InvestmentHouse Weekend Update:
investmenthouse.com
TONIGHT:
- Market takes a breather ahead of weekend after a strong surge.
- Economic data continues to erode as sentiment hits decade low.
- Waiting for a follow through session if it will come.
- Subscriber Questions
Market pauses ahead of weekend.
The market range traded Friday with no real direction ahead of the weekend. The big rally took some of the war premium out, and after shorts covered and the longs got some pent up demand out of their system no one was ready to short, cover, or go long Friday in the absence of anything new related to the war other than more indecision. Volume was above average again though lower as the indexes closed basically flat. The market was spent after the upside binge, needing a rest. If it is going to hold up it will need to take a breather anyway, and it started to do that Friday.
THE ECONOMY
PPI up on energy costs, down otherwise.
Producer prices rose 1% versus a 1.6% January increase. That continued the increase in prices that manufacturers pay for the goods they use to make their products. Without energy prices, however, prices fell 0.5% after the core prices showed a 0.9% rise in January. Oil prices rose 7.4%, gas prices surged 18.8%, and heating oil spiked 25.2%. The data indicate that rising commodity prices are still posing a threat to inflation though of late it is focused in the energy sector. As we have been discussing, however, that poses some of the greatest risk to the economy both from the producer and consumer side.
Michigan sentiment hits 75.0, lowest in 10 years, down from 79.9 in February. Current conditions fell to 87.1 from 95.4; expectations fell to 67.2 from 69.9. After the 1.6% drop in retail sales announced Thursday, the lower confidence was no real surprise. Housing continues on its own momentum, but that is primarily run by refinancing at this stage. It cannot carry the load by itself, and without some catalyst to induce spending the economy is going to continue to struggle.
Many competing forces.
The economy hangs in the balance right now with several undercurrents, some positive, some negative. Higher energy prices, a flagging consumer, and a pre-war standstill are heavy drags. A continued budding recovery in business spending holds the most promise, and there are those that believe that a quick war resolution will allow them to resume their spending. Heck, there might even be some pent up demand according to some economists.
That would certainly be nice, but there needs to be a big shot of spending as opposed to a resumption of the meager and tentative buying seen thus far. Congress is haggling over the economic package with two current competing lined of thought. The first is almost too good to be true. It is championed by the head of the senate budget committee and it preserves the entire economic package while making cuts to the proposed budget. Instead of a budget increasing by 4%, it reduces spending by 1%. Not huge but it is exactly the direction an overspending government needs to take.
The second is the familiar, static view taken of the economy. They are saying that the economic package has to be cut in half and there is no call to cut spending. They want more revenue, but instead of taking action that would really boost economic output and thus tax revenue they view a dollar in tax cuts as a dollar in tax revenue lost. They refuse to consider that a growing economy generates more income subject to taxes and thus higher tax revenues. So they want to cut back economic incentives designed to grow our way out of trouble (and that is how every recession and deficit is ultimately defeated), afraid to really address the core problems of a slack economy and runaway government spending. The end result is an economic Viet Nam: instead of devoting the resources needed to win, you put in just enough to limp along. In the end you lose because there was no commitment. It is like buying defensive stocks in a raging bull market. In a strong bull you buy growth stocks that are surging, focusing your money on winners and making real money. You don�t buy those that grow 2% a year; you don�t get where you need to go, or at least you limp along taking much longer than need be.
ECRI notes the problems in the economy.
The weekly ECRI readings (a faster and broader measure of leading economic indicators) fell to a 9-week low last week. By the ECRI measure the economy is at a critical juncture (we came to that conclusion by a different route) with the length of a war with Iraq and how long energy prices remain higher. ECRI believes that if a war lasts longer than �a month or two� that would mitigate any positive effects of getting the war over. ECRI also puts Asia and Europe at the tipping point of a recession. If the US re-enters recession, that is the type of shock that would send them down. After all, without US consumption there is not much propping those economies up.
We won�t go into what a global recession would do. The trade deficit is a big issue at that point that would come back to bite us. The currency market would be a problem for everyone, but particularly the US with all of those foreign dollars coming home as foreigners sell US investments. That would add inflationary pressure in the US as more dollars would be coming home to chase the same amount of goods. With a slack economy to sop them up, those excess dollars would really increase the already present risk of stagflation. We need to be very careful here, but there is no focus on this. Bush is trying to eliminate overseas threats and then focus on the economy. Regardless of which economic plan is favored, it needs a strong force in D.C. to push it. Hopefully after Iraq it will get that strong force behind it.
