Wednesday, April 9, 2008
4.1 S&P 500 Index (SPX)
5.0 Featured Industry Groups
5.1 Banking Index (BIX)
6.1 U.S. Dollar (DXY)
7.1 Oil Fund and Index (USO and OIX)
9.0 Summary and Key Trading Levels
1.0 Overview--Today's Numbers
I titled this report the Three-Step Pattern because when you look at the "rally" off the March lows that's what it seems we're doing--two steps up and then one step back. The highs and lows within the rally off the March lows are overlapping and that gives it a corrective look. A corrective pattern to the upside suggests the downtrend will resume once the correction is finished. Whether that leads to only a pullback and then another leg higher for a larger upward correction or instead heads immediately for new lows for the year is the big question.
There's an even bigger debate as to whether or not we've seen the market lows for the year but in my analysis it's not a valid argument. We're in a bear market and we will see new lows below the January-March lows. For me it's a matter of identifying where the top of the bounce might occur and this choppy price action is making it incredibly difficult to figure out what the larger corrective bounce is forming but that's why I include key levels on the charts and then let price tell me what's likely happening. We can all argue until we're blue in the face about what the market should do but in the end it is of course price that is the final arbiter.
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So far we could say the February 1st highs are holding and that means we could stay trapped in a large trading range for another couple of months (between the January-March lows and the February-April highs. That would make it very difficult if you're a directional trader and looking for at least a trend that lasts a few days for a decent trade. If you're a market neutral trader, such as one who sells credit spreads above and below resistance and support then this has been, and could remain for a while, the market for you.
But as I've said more than once, be careful if you're selling bull put spreads since the kind of consolidation we're seeing here could suddenly let go to the downside (usually without warning and the reason it scares the pants off the bulls) and the next leg down, from an EW (Elliott Wave) perspective, could be a very fast and strong move down.
2.0 Hot Topic--Where to Park Your Money
I'll answer that question at the end of this section. First I wanted to get into earnings (since we're into earnings season) and what they could mean for the market. Part of the disagreement about whether or not the market has made a significant bottom for the year has to do with earnings. The estimates for earnings have not been downgraded that much and many believe a recession could soon be over (even before it's officially declared). The earnings/stock market argument can be thought of as a chicken and egg thing. I suspect most believe that earnings expectations drive the stock market's ups and downs. I argue the stock market reflects changing social moods which in turn affects businesses which in turn affects their earnings. In other words the ups and downs in the stock market drives earnings and not the other way around.
When surveys are taken of company management the results have shown that they tend to be an optimistic sort. Very rarely does management see a slowdown in their earnings which subsequently shows up. In fact even if they see an overall slowing in the economy, and a slowdown in corporate earnings for other companies, they see themselves as more immune and expect to do better than the rest. The data shows they're usually incorrect in their assessment. That raises a question about the value of insider trading when we hear about the number of insiders buying their own stock, which is supposedly a bullish sign, but that's a different topic.
Analysts who follow particular stocks have shown a tendency to follow management's assessment of earnings rather than doing their own research. The data shows that analysts typically lag the market in their earnings estimates. After earnings have convincingly changed is when the analysts then revise their estimates. It makes one wonder what is the value of analysts. That also is a different topic. The following chart shows earnings (in red) vs. analysts' forecasts (chart courtesy SG Equity Research):
The chart shows that analysts are consistently another lagging indicator and more or less follow actual earnings up and down when they report their forecast. These estimates are then used to evaluate stock values (with buy and sell recommendations, mostly buy). You can see by the chart that analysts' estimates have not yet reflected the actual drop into this year. The coming earnings season will likely start the analysts on their downward revisions and stock valuation downgrades. Prepare for it. To expect a bull market rally in light of this is simply hard to imagine. We also still have a huge credit problem out there (does anyone honestly believe Bear Stearns is the only major player in trouble?), continuing housing contraction and a slowdown in consumer spending.
So back to the heading for this section of the report--where is a good place to park your money? You know, that fabulous stash of cash you've earned by following the trade recommendations from OptionInvestor (wink). I've just been through a lot of this with some family members and tried to make the argument that it's better to be in bonds right now. That suggestion of course immediately drew sneers and other obscene gestures from some. Everyone knows stocks outperform bonds in any (pick one) 5, 10, 15 or 20-year period. Right? It depends.
