Don't like the current market direction just wait until tomorrow and catch the next wave in the opposite direction. This has been a very volatile week for traders with alternating triple digit moves and bipolar indexes. On Friday the Dow was down -54 while the Nasdaq was up +15. What market are you going to trade? On Thursday the Dow lost -133 and more than the +128 it gained on Wednesday. Confused? Join the club you are in good company.
Dow Chart - Weekly
Nasdaq Chart - Weekly
SPX Chart - Weekly
NYSE Composite Chart - Weekly
The main reasons for Friday's divergence were CAT and PFE on the Dow and GOOG and SNDK on the Nasdaq. Earnings continue to be either very hot or very cold and stock reactions have been dramatic. On Friday CAT reported earnings and warned that future results would be lower due to higher costs and supply shortages. CAT dropped -$5 and put the Dow into another tailspin. Pfizer was also down another buck and traded 100 million shares for the second consecutive day after warning about patent expirations on Thursday. With CAT and PFE falling off the cliff the Dow never had a chance. The Nasdaq benefited from Google gains with a whopping jump of +$36 or +12% on earnings that surprised even the most optimistic analysts. Google revenue rose +108% and profits jumped more than seven hundred percent. Analysts were quick to raise price targets on GOOG. First Albany, Lehman and RBC raised targets to $450 and Piper Jaffray nudged just under at $445. There were a host of other increases but most now average around $400. Also helping the Nasdaq and the SOX was very strong earnings by Sandisk of 55 cents and 20 cents over analyst estimates. SNDK jumped +$10.70, a gain of +22%.
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With the strong gains by GOOG and SNDK the Nasdaq shook off the weakness in the other major indexes and powered ahead to test resistance at 2090 at the open and again after lunch. Both times resistance held and the Nasdaq finished with a gain of only +14 points. The Dow was the weakest link once again losing -65 points with CAT -5.11, BA -1.28, UTX -.91 and PFE -.65. Only 12 Dow stocks were positive but only four had gains over 25 cents with SBC the biggest gainer at +46 cents. It was definitely not a strong showing by the blue chips. Big losers for the week were HON -3, BA -3, PFE -3, XOM -3 and of course CAT -7. These losses offset very nice gains for the week by SBC, JPM, MO, HD and MMM.
As I illustrated on Tuesday the Dow, an index of 30 stocks, is the least reliable indicator of market direction despite it being the most watched. The NYSE composite of 2057 stocks ($NYA) posted a gain of +20 on Friday, the Wilshire-5000 (DWC) gained +43 and the Russell-2000 added +5. The index with the most money indexed to its performance is the S&P-500 and the SPX barely broke even on Friday with a gain of only 1 point. These conflicting indexes are providing investors with a strong dose of confusion. If you are feeling frustrated by the markets you are not alone.
We have discussed for the last couple weeks that this earnings cycle could be rocky. Expectations were for double-digit earnings growth in the +15% range but expectations for guidance were mixed. We have definitely gotten mixed guidance. We have warnings that revenues have fallen due to hurricanes and evidence of slowing computer sales in Q3. Companies are also warning that energy prices are raising their costs and in many cases they can't pass these costs on to the consumer. Those that can pass along the costs increase the chance of inflation at the consumer level. This is providing a host of problems for market watchers.
Earnings are expected to be bolstered by the energy sector when it announces next week. Schlumberger reported earnings on Friday and they grew +70% over the prior year. +70% is right inline with what analysts are expecting for the sector. What is even more amazing is that SLB lost 25 days of operations in the Gulf due to hurricanes and still posted strong earnings. SLB posted earnings of 86 cents and inline with analyst estimates. They said the hurricanes knocked -6 cents or -$36 million off their potential earnings due to that 25-day outage. Unfortunately SLB is not impacted by lost production as we might see from many other energy stocks. If we start seeing some high profile misses next week the +15% overall earnings scenario could be in trouble. Those refiners with plants still offline and likely to be offline for weeks to come are going to be hurting. Conversely those refiners still online have been reaping the benefits of higher gasoline and diesel and falling oil prices.
We have seen investors running from the sector over the last week with a 24 million share block trade on XOM ($1.4billion) on Tuesday and on Thursday a 6.2 million share trade on Chevron worth a paltry $353 million. On Friday oil fell below $60 for the first time in three months. This weakness in the oil sector ahead of next week's earnings suggests there is some consternation about those earnings and confusion about rising inventory levels. We did see some buyers appear Friday afternoon but I believe it was short covering and speculation ahead of Wilma. Currently it is not expected to hit the oil patch but until it actually makes the right turn towards Florida there is still a risk.