THE MARKET
The indexes hit a new low for the year with the DJ30 and SP500 undercutting their July 2002 closing lows (DJ30 blew out all July prices), and coming within a few whiskers of the October closing lows. The immediately, however, reversed and shot higher. They did not just rally, they shot higher. Volume surged to levels not seen in months, hitting volume highs for the year.
Nasdaq hit a new low for the year, but it held right at the February low, not coming close to the July or October lows. It played the role SP500 did back in October when the large cap index was the only major index not to give up its July low on the October close. Indeed, Nasdaq set up a short double bottom off the February low and blasted higher. It has yet to take out the early March high or the 200 day MVA, but it is a start. It has to lead; DJ30 and SP500 look horrid, still in bearish 8-month descending triangles. It is up to Nasdaq to lead them out.
It is still very early. The Nasdaq just killed off the last rally attempt when it undercut the February low. This rally that stared on the heels of the last failed rally still has to put together a follow through, a session of a 2% or better gain on very strong volume and breadth. It does not have to be a day as strong as Thursday, but it has to be strong. That could come as early as Monday, but we would prefer to see it Tuesday or Wednesday as that gives the market more time to rest and consolidate the move and it also would indicate less short covering and more longer term buying by institutions. Rallies start with short covering, but then long term buyers have to come in and pick up the torch to carry a rally. That is what the follow through that everyone looks for is. It is what gives a rally a chance to go further as it signals there is some more interest in the upside beyond the initial covering.
The small cap and mid-cap indexes need to come around as well, They are in worse shape than the other indexes as both have just made it back to the 18 day MVA. This is one reason we see (beyond the obvious) that the market has yet to forecast any economic recovery. Small cap and to a certain extent mid-cap stocks tend to perform better in the early stage of an economic recovery as their percentage gains in revenues far exceeds the plodding large caps that require hundreds of millions of dollars of revenue increases to show a significant percentage move. Thus investors move into those stocks early to take advantage of their strong early gains in a recovery. The fact that these indexes are lagging the large caps on this move is a signal that the rally thus far is based on short covering in beaten up large cap stocks. That is one reason follow through sessions have to show very strong breadth. Money has to be spread around the market as opposed to just covering up those stocks that have been shorted in their steep downtrends.
Market Sentiment
VIX: 36.33; +0.4
VXN: 45.8; +0.82
Put/Call Ratio (CBOE): 0.7; -0.05
Nasdaq
Rallied to the 200 day MVA on the high and then faded to close flat. A needed day of rest, but the real test is ahead.
Stats: -0.44 points (-0.03%) to close at 1340.33
Volume: 1.612B (-10.85%). Strong, above average volume, but lower than the nice gain Thursday. The market needs a few days of lower volume rest before trying to take out the next important resistance levels.
Up Volume: 675M (-982M)
Down Volume: 913M (+775M)
A/D and Hi/Lo: Decliners led 1.08 to 1. Breadth matched the session, relatively flat.
Previous Session: Advancers led 2.55 to 1
New Highs: 46 (0)
New Lows: 56 (-12)
The Chart: (Click to view the chart)
The Nasdaq is getting interesting, about the only index chart doing so. It is at the verge of making a higher high if it can clear the February tops (1353.31), tapping at that level on the Friday high (1352.84). That also marked the 200 day MVA (1351), a key resistance level that has stymied Nasdaq each time it has tested it for over a year. Obviously this is a key point for Nasdaq. Two or three days of lateral movement along the 50 day MVA (1330) on lower volume would be excellent. It would show the index is able to rally and hold its gains while some profits were taken and set it up for a follow through that would take it the next leg higher. Many of the large cap techs are still in downtrends and the SOX has components going both ways. It has to break over its 200 day MVA as well.
S&P 500/NYSE
Still deep in its downtrend, the large caps managed to hold over the 18 day MVA as it tries to consolidate the big move.
Stats: +1.37 points (+0.16%) to close at 833.27
NYSE Volume: 1.528B (-12.29%). Volume dropped as the large caps held steady. Still strong and above average, but good to see it fade as the index showed some need to consolidate.
Up Volume: 781M (-652M)
Down Volume: 709M (+402M)
A/D and Hi/Lo: Advancers led 1.25 to 1. Very even on a very even day.