When earnings have been historically high, as well as P/E ratios, as they have been, the stock market tends to do poorly over the next 10-15 years and that's the period we've been in since 2000. Therefore from a historical perspective, now is not a good time to be in stocks. But there's a relatively easy way to determine when the timing is right to be invested heavily in stocks vs. bonds and when it's time to switch sides.
John Murphy practically wrote the book on technical analysis and one of his real strengths is in relative strength analysis. A very good book, and highly recommended, is his "Intermarket Analysis" where he describes relationships between all kinds of markets. Back in February he highlighted an opportunity to rotate out of stocks and into bonds. By looking at the long term relationship between bonds and stocks, and the relative strength of bonds to stocks, you can see from the following chart (courtesy John Murphy and stockcharts.com) that the period of 1980-2000 clearly favored stocks over bonds:
This chart shows the ratio of the price of the 30-year Treasury Bond divided by the S&P 500 index price. As long as the ratio is dropping it favors stocks and then when the ratio starts rising and breaks its downtrend then it favors bonds (bonds start to outperform stocks). Remember, this is a ratio--both could be dropping or rising together but it's the relationship of bonds to stocks. Most investors today do not know what a secular bear market is and therefore have only heard that the only surefire way to make money is to be invested in stocks. From 1980 to 2000 that's definitely been true. But from the 2000 bottom on the above chart, and especially once the ratio broke the downtrend line in 2002, it told us there was a fundamental shift going on.
The period of 2002-2007 showed stocks doing better than bonds but the ratio finally bounced off the broken downtrend line, at a higher low, and has been rallying since, as shown in the next chart (also courtesy of John Murphy):
After breaking the downtrend line from 2003 in July 2007 (which is when the stock market was topping out) the ratio started rally again off that trend line and it shows bonds have been the better investment, and continue to be.
So if you're looking for a convenient way to "time the market" between bonds and stocks, here's a relatively simple tool to use.
3.0 Economic Reports
Not much to report on for the economic reports this week and very little to move the market.
4.1 S&P 500 Index (SPX)
SPX chart, Daily
The dark red price path is the one that calls for a continuation of the sideways trading range we've been in since the January low, and could continue into June before it starts the next leg down in the bear market decline. There remains the potential to rally a little higher to about 1415-1430 before starting back down (for either a pullback (green) or a new leg down (pink).
Key Levels for SPX:
SPX chart, 120-min
There are a couple of Fibs near 1340 that have me thinking we could see a little more downside on Thursday before potentially heading higher again. The Thursday before opex week is known as the "head-fake" day and an early low Thursday morning could set a bear trap so be careful about that possibility. Much below 1340 would turn the price pattern more bearish and could indicate we're in the early part of a leg down to the bottom of the trading range (1275). But another rally leg into next week could target the confluence of trend lines and Fibs near 1415 by the end of opex week.
4.2 Dow Jones Industrial Average (DOW)
DOW chart, Daily
Between trend lines and Fibs I have an upside target zone of 12860-13040 by next week. If it rallies much higher than that I can see the potential for a rally up to a Fib projection at 13565 (if it can first get through the 200-dma currently at 13123). I haven't drawn in all the potential wave counts on the DOW chart and the one I'm showing is in my estimation the most likely scenario. It calls for another strong decline once the current correction to the October-January decline is finished. If it plays out the way I'm showing, two equal legs down from October gives us a downside projection to the 10500 area. Much lower potential exists.
Key Levels for DOW:
DOW chart, 120-min
A parallel up-channel for price action off the March lows shows the DOW could be ready to rally right from here. But the lower line is more of a guide than an actual trend line (it's parallel to the trend line along the early highs of the bounce) therefore we could see an early decline Thursday morning before another rally leg gets started. A break much below 12400 would look more bearish.
4.3 Nasdaq-100 Index (NDX)
Nasdaq-100 (NDX) chart, Daily
The downtrend line from October crosses a Fib projection at 1945 next week and the coincidence with opex makes for a compelling argument that we're going to get the rally up to there. The 200-dma is not further above that level. I would look for some longer term short plays if and when that level gets tagged since the potential is for another leg down to a new yearly low. It could just pullback and then rally again (green) but that can't be known yet.
Key Levels for NDX:
Nasdaq-100 (NDX) chart, 120-min
Like the others, I see the possibility for an early decline Thursday morning to about 1790-1800 to the bottom of its parallel up-channel from March. Much below 1790 would look more bearish. Another rally leg should target 1925-1945 next week.
