Option Investor

Daily Newsletter, Wednesday, 01/02/2008

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Table of Contents

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

Market Wrap

Bah Humbug!

The headline I saw after the market closed was "DOW suffers biggest first-session-of-year point loss ever; 29 of 30 components fall." Well that's no way to ring in the new year. Of course the other saying for this time of year is "If Santa Claus should fail to call, bears may come to Broad and Wall." I think it was Santa who uttered the words "bah humbug" this year.

Today's decline started with a swift drop shortly after the open. But the market internals initially supported the idea that the decline was a setup to catch some bears sleeping so as to get some short covering fuel to start a rally. But as the day wore on, and the techs joined in the selling, the selling pressure confirmed the drop in the indices. They tried to rally it in the afternoon but it got pushed right back down to the low and then they rallied it again into the close but so far it's to a lower high. The numbers in the table above show fairly strong volume and most of it was down volume. Declining issues and new 52-week lows beating out new highs also supported the down day we saw in the indices.

From a bigger picture perspective, since my last update last Wednesday, I'd say we have a little more clarity in the price pattern but not enough yet. With price bouncing up and down inside a potential sideways triangle we could see a lot more whipsawing price action over the next couple of weeks. I will of course update the charts with some ideas for where price may be headed. But recognize that we're currently in a very risky period for both sides.

Regardless of how 2008 is starting, and whether or not Santa showed up, these kinds of things are only guidelines for how the market may behave in the next few weeks. We've been in a market that has been acting "opposite" from the normal pattern and that could very well continue.

One sell signal that did follow through from last week was the signal we got from the VIX. Last week I showed the VIX having dropped to its 200-dma and close to its uptrend line from December 2005. The last time it did that was in October and called the market high. Since last week's touch of support it has now bounced back up and broken the downtrend line from the November high:

Volatility index (VIX), daily chart

The sharp spike back up in VIX coincides with the selloff in the market so now watch to see what kind of pullback we see in the VIX. If it pulls back and finds support at its broken downtrend line and then rallies again, it will be bearish confirmation for the equity market.

Today's economic reports, especially the ISM, were not at all helpful for those hoping to see signs of improvement in the economy.

Economic reports
Scheduled reports for the morning were the ISM (Institute for Supply Management) and the construction spending. This afternoon we had the release of the FOMC minutes from the last meeting on December 11th.

ISM index
The U.S. factory sector contracted in December with the ISM dropping to 47.7% from November's 50.8%, and lower than the 50.5% that economists had been expecting. This is the lowest reading since April 2003 (just off the low in the stock market). The ISM is one of the better leading indicators for the economy (and therefore the stock market). It's the first sub-50 reading since January 2007.

New orders were hit particularly hard, dropping to 45.7% from 52.6%, coming in lower than at any previous time since October 2001. The production index fell to 47.3% from 51.9%. The following chart shows the decline in the index since the 14-month high in June:

ISM index, November 2006-December 2007, courtesy briefing.com

It's been a consistent decline since June but the sharp decline in December is what caught many by surprise. The market was not happy about this report this morning. For a larger perspective, this chart shows data since 1991:

ISM index, January 1991-December 2007, courtesy briefing.com

The 1991 low and 2001-2002 lows, just below 40, are suddenly not that far away. Clearly the trend since the high near 70 is not favorable for the stock market and it's actually surprising the "all-knowing" market has held up as well as it has.

Construction Spending
Construction spending, while hurt by the drop in residential construction, hit a two-month high in November by rising +0.1% on strong public, state and local construction projects. But residential construction continued its decline and dropped -2.5% in November, following a -2.3% drop in October. The drop in residential construction made for 17 straight months of declines and is down -17.5% year-over-year. Total construction spending is down -0.1% on a year-over-year basis which was greatly helped by commercial construction being up +18% year-over-year and public spending up +15%.

