Option Investor

Daily Newsletter, Tuesday, 1/5/2010

Table of Contents

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

Market Wrap

Cracks In Market Armor

by Jim Brown

Click here to email Jim Brown

Monday's big rally gave back some ground intraday as cracks began to form in market support. However, the buyers stepped in once again and brought the indexes back to level before day's end.

Market Stats Table

After a +155 gain on the first trading day of the year we should not expect much on the second day. Monday's rally came on low volume and today was not much better although a two week high. Not all traders are back to work and there is no conviction ahead of the Non-Farm Payroll report on Friday. Today's conflicting economics did not help in convincing traders that better times are ahead.

The first piece of negative news came from a -16% drop in the pending home sales for November. This is a lagging report but it was still a major decline and much stronger than analysts expected. The pending home sales index fell to 96.0 from October's 114.1 reading. This was the largest one-month decline on record. The level of sales fell back to levels not seen since June/July. The drop in sales ended a nine-month string of consecutive increases.

Sales still rose +15.5% over November 2008 but nobody was buying homes last November because nobody could get a loan. Sales were boosted in Sep/Oct by the homebuyer tax credit and buyers raced to make purchases before the November cutoff. The credit has since been extended but apparently there was a sell forward effect that moved sales into the Sept/Oct period. Since this index tracks contract signings and not closings it makes sense that few buyers waited to sign a deal in November when they knew it had to close in November. With financing a struggle buyers signing a contract after October would have likely been unable to close in November. The new homebuyer credit program only requires that a contract be signed before May 1st. That should make March and April home sales rather brisk.

Pending Home Sales Chart

Auto sales came in at a 11.2 million annual rate for December compared to analyst estimates for 10.8 million. However for all of 2009 sales totaled 10.4 million units and the lowest on record since 1982. Sales were down -21% below 2008 levels. All of the improvements in December sales came from autos with truck sales flat. Ford was the standout performer with a market share increase to 17% in December from 15.9% in November. You may remember that market share was 24% at the beginning of the decade. Ford sales increased +23.3% in December and Toyota +23%. Chrysler sales fell -10.5%.

GM saw sales fall -12.8% for December and this was much weaker than analysts expected. GM sold 208,511 cars and trucks in December. They have about 385,000 vehicles in inventory and the VP of sales said that was about a four-month supply at current sales rates. They only have 900 Saturn cars and 700 Pontiacs left as they wind down and discontinue those brands. If you want one they have cut prices to dealers by nearly 50%. To say they were giving them away would almost be true. GM is moving to four brands from their prior eight brands. Hummer sales declined by -85%, SAAB -26.4%, Saturn -59%, Pontiac -49% and Buick bucked the trend with a rise in sales of +37%. GM was forecasting 2009 sales in the auto sector to be in the range of 10.6 million units. This is below the 10.8-10.9 million analysts were expecting but everyone was well above the actual number at 10.4 million.

On the positive side Factory Orders for November rose +1.1% and nearly double the +0.6% rate in October. This was still slightly less than the +1.5% increase analysts had anticipated. However nondurable goods orders rose +1.8% for the month. The report showed a continued improvement in the manufacturing sector but the pace of improvement is at a snails pace. Both consumer goods and capital goods showed small gains. Business investment is expected to decline slightly in early 2010 as the initial impact of stimulus fades.

Reports due out on Wednesday include Mortgage Applications, Challenger Employment, ISM Services, Oil and Gas Inventories and FOMC minutes for December. By far the most important is the FOMC minutes. With everyone worried about when the Fed will begin to raise rates this could be a highly volatile release.

The biggest report for the week is still the Non-Farm Payrolls on Friday. Estimates are all over the board and have been changing daily. Over the weekend I reported that analysts were expecting a gain of 25,000 jobs but that has now changed to a consensus decline of -23,000 jobs. Regardless of the estimate the actual number reported on Friday will be extremely important. A positive number means the Fed is that much closer to raising rates. Another job loss puts the Fed months farther out into the future on rates. Because of seasonal factors the January and February reports are expected to show strong losses. A positive report on Friday could change the perception of those reports and the outlook for Fed action.