DDecember Crude Oil Chart - Daily
Currently 65.79% of oil is still offline in the Gulf along with 53.37% of gas production. Those numbers actually rose over the last two days as some companies took precautions ahead of Wilma. There was also news of an oil strike in Nigeria at a facility that produces 240,000 bbls per day. Just because oil stocks are taking a well deserved breather does not mean the oil crisis is over. It just means the disaster in the Gulf has disrupted demand and production patterns and the price spike around the globe has not yet been digested. Give it time and all of these clouds will clear and by summer prices will be soaring again. For now the weakness in the oil sector is crimping the potential gains in the broader market. Without support from energy the broader market is at risk for those conflicting earnings now being given by techs, industrials and manufacturing companies.
We are half way through the Q3 earnings cycle and the markets still can't decide if the outlook is positive or negative. We have seen huge wins and huge disappointments and massive swings in the market. However I am not convinced those massive swings were the result of earnings concerns. OptionsXpress said on Thursday that five of the top ten all time volume days for options have been in this October and two of those were this week. With Friday OpEx day there is a very good chance the market swings were option related rather than earnings related. Actually there is still a very strong rumor in the market that both swings were related to the liquidation of Refco. They are said to have had billions of dollars in options and futures positions for themselves and their hedge fund customers primarily in energy and techs. I believe we saw a perfect storm of a lackluster market with no conviction and the sudden unwinding of billions of dollars in options and futures positions. Thursday was the last trading day for November crude futures and a better than -$2 drop was the result. This knocked support from under the sector and many oil stocks were down -$3 to -$5 on the news.
The lack of conviction continues to come from a barrage of Fedspeak from nearly every board member. The deluge of dread has people talking now about a Fed funds rate of as much as 6% in 2006. This has exceeded the bounds of what investors can reasonably expect to ignore. When the target rate being discussed was in the 4.0% to 4.5% range that is right on the edge of acceptability. Once you get over 5% the bond yields will be another point or so higher and putting money safely into bonds for that kind of return becomes very attractive to institutions compared to a risky market.
The market risk comes from the historical fact that of the last 14 Fed rate hike cycles 12 resulted in recessions. The Fed typically tends to be behind the curve, as it appears they may be now, and by the time they quit they have gone too far. The constant pounding on the inflation issue by Fed heads this week helped to kill any positive market sentiment.
The recent economic data has been positive with the October Philly Fed on Thursday blowing past consensus estimates of +10 to post a scorching 17.3. You may remember that September's reading was only 2.2 and a major drop from 17.5 in August. That one month pause was likely hurricane related with Katrina hitting in the last week of August. We saw dips in several economic reports for the September period as a direct result of Katrina. Now it appears the economy is heating up again despite the higher energy costs as orders for replacement of goods lost in the hurricane are filling up the supply chains. You would think this would be a positive scenario but the earnings warnings and the fear of the Fed is holding investors back. At least those not invested in Google.
There are no positives for Research in Motion after an appeals court denied their request for a stay on an injunction keeping them from marketing the BlackBerry. Despite several errors in the case the court refused to grant the stay and sent the case back to the lower court to decide if there is enough discrepancy for a new trial. NTP claims it will seek to enforce the injunction and force RIMM to cease selling BlackBerry devices unless RIMM settles on NTP terms. RIMM is trying to make the court force NTP to settle for $450 million as both parties had previously agreed but NTP is now claiming their was never an agreement. Time is running short for RIMM and they will either have to pay up, rumors are as much as three times the prior $450 million number or quit selling Blackberry's until the Supreme Court hears the case. RIMM has traded between $60-$80 for three months as the case nears completion and Friday's close at $62 may be the calm before the storm. Puts anyone? Jan-$60's are $5.00. The downside for put buyers is the possibility for a settlement. Even if it is a massive number at least the cloud would be gone. Jan $70 calls are $3.50. Either side could be deep in the money by then depending on the outcome. If you could only see the future!
Next week is a big week for economic reports culminating in the first look at Q3-GDP on Friday along with Consumer Sentiment, NAPM-NY and the Employment Cost Index. Initial Q3-GDP is expected to be +3.7% compared to +3.3% in Q2. Overall the reports should confirm that the impact from Katrina was temporary and give retailers a chance to rebound from what appeared to be a dreary holiday season headed their way. The ISCS said this week that the majority of retailers were already discounting heavily as they headed into the selling season on worries that higher gasoline prices would crimp buying habits. If oil prices languish in the $60 range consumers could benefit from the drop in panic prices for gasoline and see numbers back in the $2.50-$2.65 range. These are still high but well off the sticker shock levels.
