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Daily Newsletter, Wednesday, 09/05/2007

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Table of Contents

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

Market Wrap

Thirty-Minute Reversal

That's all it took today to wipe out Tuesday's bullish day. Not only are we getting volatility in market prices but we're also getting it in the market internals. Many technical analysts watch for "90%" days. If a market experiences a series of days in which up volume or down volume is equal to or greater than 90% of the total volume then it can indicate a very strong trend or overbought/oversold. In the past month we've experienced more 90% days than in the past 40 years. The trouble with using it in one's analysis is that they're flip-flopping back and forth between positive and negative days.

What this extreme volume to the plus and minus sides is telling us is that there's a lot of mixed opinions on the market right now and herd mentality is running strong. With so many hedge funds using the same computer models they all tend to trade together and in the same direction. And when one side says it's time to buy or sell it appears the other side just steps aside. Without the uptick rule since July 5th that might explain the big down-volume days. The big up-volume days could be aided by short covering. Regardless, it's creating havoc for those who are trying to get a bead on this market.

If someone ever tells you to run away while they try to shoot you your best defense is to run an erratic zigzag pattern as you run away. That way the shooter can't get a steady aim and can't predict where you'll be after he pulls the trigger. So now we're the shooter and the market is the shootee and it's doing a fine job in employing this tactic. Today was another lopsided day on the negative side but it wasn't a 90% day.

Bonds are still getting the loving as more money piles into the security of them vs. the worry about the stock market. We've entered the vulnerable period of the year (seasonal and decennial pattern as I discussed last Wednesday) so it makes a lot of sense to look for the relative safety of bonds. But even bonds have been volatile this year so there's no sure thing in investments.

The daily chart of the 10-year yield (TNX.X) shows it made it down to the 44.75 level (4.475%) which is where I think it will find support:

10-year Yield (TNX.X), Daily chart

I've labeled the move down from June as a 5-wave move and that means we should start a correction of that decline at a minimum. After the expected bounce I'll be trying to determine the next move. If it's going to be a correction of the decline then it will typically take about 62% of the time as the decline (shown with the vertical lines for Fib time projections) and retrace about 50% of the price move. That would take it back up near 4.9% by the 3rd week of October. If the June-Sept decline was the end of a larger sideways move (shown on the weekly chart below) then we'll see rates continue to rally above 5.4%.

The interesting thing about the wave pattern is that it calls for a rally through September and into October. That suggests the Fed will Not be lowering the Fed funds rate on September 18th (which the market is pricing in).

The weekly chart keeps these moves in perspective:

10-year Yield (TNX.X), Weekly chart

With TNX breaking its uptrend line from March 2003 it looks bearish (bullish for bond prices). So after a bounce to correct the June-Sept decline we should see yields drop hard into 2008. That scenario suggests the economy will be slowing rapidly as we enter a recession and yields will drop accordingly. The Fed will follow rates down in that case. But the internal wave pattern of the move from the June 2006 high has me thinking we could get another rally leg into 2008 instead. I think 5.0% will be a key level in this regard and I'm going to see what kind of bounce pattern we get (assuming we'll get one).

Speaking of the Fed following yields, this chart shows how the Fed is typically just behind what the market has already done:

Federal Reserve funds rate vs. Market rates, courtesy elliottwave.com

You can see how the 3-month Treasury Bill yield dropped from 2000 to 2003 and then a little later the Fed dropped its funds rate. Then the market rates started climbing to the 2006 high and the Fed was right behind it. Rarely if ever does the Fed lead the market but instead almost always follows the market.

The next chart shows we're not alone--stock markets around the world lead the central bankers' actions and not the other way around.

Central bank rates vs. stock markets, courtesy elliottwave.com

After the stock market crash in 1929, and the continuing decline into 1932, the Fed kept lowering the discount rate to no avail. They even tried raising interest rates in 1932 to protect the dollar and gold but that only made things worse. The Bank of Japan lowered rates right to zero but the stock market kept heading lower for the past 15 years. There were lots of rallies and flat periods along the way but the reduction in interest rates were not helpful. The dotcom bomb after 2000 was met with a lot of rate reductions, especially in 2001 and 2002. Again, they just followed the market lower.

The last graph on the bottom shows the current stock market drop and bounce with the first of probably many rate reductions. If the pattern follows history we'll probably see another stock market decline with the Fed in hot pursuit.

This of course begs the question why the stock market is excited about the idea that the Fed might lower interest rates at their September 18th meeting. If people would only study a little history and look at what has happened in the past then the "threat" of a rate reduction should be scaring the bulls. Live and learn, again.