In stock news Google unveiled the long awaited super phone. The new phone is a slimmer, lighter iPhone clone but uses the Android operating system. Despite good reviews the phone is not expected to be a game changer to anyone but existing Android phone makers. The new phone will retail at $529 unlocked and ready to run on any network. It will be offered on T-Mobile for $179 for a two-year contract. Google hopes the Nexus One can compete with the iPhone but nobody expects it to make a big dent in Apple's popularity. There will also be Verizon and Vodaphone versions available in the spring.

Some view it as more of a pocket PC than a smart phone. The Android system is now running on more than 20 phones from vendors including Motorola and Samsung. Phones using the Android operating system now account for more than 25% of the phone data traffic with the iPhone just over 50% today. The Android phones have only been out a little less than a year and they are rapidly gaining market share. Now that Google has created their own phone they are actually in competition with other vendors using the Android operating system. If you are a minor phone maker using Android you have to wonder when Google will start restricting usage or upgrades to give the Google phone a marketing edge. The lukewarm anticipation of the phone appears to have slowed Google's momentum over 620.

Google Chart

Goldman Sachs was in the spotlight after Meredith Whitney lowered her earnings estimates on Goldman for the second time in three weeks. Must be tough to have a new business and no clients and you have to resort to constant highly visible upgrades and downgrades to attract attention. Whitney cut her estimates for Q4 to $5.50 per share from $6. She also cut fiscal years 2010 through 2012. It should be noted that her estimates are still above the street consensus of $5.43 for Q4. Goldman was up +2.5% before the Whitney downgrade and nearing $176. After the cut Goldman fell to near $173 but recovered quickly to close at the high for the day. Apparently people are paying less attention to Whitney's weekly announcements. Another analyst said he would use the downgrade as a buying opportunity whenever Goldman neared its 50-day average currently at $170. Yet another analyst, Douglas Sipkin at Pali Research, called Goldman the "most attractive stock in the banking universe." Goldman reports earnings on January 21st at 7:30 ET.

Goldman Sachs Chart

Goldman was also in the news with an upgrade on the chemicals sector. Deutsche Bank upgraded the refining sector and Credit Suisse upgraded the fertilizer sector. Credit Suisse said they were raising ratings on Potash (POT) to outperform from neutral based on new contracts with Chinese firms. These contracts will put a floor under prices and provide a base for prices elsewhere to move higher. The analysts also said that existing inventory had been consumed last year and needed to be restocked. They like POT best of the fab five but she also upgraded Agrium (AGU) and Intrpid Potash (IPI). No comments on Mosaic (MOS) and Bunge (BG).

Mosaic (MOS) reported earnings after the bell and it was not pretty. Mosaic missed estimates for the fifth time in six quarters. They reported a 24-cent profit, 32-cents excluding charges. Analysts were expecting 35-cents per share. Mosaic said it lost $22.6 million in currency translation during the quarter. Sales declined -43% to $1.71 billion. That was slightly above analyst estimates of $1.68 billion. CEO Jim Prokopanko said he was confident in the long-term demand as the recovery continued. Prokopanko said nutrient depleted soils in the U.S. was driving increased sales of potash fertilizer. Shares were volatile after the close but ended the session flat.

Chart of Mosaic

AT&T and Accenture have already abandoned the Tiger Woods entourage but Electronic Arts (ERTS) said today they were sticking with the disgraced sports star. "We entered the relationship with Tiger in 1997 because we saw him as the world's best, most talented and exciting golfer. He has made some mistakes off the course but he is still one of the greatest athletes in history." The said their Tiger Woods online game has been in closed beta test for eight months with more than 75,000 people playing the game. It is reportedly a "breakthrough experience" in online gaming. Let's see, does the fact that they have millions tied up in development of this online game affect their decision to "stand beside" Tiger? Do fish swim?

Crude prices rose to $82 intraday as retirement money flowed into commodity funds. However, there are signs of trouble ahead. The API inventory report after the close showed that gasoline stocks rose by 5.6 million barrels in the week ended on Jan-1st. They also said oil supplies declined slightly but I expect that will be the last report for several weeks that will show a decline. Prices dropped in after hours after the report but the decline was muted. Wednesday's EIA inventory report is the one that moves the crude market. Since it is for the week ended Jan 1st it may not show a big gain but I am betting that next week's report is a blockbuster.

