Volatility may have eased but skepticism increased significantly. The markets rebounded to their biggest gain in months but traders appeared increasingly wary as time ran out. We did not sell off into the close but the momentum slowed significantly suggesting shorts were not covering and bulls were not chasing prices higher. News from Bernanke and Greenspan failed to tank the indexes and negative economics were ignored. Was this a dead cat bounce or the beginning of a rebound?
Dow Chart - Daily
Nasdaq Chart - Daily
The Factory Orders report for January showed that orders fell -5.6% and a much sharper drop than the -3.8% analysts had expected. Ex-transportation, orders were still down -2.9% with core capital goods down -6.3%. That was the largest drop since Sept-2001. Durable goods orders fell -8.7% overall and -6.3% after removing the aircraft component. These drops were the sharpest declines since July 2000. The ISM news from last week suggests the decline in orders will continue through February and possibly into March. This report would be Fed positive but other reports are negating that impact.
Productivity and Costs for Q4 rose +1.6% and just slightly over consensus of 1.5%. However, unit labor costs spiked +6.6% with compensation per hour soaring +8.2%. Real hourly compensation rose +10.5%. These numbers are huge and should keep the Fed in tightening mode for the foreseeable future. Wage inflation is the number one target for the Fed and this shows rising inflation pressures at the employee level. Meanwhile Q4 productivity growth was revised down by -0.5% making productivity in all of 2006 at +1.6% the lowest since 2001.
With the March FOMC meeting only 9 trading days away there had been speculation they would move to a neutral bias given the meltdown in the subprime market and the drop in the stock market. Today's sharp rise in unit labor costs should negate that change in bias.
Greenspan made the news again with more input on his recession outlook. Since his initial comments nearly two weeks ago put significant pressure on the global markets he tried to smooth over that reaction late last week saying a recession was only "possible" not "probable." This week he told Bloomberg News that there was a 33% chance of a recession later in 2007. He said there are signs of aging in the current six-year recovery. Historically six-year recoveries are already stretching the normal life cycle. The markets ignored his comments today but you can bet they will remain in our long term subconscious for months to come. Greenspan turned 81 today.
Bernanke also spoke today but failed to make any comments about the current economy. Instead he took aim at Fannie (FNM) and Freddie (FRE) and their current portfolio of mortgages. He said Fannie and Freddie should switch to providing affordable mortgages only. That would be a substantial move and back to more of what their original mission was seen to be. Currently less than 30% of their portfolio can be classified as loans on affordable housing. A move like this would take considerable pressure off the mortgage community by expanding the offerings available to low end borrowers. Bernanke did make it clear he was not suggesting a change in their exposure to subprime loans, only to mortgages at the lower end of the spectrum. Fannie and Freddie are government sponsored enterprises (GSE) and are tasked with providing mortgage services. Over the years they have grown to huge proportions by acting as loan buyers for nearly any type of mortgage. They package the loans and resell them as securitized investments. Last week Freddie said it would no longer buy certain high-risk subprime loans. Bernanke suggested the GSEs be instructed to provide a "measurable public purpose such as the promotion of affordable housing." Bernanke said new legislation to strengthen the regulation and supervision of the GSEs is highly desirable both to ensure that these companies pose fewer risks to the financial system and to direct them toward activities that provide important social benefits. Representative Barney Frank, Chairman of the House Financial Services Committee is proposing legislation allowing regulators to limit or reduce the holdings of Fannie and Freddie.
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Treasury Secretary Hank Paulson may have had more impact on the market today than both the Fed heads combined. Speaking overnight in Tokyo he called the global economy "as strong as I have seen in my business lifetime." Other comments included "I see no downturn" and housing in the US is "close to bottoming out." He also said the recent market volatility was not necessarily a cause for concern. These comments spiked the futures overnight and caused the US markets to gap open as well.
The financial sector saw a significant rebound on the various comments from Paulson and Bernanke. Goldman Sachs spiked +7 to lead the sector but that was only a drop in the bucket after their $32 decline over the last two weeks. Bear Stearns gained +4.50, Lehman +3.11 and Merrill +2.13. Even subprime lender New Century (NEW) managed a fractional bounce on its way to zero. NEW has lost -85% from its February highs and is expected by most to eventually file bankruptcy. Accredited Home Lenders (LEND) managed a slightly larger rebound of +1.51 but the subprime sector remains under pressure.
Intel said today it had lost some critical emails pertaining to the antitrust suit by AMD. Intel did not actually say it "lost" the emails but rather admitted to a number of "document retention lapses." It seems some Intel employees failed to archive their "sent mail" messages and they were deleted. On my Outlook that takes a conscious act by me to delete sent messages. Does that mean those very smart Intel engineers were consciously protecting themselves? More likely Intel has a central email repository that is periodically flushed to reduce storage requirements AND erase any unwanted tracks. Other employees said they thought Intel's information technology group would automatically save their email. Others claimed they were not notified to save their email. All of these events may turn out to be beneficial for Intel despite fines for losing the data. Email has turned into a gold mine for corporate lawyers. They can put very smart email search programs to work on the electronic files and produce extensive lists of possible emails that could be smoking guns on everything from corporate theft to sexual innuendo. After Enron most corporations put into force email retention rules on a corporate scale to reduce the information available for future hostile searches. AMD warned on Monday that they would miss earnings targets for Q1.
