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Daily Newsletter, Thursday, 05/17/2007

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Table of Contents

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

Market Wrap

Another Consolidation Thursday

I could have written that title yesterday and almost did. If my Wraps begin to sound redundant, it's because the market action so often is. Wednesdays have often tended to be big up days while Thursdays are often spent consolidating the previous day's gains. Add in the typical opex pin-them-to-the-numbers action, and today's consolidation could have been predicted. However, I'll give you all the so-called reasons for the day's actions.

Introduction

If the yen carry trade truly governs our market behavior, developments in Japan last night hinted at a strong open in our markets. Instead, other clues surfaced that hinted at something different.

Japan's GDP disappointed last night, likely pushing back any rate hike in that country for a few months. The Bank of Japan left rates unchanged at its just-concluded meeting. The yen weakened.

However, Japanese equity investors did not celebrate the news and neither did our futures traders, as our futures were slightly below fair value heading into the open. Perhaps Japan wouldn't be raising rates any time soon, but that outlook wasn't true of many of the rest of the global economies where rate-hike worries seem to be the norm.

Then the weekly claims number dropped again, sending bond-yields higher and our equity futures even lower. Our FOMC doesn't want to see wage pressures added to other inflationary concerns.

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Even before the weekly claims number was released, futures traders may have had another often-mentioned worry on their minds: sub-prime loan failures and how they might impact the economy. FOMC Chairman Ben Bernanke was scheduled to speak on that topic today in Chicago at about the time the market opened. If anything had the ability to sour investors' party moods, it was a hint from the chairman that the sub-prime problem would bleed over into other sectors, especially with the weekly claims number already beefing up worries about tightening credit. If you didn't read Keene Little's discussion of some of the worries about the sub-prime problem in his opening comments in last night's Wrap, I suggest you find time to read them.

The Philly Fed was scheduled, too, and some might have been nervous that it, like Japan's GDP last night, would show more weakness than anticipated. Signs of a weakening economy combined with stronger wage pressures would not be welcome.

Charts

Annotated Daily Chart of the SPX:


I've removed trendlines from the Dow chart so that it's more easily apparent just how parabolic and unsupported its rise is as the Dow drives further and further away from strongest support.

Annotated Daily Chart of the Dow:


Annotated Daily Chart of the Nasdaq:

A look at a key tech index may provide clues as to why the Nasdaq churns.

Annotated Daily Chart of the SOX:

The SOX appears ready for a bounce, but if it instead begins closing daily bars beneath the 492-ish historical and Fib support and the 30-sma, it may be due for at trip down to deeper support at 484.

Rising interest rates today likely pressured the interest-rate sensitive small caps.

Annotated Daily Chart of the RUT:


Annotated Daily Chart of the Ten-Year Yields:

The sometimes inverse relationship of yields to equities (yields up, equities down) does not always hold. The relationship is governed by a complex interaction of equities, yields, currencies and commodities. I don't pretend to always understand it, not having a background in economics. I do know enough to know that this action can prompt some worry on the part of equity bulls, especially if yields should successfully push above their April high.

Annotated Daily Chart of the TRAN:


Today's Developments

The first economic report of the day was the usual weekly Initial Claims for the week ending May 12. Expectations were for 310,000-315 claims, up from the previous week's 297,000. Instead new jobless claims fell again, by 5,000 to 293,000, with the previous week's claims revised slightly higher to 298,000. This didn't soothe bond traders, with bonds being sold and yields being sent higher in the pre-market session. The bounce in ten-year yields sent them above a descending trendline that had held since late June, 2006. If anything signaled some concern about equities, gaining in that same period while yields dropped, that could have been it.

For newbies, yields probably rose because of the fear that a tightening labor market (fewer jobless claims) would lead to wage pressures that would increase inflation. If inflation is the Fed's primary concern, then rising rates may be indicating that bond traders, at least, don't put much credence in the Fed's ability to lower rates and have upped the possibility that rates might be raised. Last week's claims numbers were particularly significant because it was during last week that surveys were being conducted for May's nonfarm payroll report. That report is closely watched by the FOMC, and the members have continually reiterated their concerns about inflation.

