from August 2004 and its 200-dma's and has since come back to the scene of the crime. So far SPX has given its broken uptrend line and its 200-dma a kiss goodbye. This is bearish price action and the form of the bounce supports the idea that the decline is not finished. There's still the potential support area around 1110 which is the bottom of its longer term up-channel from August 2004's low. The October 2004 low near 1090 could also be a downside target for any further decline. If we get another leg up tomorrow in the current bounce from last week's low, the downtrend line from March 7th sits near 1172 but that broken uptrend line on this daily chart at 1165 could hold down any further rally.

Nasdaq chart, Daily

The Nasdaq (and the Russell 2000 small cap index) continues to have a more bearish pattern. After breaking down from its long term uptrend line from October 2002, the NAZ hasn't even been able to bounce back up to give it a kiss. It's been trapped in the same price range it was in last October 2004. Just as that consolidation lead to a rally out of it, I believe the current consolidation will lead to another leg down. The bottom of its current down-channel coincides with potential support at its September 2004 low near 1850. If that doesn't hold then the next support level is down at the August 2004 low near 1750. As for tomorrow, if the market rallies further, there's some good upside potential to 1950-1970.

SOX index, daily chart

The chippers don't look so chipper. The SOX broke below its long term uptrend line from October 2002 and has so far only managed to come up and give it a kiss goodbye (are you getting a similar picture about now?). The bounce in the SOX, like the broader markets, looks corrective and looks like it should head to new lows once this correction is finished. Like the broader market, the SOX appears ready to continue a little higher tomorrow but I would expect this broken uptrend line to continue to offer resistance (currently near 398).

The earnings picture continues to look mixed, depending on which sector the company is in. It continues to be a stock-picker's market in that regard. As usual it's also hard to accurately predict the market's reaction to earnings. We continue to see odd reactions at times to good/bad earnings reports. Follow your charts and you'll probably have better luck predicting what will happen to the stock. Speaking of sectors, it was a bit of a mixed bag today. The leaders in the plus column were the financial indices and then the healthcare and pharmaceuticals. The losers were lead by the XAU (gold and silver index), oil service and energy indices. Most everyone else had a near neutral day. Speaking of oil, the oil inventory numbers this morning sparked a sell-off in oil which in turn sparked a rally in equities. Crude oil inventories rose a much larger than expected 5.5M barrels (consensus was for +650K), which was the highest weekly jump since May 2002, the smaller than expected usage of 300K barrels in gasoline inventories (consensus was for a draw of 1.0M barrels) has relieved some of the nervousness about the impact of high gas prices on discretionary spending. But distillates fell 1.4M barrels, which was more than the 100K buildup that analysts had expected. The debate (which influences the debate on interest rates) continues about how much of an impact this commodity has on overall spending as we head into the summer driving months. Oil dropped from near $54 this morning to $51.70 by the end of the day and then dropped further to $51.35 this evening.

As cam be seem in oil's chart, price broke decisively back below its uptrend line from December 2004.

Oil chart, June contract, Daily

It looks like oil has a date with its 200-dma which coincides with it longer term uptrend line from the beginning of 2004, both around $47.50. One would think this kind of a drop, especially a price that trades below $50 would be bullish for equities. Lately, and certainly this month, oil and equities have trades in synch--both down. So it remains to be seen how well oil's price has an impact on equity prices.

Oil Index chart, Daily

No surprise, the oil index reflects the price of oil. After breaking below the bottom of its steep up-channel from December 2004, price rallied back up to give the broken trendline a kiss goodbye. It looks like it's dropping back into its longer term up-channel that price was in for much of 2004 before rallying strongly out of the channel in January 2005. Like oil, it looks like the index has a date with its 200-dma in its future. This also coincides with its longer term uptrend line.

Transportation Index chart, TRAN, Daily

The Trannies have been attempting to regain its 200-dma after breaking below them on April 14th. It's bounced above and below this important support/resistance level since then but the whole thing looks corrective and should lead to another leg down. Even though there was an end of day recovery in the index today, it doesn't look like it will lead to much. It could bounce a little more with the broader market tomorrow but it looks like the next leg down has already started.

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

The home construction index actually looks similar to the oil index. After breaking below its steeper uptrend line and falling back inside its longer term up-channel that contained price since March 2003, price fought to get back up above the channel but finally fell away in early April. Like the rest of the market the current bounce looks corrective and should lead to another leg down. The 200-dma's should provide some support but if they eventually break, watch for a drop back down to its longer term uptrend line.