4.4 Russell 2000 Index (RUT)
Russell-2000 (RUT) chart, Daily
From a Fib and trend line perspective it looks like the RUT could be closer to a top for the leg up from March (if it hasn't already topped)--725 looks like a good upside target. If it makes it much above 725 then the upside potential is to near 775. A break below 681 would be more immediately bearish.
Key Levels for RUT:
Russell-2000 (RUT) chart, 60-min
The lower line of its parallel up-channel was nearly tagged so it too could see a brief move lower on Thursday before rallying again. Much below 670 would have me thinking more bearishly.
5.0 Featured Industry Groups
5.1 Banking Index (BIX), Daily chart
After the sharp poke above the top of its down-channel on March 24th the banks rolled back over and the index is back inside the down-channel and appears to be heading lower. The price pattern has me thinking it's an ending pattern (the 3-wave move down from February 1st is what started me thinking it). This pattern typically sets up a descending wedge which is what I've drawn in. Until I see evidence to the contrary I'm expecting it to chop its way lower into June before finding a meaningful bottom (which could mean the banks will find a bottom long before the broader market which is typical). It takes a rally above 275 to suggest a move at least back up to the February 1st high near 300.
5.2 U.S. Home Construction Index (DJUSHB), Daily chart
The home builders fought hard to get through the 200-dma and downtrend line from February 2007. Today's drop has the index back below both. The final rally leg from the March low looks like a good finish (5-wave move) to the bounce so it's entirely possible we'll see a move down to at least a minor new yearly low. I'm depicting a move down to the 216 area in May. Hard to believe, after the amount this index has dropped already, that it would be a 50% haircut from the April high. Assuming for now that this index will drop a little further, there remains the possibility that we'll get another bounce leg up to 500 in May instead. We won't know that until it tests its uptrend line from January.
5.3 Transportation Index (TRAN), Daily chart
I bolded the 200-dma on the chart to show where the pullback stopped today. The bulls would like to see this hold and drive back up in which case I continue to like the Fib and trend line at 5147 for a top to the corrective rally off the January low. It would be an excellent short play up there. A drop back below 4700 would likely spell trouble for the bulls (and likely have bearish implications for the broader market, at least into May).
6.1 U.S. Dollar (DXY), Daily chart
The US dollar appears to still be consolidating and potentially in a sideways triangle pattern. No change to my expectations for another, and should be final, leg down into May.
7.1 Oil Fund and Index (USO and OIX)
Oil Fund (USO), Daily chart
New highs for oil. USO is getting closer to the top of its parallel up-channel (didn't quite make it in March) so watch for potential resistance around 92. This could be the last leg up for its rally. There is the potential for a small consolidation before proceeding higher into the end of the month (green).
Oil Index (OIX), Daily chart
All those little white candles shows steady accumulation which obviously looks bullish. Like oil I'm thinking we'll see a small consolidation before pressing higher and I'm thinking it could make it up to the 900 area before potentially topping out. There would be a lot more bullish potential if it can rally higher than 900 (and its previous high in January).
7.2 Gold Fund (GLD), Daily chart
Gold is clearly not as bullish as oil and that has me wondering whether the oil rally is more a sign of an expected longer-term shortage in oil (peak oil and all that) or is instead more speculation going on. There's currently not a shortage since inventory levels are high and demand is down but there could be a lot of hedging by major organizations to lock in current prices (by buying futures contracts) in case oil continues to press higher.
On the gold chart I made the 50-dma bold since that could cause trouble on Thursday for gold bulls so be careful if long the metal here. The price pattern still supports the idea we've seen a major high in gold for a while so a continuation lower, in a very swift decline, is the bearish potential here.
9.0 Summary and Key Trading Levels
If the market is in one big treading-water pattern here, since the January low, there is going to continue to be some very ugly trading. All the choppy and whipsaw price action we've seen since January could continue into late May/early June. Keep your powder dry if you haven't done well in this environment--maintain your capital base for better trading days. You'll have plenty of opportunities to trade a trend once one reestablishes itself.
If you like to play the short side I see some potential setups next week if the market can rally a little further into opex. If it instead drops lower from here, and breaks the key levels to the downside, I'm not sure yet whether it will continue to be a very choppy move or instead will be the signal that we've started the next big leg down. I'm not ready yet to jump on the idea of the start of a big leg down from here so hold your fire on that.