We are also facing the annual rebalancing of various commodity indexes on Friday. This rise in crude prices could be an advance shift on the expectations that oil will be a larger weighting in the new index ratios.

Crude Oil Chart

The market rally late in the day really came on the rebound in financials driven by the intraday rebound in Goldman Sachs. The financials have rallied both days this week but they are reaching a level where we are either going to see a major breakout or another failure at resistance. The Bank Index (BKX) rebounded from Thursday's ugly close to a dead stop just under $45. A break over $45 would be very bullish and a market leading event.

Banking Index Chart

Despite the nearly flat close I thought it was a bullish recovery on bad news. The housing market took a serious hit with the pending home sales but the Housing Index rallied over +1% to close just shy of a breakout. For two days financials and homebuilders have done well. Historically the first 2-3 days of January are bullish due to the inflows of retirement cash. So far the scenario is going according to plan. Obviously some of that retirement cash is find its way into banks and housing. That suggests we may have seen the bottom in those sectors. Both declined over the last couple months but both are now on the verge of a breakout. It appears a violent trend change is about to appear.

Housing Index Chart

I view the new high on the Dow as right on schedule with the scenario I laid out a couple weeks ago calling for a minor new high on the indexes in the first couple days of January and then a decline. Last weekend I had modified that thinking a little and thought maybe the new high last week could have been that false breakout I was expecting. The high on the Dow this week was about 24 points over last Tuesday's high at 10580. Only 24 points on an index that large is only a blip on the screen and not a major change in the trend.

However, the VIX is now suggesting a change and the change could be violent. The VIX closed at 19.35 and 17.18 on the VXO. That is the old version of the VIX. At 19.35 that is the lowest level of volatility since August of 2008. You might remember that period since it was about a week before the markets unexpectedly fell off the cliff. The Dow was trading around 11,700 and the markets were calm. Analysts were talking about a rebound from the subprime problem just before the various news events exploded in their face.

I am not expecting any specific news event. I am simply warning that the VIX under 20 and the VXO under 18 are serious warning signs of strong complacency. The number of newsletter writers with a bearish outlook is at a ten year low. Everybody in the market is expecting a continued rally ahead. I do too but just not in the very short term.

VIX Chart

VXO Chart

I may have to change that view if conditions continue to improve. I view the Dow rebound on Monday from that drop to 10424 on Friday as a strong bullish event even though it was probably mostly short covering and retirement cash flows. That was a strong bounce regardless of the reason.

For me to change my stripes I would need to see it hold these levels until Friday and then move sharply higher on the jobs data. The Dow does not have any meaningful resistance until just over 10750 so it has plenty of room to run. Support is 10525 and it was tested twice on Tuesday. A break under 10500 would have the bears sharpening their claws.

Dow Chart

The S&P chart is much more bullish than the Dow. The S&P closed at a new high on Tuesday and is clearly in breakout mode if it can hold the gains for the rest of the week. Support at 1115 was tested on Friday and the rebound was very bullish.

However, remember, this is mostly year-end retirement inflows to index funds. These flows will cease over the next 24-28 hours. What happens after that is the key.

S&P-500 Chart

The Nasdaq blasted out of its three-day slump on Monday and is so far above its prior pattern that it is no longer relative. Current support should be the fib retracement at 2251. Tech stocks are in favor despite the fractional gain today. Just holding the big gains from Monday is bullish. It is however very over extended. The Nasdaq seems to like stretching 8-10 days of gains together before it rests. Just on the chart below there are five periods where gains ran for long strings before resting. Watch 2251 as support and a break below that level indicates a trend change.

Nasdaq Chart

In summary the markets are defying gravity on inflows into index funds from retirement accounts. When that cash flow ends the markets will be on their own to find direction. With multiple sectors being upgraded every day the bullish outlook for the economy is increasing. The FOMC minutes on Wednesday and Payrolls on Friday will either confirm or refute that current outlook. If you are long I would keep your stops tight in case the normal end of the first week of the year profit taking appears.