The four-week moving average, usually considered more significant, fell to 305,500, the lowest level in more than a year. Continuing claims fell, too, as did the four-week moving average. The number of workers still collecting benefits remained steady.

April's Leading Indicators followed at 10:00 EST. This Conference Board release does not often prove market moving, but today it might have added to the concern apparent in early trading. Expectations ranged from a drop of -0.2 percent to flat, but the index actually dropped 0.5 percent. Worse, seven out of the ten indicators declined, and the ones that did rise were stock prices and money supply. What happens if tightening credit dries up the money supply and stock prices dip as a result?

Ameliorating part of the concern was a sharply higher revision of March's number, to a 0.6-percent rise. The previous number had been higher by 1 percent.

Natural gas inventories came next, at 10:30 EST. Inventories rose 95 billion cubic feet, just shy of expectations. Natural gas prices spiked, but they may have also been reacting to hurricane-related fears or other developments in the energy complex. Crude futures rallied, too, closing at $64.85 according to my feed. The AAA reported today that demand would likely be higher during the Memorial Day holiday, despite gasoline today reaching prices not seen since last August. In addition, refinery production problems, a diversion of some tankers due to weather problems in the Gulf of Mexico and heightened geopolitical concerns added to upward pressure in the energy complex.

The last release of the day was one of the most important of the week, the May Philadelphia Fed's Index. Not all the Fed's district reports prove important in predicting the Institute of Supply Management's read on manufacturing activity (ISM), a report the FOMC considers important, but the Philly Fed report is one that is. May's index measuring sentiment in the manufacturing index rose to 4.2, the highest reading seen since January's. April's had been 0.2. The rise was higher than the 3.0 analysts had predicted.

Both encouraging news and worrisome news could be found under the headline number. Worrisome news included a rise in the prices-paid index to 32.3 from the previous 24.3. Although one article concluded that most manufacturers were able to pass the increased costs onto customers, that same article noted that the prices-received index fell to 2.2 from 5.2. I don't know, but rising prices paid and falling prices received doesn't indicate that firms were able to pass on price increases to their customers to me. That's bad news for firms, but good news for consumers and the Fed, watching for increasing inflation concerns, so it could be spun any way you wanted it.

Job growth was strong, too, rising to 12.9 from the previous 2.5, and that, too, could be worrisome for those watching out for wage pressures to increase inflation pressures. Other components were more upbeat without the troubling overtones. New orders, unfilled orders, production and shipment indices all increased.

Fed Chairman Ben Bernanke, speaking at a banking conference at the Chicago Federal Reserve, spoke about the sub-prime issue. Although most headlines characterized his talk as reassuring to the markets, it wasn't totally good news. While he thought the broader impact from the sub-prime sector difficulties would "limited" on banks or thrift institutions, he did not believe that housing had bottomed. He predicts more delinquencies and foreclosures this year and does believe that the slowdown in the housing sector has been one important reason for the slowdown in the economy. Headlines ran with his positive comments, while fewer featured his warnings that institutions are already tightening their lending standards, with that tightening already spilling over into the prime market.

More M&A activity news was released today. AirTran Holdings Inc. (AAI) extended its offer for Midwest Air Group (MEH) until June 8. Neither of these two comprises a component stock of the Dow Jones Transportation Index (TRAN, DJT, depending on the quote source). In addition, Alliance Data Systems (ADS) and Acxiom Corp (ACSM) are both being acquired.

In other company news, firm Stifel Nicolaus downgraded Caterpillar (CAT) to a hold rating from its previous buy rating, noting that the firm felt that the climate for consumer spending might pressure economy-sensitive stocks like CAT. That downgrade was blamed for CAT's performance today, but it was time for profit-taking or hesitation in many of the high-flying stocks of late. CAT closed at 74.84, after gapping below yesterday's 75.95 close, but it also bounced well off the intraday low.

J.C. Penney (JCP) reported earnings of $1.04 a share or $238 million, with sales of $4.22 billion. This beat EPS estimates of $1.03 a share but appeared to miss sales expectations of $4.39 billion. The company appeared to raise expectations for the second quarter, however, according to a www.Marketwatch.com article. JCP gapped higher but found resistance at its converging 30- and 50-sma's.