Turnaround Tuesday or just an oversold bounce? We would all like to know the answer to that question. The markets had their best day in months but those gains came after a two-week decline that saw the Dow lose -5.9% from its recent high to Monday's low. The Nasdaq declined -7.5% over the same period and the Russell -8.4%. Those are huge numbers and illustrate the severity of the oversold conditions. Internals were very strong today with up volume running 15:1 over down volume. That is strong but less than half of the 38:1 imbalance in favor of down volume we saw last Tuesday when the markets were crashing. As you can see in the table below the internals have been all over the board for the last week. Volume was light most of today and only picked up in the last hour. Unfortunately that last hour was when the rebound faded.
Market Internals Table
There was a strong imbalance in the internals but there was also a strong dose of skepticism in the markets. There was a gap open in the morning due to a +2% rise in the Asian markets and the Paulson comments. This gap open from a severely oversold condition produced a small bout of short covering but it was not necessarily what you would call a squeeze. Bears were not convinced the selling was over. When the indexes failed to give up their morning gains by noon we started to see additional shorts cover on a gradual basis. There was not a material short squeeze as you would expect from the severely oversold conditions. Traders on the floor were simply not buying the rebound theory and were not joining the party. The clincher for me was the last 45 minutes of trading. Volume increased but momentum died and the indexes began trending lower. On a true short squeeze day the last hour is marked with capitulation as the remaining shorts rush to cover by the close. That sends the indexes higher and normally they close at the high for the day. This was suspiciously absent from Tuesday's trading. Also, there was no rush by retail traders to buy the afternoon move. The indexes may have had their best day in months but most traders clearly were not buying the concept that the correction was over.
The Dow hit 12100 last Wednesday and then put in two lower lows and a succession of lower highs over the next three days. Monday's close at 12046 was only 6 points off the morning low and a whopping 140 points off the intraday high. This complete retracement of the intraday gains appeared to be signaling more selling ahead. Tuesday's gap open on Asia and Paulson was a knee jerk reaction and not a change in market sentiment. The Dow rallied to hit 12224 intraday and closed at 12204. Both numbers are well below the strong resistance, which has developed at 12250 and again at 12325.
The Nasdaq managed to rebound +44 points to 2384 but faces formidable resistance at 2400 and 2425. With a 1395 close the S&P faces similar hurdles at 1400 and 1410. We had a nice rebound but I am going to be very surprised if we see any follow through tomorrow. Until those primary resistance levels on all three indexes are broken we will not see any broad based support. There is simply too much skepticism that the bottom has not yet formed. In any major correction there is normally a first bottom and then a retest of that bottom on later days. That second successful retest is critical in erasing doubt and convincing traders that the drop is over. A failure on that retest starts the process over again at a lower level.
S&P-500 Chart - Daily
Russell 2000 Chart - Daily
The Russell was the most bullish index posting a +2.47% gain compared to +1.3% for the Dow, +1.89% for the Nasdaq and +1.54% for the S&P-500. Based on the sentiment value of the Russell I would be more confident in follow through except for the sharp decline in the Russell futures at and after the close. The Russell has strong resistance at 782 and that is exactly where it halted the advance in late afternoon. This resistance level corresponds to the 12250, 2400, 1400 levels on the other indexes. The fact the Russell beat the others to those levels is slightly bullish for sentiment. Because it failed there it produced a more cautionary tone for tomorrow.
Economically the calendar is slim for Wednesday with the Fed Beige Book the only material report. This is not likely to rile the market and because it is not released until 2:PM it will have zero impact on the open. With Paulson on a road trip to Asia we will be dependent on his comments and their markets to give us motive power. After that we are on our own and while I wish the rebound would continue I have found that wishing about market direction only complicates my bias and seldom has any impact on the actual outcome. Because the Russell is my fund manager sentiment indicator I am going to look for a move over 782 as a key to go cautiously long and any move under 780 as confirmation the selling may not be over. If we do get a move lower I would look for buyers to appear at 12050 on the Dow in hopes the 4th time is the charm. Should that charm fail it could get very ugly very quickly.
Play Editor's Note: Market internals for Tuesday's market-wide bounce were pretty good. However, sentiment still seems shaky and we remain very skeptical of the rebound. However, if the market does continue to bounce we want a part of the move so we're listing a few bullish positions. Traders should be very cautious about adding new bullish positions since many believe the worst may not be over for stocks.