Long-only players in my opinion have a tough market here (actually both sides do). If the market continues higher from here, or after a morning dip on Thursday, I would look to buy the dips but only if you can watch the market intraday. I still believe surprises will be of the nasty variety and this market has shown the ability to move several hundred DOW points in the blink of an eye. Remember, we have no up-tick rule so selling can get carried away very quickly.
One bearish signal I see is from what the VIX chart is now showing:
Volatility Index (VIX), Daily chart
I mentioned last week that we could see the VIX drop down to its uptrend line from last June, near 21.30 and it did that on Monday. A bounce in the VIX from here would obviously mean bearish things for the stock market.
We're approaching opex week and as mentioned earlier, the Thursday prior to opex week is often a head-fake day and usually the head fake has been to the downside. This has typically been followed by a rally into opex. I've got Fibs and trend lines that support this expectation. If only that VIX weren't bouncing...
Good luck in this market and I'll be back with you next Wednesday.
Key Levels for SPX:
Key Levels for DOW:
Key Levels for NDX:
Key Levels for RUT:
Play Editor's Note: We mentioned DELL as a potential short play under $18.80. The stock lost another 1.6% today and closed under the $18.80 level on HUGE volume. This looks very bearish. We would add it to the newsletter as a bearish play but just ran out of time tonight. These are new multi-year lows so it's hard to pick a target. We would probably choose a target in the $16.00-15.00-13.00 region. The P&F chart points to a $7.00 target for DELL.
New Long Plays
New Short Plays
Long Play Updates
DuPont - DD - close: 49.04 chg: -0.42 stop: 46.95
There is nothing new to report on for DD. Shares traded flat to down during the market's decline on Wednesday. Should DD turn lower we can expect support near $48.00. We are going to suggest readers buy dips near $48.00 but you might want to raise your stop loss to reduce your risk. Our target is the $52.50-54.00 zone. We don't want to hold over the late April earnings report. FYI: The Point & Figure chart has a bullish triple-top breakout buy signal and a $63 target.
Picked on April 02 at $48.84
Energen - EGN - close: 66.74 chg: -0.06 stop: 61.69
Oil and natural gas continued to rally but EGN eventually succumbed to some minor profit taking. We suggest buying dips near $65.00 as a new entry point. Our short-term target is the $69.50-70.00 zone. If we have time we'll consider a secondary, more aggressive target above $70. The P&F chart is bullish and the upside target just jumped from $77 to $80. We do not want to hold over the late April earnings report.
Picked on April 07 at $64.65 *triggered
Corning Inc. - GLW - close: 25.30 chg: -0.81 stop: 23.65
GLW really under performed the market today with a 3.1% sell-off. Shares plunged right from the opening bell yet we could not find any specific news or catalyst that might explain the sudden weakness. At this point we would expect a dip to $25.00 and readers can use a pull back near $25.00 or even $24.50 as a new entry point for bullish positions but you may want to wait for a bounce first. We're listing two targets. Our first target is the $27.00 level. Our second target is the $29.00 level. We do not want to hold over the late April earnings report. FYI: Today's move over $26.00 has produced a brand new Point & Figure chart buy signal with a $39 target.
Picked on March 25 at $25.14
Honeywell - HON - close: 58.03 chg: +0.84 stop: 54.49
The $23 billion jet-engine deal we reported on last night helped HON out perform the market today. Shares spiked higher at the open today and while HON pared its gains traders were buying the dip this afternoon. We are not suggesting new positions. Our target is the $59.90-60.00 zone. More aggressive traders could aim for the top of the larger range near $62.00. Keep in mind that we do not want to hold over the April 18th earnings report.
Picked on March 25 at $56.00
Hormel Foods - HRL - close: 41.94 change: -0.11 stop: 39.85
HRL essentially spent the session trading sideways. We would expect a dip toward $41.50 at this time. Right now our stop loss is at $39.85 but we're thinking about raising it toward $41.00 or even $41.50ish. Our target is the $45.75-46.00 range. We anticipate holding this stock on the newsletter for about six to eight weeks. The Point & Figure chart is bullish with a $64 target. FYI: HRL declared a quarterly cash dividend of 18.5 cents per share payable on May 15, 2008 to shareholders of record on April 19th. HRL has been paying quarterly dividends for almost 80 years.