FOMC Minutes
There were no real surprises in the minutes and the market barely reacted to them. The Federal Reserve officials were apparently surprised by the weakening in the credit markets and the effect on the economy. They worried things get could worse and the vote to reduce the federal funds rate was unanimous. Only one Fed governor, Eric Rosengren, argued strongly for a larger cut. They worried that restrictive credit conditions could lead to an "unfavorable feedback loop," with tight credit restraining growth. That in turn could lead to further restrictions on credit which might require "substantial further easing of policy."

They did discuss their concern about the rise in inflation and said they'd be quick to raise rates if the credit problem looked to be easing and inflation worsening. They believe that core inflation will trend down over the next few years.

Let's get to the charts and see how the new year is starting.

DOW chart, Daily

Prices since the October high (and in actuality since the July high) have been very choppy. From an EW (Elliott Wave) perspective price action has been doing nothing but 3-wave moves up and down and this leaves open several possibilities for where price will head next. Using trend lines and Fib projections can be very useful to help determine where support and resistance might be found. For example, I show a Fib projection at 12874 which is where the move down from the December high would have two equal legs (light green a-b-c). Just a little lower is trend line support near 12800.


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If the light green wave count is correct then we'll get a strong rally out of the sideways triangle that has been building since the August low and October high. Confirmation for the bulls would be a rally back above the late-December high of 13563. The dark green wave count is slightly different but it too calls for another rally to a new all-time high once the current decline finishes. Both of those counts would be in jeopardy if the DOW drops below the November low near 12724 (although the light green count would not be negated until it drops below the August low at 12518. But if the DOW does drop below 12724 then the bearish wave count (dark red) would become the more likely count. In the meantime be careful of the chop.

DOW chart, 60-min

The small bounce attempt late in the day today does not look bullish yet. If the small consolidation is followed by another low then we could see a drop down to the Fib projection at 12874 (shown on the daily chart) or trend line support near 12800. The DOW does not need to drop any further though, or could turn around at any time, and start a rally back above the key level at 13563. In between, and inside the contracting triangle, prices could whip around a lot.

When looking for potential turns in the market we often look at price levels. But time is also an important consideration. Back at the end of October I had suggested we could be at an important turn in the market based on equal time sequences that had been playing out since the October 2002 low. I showed a chart of NDX and SPX with time projections that showed how well the market was following time sequences in marking important highs and lows. This chart of SPX shows what I was looking at back then:

SPX chart, Weekly

Starting at the October 2002 low I attached the Fib time projection at the January 2004 high and you can see how the market turned at succeeding Fib projections for time based on that initial move up. The last turn window was the week of October 29th and the high on October 31st fit that nicely.

Now looking at SPX's daily chart since the July high we can see a similar time sequence between important highs and lows:

SPX chart, Daily with Fib time projection

Starting at the July high I attached the next point on the October high. Each of the 50% time lines has marked a market turn. The next one is on January 10th. As shown with the price projections this is giving us a potentially interesting setup. Whichever direction the market is heading into that date could see a reversal of that move. Therefore while a move below the December low will look bearish, and would probably mean a move down to the uptrend line from March 2003 near 1425, it could set up a bullish resolution to the mess we've been in. On the flip side, if we see a rally up to the 1506-1511 area (some Fibs point to resistance in that area), that could set up the next significant decline. So bulls and bears, be careful what you wish for over the next week.

SPX chart, Daily

Taking the above chart and going back to my "normal" (and messy) daily chart, I show the time line at January 10th and how the wave counts would fit the price projections.

SPX chart, 60-min

Price could consolidate a little longer near today's low and that would likely be bearish for another leg down to support at the uptrend line from March 2003. This is the trend line that supported the decline from the July high and then again from the October high. It's an important trend line. If the market gets a rally started tomorrow then upside potential is first to 1506 (two equal legs up from December 18th) and then 1511 (62% retracement of the October-November decline). If SPX can rally above 1512 then I see the likelihood for a rally up to the 1540 area if not new all-time highs.