Euro chart, Daily

Lastly, the currencies are at an interesting point and this Euro chart shows the Euro ready to drop further which will have the US dollar rallying. After breaking below its uptrend line from Sept 2004, the Euro has been attempting to get back above that line but has repeatedly failed to do so. It looks like an impulsive decline from its last attempt a week ago. If the Euro drops below its recent low near 1.28, we could see an opposite trade in the US dollar as it rallies to new near term highs. And if that happens it may have a negative impact on the price of metals which seem to be in their own consolidating patterns since their December 2004 highs.

Since bellwether GE is widely regarded as a strong gauge of broad global economic conditions, and with Immelt saying the U.S. economy is "still pretty strong," his comments relieved some anxiety about the slowdown in the economy. It could be nothing more than GE trying to manage expectations but when GE speaks, people still listen. Interest rate-sensitive sectors like Financial (+1.3%) and Utility (+0.7%) attracted buyers today following better than expected earnings from AFLAC Inc. (AFL 39.63 +3.48) and First Energy (FE 42.87, +0.35). Treasuries shot higher this morning after reacting to the disappointing durable goods data as well as short-covering ahead of tomorrow's advance read on GDP. The resulting drop in bond yields helped the financials. Bonds pulled back some as the day wore on and the benchmark 10-year note closed up 7 ticks to yield 4.23%. Health Care (+0.9%) got a boost from strong Q1 reports from WellPoint (WLP 124.45 +6.42) and Becton Dickinson (BDX 58.73 +2.18). Even Technology gained ground, as Microsoft (MSFT 24.99 +0.23) bounced ahead of its Q1 report tomorrow after the bell (this could actually be a negative). And tech bellwether Intel (INTC 23.51 +0.19) offset overall losses in Software (-0.2%) and Semiconductor (-0.2). After the bell, investors had earnings from 99 companies to sift through.

Some big economic reports tomorrow morning could have an impact on initial direction in the morning. At 8:30 ET, an advance read on Q1 GDP (consensus 3.5%) and its chain deflator (consensus 2.1%), which is a key inflation measure, and the Labor Dept.'s release of weekly jobless claims (consensus 230K) will all be released. It could cause some gyrations early in the morning and you might need to be quick to follow that ping pong ball as it gets batted back and forth between the bulls and the bears. Don't get so close you end up getting a paddle upside the head. The increased volatility, while making for some great trading opportunities, is also fraught with danger. Trade carefully and quickly.


New Plays

Most Recent Plays

New Plays
Long Plays
Short Plays

New Long Plays

None today.

New Short Plays

Broadcom - BRCM - close: 29.90 chg: -0.30 stop: 31.11

Company Description:
Broadcom Corporation is a global leader in wired and wireless broadband communications semiconductors. Our products enable the convergence of high-speed data, high definition video, voice and audio at home, in the office and on the go. Broadcom provides manufacturers of computing and networking equipment, digital entertainment and broadband access products, and mobile devices with the industry's broadest portfolio of state-of-the-art system-on-a-chip and software solutions. These solutions support our core mission: Connecting everything. Broadcom is one of the world's largest fabless semiconductor companies, with annual revenue of more than $2 billion. The company is headquartered in Irvine, Calif., with offices and research facilities in North America, Asia and Europe. (source: company press release)

Why We Like It:
We still believe that the intermediate trend for the markets, especially the NASDAQ is down. This recent strength has been nothing more than an oversold bounce and a set up for bears to pick new short positions. The same can be said for the SOX semiconductor index. Looking at a Point & Figure chart of the SOX we see the index in a sell signal pointing to a 368 target. If we combine a bearish trend in the NASDAQ, a sell signal in the SOX and a failed rally at resistance in BRCM it all adds up to a new bearish play. BRCM has been struggling for months. It's recent rally stopped right at resistance at the $31.00 level and its 200-dma. Now short-term technical oscillators are rolling over into new bear signals while its P&F chart is bearish with a $21 target. We are suggesting shorts at current levels with a target in the $27.00-26.00 range. However, readers should note that opening bearish positions in BRCM tomorrow (Thursday) does carry extra risk. The semiconductor billings data is due out on Friday morning. A positive number and the whole sector, including BRCM, could rally sharply. Obviously a negative number should hasten BRCM's decline. It's up to you on whether you open a short position tomorrow or wait until after the report on Friday.

Picked on April 27 at $29.90
Change since picked: - 0.00
Earnings Date 04/21/05 (confirmed)
Average Daily Volume: 7.9 million

Play Updates

Updates On Latest Picks

Long Play Updates

Northfield Labs - NFLD - close: 14.60 chg: -0.42 stop: 14.14

It's time to go to yellow alert. NFLD did not participate in the market bounce today. Furthermore the technical oscillators are starting to look vulnerable. The lack of a bounce in the BTK biotech index doesn't help. We realize that we labeled NFLD a higher-risk aggressive play but traders may want to consider exiting early right here. We certainly would not be considering new bullish positions. Yesterday we suggested that an aggressive player might consider going long on a bounce from the $14.50 level. That's exactly where NFLD dipped to today but the bounce was very anemic.