Picked on March 31 at $41.83 *triggered/gap open
iShares Telecom - IYZ - close: 23.78 chg: -0.49 stop: 22.89
IYZ has taken a turn for the worse with a 2% drop today. We would expect a pull back toward $23.50 probably $23.40. A bounce from the $23.50 region can be used as a new entry point for bullish positions. We have two targets. Our 1st target is the $25.85-26.00 range. Our second target is the $27.85-28.00 zone.
Picked on March 25 at $23.50 *triggered
Coal ETF - KOL - close: 41.17 change: -0.72 stop: 38.45
Coal stocks experienced some profit taking today. We're still waiting on a deeper pull back in KOL. Currently we're suggesting readers buy a dip in the $40.00-39.50 zone. If triggered at $40.00 our target is the $44.75-45.00 range.
Picked on April xx at $xx.xx <-- see TRIGGER
Agribusiness ETF - MOO - close: 57.20 chg: -0.54 stop: 53.95
MOO also hit some profit taking today but we expect more to come. Our plan calls for investors to buy a dip in MOO in the $56.00-55.00 zone. If triggered our target is the $59.85-60.00 range. The Point & Figure chart is bullish with a $72 target.
Picked on April xx at $xx.xx <-- see TRIGGER
Nintendo Co - NTDOY - close: 66.85 chg: -0.25 stop: 63.95
NTDOY continued to slip but is still trading above its bullish trend of higher lows. A bounce from here can be used as a new bullish entry point. Our target is the $74.00-75.00 zone. Keep in mind that NTDOY is traded as an ADR here in the United States and shares will gap open up or down every day as they adjust to trading overseas. FYI: Some quote services might ask you to use the symbol NTDOY.PK to pull up data on NTDOY.
Picked on April 07 at $68.50 *triggered/gap open
Short Play Updates
Amgen - AMGN - close: 41.59 change: +0.10 stop: 42.55
Hmm... today's action in AMGN wasn't what we had in mind. The BTK biotech index,
which had grown overbought, hit some heavy profit taking with a 2.8% sell-off
today. AMGN bucked the trend in the sector and posted a gain. We remain bearish
on AMGN with the stock under $42.00 but today's relative strength is a surprise.
Readers might want to wait for a move under $41.20 before initiating short
positions. There is potential support in the $39-40 zone but our target is the
range. We do not want to hold over the late April earnings report.
Remember, we always consider biotech stocks higher-risk and aggressive plays.
These stocks are very sensitive to headline news. You almost never know when the
next FDA decision or clinical trials results will come out and they could send
the stock gapping higher or lower overnight, which would make our stop losses
Picked on April 08 at $41.49
Cognizant Tech - CTSH - cls: 27.83 chg: -0.69 stop: 30.26 *new*
CTSH dropped again, this time with a 2.4% loss. The MACD on the daily chart has rolled over into a new sell signal. We are adjusting the stop loss to $30.26. Our first target is the 26.25-26.00 zone. Our second, more aggressive target is the $24.25-24.00 range. The P&F chart is bearish with an $18 target.
Picked on March 30 at $29.18
Freddie Mac - FRE - close: 24.83 chg: -0.63 stop: 29.35
The potentially bullish Citigroup news last night failed to buoy the financials. FRE lost 2.4% and broke down under the $25.00 mark. One of our suggested entry points for shorts was $24.90. The play is now open. At the moment we have a VERY wide, aggressive stop loss and readers may want to consider a tighter stop. Our first target is the $20.50-20.00 zone.
Picked on April 09 at $24.90 *triggered
Longs Drug Stores - LDG - cls: 38.16 chg: -0.87 stop: 41.31*new*
Target achieved. LDG lost another 2% today and shares hit our first target in the $38.25-38.00 range. Technicals continue to deteriorate but the stock is nearing potential support at its March lows. We should expect a potential bounce in the $37.50-37.00 region. Please note we're adjusting the stop loss to $41.31. Our second target is the $35.25-35.00 zone. The P&F chart is bearish with a $29.00 target.
Picked on March 30 at $41.30 /1st target hit 38.25
Closed Long Plays
Meritage Homes - MTH - close: 19.49 chg: -1.41 stop: 19.49
We have been suggesting that readers take profits in MTH for the last several days. Hopefully you were able to lock in a gain near $22.00. We had adjusted our target to $24.75 but the closest MTH got was $24.49 on April 3rd. Shares of MTH hit our stop loss at $19.49 today ending the play.
Picked on March 24 at $18.60 *triggered
Closed Short Plays
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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