The forecast for next week is very tough. Regardless of reason for the huge buy spike on Wednesday it was completely erased on every index but the Nasdaq and Russell. The least reliable index, the Dow, is right back at 10200 and looking very ugly once again. Only five stocks are causing most of the damage but there is little support from the rest of the gang. It looks very likely that it could easily retest the 10150 level from the prior week if not go all the way to 10000.
The Nasdaq in a reverse of the Dow got all its support on Friday from only a couple of stocks led by GOOG and SNDK. Those rockets provided copycat buying in other Internets like BIDU, NTES, COHU and chips like CREE, FLSH and QCOM. Other than that the rest of the Nasdaq stocks were relatively quiet.
The NYSE composite gained +20 to 72.54 but finished -30 off its highs. The sell off on Thursday took it to a new four month low at 7211. It is heavily weighted to financials (22%) and industrials (17%) with consumer goods and services accounting for 26%. Oil and Gas is only 7% and techs only 5%. The index represents more than $17 trillion in market cap in 2057 companies. Given its component weightings and its lackluster rebound from Thursday's carnage I am basing most of my market bias today on its performance. This is a broad representation of corporate America without the hyper activity of the tech stocks.
The S&P gave anyone following my 1185 advice whiplash this week with a failure at 1185 on Tuesday to hit 1170 at Wednesday's open. The rocket ride on the buy program and related short squeeze took it from 1170 to 1197 by Thursday morning only to reverse back to a low of 1173 on Thursday afternoon. If you were adept enough to change sides on each cross of 1185 you profited greatly. On Friday we saw 1185 return as strong resistance and a failure into the close to 1179. 1185 just happens to be the down trending overhead resistance since early October.
For next week we are faced with multiple opportunities. That sounds more optimistic than saying multiple problems. First there are the energy earnings beginning with ACI, ASH, FDG, HYDL, MVK, NBR and WLL to name a few. However, they are just a footnote to the flood of major earnings from other sectors including financial, healthcare and semiconductors. More than 150 companies report on Monday and another 500 over the rest of the week. Over 100 of those are energy stocks. We thought that by last Friday we would know what the earnings picture looked like. Unfortunately we have seen good news, bad news and a lot of noise in the middle but there is really no clear guidance picture forming yet other than negative comments about energy costs. The Q4 rally out of the October depths has yet to appear and the dips are not being bought with any conviction.
On Tuesday I mentioned that a big miss by a major company could provide the capitulation dip we needed to stimulate buyers to rush into the market. From my keyboard to buyers ears it appeared on Wednesday as the market gapped down substantially only to finish +185 points higher on that massive burst of buying. I could not believe it since the Intel dip was weak at best and really did not fit the picture I had in mind. But, sometimes the smallest things can provide the needed spark to light a fire under buyers. Oil prices may have provided the spark on Friday to ignite an energy fire next week. Oil fell on Friday morning to a low of $59.10 before rallying to close at 60.65 and +.61 for the day. It appears to me that oil retreated to strong support at $59 in advance of energy earnings to be ready for a strong move next week. It could be just my imagination or maybe wishful thinking but this is the level where it could begin a meaningful rebound. The price of oil has corrected -$10 from the Katrina high of $70. It corrected -$10 in April-May and -$8 in Nov-Dec-2004. That is the only three times the 100-day average has been tested since early 2002. The 200-day average, currently $57, has not been touched since Feb-2002. This is definitely the ideal place for a rebound if one is headed our way. If companies beat strongly and hurricane damage is not too extensive then buyers may decide that +70% growth in energy is far better than they can get an any other sector. Conversely, a drop under $59 is lights out for the oil rally until all the hurricane confusion evaporates. We also have the Wilma problem. If Wilma fails to take that right turn around Cuba it may just end up running smack into the oil patch and prolong the confusion. In theory the jet stream is working against that possibility and providing a solid wall of resistance to the northern portion of the Gulf. We all know how theory works in practice. The oil sector will not breathe easier until Wilma is moving up the Eastern seaboard and providing all the easterners with torrential downpours.