Previous Session: Advancers led 2.62 to 1
New Highs: 43 (+3)
New Lows: 51 (-31)
The Chart: (Click to view the chart)
Rallied to 841.39 on the high, holding over the 18 day MVA (828), testing that level on the low. It was unable to hold most of the gain, falling short of the 50 day MVA (849; 858 simple). The move up was impressive as the large caps worked off some of the war premium from their steep downtrend. At this point, however, that is all it is. There is resistance at 850 from the February high and the 50 day MVA. That is the first in a series of resistance levels. We anticipate the large caps will again approach the 50 day MVA and stall. It will need the Nasdaq to hold up and then move through its resistance to drag the large caps along with them. It is important right now to keep things clear. The large cap index is in a serious downtrend and an overall bearish pattern. There are few large caps that are not in their own downtrends. That makes the 50 day MVA all the more key.
DJ30:
Blue chips are in their own downtrends as well, reflected in the ongoing DJ30 downtrend. Wednesday it was 135 points from the October closing low when it reversed and started the strong volume rally. DJ30 stalled out Friday at 7931, still below resistance at 8000 and the 50 day MVA (8009; 8108 simple). The next level after that is 8250. The list of resistance is a long one. It will need to make a series of runs and rests to be successful, the first resting period starting below the 50 day MVA.
Stats: +37.96 points (+0.49%) to close at 7859.71
Volume: 1.528B (-12.29%)
The Chart: (Click to view the chart)
THIS WEEK
We saw the market setting up for a move, in particular with Nasdaq showing some relative strength to the rest of the market and several stocks that continued to hold their patterns, refusing to give in and follow the rest of the market down. Before early last week when oil and gold rose and the dollar fell, the former had been falling while the latter had stabilized. That was another indication to us that the market was up to something. With the war premium being built in we felt that the market was ready to put together an upside move.
It has done that and now comes the nerve wracking period that follows the start of each rally attempt inside an overall downtrend. That is the period where the first move runs out of gas below some important resistance point and tries to consolidate the move. A necessary part of a rally attempt, but after a long downtrend that has seen rally after rally turned back, investors can get kind of nervous waiting for the move to continue. That can have a positive effect, however, as the short term buyers are shaken out. If the shorts are not interested in trying to sell the market again, the rally has a chance once the nervous buyers are gone.
As long as the market continues to move more or less laterally on lower volume for the next few sessions that is fine. That is good action after a strong move higher. It will then need to provide that follow through rally that will set up the potential for a further upside move. There will need to be strong stocks breaking higher at that time. Many of the stocks that were leading up to the rally were medical stocks, the defensive part of the market. They were not all defensive stocks, but there are not waves of stocks in great patterns just straining to race to new highs.
Thus we need to keep in mind that any rally could just be another bounce to a higher point in the downtrend. There are those convinced it is just that and there are those that hope it is something that leads the market out of the bear. Who do you believe? You believe what the market is telling you. That is why we were not getting into downside plays the last week or so before the reversal; the market was showing indications something bigger to the upside was coming. Even if it is not the move that ends the bear market (I would love to see a poll of investment gurus to see which ones if any are going out on a limb on that one) it was worth starting upside positions, and if it consolidates here at resistance and then moves through that resistance it is definitely playable just as the rally from the October low was playable up through November and made us a lot of money. Do you not play that move just because you believe the move won�t last? Not in this market. If a strong move either way sets up, try to grab onto it.
Thus you play the tradable moves as they set up, and this one thus far has set up. It needs to take it to the next level, but we think the chances are better than not that it will try a further move. Call it a war rally (pre-war) or whatever, but we were looking for a move up when the war was a reality given the selling done in anticipation of the war. That may be all we get before it turns south again in the harsh light of high oil prices, North Korea, terrorism, a weak economy. We will take, however, what the market gives us.
This week we will look for stocks that set up and give us a buying opportunity while we look for the market to consolidate and then provide a follow through. There will be stocks that lead the rest of the market, and we are going to be watching for those. They are always there on upside or downside moves, the stocks that tip their hand early. Those are the ones we will be watching and opening some positions in as we wait for a follow through move.
Support and Resistance
Nasdaq: Closed at 1340.33
- Resistance: The simple 50 day MVA (1343). 1357, the 1998 bear market low. The 200 day MVA (1351). The January 2002/January 2003 down trendline at 1358.