Nasdaq (COMP) chart, Daily

If the COMP is able to work its way higher I suspect it will do so in a rising wedge. This is based on the corrective price structure since the November low (which would be found inside a rising wedge). These are very choppy patterns with lots of whipsaws so trade any rally carefully. On the other hand, a drop below 2554, the December low, would suggest the next strong decline (3rd wave down) is likely underway.

Nasdaq (COMP) chart, 60-min

Even if the COMP is in the bearish wave count (calling for a drop below the December low), it could finish its first leg down above the key level of 2554, bounce back up to correct the decline from December 26th, and then drop hard from there (in a 3rd of a 3rd wave down). If that sets up I'll be looking for a juicy short play. A rally from here could get very bullish, especially with a break of its downtrend line from October, confirmed with a break above the December 26th high near 2727.

Semiconductor Holders (SMH), Daily

The techs are not being helped at all by the semis. They broke below the December low today and they're not far from the November low. The COMP is still holding above its December low. After bouncing up to its broken H&S neckline in early December and back below its uptrend line from October 2002, SMH bounced back up to that long term trend line and gave it a kiss goodbye. Two kisses in one month and two slaps. The price pattern looks bearish here for at least a drop down to $30 if not $28. But so far, like the broader indices, the price pattern since the November low is full of 3-wave moves and that leaves open the possibility for another rally attempt, especially if the broader market is rallying over the next week.

Russell-2000 (RUT) chart, Daily

Like the COMP, I see the possibility for a continuation of the rally into February but it would likely be in a rising wedge and full of choppy moves. But this is a bit of a stretch and just speculation at the moment. I'm not seeing a lot that gets me feeling bullish about the small caps. A climb back above the December high (basically back above 800) would be bullish whereas a drop below the December low at 735 would be bearish.

Russell-2000 (RUT) chart, 60-min

The RUT is in a nice tight down-channel since the December 26th high so let that be your guide for now. It's a bit of a strange pattern (as are the others) in the decline and while it's steep there are enough question about how impulsive versus corrective it is that keeps me from jumping all over this decline. For now watch for potential support at the December 18th low near 735. If price does break out of the channel and gives us just a 3-wave bounce followed by a new low then it will be bearish and you'll want to be short for a potentially big ride down.

BIX banking index, Daily chart

The banks have a big bullish divergence at the December low but it hasn't amounted to anything yet. If it drops to a new low it could drop fast. But I also see the possibility for an additional leg up in its bounce off the December low before heading back down. A rally above 309 would suggest at least a larger correction of the decline from October. The pattern of the decline in the banks leaves a lot to be desired as far as figuring out the next move (which is the story of the charts lately).

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

After breaking the downtrend line on RSI it has been coasting down along the top of that trend line since. That and the choppy price action since the December high has me thinking it will get at least another leg up in its bounce, maybe even as high as 412. The whole market is acting this way--there's just no clear direction at the moment. Price could chop sideways over to the top of its parallel down-channel or simply drop lower from here (downside projections are at 216 and 154).

Oil chart, Oil Fund (USO), Daily

There was supposedly a trade at $100 for the oil contract today but my service shows a high of $99.81. Close enough for government work? I'm guessing oil will be able to tag that and then some. I'm showing upside potential to about 85 for USO (maybe $105 for oil) by mid January although the pattern is now at the point where failure could occur at any time. I think the risk here is on the bulls' side.

Oil Index chart, Daily

Like the commodity I see the possibility for a little higher for the oil stocks. The parallel up-channel since the November low should be your guide if you're long these stocks since a break below the bottom of the channel would indicate a high is in. Until that happens I like the projection near 925 where the top of the two channels meet in mid January.

Transportation Index chart, TRAN, Daily

Another index and another chart full of corrective 3-wave moves. This chart looks bearish though. After being pushed back down by its 50-dma and now back inside its down-channel, it's showing bearish price behavior. MACD tried to rally with price into late December but couldn't get back above the zero line. It has curled back over and that's bearish. RSI is confirming the new price low below the December low. It could certainly bounce again if the broader market rallies but I don't see it in this chart.