This is absolutely the last day to take advantage of the End of Year Special. We only have about seven DVD sets left and the offer will be removed from the website tomorrow. This is the lowest price for the year and you get the free gifts. Last chance!

Only one profitable trade or a vital piece of information in a market commentary can pay for the entire years subscription.

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Jim Brown

New Plays

Diversified Electronics

by James Brown

Click here to email James Brown


Vishay Intertechnology - VSH - close: 8.74 change: -0.02 stop: 8.20

Why We Like It:
VSH makes a number of different electronic components including semiconductors, infrared emitters and detectors and more. The stock is in a bullish trend and should stay that way with global manufacturing on the rise. Currently shares are in a sideways consolidation. I'm suggesting readers open small bullish positions with a trigger to buy the stock at $8.85. If triggered we'll use a stop under the current trading range. I say "small" positions because I'm still concerned that the market could see a correction in January and we want to keep our exposure down. If triggered our first target to take profits is at $9.95.

Annotated chart:

Entry on   January xx at $xx.xx <-- TRIGGER @ 8.85 (small positions)
Change since picked: + 0.00
Earnings Date 02/09/10 (unconfirmed)
Average Daily Volume: 1.1 million
Listed on January 05, 2009

In Play Updates and Reviews

A Handful of New Stops

by James Brown

Click here to email James Brown

The market's late day bounce appeared to be strongest in the big caps. We're updating four stop losses.

BULLISH Play Updates

Bank of Hawaii - BOH - close: 46.95 change: -0.11 stop: 46.25

The banking sector was one of the market's best performers today. Seeing relative weakness in BOH today is definitely bearish. The stock is hovering above previous resistance and what should be support near $46.50. A bounce from here could be used as a new entry point but investors might do better with a faster moving bank stock than BOH. Our target to exit is $49.85.

Entry on  November 18 at $46.20 
Change since picked: + 0.75
Earnings Date 01/25/10 (unconfirmed)
Average Daily Volume: 424 thousand
Listed on November 17, 2009

EMCOR Group - EME - close: 27.32 change: -0.56 stop: 25.75

EME ran into some profit taking with a sharp 2% decline and on above average volume, which should put bullish traders on alert. The move was sparked by an analyst downgrade. There is no change from my prior comments. No new positions at this time. The Point & Figure chart is bullish with a $42 target. I'm listing our first target at $29.85. Our time frame is several weeks.

Entry on  December 21 at $27.18 
Change since picked: + 0.14
Earnings Date 02/25/10 (unconfirmed)
Average Daily Volume: 514 thousand
Listed on December 21, 2009

Home Depot - HD - close: 28.88 change: +0.21 stop: 27.75

HD dipped toward its 30-dma and bounced. Unfortunately if you look at an intraday chart (like a 30-minute chart) it looks like the oversold bounce is stalling at resistance near $29.00. At this time I'm still expecting a dip to the $28.00 level. Our first target is $30.60. Our second target is $32.45. We'll plan to exit ahead of the February earnings report. FYI: The P&F chart is very bullish with a $44 target.

Entry on  December 14 at $28.82 *gap higher entry  
Change since picked: + 0.06
Earnings Date 02/23/10 (unconfirmed)
Average Daily Volume: 15.7 million
Listed on December 12, 2009

Hologic Inc. - HOLX - close: 14.94 change: +0.00 stop: 14.40

HOLX is still hovering near resistance at $15.00 and shares closed unchanged on the session. I am suggesting a trigger to buy HOLX at $15.15. If triggered our first target is $16.45 although we'll have to keep a cautious eye on the 100-dma, which could be resistance. I would keep positions small. There is still a chance for the market to correct in January.

Entry on   January xx at $xx.xx <-- TRIGGER @ 15.15  (small positions)
Change since picked: + 0.00
Earnings Date 02/01/10 (unconfirmed)
Average Daily Volume: 2.7 million
Listed on January 04, 2009

Potlatch Corp. - PCH - close: 32.27 change: +0.13 stop: 30.45

PCH is still trading sideways. If almost looks like another bull-flag pattern. I remain very cautious on PCH and I'm not suggesting new positions. Our first target to take profits is at $33.60. Our second target is $35.75. No new positions at this time.