In the meantime, the man behind the curtain has been active in the market again, or at least in stuffing money into the market. As this calculated M3 chart shows, the Fed and Treasury have been busy the past month:

Caculated M3 Money Supply, courtesy nowandfutures.com

After draining liquidity from the market from about April to June (in an attempt to slow down inflation) the Fed and Treasury department have been burning the midnight oil to operate their printing presses. The spike back up in the money supply since July is quite revealing and says they're worried. The reinjection of liquidity into the system will of course only make things worse since it adds to inflationary problems (hence my wondering on the TNX charts whether or not we'll get another spike higher in yields) and it doesn't allow the system to cleanse itself of bad credit risks. As I've been saying for a while now, the Fed is stuck between a rock and a hard place and they've successfully painted themselves into a tight corner.

While the Fed will be doing everything in its power (which turns out to be not much actually) to ease the liquidity crisis, the banking system continues to choke on lack of cash. I've said the Fed will be pushing on a string when it comes to getting cash out into the monetary system because they'll be fighting human emotions. If a banker is afraid to loan money for fear he'll be saddled with yet another bad loan on his books, for which he'll then have to set aside reserves, then he's not going to borrow from the Fed to make those loans.

Equity markets have calmed down a bit over the past few weeks but things haven't gotten any better in the banking world. The LIBOR index is the London Interbank Offered Rate which is a 3-month rate fixed each day by the British Bankers' Association. They set the benchmark rate used for interbank transfers. The LIBOR rate is a common index used by other banks around the world including many of our adjustable rate mortgages (ARMs). The trouble is most banks don't want to lend and the actual interbank rate has shot higher than the LIBOR. The same thing has happened to the 13-week T-Bill rate after it plunged lower in August.

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This suggests the Fed's and ECB's actions to inject massive quantities of funds into the banking system haven't worked. One senior international policymaker was quoted as saying "The interbank lending business has broken down almost completely...it is a global phenomena and not restricted to just the euro and dollar markets." The danger from not getting liquidity through the banks and into the money markets where it is needed most is that people, institutions and businesses find they no longer have access to money that they thought was already committed to them. We're seeing this most visibly in the mortgage markets where previous commitments are not being funded and many home sales are falling through.

This is forcing many to tap banking credit lines since much of the asset-backed commercial paper--short term notes backed by collateral such as mortgages--is getting locked up. Investors have increasingly been refusing to re-invest in this paper and that has locked up capital. Everyone seems to have rushed into hoard mode--banks have been attempting to raise cash levels but they're not willing to lend it out. And this is what has raised short term interest rates in the market as some are enticing banks with a higher rate of return just to get them to let go of some of their cash.

This then has led to a rapid reversal in the yield curve again where the shorter rates are rising above the 6-month and 12-month rates. One banks treasurer said "The system has just completely frozen up--everyone is hoarding. The published LIBOR rates are a fiction." This could become a significant problem in the near future as a large volume of asset-backed commercial paper is due to expire in the coming weeks. This will cause a scramble to find cash to buy these vehicles back.

This is what caused the initial problem with the subprime loans--when it became nearly impossible to find buyers of these loans the value of them dropped precipitously. This then caused the first dislocation in the stock market and the steep selloff from the July high. The problem has now spread to all kinds of commercial paper and the problem is worse because the volume of these contracts is huge. All of the credit that has been created in the past few years is about to collapse. And the Fed will be over there pushing on its string. Good luck Mr. Bernanke, you'll need it.

That's our fundamental setup in the stock market as we head into the most vulnerable period of the year. As another reminder of a period not long ago, here's how the stock market looked leading up to October 1987:

SPX in 1987, Daily chart

After the initial hard drop in August the stock market did a 3-wave bounce into the end of September to correct that drop and then the bottom fell out in October. But notice the warning period for those who were ready to protect themselves. When the September low was violated in October there was no stopping the selling. Will the same thing happen this year but in September? One can only speculate but just in case, you might want to be thinking of some way of protecting yourself. Perhaps a few puts in your pocket in case of a rainy day.

Economic reports
Pending home sales and the Fed's Beige Book were then only economic reports today.

Pending Home Sales
Contracts signed on existing homes fell -12.2% in July which is the largest drop since the start of data collection in 2001. September 2001 was the previous lowest level. This calls into question the +5% gain in June and most believe it to have been an anomaly. Pending sales are -16.1% below July 2006 and all four regions of the U.S. saw sales drop. And this is before the August collapse in the banking industry. Since this is a measure of contract signings and not sales the next hurdle to get through is to find money from a mortgage company.