U.S. Dollar chart, Daily

The US dollar has been very whippy the past three days. It left a bullish engulfing candle on Friday and promptly negated it today. If the pullback from the December high is just a correction of the rally off the November low then the dollar should resume its rally soon and head for a new high for the move up from November. But the rally can easily be counted as a corrective wave count which would call for a new low for the dollar before it could try again. And of course what the dollar does will have an impact on the price of oil and gold.

Gold chart, February contract (GC08G), Daily

Gold rallied very strong today, up +21.80 (+2.6%) and it managed to tag its first Fib projection for this rally leg at 863.27 (today's high was 864.90). There is the triangle projection near 876 and then an upper Fib projection just under 909. The pattern of the rally from the December low can satisfactorily be counted as a completed 5-wave move and therefore the risk now is that that's all there will be to the gold rally.

A move out of a triangle pattern like this is typically the last move so the risk here is on the bulls' side. It could pull back before proceeding higher (light green) so gold doesn't turn bearish until it breaks below its uptrend line from August (and 50-dma), currently just below 810. The key level for the downside is back below the December low near 789.

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

Thursday will be a little busier for economic reports but nothing should rock the markets. Friday's reports could be more important in showing us where the economy is headed vs. the inflation picture (and give us an idea how much flexibility the Fed might have).

SPX chart, Weekly

The weekly oscillators have turned back down but basically they're in "wiggle" territory and may not be telling us a whole lot. Price remains trapped inside a very choppy range (where it's been for over a year now) and there's no telling which way from here.

I said I will continue to update the AAPL chart since I left a trade hanging in the special end-of-year report I did for those who signed up for another year. I had hoped AAPL would give us one more marginal new high, up to around 205, to finish its rally but it has since pulled back more than I expected:

Apple Computer (AAPL), Daily

Price is still above its uptrend line from November so there's nothing bearish about this chart yet. A break much below 190, with a confirmed break below 178.60, would be bearish and tell us the high is in. Until that happens I show the possibility for another leg up as part of a larger rising wedge pattern for the 5th wave up from November. The upside projection would then become a little trickier and could be at the original 205.54 on up to about 210-215. Hopefully the pattern will clear up a bit to help call a top. If the top is missed then I'll simply wait to get short on a bounce once the high has been confirmed. I consider the upside risky on this stock right now.

The bottom line is that the bulls and bears continue to battle and this is causing a lot of choppy price action. This has muddied the waters considerably and made it much more difficult to make price projections from an EW perspective. I haven't seen it this bad in a long while. Therefore my only recommendation is to be flat and wait for clarity. If you're trading short term moves then just be quicker than normal to take profits. Don't worry about the market continuing without you. Taking small bites out of the market is better than it taking small bites out of you.

Good luck and let's hope there's a little more clarity this time next week, especially since we'll be into the potential turn window of January 10th, +/- 1 day. See you then.

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Play Updates

Updates On Latest Picks

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Long Play Updates

Advent Software - ADVS - close: 53.53 change: -0.57 stop: 51.90*new*

It was another volatile day for ADVS but once again bulls were stepping up this afternoon to buy the dip. The afternoon bounce looks like a new bullish entry point to buy ADVS but given the market's performance today we would hesitate to open new positions. More conservative traders may want to raise their stops toward $52.00. Actually we are going to adjust our stop loss to $51.90. Our target is the $57.50 level. More aggressive traders may want to aim for the $60 region.

Picked on December 21 at $53.83 *gap open entry
Change since picked: - 0.30
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume: 245 thousand


Fiserv - FISV - close: 55.26 change: -0.23 stop: 53.99

Everybody say it with me now, "uh-oh!" The action in FISV was bearish. The stock produced a failed rally after spiking to a new five-month high this morning. Now normally these types of reversal patterns need to be confirmed, especially when it is in an up trend, but given the market's current short-term trend odds are good that FISV will see more profit taking. More conservative traders will want to tighten their stops. If FISV breaks the 10-dma we would expect a dip to the $54.25-54.00 zone. We're not suggesting new positions at this time. Our target is the $59.75-60.00 range. As expected the move over $56.00 has produced a new Point & Figure chart triple top breakout buy signal. The P&F chart now points to a $69 target.