Tomorrow's Economic and Earnings Releases

Tomorrow's lone economic release of importance is May's Preliminary Michigan Sentiment, released at 10:00. Expectations are for a slight drop, to 85.0-86.5, depending on the source, from the prior 87.1. This release used to have great import in the markets before everyone decided that sentiment would remain positive forever. If it weakens considerably, it could do impact markets again. If you're in plays at the open tomorrow morning, or considering them, decide ahead of time if you want to exit plays before the release or wait until after it to enter new ones.

What about Tomorrow?

Tomorrow is due to be either another consolidation day or a real decline, but when has what it's "due to be" mattered lately? Do watch the futures' reaction to overnight trading in foreign bourses and tune into the TNX's chart when bonds open prior to the cash equity market open. A further rise in bond yields may continue to pressure markets that already look toppy and in need of a retracement to support.

We've all warned at various times that any deeper retracement, any go-away-in-May type of move, could occur quickly, if it does occur. If you traded through some other toppy periods, such as the late 1999 and early 2000 period, you understand how quickly your winning positions can be converted to losing ones, so maintain sound account-management practices. When you can enter a long almost anywhere, no matter how bad the entry, and eventually prosper just by holding on, those account-management skills are sometimes lost or forgotten.

The problem is that these markets are momentum driven, so anything that's showing up in the charts can and often is undone, and momentum can keep going on far beyond the time when warning signs begin to show, so bulls continue to be rewarded for going long, no matter how good or poor their entries. Bears have mostly been scalded, no matter how much evidence is behind their entries..

All that is just to say that no matter what's showing up on short-term or long-term charts, no matter the typical big-gain-consolidate-sideways pattern that has been long established, anything can happen.

In today's choppy trading, I watched the SPX's three-minute Keltner chart for some guidelines. Some of the things seen on this chart might give you some insight into what's happening fist thing tomorrow morning.

AAnnotated 15-Minute Chart of the SPX:

As you can see on the far right, the setup again favors a rise through the channel . . . if all conditions are the same as they were Thursday. Your first sign that something is different would be if you're seeing three-minute closes beneath that black-channel support, especially if the SPX should gap beneath it tomorrow morning and then find resistance at it. That would suggest a fairly quick trip down toward 1508.50 or so. Be really careful if the SPX should gap lower and move quickly down to that lower-channel support at about the time that the Michigan Sentiment number is released, because that release could break prices either direction. The same should be said for a move up toward either 1515.70 or 1517 early tomorrow morning ahead of the Michigan number.

Remember this setup is only for the beginning of trading, and this is a three-minute chart, so the setup can be overruled by larger market forces. It may help you gauge what's different or what's the same tomorrow morning, however, getting a handle on whether choppy consolidation might be again expected or whether a more directional move will likely occur. For those of you who don't have access to Keltner channels, you can still set up the moving averages employed here. The important aqua midline is a 120-ema. The smallest channel uses a 9-ema and the middle, black channel employs a 45-ema. I watch the SPX and OEX's intraday moves most often on 3-minute, 7-minute and 15-minute charts, although I also use a 30-minute chart to give me the bigger picture for intraday moves.

Keltner charts give me targets, the outside of the channels. If you're using only the moving averages, you won't have those, but you will have the ability to see if the moving averages are providing support or resistance and if the short-term ones are crossing below or above the longer-term ones, clues as to the short-term bullishness or bearishness.

I don't know how charts will set up tomorrow. The SPX usually tends to consolidate sideways for three or four days before beginning to dip down toward the 10-sma again, but lately, it's shown more volatility and it's tended to trade across the 10-sma and linger there a bit longer. That may be speaking of a little more weakness creeping in, but that's just a warning for you bulls. It's not advice for you bears to plow into new plays. If you're a good scalper, you can look for your plays, but if you're not, wait for evidence.

For tomorrow, then, prepare for either sideways-to-sideways up consolidation or an actual downturn, but don't be too surprised if the bulls prevail again. Watch the TRAN and MID for guidance. Both have tended to lead the SPX a bit lately.