To all those who are trying to buy or sell a home right now I say good luck. My sister finally closed on her NY home and while the money was late from the mortgage company (they needed to wait until September from an originally scheduled August 15th closing date), she finally got her check. It's a real nail biter these days.

Fed's Beige Book
The credit crunch and resulting market turmoil has had little impact on economic activity through the end of August, according to the Fed's report. The 12 districts report on their region's economies and 4 of them--Philly, Richmond, Dallas and San Francisco--reported growing economies but at a slower pace. The report acknowledged that the financial turmoil has led to tighter lending standards for residential mortgages and that this was dragging down housing activity. The same is true for commercial real estate. Retail and manufacturing activity continues to expand modestly.

And now let's see what the charts are telling us:

DOW chart, Daily

The DOW has almost made it up to the mid line of its longer term parallel up-channel from July 2006. If this line acts as resistance then the next likely price path will be a break of the up-channel. A climb back above 13600 would be more bullish whereas a break below 13K would be bearish.

DOW chart, 60-min

The bounce off the August 16th low is subject to a few different EW (Elliott Wave) counts so I'm watching trend lines carefully here. Today's break of the uptrend line from August 16th is bearish. Price held above the broken downtrend line from July 19th so that would be bullish if the retest holds. We could see another pop higher in the bounce off this morning's low in which case watch for a potentially bearish kiss goodbye against its broken uptrend line. Follow the break of whichever trend line goes first (just be careful of the head fake break).

SPX chart, Daily

SPX looks the same as the DOW. After being rejected at its 100-dma (and a Fib projection for the 2nd leg up at 1495) price close below the 50-dma again. The uptrend line from August 16th held today so it's possible we'll see another rally leg to finish the bounce off the August low. It takes a break below 1432 to put the bears back in the driver's seat.

SPX chart, 60-min

The uptrend line from August 16th held today (unlike for the DOW) so a break of it would confirm the DOW's break. Then the broken downtrend line from July 19th just below 1460 would be the next potential support. There are two Fib projections at 1531 and 1533 that are based on the potential wave counts for the bounce. The trend line across the highs of the bounce crosses through this level on late Friday/early Monday so if we get a rally up to that level then watch for a short play to set up. A break below 1432 would be more immediately bearish with a break below 1450 a heads up in that regard.

Nasdaq-100 (NDX) chart, Daily

The techs have received all the lovin' the past couple of weeks and I'm not sure why. The small caps haven't received the same attention so I can't say it's because funds are feeling bullish. Perhaps it has to do with the volume of money coming into the market from the Fed/Treasury and a lot of it is going into the sexy techs (good for retail psyche). But the techs, like the weaker DOW, appear to have been stopped by the mid-line of its longer term parallel up-channel from July 2006. A failure to proceed higher here would likely see NDX breaking to new lows next.

Nasdaq-100 (NDX) chart, 60-min

NDX has rallied from the August 16th low in a nice parallel up-channel so use it as your guide for trading. The bulls will want to see the mid line hold (it's trying) since a break lower will very likely have the bottom of the channel tested next (about 1963). That kind of drop would look more bearish and a bounce back up to its mid line (if we get it) would make a nice short entry.

Russell-2000 (RUT) chart, Daily

Yesterday's new high for the bounce in the RUT negated a more immediately bearish wave pattern and now has it on one that is similar to the other indices. So in this regard it's looking like the various indices are in synch. The 50-dma has already crossed below the 100-dma and is about to do it to the 200-dma, both of which look like they're holding down the RUT at the moment. A key level for the RUT remains the 800 area (got slightly higher) so continue to use it as your guide--short below, long above.

Russell-2000 (RUT) chart, 60-min

I show a potential ascending wedge pattern for the RUT, which is a similar pattern for the DOW and SPX as well and this pattern calls for another leg higher (pink wave count). A rally to the top of the pattern, or a throw-over to the Fib projection near 826, would be the setup for getting short this index. Otherwise a break of the uptrend line from August 16th and the broken downtrend line from July 19th (also like the DOW and SPX) is needed to get the bears a foot in the door of this market.

NYSE (NYA) vs. Advancing-Declining Volume chart, Daily

While the NYSE was making new highs for its bounce off the August 16th low, the advancing-declining volume was not keeping up. In other words we were getting a negative divergence between price and market breadth. This is normally a very good indicator to watch in order to give you a heads up that the move up, in this case, is running out of steam. It says get ready to short a breakdown.

BIX banking index, Daily chart

If the techs are receiving the love then the banks are receiving something else and it's not love. The 3-wave bounce in August corrected the May-Aug decline and now it looks like the next leg down has begun. The EW count on the chart calls for some very hard selling, bordering on panic selling, is right around the corner. A rally back above 380 would suggest we instead will have at least a larger upward correction.