Picked on April 25 at $15.39
Change since picked: - 0.79
Earnings Date 04/11/05 (confirmed)
Average Daily Volume: 471 thousand

Short Play Updates

Boston Scientific - BSX - cls: 29.37 chg: +0.26 stop: 31.51

There was a small press release today about BSX's carotid stent trial meeting its goals but we don't see it affecting the stock price any further. No change from our previous update on 04/26/05 and 04/24/05.

Picked on April 19 at $29.05
Change since picked: + 0.32
Earnings Date 04/19/05 (confirmed)
Average Daily Volume: 5.4 million


Greenbrier Co - GBX - close: 30.91 chg: -0.59 stop: 34.25

More good news. GBX has continued to sink and closed under what looked like minor support at the $31.00 level today. Shares are under their 40 and 100-dma's but testing the 50-dma. Our target remains the $30.00-28.00 range so prepare to exit.

Picked on April 11 at $33.20
Change since picked: - 2.29
Earnings Date 03/30/05 (confirmed)
Average Daily Volume: 123 thousand


Lowes Companies - LOW - cls: 52.28 change: +0.18 stop: 54.01

Shares of LOW continue to struggle with resistance near $53.00. At the moment we can't tell if LOW is trying to build a base of support or a faintly sloping bear flag pattern. The technical oscillators are helping at the moment but we remain bearish and continue to target the $51.00-50.00 range. We would probably not consider new positions at this time.

Picked on April 10 at $54.81
Change since picked: - 2.53
Earnings Date 05/16/05 (unconfirmed)
Average Daily Volume: 3.0 million


Catalina Mktg - POS - close: 23.16 chg: -0.19 stop: 25.25

No change from our previous update on 04/24/05 although the stock does look a bit oversold and due for a bounce. Look for the $24 level to act as new short-term resistance. Our target remains $21.25-21.00.

Picked on April 22 at $23.80
Change since picked: - 0.64
Earnings Date 05/18/05 (unconfirmed)
Average Daily Volume: 468 thousand


Sina Corp - SINA - close: 26.08 chg: +0.27 stop: 28.61

SINA did manage a minor bounce today. The positive earnings news from NTES must have overpowered the negative earnings news from AMZN. We remain bearish and continue to target the $25 level. However, if SINA does produce an oversold bounce then look for resistance near $28.00.

Picked on April 13 at $28.52
Change since picked: - 2.44
Earnings Date 05/05/05 (confirmed)
Average Daily Volume: 3.5 million


Westlake Chem. - WLK - close: 27.00 chg: -0.55 stop: 30.01

No change from our previous update on 04/25/05. WLK continues to sink and has closed at a new relative low. Our target is $25.50-25.00.

Picked on April 08 at $29.19
Change since picked: - 2.19
Earnings Date 05/04/05 (confirmed)
Average Daily Volume: 207 thousand

Closed Long Plays


Closed Short Plays

BEA Systems - BEAS - close: 7.05 chg: -0.17 stop: 7.71

Target achieved. It was another tough day for shares of BEAS. The stock dipped to the $7.00 level and then traded to $6.99 before bouncing. Our target was the $7.00 level so we are closing the play. The move was probably fueled partly by news that a broker-analyst firm had dropped coverage on BEAS. Some firms will choose to just drop coverage on a stock instead of issuing a sell rating.

Picked on April 15 at $ 7.68
Change since picked: - 0.63
Earnings Date 05/18/05 (unconfirmed)
Average Daily Volume: 7.6 million


Flextronics - FLEX - close: 10.94 chg: -0.12 stop: 11.76

Semiconductor stocks struggled a bit today after one company's lackluster earnings report. Shares of FLEX lost another 1.08 percent to close under the $11.00 level. We are closing the play per our previous instructions to avoid holding over FLEX's earnings report due out tomorrow. Wall Street is looking for earnings of 16 cents a share.

Picked on March 16 at $11.95
Change since picked: - 1.01
Earnings Date 04/28/05 (confirmed)
Average Daily Volume: 5.5 million


West Marine - WMAR - close: 19.40 chg: -0.48 stop: 20.75

Target achieved. Investors appeared to lose confidence in WMAR just one day ahead of its earnings report due out tomorrow. We had planned to close the play this afternoon to avoid holding over the report. However, today's weakness sent WMAR past our target/exit point at $19.50.

Picked on March 17 at $21.20
Change since picked: - 1.80
Earnings Date 04/28/05 (confirmed)
Average Daily Volume: 155 thousand

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