Entry on  November 16 at $30.30
Change since picked: + 1.97
Earnings Date 02/11/10 (unconfirmed)
Average Daily Volume: 503 thousand
Listed on November 11, 2009

Renolds American - RAI - close: 53.30 change: +0.06 stop: 51.75 *new*

It looks like RAI is still in hibernation mode. The stock has been trading sideways for weeks. I am adjusting our stop loss to $51.75. I am not suggesting new positions at this time. Our target to exit is $54.90. More aggressive traders may want to aim for the $56.50-57.00 zone.

Entry on  November 14 at $50.32 
Change since picked: + 2.98
Earnings Date 02/11/10 (unconfirmed)
Average Daily Volume: 1.6 million
Listed on November 14, 2009

Starbucks Corp. - SBUX - close: 23.59 change: +0.54 stop: 21.75

SBUX displayed some relative strength with a 2.3% gain. The stock actually spiked to resistance near $24.00 intraday. I didn't see any specific news behind the rally. I'm not suggesting new bullish positions at this time. Our target to exit is $24.90.

Entry on  December 10 at $22.25
Change since picked: + 1.34
Earnings Date 01/28/10 (unconfirmed)
Average Daily Volume: 10.9 million
Listed on November 30, 2009

Sonoco Products - SON - close: 30.49 change: +0.44 stop: 29.20 *new*

SON is showing strength and the stock broke out to new 52-week highs. Volume was above average, which is a good sign. This looks like a new entry point but I am raising our stop loss to $29.20, just under last week's low. Our first target is $34.50.

Entry on  December 26 at $30.31 
Change since picked: + 0.18
Earnings Date 02/04/10 (unconfirmed)
Average Daily Volume: 343 thousand
Listed on December 26, 2009

Steel Dynamics - STLD - close: 18.18 change: -0.11 stop: 17.49

The rally in steel stocks stalled today. We're waiting for a breakout past resistance. I am suggesting a trigger to open small bullish positions at $18.75. I'm suggesting small positions because this sector can be volatile and we're still at risk for a market correction in January. If triggered at $18.75 our first target to take profits is at $19.95. Our second target is $21.50.

Entry on   January xx at $xx.xx <-- TRIGGER @ 18.75 (small positions)
Change since picked: + 0.00
Earnings Date 01/26/10 (unconfirmed)
Average Daily Volume: thousand
Listed on January 04, 2009

Seagate Technology - STX - close: 18.52 change: -0.37 stop: 17.45 *new*

STX managed a new high this morning and then reversed. Volume was way above average and that makes me a little nervous. Investors could be selling into strength to get out. I am raising our stop loss to $17.45. Our target is $19.75 as the $20.00 level will probably act as round-number, psychological resistance. We will plan to exit ahead of the mid January earnings report. The plan was to keep positions small to limit our risk.

Entry on  December 19 at $17.83 /gap open higher (small positions)
Change since picked: + 0.69
Earnings Date 01/19/10 (unconfirmed)
Average Daily Volume: 8.2 million
Listed on December 19, 2009

Texas Instruments - TXN - close: 25.86 change: -0.15 stop: 25.45 *new*

Once again I'm concerned about relative weakness in TXN. I am raising our stop loss to $25.45. If TXN does not close above $26.00 tomorrow we'll drop it as a bullish candidate. Don't get me wrong, the larger trend is still very bullish but short term I'm concerned the stock could see a correction. I'm not suggesting new positions. Our target to exit is $29.75.

Entry on  December 02 at $26.15
Change since picked: - 0.29
Earnings Date 01/26/10 (unconfirmed)
Average Daily Volume: 12.6 million
Listed on December 01, 2009

iPath VIX ETN - VXX - close: 32.09 change: -0.62 stop: 31.99

Odds are really good that we're going to get stopped out of the VXX tomorrow. Last week's rebound looked like a bullish reversal. I think we may have been a few days early. Aggressive traders may want to keep a bullish position open over the jobs report announcement on Friday.