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

The bottom of the parallel down-channel for price action since February looks to be acting as resistance. This is very common to see and as long as it does then we should see this index continue its southbound march.

Oil chart, December contract (CL07Z), Daily

Oil is almost up to the Fib projection for its corrective bounce where the 2nd leg up will achieve 162% of the 1st leg up (at 73.87). Just a little higher would be a retest of its broken uptrend line from January. It should resolve lower once this bounce is finished.

Oil Index chart, Daily

The oil stock index is looking a little like the commodity at this point--the current bounce should be correcting the July-Aug decline and then resume its decline in a stronger leg down to new lows, likely well below 600 and thus breaking below its up-channel in place since the October 2005 low.

Transportation Index chart, TRAN, Daily

MACD has remained below zero and RSI has stayed below 50, both of which suggest weakness in its bounce. Whether it tips back over from here or after a little higher first, we should get some strong selling to follow next.

U.S. Dollar chart, Daily

The U.S. dollar just can't seem to get a rally going. The drop from the August high is looking impulsive which suggests a bounce will be followed by more new lows. But right now I'm watching to see if we get a minor new low from here and then a rally since the decline from the August high could then be considered corrective (from an EW perspective). The important level is the previous low just below 80--break that and the bears still rule in the US dollar. That would obviously result in a stronger bid for gold but the EW pattern in oil does not suggest this will happen.

Gold chart, December contract (GC07Z), Daily

Because gold has been in a very choppy sideways pattern for the past year there are several possibilities for its wave count. I continue to show a bearish wave pattern because of my bearish bias based on some of the fundamental problems I see ahead for commodities, gold included. The key level for the bulls is 717 since a rally above that level would say the sideways consolidation has been a bullish pattern. We could see a slight push higher to the Fib projection at 697.50 for two equal legs up from the August low but right now it's facing potential resistance at its downtrend line from April. A break below 670 would be a heads up that something more bearish is happening and the key level for gold bears is 651.

The weekly chart of gold shows how this sideways pattern fits in a bearish wave count:

Gold chart, December contract (GC07Z), Weekly

If the sideways consolidation over the past year has been a wave-B, after the 3-wave move down from May to October 2006 for wave-A, then wave-C down is next. That move down projects to at least the 500 area, potentially lower.

Results of today's economic reports and tomorrow's reports include the following:

The productivity report and ISM services might affect the market if people think it will affect the Fed's thinking as it relates to a rate reduction. Otherwise the bigger report will be Friday's nonfarm payrolls number. The employment numbers out of ADP today suggests we could see half the 130K that is expected. That would likely get the bulls excited since they'll think the Fed will be more inclined to lower rates with a slowing employment picture. But go back to the beginning of this report and you can see why any bounces in the stock market during a rate-reduction phase are just golden opportunities to short the market. Then take your profits on the next decline, put it in the bank and order up another rate reduction to do it again, and again, and...

SPX chart, Weekly

If the bounce from the August low is a 2nd wave correction (it could be a b-wave correction in what will be a more complex pattern for the decline) then the next leg down is going to be strong (as it will for a c-wave decline as well). At this point I'm trying to identify the top of the bounce in anticipation of catching this decline. I could of course be wrong on the wave count and we'll instead get a new high before finding the next market high but right now the longer term wave count looks good for a top, the seasonal and decennial pattern suggests I should be looking for a shorting opportunity and the short term EW pattern suggests it could be here or perhaps a tad higher. It's worth testing the highs at this point since we're in a period where surprises will likely be to the downside.

I've shown the support and resistance levels on the charts to help guide us for the next day or two. Follow whichever way it breaks but if it breaks to the upside then it might only be good for a day or two or maybe even a week. If it breaks to the downside then short players should get a nice ride. Continue to play this fairly tight (as much as the volatility will allow--trade lighter with wider stops to keep your per trade risk the same) and take your stops if hit, even if it's often. When you get the winning trade with the kind of volatility we've been seeing then all the small losses will be quickly recovered.

We've got everyone back from vacation so hopefully volume will improve (it was low today) which will make it a little more difficult to push the pile around. The volatility is tough enough to trade around without a big fund jockeying the market around so they can take a couple of points out of the market. Good luck this week and I'll be back next Wednesday and on the Market Monitor tomorrow.
 

New Plays

Most Recent Plays

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New Plays
Long Plays
Short Plays
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New Long Plays

None today.
 