- Support: Exponential 50 day MVA (1331). The 18 day MVA (1313). The 10 day MVA (1311) and some price support at 1300. 1261 (the February low) and 1250 is point where some lows have held. After that there is not much before 1200.
S&P 500: Closed at 833.27
- Resistance: Price resistance at 850 to 860. The exponential 50 day MVA (849), the simple 50 day MVA (859). The bottom of the October consolidation range at 875.
- Support: The 18 day MVA (828). The 10 day MVA (823) and price support at 825. The September 2000/May 2001 downtrend line at 794 and some price support at 799.
Dow: Closed at 7859.71
- Resistance: 8000 and the 50 day MVA (8009). The simple 50 day MVA (8108). A range of resistance at 8000 to 8150 from the late January lateral move. Then 8250, the bottom of the October consolidation range.
- Support: The 18 day MVA (7786). The 10 day MVA (7737) and price support at 7750. 7532, the July low.
Economic Calendar
3-18-03
- Housing Starts, February (8:30): 1.755M expected, 1.850M January
- Building permits, February (8:30): 1.745M expected, 1.779M January
- FOMC one-day meeting (1:15): Expect a bias change but no rate cut.
3-20-03
- Initial jobless claims (8:30): 410K expected, 420K prior.
- Leading economic indicators, February (10:00): -0.4% expected, -0.1% January
- Philly Fed, March (12:00): 4.0 expected, 2.3 February
- FOMC minutes (2:00)
- Treasury Budget, February (2:00): -$80.0B expected, -$76.1B January
3-21-03
- CPI, March (8:30): 0.5% expected, 0.3% February
- Core CPI (8:30): 0.2% expected, 0.1% February
SUBSCRIBER QUESTIONS
Q: Thank you for the great service that you provide. I look forward to the daily newsletter and e-mail alerts. I wish I had known about it long ago.
Regarding option strike date selection. You are looking at PRX for a possible play and the pivot was hit but the volume was not there so the buy was not issued. Why select the Aug 30 call which is trading at 8.50-9.00 instead of the May 35 call which is 3.70-4.00. I do not understand the reason to purchase the call with that much intrinsic value or that far out in time.
A: Thank you for the kind comments. You are correct in focusing on the right option to purchase as the price you pay versus the delta and and the time to expiration directly impact your return. You need to get enough movement to cover the spread (the bid versus ask spread is larger on options to take into account some of the time element) and make you money with plenty of time left before expiration. As you get closer to expiration, time value starts to eat the value of your option at a faster and faster pace. It starts about 60 days out, and then really accelarates when you hit 30 days to expiration.
In that respect we prefer slightly in the money options with a minimum of 2 full months to expiration for upside plays where we are looking for an explosive move higher. If the stock is a slow mover, 2 months is not really enough. Typically we prefer more time, balancing that with the cost to acquire more time and any decrease in the delta (the futher from expiration, the lower the delta, i.e., the amount the option price will move for each $1 move in the stock price). Over the years it is clear that we have done better with extra time simply because you don�t have to have down to the minute accuracy on entering the play. You hate to be right about the move but just not have enough time to take advantage of it.
As to the specific play, the August expiration is not bad though the May could work as PRX can move up rapidly and we were looking at roughly a 15% move as opposed to 20% or more. PRX can move $6 in short order; a �typical� 2-week bounce up off the moving average in its uptrend returns that $6. As for the strike price, the $30 strike was a misprint. You are correct that we were looking for the $35 strike; with a buy point of roughly 37, the 35 strike put us just in the money with a sufficient delta (about 65) to make us a nice 65% or so gain ($6 move x .65 delta / $5.70 option cost = .68). Compare that with the August 30 strike: $6 move x .85 delta / $9.40 option cost = .54 or 54%. Even with the higher delta, the extra cost impacted your gain on the move.
Now there are benefits to a deeper in the money (higher intrinsic value) option. If the stock just sits there and does nothing, the option will lose time value. The $35 strike is just $2 in the money. The $30 strike is $7 in the money. At expiration, the $35 strike option is worth $2; you lose $3.70 or 65% of your investment. The $30 strike option at expiration is worth $7 (you could buy the stock for $30 and sell it at the $37 market price). In that instance you lose $2.40 or 25% of your investment. Thus buying more intrinsic value can benefit you if you don�t sell the option before it starts to lose value.. Now if the stock tanked, you are going to lose value on both though the deeper in the money option will hold more value and recover faster if the stock recovers. |