That leaves the rest of us to wonder about the market direction rather than hurricane direction. I dissected index charts for nearly an hour Friday night and came up with no solid answers. The tech sector as evidenced by the NDX appears to be struggling higher from a solid low on the 13th. The Nasdaq Compx however is still fighting that strong resistance at 2090. It has not broken out from its October congestion range. If the Compx had broken above 2100 I would not hesitate to suggest the ugly was over and blue skies ahead. Unfortunately reality continues to rear its ugly head in the form of the Dow and NYA. While the Dow is not relative in terms of market health it still functions as a broken thermometer that suggests to traders that the patient is deathly ill. The NYA seems to be confirming the Dow weakness and I am hoping it is not contagious for the other indexes. While there is no vaccine for the bird flu a strong bought of positive earnings guidance this week could go a long way in staving off a bad case of bear-itus.
NDX Chart - 30 min
Nasdaq Chart - 30 min
NYSE Composite Chart - 30 min
Whichever direction the markets choose I expect it to happen quickly and not take all week to pick that direction. Microsoft does not report until Thursday after the close and I am hoping the decision has already been made before that event. I expect MSFT to beat but I don't think anybody really cares at this point. As for the markets I am still hoping for that big capitulation dip that clears out the rest of the weak holders and sends institutions rushing into the gap for bargains. A strong breakdown under 2050 on the Nasdaq would be troublesome, as would a Dow drop under 10000-10050. The SPX has support at 1170 and disaster support at just under 1150. With October heading into Halloween with no rally in sight it is time for something to happen and happen quickly or funds are going to start boarding up the windows and doors and go into hoarding mode with their cash. Managers wait all year for the October buying opportunity and should it not appear soon the fear will begin to grow. Personally I am not going to try and pick a direction and continue to go with the flow using SPX 1185 as my guide. I will continue to short the bounces below that level and buy the dips above it. Use a move over SPX 1200 as confirmation of any breakout and a move under 1170 as confirmation of a new leg down. That gives us a 30-point range to play and a range that has held since Oct-5th. Until that range breaks to either side I would not get too excited about loading up on lots of positions. Keep positions small and be alert as October volatility continues to plague investors. A lot of money can be made on these swings if you don't get married to your positions. I normally end my commentaries suggesting passive entries but in situations like we saw last week you need to act quickly to any abnormal dips/spikes and then act just as quickly to exit those positions when the next reversal appears within that 30 point range. Once the range breaks it is time to load up and hang on. Until then you are either quick or dead. If you would rather not play in traffic just watch calmly until 1200 breaks and then join the crowd.
New Long Plays
HR Block - HRB - close: 24.09 change: +0.74 stop: 22.99
Why We Like It:
Picked on October 23 at $24.09
Outback Stkhse - OSI - close: 37.21 chg: +1.21 stop: 34.75
Why We Like It:
Picked on October 23 at $37.21
New Short Plays
Elkcorp - ELK - close: 31.14 chg: -1.07 stop: 32.75
Why We Like It:
Picked on October xx at $xx.xx <-- see TRIGGER
Sanderson Farms - SAFM - close: 35.17 chg: -0.85 stop: 37.51
Why We Like It:
Picked on October 23 at $35.17
Long Play Updates
Network Appl. - NTAP - close: 26.50 chg: +0.52 stop: 24.49*new*
Another strong day for tech stocks, well at least some tech stocks, helped push NTAP to another two-percent rally on volume slight above average. We remain optimistic and continue to target the $29.00-30.00 range but we are not suggesting new bullish positions at this time. Actually we're thinking about adjusting our target to the simple 200-dma near $27.60. We are going to raise our stop loss to $24.49.
Picked on October 16 at $25.12
Short Play Updates
Trinity Ind. - TRN - close: 36.01 chg: +0.02 stop: 38.01*new*
We have one week left before TRN is due to report earnings on October 31st. That is enough time for the stock to make a significant move but right now TRN's direction is unclear. Shares have been consolidating sideways the last few days. Now the daily chart does show a bearish double-top pattern and a breakdown under its bullish trend and 50-dma. Plus, the Dow Jones Transportation sector index would suggest the path of least resistance is down. However, if crude oil continues to slip lower then the transports could easily rally. We are not going to suggest new positions at this time. We're also going to lower the stop loss to $38.01. Our target is the $32.50-32.00 range.
Picked on October 11 at $36.88
Closed Long Plays
Closed Short Plays
Today's Newsletter Notes: Market Wrap by Jim Brown and all other plays and content by the Option Investor staff.
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