New Long Plays
Boardwalk Pipeline - BWP - cls: 36.48 chg: +0.51 stop: 35.35
Why We Like It:
on March 06 at $36.48
Redwood Tr. - RWT - close: 54.80 chg: +4.61 stop: 52.45
Why We Like It:
Picked on March xx at $xx.xx <-- see TRIGGER
TEPPCO Part. - TPP - close: 42.88 chg: +0.22 stop: 41.95
Why We Like It:
Picked on March 06 at $42.88
New Short Plays
Long Play Updates
eBay Inc. - EBAY - close: 31.34 chg: +0.98 stop: 29.49
Right on cue, shares of EBAY have produced a bounce for us. Fueling the move was an upgrade and some positive comments from Yahoo's management that the Internet sector should see strong growth for the next couple of years. With regard to the upgrade, shares of EBAY were initiated with a "buy" rating before the opening bell. Readers can choose to buy this bounce if you missed yesterday's entry point. However, bear in mind that the markets may not be out of the woods yet and there's still a chance that EBAY will retest support near $30 and its 200-dma first before moving much higher. We have two targets. Our first, more conservative target, will be the $33.85-34.00 range. Our second, more aggressive target, will be the $37.00-38.00 zone.
Picked on March 05 at $30.49
Level 3 Comm. - LVLT - cls: 6.24 chg: +0.14 stop: 6.46
We do not see any changes from our previous updates on LVLT. More aggressive traders might be interested in buying this bounce. At the moment our plan is to buy a breakout over resistance near $6.80. We're suggesting a trigger to buy the stock at $6.81. If triggered our target is the $7.35-7.40 range as LVLT has long-term resistance near $7.40. More aggressive traders may want to aim higher near $8.00. The P&F chart is very bullish with a $12.75 target.
Picked on February xx at $xx.xx <-- see TRIGGER
Short Play Updates
Agilent Tech. - A - close: 30.83 chg: +0.14 stop: 32.55
The market's bounce on Tuesday didn't have a very big impact on A. The stock's rebound struggled near the $31.00 level, which held as resistance all day. The move today might be used as a new entry point for shorts. We don't see any changes from our weekend comments. Traders have a choice to either watch for an oversold bounce and failed rally under $32.00 or wait for a new decline under potential support near $30.00. The H&S pattern projects a $26.50 target. We are aiming for the $28.50-27.50 range since A might have additional support near its September 2006 lows around $28.50. The P&F chart points to a $14 target. There doesn't not appear to be any significant amount of short interest in the stock. FYI: A announced an upcoming investor webcast for March 8th, 2007 8:30-12:00 ET.
Picked on March 04 at $30.72
Avid Tech. - AVID - close: 33.79 chg: +1.01 stop: 34.25
Warning! AVID displayed a lot of relative strength on Tuesday. Shares rose more than 3% outpacing the market rebound. The rally stalled near old resistance near $34.00 but if the market continues to bounce tomorrow we wouldn't be surprised to see AVID breakout higher. More conservative traders may want to exit early to preserve any sort of gain or avoid any losses. We're not suggesting new positions at this time. Our target is the $30.50-30.00 range. FYI: Readers should note that the most recent (January) data puts short interest at 12.2% of AVID's 40.9 million-share float, which is relatively high and raises the risk of a short squeeze.
Picked on February 05 at $34.65
Cons Energy - CNX - close: 35.10 chg: +0.83 stop: 36.86
CNX is still bouncing and shares rose 2.4% on Tuesday. Volume came in above average, which is generally considered bullish on an up day. The stock has short-term resistance near $36.00. More conservative traders may want to tighten their stops while more nimble traders may want to watch for a failed rally under $36 as a new entry point. Our target is the $30.50-30.00 range.
Picked on March 05 at $33.95
Comptr.Prog.&Sys - CPSI - cls: 27.05 chg: +0.05 stop: 30.05
The lack of participation in today's market-wide rebound is very bearish for CPSI. Shares rose a mere five cents on above average volume and closed off its best levels of the session. We remain bearish but we're not suggesting new positions at this time. Our target is the $25.50-25.00 range. The P&F chart's bearish target has fallen from $18 to $16. The most recent (January) data puts short interest at 10.3% of the company's 9.3 million-share float. That is a high amount of short interest and with such a small float it really increases the risk of a short squeeze so trade cautiously!
Picked on February 06 at $29.52
Federated Dept. - FD - close: 43.89 chg: -0.28 stop: 45.05
The trading in FD on Tuesday is very interesting. Shares spiked higher this morning but quickly failed under resistance near $45.00. Instead of bouncing higher with the rest of the market shares of FD were slipping lower into what now looks like a bearish reversal. Aggressive traders might want to jump in early right here. We'll stick to our plan and use a trigger at $43.43 as our suggested entry point. If triggered our target is the $40.50-40.00 range.
Picked on March xx at $xx.xx <-- see TRIGGER
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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