Annotated 15-Minute Chart of the Nasdaq:

 

New Plays

Most Recent Plays

New Plays
Long Plays
Short Plays
None None

Play Editor's Note: We feel the need to caution traders again about their bullish positions. The market's lack of follow through on Wednesday's big bounce is a warning sign. The major averages, especially the DJIA, are very overbought and due for a correction. We would seriously hesitate about opening new bullish positions and suggest you re-consider your stop loss placement or an early exit.


New Long Plays

None today.
 

New Short Plays

None today.
 

Play Updates

Updates On Latest Picks

Long Play Updates

Arch Coal - ACI - close: 38.93 change: +0.71 stop: 35.89

Coal stocks were strong on Thursday. Traders bought the dip in ACI (again) and the stock posted a 1.8% gain. Volume was a bit light but the move looks like a new entry point - granted you'll want to consider current market conditions before opening new positions. The P&F chart is already bullish with a $55.00 target. We see some resistance near $40.00 but our target is the $42.50-45.00 range.

Picked on May 09 at $38.44
Change since picked: + 0.49
Earnings Date 07/23/07 (unconfirmed)
Average Daily Volume: 3.6 million

---

Aracruz Celulose - ARA - close: 59.19 chg: +1.20 stop: 53.95

The rally in ARA was very bullish with a 2% gain and big volume behind the move. ARA broke through resistance in the $58.00, 58.50 and $59.00 levels. It also broke through the neckline to an inverse head-and-shoulders pattern. Meanwhile the P&F chart looks very bullish with a triple-top breakout buy signal with a $70 target. This definitely looks like a bullish entry point. However, we want to caution you about the U.S. market's major indices looking vulnerable and potential resistance for ARA at the $60.00 mark. It is possible that as a Brazilian company (and stock) ARA might be able to avoid any serious correction if the U.S. market turns lower. Our target is the $62.00-62.50 range.

Picked on May 06 at $56.29
Change since picked: + 1.70
Earnings Date 04/09/07 (confirmed)
Average Daily Volume: 383 thousand

---

British Amer. Tob. - BTI - cls: 64.36 chg: -0.12 stop: 61.85 *new*

BTI didn't make any progress on Thursday. Shares bounced around the $64.00-64.50 range. The stock continues to look bullish above $64.00 and as a tobacco stock, which tends to be defensive, it could out perform if the U.S. markets correct. We are inching up our stop loss to $61.85. Our target is the $67.50-70.00 range. BTI doesn't move very fast so this could take several weeks.

Picked on May 07 at $64.05
Change since picked: + 0.31
Earnings Date 04/27/07 (unconfirmed)
Average Daily Volume: 105 thousand

---

Anheuser Busch - BUD - cls: 49.68 chg: -0.60 stop: 48.95

The bounce attempt in BUD did not last long. Shares reversed course and closed under the $50 level, which is bearish. At this time we're expecting a dip toward $49.00 and its rising 200-dma. Watch for a bounce near the bottom edge of its wide, rising channel near $49. More aggressive traders may want to give themselves a wider stop loss to give BUD more room to maneuver. We are leaving our stop at $48.95. It could take several weeks before shares hit our target in the $53.85-54.00 range.

Picked on May 06 at $50.50
Change since picked: - 0.82
Earnings Date 07/25/07 (unconfirmed)
Average Daily Volume: 3.1 million

---

ENSCO - ESV - close: 59.54 change: +1.09 stop: 55.85 *new*

Strength in crude oil fueled a rally for the energy sector. ESV rose 1.8% and broke out to a new high. The stock is now challenging round-number, psychological resistance at the $60.00 level. We are raising our stop loss to $55.85. Currently our target is the $61.50-62.50 range. More conservative traders may still want to lock in a gain at $59.85. The Point & Figure chart points to an $82 target.

Picked on April 29 at $56.84
Change since picked: + 2.70
Earnings Date 04/24/07 (confirmed)
Average Daily Volume: 2.9 million

---

Georgia Gulf - GGC - close: 18.61 chg: -0.06 stop: 17.75 *new*

Shares of GGC are coiling sideways. We use the term "coiling" to suggest GGC is winding up like a spring ready to breakout. Given the short-term trend, which is bullish, we would expect the breakout to be higher but there is no guarantee. Please note we're raising the stop loss to $17.75. We're not suggesting new positions at this time. Our target is the $19.90-20.00 range.