Picked on December 28 at $56.11 *triggered
Change since picked: - 0.85
Earnings Date 01/31/08 (unconfirmed)
Average Daily Volume: 1.5 million


Ingles Markets - IMKTA - close: 25.60 chg: +0.21 stop: 23.95

IMKTA out performed the market today but the rally stalled late this afternoon. Given the market's performance we would not be surprised to see IMKTA slip back toward $25.00 or its 50-dma again. Wait for the dip and signs of a bounce before considering new positions. Our target is the $27.75-28.00 range. More aggressive traders could aim higher. FYI: Normally we do not play stocks with an average daily volume of less than 250,000 shares so we're tempted to label this play as aggressive.

Picked on December 23 at $25.66
Change since picked: - 0.06
Earnings Date 12/03/07 (confirmed)
Average Daily Volume: 81 thousand


Sonoco Products - SON - cls: 32.87 chg: +0.19 stop: 31.95

Posting a gain during today's session is a positive sign but we remain defensive here. We warned you earlier that the MACD was near a new sell signal. We are strongly considering an early exit! We're not suggesting new positions at this time. More conservative traders may want to exit early to preserve their capital. There is potential resistance at the exponential 200-dma near $34.50 and then again near $35.00. We're setting our first target at $34.85-35.00. Our second, more aggressive target is the 200-dma (currently near $36.75).

Picked on December 20 at $33.36
Change since picked: - 0.49
Earnings Date 02/07/08 (unconfirmed)
Average Daily Volume: 587 thousand


XTO Energy - XTO - close: 52.14 chg: +0.78 stop: 51.79

There is no change from our previous comments. We are waiting for a breakout over resistance. We have been suggesting a trigger to buy the stock at $54.15 but we may never be triggered. The MACD on the daily chart looks like it just produced a new sell signal and we may be witnessing a potential double top forming. If XTO can breakout over $54.00 it would produce a new buy signal on the Point & Figure chart. Speaking of the P&F chart XTO has a habit of producing a sell signal and then reversing higher. The P&F chart currently sports a sell signal and it looks poised to reverse higher again. If triggered our target is the $59.00-60.00 range.

Picked on December xx at $xx.xx <-- see TRIGGER
Change since picked: + 0.00
Earnings Date 02/23/08 (unconfirmed)
Average Daily Volume: 4.1 million

Short Play Updates

Bob Evans Farms - BOBE - cls: 26.43 chg: -0.50 stop: 28.55*new*

BOBE's bounce failed at the 10-dma and shares lost 1.8% today. The stock is trading near the bottom of its two-week trading range. We're not suggesting new positions at this time but a decline under $26.00 would look like a new entry point. We are adjusting our stop loss to $28.55. Conservative traders might want to place theirs closer to $27.50. We're aiming for the $25.25-25.00 zone. FYI: The most recent data puts short interest at 11.6% of the 32.74 million-share float. That is a relatively high amount of short interest and raises the risk of a short squeeze.

Picked on December 16 at $29.01
Change since picked: - 2.58
Earnings Date 02/14/08 (unconfirmed)
Average Daily Volume: 467 thousand


Fist Community Bancorp - FCBP - cls: 40.30 chg: -0.94 stop: 43.26

Once again the financials stocks were one of the worst performing sectors. Shares of FCBP lost more than 2.2% and produced another failed rally under $42.00. We would still consider new positions here although momentum traders may want to wait for a drop under $40.00. Our first target is the $35.25-35.00 range. Our second target is the $32.00-30.00 zone. The P&F chart is bearish with a $30 target. FYI: We do not want to hold over the late January earnings report.