New Short Plays

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Play Updates

Updates On Latest Picks

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Long Play Updates

Boyd Gaming - BYD - cls: 41.25 chg: -0.74 stop: 39.49

The market looked pretty weak today but the move in BYD looks like another bullish entry point. Traders bought the dip at its rising 10-dma. While we would suggest new positions here do so cautiously. If the major indices continue to decline tomorrow we'd probably step back and wait before opening any new bullish plays. Our target is the $44.90-46.00 range. Keep a wary eye on the simple 50-dma for potential overhead resistance. The Point & Figure chart is still very bearish following the late summer sell-off.

Picked on September 04 at $41.55
Change since picked: - 0.30
Earnings Date 10/25/07 (unconfirmed)
Average Daily Volume: 1.0 million

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Cameco Corp. - CCJ - cls: 40.50 chg: -0.53 stop: 37.40

CCJ spent most of today's session trading sideways. The pull back toward $40 looks like another entry point to buy the stock. However, we would hesitate to open new bullish positions if the major averages keep sliding tomorrow. Our target is the $44.50-45.00 range. Readers should note that the 50-dma and the 200-dma could be serious overhead resistance.

Picked on August 27 at $40.26
Change since picked: + 0.24
Earnings Date 10/30/07 (unconfirmed)
Average Daily Volume: 3.6 million

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Brinker Intl. - EAT - cls: 29.13 change: -0.37 stop: 27.99

EAT couldn't avoid the profit taking on Wednesday. The correction may not be over. Don't be surprised to see a pull back into the $28.50-28.00 zone although a bounce anywhere above $28.00 could be used as a new entry point to buy the stock. EAT does not move super fast so this could take a few weeks but our target is the $31.75-32.00 range. We do expect to see EAT find temporary resistance near $30 and again at the 100-dma and 200-dma both overhead. FYI: The P&F chart is still bearish from the June-July sell-off. Meanwhile it just happens to be dividend season for EAT and they are paying a 9-cent quarterly dividend on September 26th to shareholders on record as of September 14th.

Picked on September 02 at $28.84
Change since picked: + 0.29
Earnings Date 10/24/07 (unconfirmed)
Average Daily Volume: 1.9 million

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EON AG - EON - cls: 54.78 change: -0.81 stop: 52.99

EON couldn't escape the market-wide profit taking on Wednesday. Look for a dip or a bounce near $54.50 as a potential entry point for new positions. More conservative traders may want tighten their stops even higher. Our target is the $57.40-59.85 range. More aggressive traders may want to aim higher.

Picked on August 26 at $54.55
Change since picked: + 0.23
Earnings Date 08/15/07 (confirmed)
Average Daily Volume: 406 thousand

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Global Ind. - GLBL - cls: 24.14 chg: +0.11 stop: 22.39

There is no change from our previous comments on GLBL. Although we will note that the stock has now ignored a big market rally and a big market sell-off. Shares have been stuck trading sideways for the last few days. Technically we're still just spectators sitting on the sidelines watching and waiting since our trigger to buy the stock is at $24.65. Conservative readers may just want to pass on this one. We're also thinking that readers may want to tighten the stop loss to last Wednesday's low near $22.95. Our target is the $28.00-29.00 range.

Picked on August xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 10/30/07 (unconfirmed)
Average Daily Volume: 2.5 million

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Starbucks - SBUX - cls: 27.44 chg: -0.28 stop: 26.61

The big news for SBUX today was that the company had joined up with Apple (AAPL) to sell downloadable music to people who buy the new wifi-enabled ipods. Unfortunately, the news wasn't big enough to push SBUX shares higher. We're not suggesting new positions at this time. Our target is the $28.00-28.25 range and we're concerned about technical resistance at the 100-dma near 28.12.

Picked on August 16 at $26.61
Change since picked: + 0.83
Earnings Date 11/15/07 (unconfirmed)
Average Daily Volume: 17.0 million

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Wyndham Worldwide - WYN - cls: 31.69 change: -0.07 stop: 29.90

Are you falling asleep yet with WYN? There is no change from our previous comments on WYN. Although we do note that the stock is now testing what should be short-term technical support at its rising 10-dma. WYN could see a bounce soon. We are suggesting a trigger to buy the stock at $32.15. If triggered we're going to have two targets. Our first target is the $33.90-34.00 zone, which should have resistance with its 200-dma. Our second, more-aggressive target is the $35.70-36.00 range. Keep an eye on the 50-dma for potential resistance. FYI: The P&F chart is still bearish from the late summer sell-off. More conservative traders may want to use a tighter stop loss near $31.00.

Picked on September xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 11/01/07 (unconfirmed)
Average Daily Volume: 1.5 million
 

Short Play Updates

None
 

Closed Long Plays

None
 

Closed Short Plays

None
 

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

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