Picked on May 07 at $17.35
Change since picked: + 1.29
Earnings Date 05/10/07 (confirmed)
Average Daily Volume: 1.2 million

---

Kansas City Southern - KSU - cls: 39.87 chg: +0.69 stop: 37.75

Bullish breakout alert! The railroad industry was one of the market's best performing groups today. The DJUSRR index rose 2% and broke out over resistance at the 500 level to a new all-time high. KSU also broke out over resistance to a new high. Our suggested trigger to buy the stock was at $39.61 so the play is now open. More conservative traders may want to wait for another rally past $40 or today's high near $40.19 before opening new positions. It's worth noting that there has been renewed rumors of consolidation (M&A activity) in the railroad sector and that's probably fueling the strength right now - not to mention the big rise in crude oil. Our target is the $43.50-44.00 range. Currently the P&F chart points to a $45 target.

Picked on May 17 at $39.61
Change since picked: + 0.26
Earnings Date 07/26/07 (unconfirmed)
Average Daily Volume: 716 thousand

---

China Life Ins. - LFC - cls: 50.03 chg: -0.73 stop: 47.74 *new*

There was no follow through on LFC's rally yesterday. That's a warning flag for the bulls. While the stock is currently inside its short-term trading range it looks like odds are growing that LFC will dip back toward $48.50-48.00. We are raising our stop loss to $47.74. We would wait for the dip and bounce above $48 or wait for a new relative high over $51.00 before buying into the stock now. Our target is the January 2007 highs in the $57.00-57.50 range. FYI: The P&F chart has produced a new triple-top breakout buy signal. The chart pattern points to a $70 target.

Picked on May 13 at $50.27
Change since picked: - 0.24
Earnings Date 08/25/07 (unconfirmed)
Average Daily Volume: 1.2 thousand

---

McGrath RentCorp - MGRC - cls: 30.26 chg: -1.15 stop: 29.89

Trading in MGRC looked very bearish today with a 3.6% decline. If MGRC doesn't bounce form the $30 level soon we'll probably drop it as a bullish candidate. Currently we're waiting for a breakout over $32.00. Our suggested trigger to buy the stock is at $32.35. More conservative traders may want to use a trigger above $32.50. If we are triggered our target is the $35.75-36.00 range. The P&F chart is bullish with a $50 target.

Picked on May xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 05/03/07 (confirmed)
Average Daily Volume: 94 thousand

---

Superior Energy - SPN - cls: 39.63 chg: +0.64 stop: 35.99

A big rally for crude oil futures powered a rise for energy stocks. SPN rose 1.6% and is challenging round-number resistance at the $40.00 level. We are not suggesting new positions at this time. Our target is the $42.50 level. The P&F chart is very bullish with a $65 target.

Picked on May 13 at $38.42
Change since picked: + 1.21
Earnings Date 08/01/07 (unconfirmed)
Average Daily Volume: 1.5 million

---

Thermo Fisher - TMO - close: 53.37 change: -0.53 stop: 51.75

Upward momentum in TMO is really starting to struggle. Given the lack of follow through in the NASDAQ and the Russell 2000 our enthusiasm for bullish positions is waning. At this time we'd wait for a rise past $54.00 or $54.35 before initiating positions. More conservative traders might actually want to just bail out now. The technical indicators for TMO are decaying rapidly.

Picked on May 13 at $53.63
Change since picked: - 0.26
Earnings Date 04/26/07 (confirmed)
Average Daily Volume: 3.0 thousand
 

Short Play Updates

Omega Healthcare - OHI - cls: 16.25 chg: -0.33 stop: 17.05

Good news! There was no follow through on OHI's intraday bounce from Wednesday. The stock reversed lower and set a new six-month closing low. We see this as a new entry point for shorts. Our target is the $14.50-14.00 range.

Picked on May 16 at $16.24
Change since picked: + 0.01
Earnings Date 04/26/07 (confirmed)
Average Daily Volume: 343 thousand
 

Closed Long Plays

None
 

Closed Short Plays

None
 

Today's Newsletter Notes: Market Wrap by Linda Piazza and all other plays and content by the Option Investor staff.

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Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.

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