Picked on December 30 at $40.80
Change since picked: - 0.50
Earnings Date 01/28/08 (unconfirmed)
Average Daily Volume: 416 thousand


Granite Constr. - GVA - close: 36.16 change: -0.02 stop: 40.01 *new*

GVA continues to look bearish even though the stock closed virtually unchanged on the session. We are adjusting our stop loss to $40.01. More conservative traders might want to take a little money off the table right now. Our target is the $34-33 range near its lows for the year. FYI: The most recent date puts short interest at 7.8% of the 34.4 million-share float.

Picked on December 16 at $38.73
Change since picked: - 2.57
Earnings Date 02/11/08 (unconfirmed)
Average Daily Volume: 1.1 million


IAC Interactive - IACI - cls: 26.28 chg: -0.64 stop: 28.01 *new*

Shares of IACI were downgraded before the opening bell today. The stock gapped lower at $26.38 and dipped to $25.79 before bouncing back. The move under $26.40 and $26.00 looks like a new entry point for shorts. We would still consider new shorts right here. Please note we're adjusting our stop loss to 28.01, just above the late December high. We have two targets. Our first target is the $25.50-25.00 range. The H&S pattern, if it follows through, is forecasting a target in the $22 region. Our second, more aggressive target will be the $22.50 level. The P&F chart is still bullish for now but is on the verge of a breakdown. FYI: The latest data puts short interest at about 4% of the 120 million-share float.

Picked on December 11 at $27.60
Change since picked: - 1.32
Earnings Date 02/06/08 (unconfirmed)
Average Daily Volume: 2.8 million


Medicis Pharma - MRX - close: 25.92 change: -0.05 stop: 27.01 *new*

We're still not seeing a lot of follow through on MRX. The trend is still bearish but there was no momentum today. That should make bears cautious. We're adjusting our stop loss to $27.01. You might want to tighten your stop toward $26.75. Bears are still faced with support near $25.50. Our target is the $23.00-22.50 zone. The P&F chart is bearish with a $19 target. FYI: Any time we play a biotech stock we're dealing with a high-risk situation. MRX seems to be more of a drug company but we're still at risk that some FDA decision or some clinical trial news could send the stock gapping one direction or the other. Furthermore the most recent data puts short interest at more than 23% of MRX's 49.2 million-share float. That is a high-degree of short interest and raises the risk for a short squeeze.

Picked on November 18 at $26.08
Change since picked: - 0.16
Earnings Date 02/05/08 (unconfirmed)
Average Daily Volume: 1.2 million

Closed Long Plays


Closed Short Plays

NII Holdings - NIHD - close: 48.77 change: +0.45 stop: 50.05

We are suggesting an early exit on NIHD. The stock is not cooperating. Shares continued to show relative strength today. The stock does appear to have short-term resistance near $49.25 and potential round-number resistance at $50.00. We don't want to wait around given the relative strength so we're suggesting an exit now. FYI: The longer-term trend is still bearish and we might reconsider new bearish plays on a drop below $47.00 or $46.00.

Picked on December 30 at $47.59
Change since picked: + 1.18
Earnings Date 02/25/08 (unconfirmed)
Average Daily Volume: 4.3 million


Tempur-Pedic Intl. - TPX - cls: 25.95 chg: -0.02 stop: 28.20

We've waited long enough. Today would have been the perfect day to see TPX dip toward the $25.00 level. Unfortunately, shares bounced at $25.44, which is very close to the August 2007 low. The lack of a real decline today with the market this weak is a warning for the bears. Thus we're suggesting an exit immediately. TPX has already exceeded our first target in the $27.25-27.00 range. Our second target was the $25.25-25.00 range.

Picked on December 12 at $30.67
Change since picked: - 4.70
Earnings Date 01/24/08 (unconfirmed)
Average Daily Volume: 1.9 million

Today's Newsletter Notes: Market Wrap by Keene H. Little and all other plays and content by the Option Investor staff.


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