Currently our target to take profits is at $39.50. FYI: The VXX is an exchange traded note (ETN) that tries to duplicate the performance of the Volatility index (VIX) through exposure to short-term vix futures.

Entry on   January 02 at $33.22 (small positions)/gap down entry
Change since picked: - 1.13
Earnings Date --/--/--
Average Daily Volume: 1.6 million
Listed on January 02, 2009

Warner Chilcott - WCRX - close: 28.50 change: -0.45 stop: 27.95

Traders took some money off the table in WCRX today. I'm suggesting our readers do the same. I am not suggesting new positions at this time. Our first target has been hit at $27.40. The newsletter is planning to exit at $29.45.

Entry on  December 01 at $24.77 gap open entry point (small positions)
Change since picked: + 3.73
/1st target hit @ 27.40 (+10.6%)
Earnings Date 02/25/10 (unconfirmed)
Average Daily Volume: 1.8 million
Listed on November 28, 2009

Wright Express Corp. - WXS - close: 32.88 change: -0.44 stop: 30.95

Traders bought the dip near $32.30 this morning and the intraday bounce in WXS looks like a new bullish entry point.

Our target is $35.90. I'm setting a longer-term target at $39.50 but we want to sell the majority of our position at $35.90. We will plan to exit ahead of the February earnings report.

Entry on  December 21 at $32.30
Change since picked: + 0.58
Earnings Date 02/10/10 (unconfirmed)
Average Daily Volume: 209 thousand
Listed on December 19, 2009

Wyndham Worldwide - WYN - close: 20.71 change: +0.43 stop: 19.90

Hmm... WYN is bouncing right where it's supposed to near support at $20.00. Today's gain appears to have broken the two-week trend of lower highs. Readers could use this move as a new entry point with a stop close to $20.00. Our first target has already been hit at $21.00. We're currently aiming for $22.40. The plan was to use small positions (1/2 a position).

Entry on  November 10 at $18.88 (1/2 position) /gap open higher
Change since picked: + 1.83
/1st target hit @ 21.00 (+11.2%)
Earnings Date 02/11/10 (unconfirmed)
Average Daily Volume: 3.5 million
Listed on November 10, 2009

BEARISH Play Updates

Best Buy - BBY - close: 41.21 change: +1.02 stop: 41.26

Retail stocks delivered a bounce today but I remain cautious on them. BBY out performed its peers with a 2.5% gain. The close over $41.00 is short-term bullish. Yet I find it more than coincidence that the rally stalled right at its old trendline of prior support. There is no change from my prior comments.

Use a trigger at $38.95 to open small bearish positions. I suggest small positions because the 200-dma just above $38 could offer some technical support. An alternative entry point would be a new failed rally near $41-42. We will consider adding to positions on a breakdown under $38.00.

Our first target is $35.25.

Entry on   January xx at $xx.xx <-- TRIGGER @ 38.95
Change since picked: + 0.00
Earnings Date 03/25/10 (unconfirmed)
Average Daily Volume: 8.0 million
Listed on January 02, 2009

Jacobs Engineering - JEC - close: 38.96 change: +0.51 stop: 39.26

This is the moment of truth for JEC. The stock has rallied straight to resistance near $39.00 and its 50-dma. We should see a bullish breakout or a bearish reversal tomorrow. If we see the reversal lower I'd use it as a new entry point for bearish positions.

Our first target is $34.05. Our second target is $30.25. I'm tempted to hold over the company's earnings report in late January.

Entry on   January 02 at $38.10 /gap higher entry
Change since picked: + 0.86
Earnings Date 01/26/10 (unconfirmed)
Average Daily Volume: 2.2 million
Listed on January 02, 2009


Disney - DIS - close: 31.99 change: -0.08 stop: 31.70

It looks like investors were not impressed by news that DIS's EPSN channel would start broadcasting certain events in 3D for the new 3D televisions. Shares of DIS dipped to $31.70 this morning, which was just enough to tag our stop loss.


Entry on  December 12 at $31.70 
Change since picked: + 0.00 <-- stopped @ 31.70
Earnings Date 02/09/10 (unconfirmed)
Average Daily Volume: 11.0 million
Listed on December 12, 2009