Zeev's Turnips Patch-No Politics (ZEEV)

[TJ Parker]

schaeffer gets paranoia

Schaeffer on Charts: Isn't It Odd?
Bernie Schaeffer
7/29/2004 12:09 PM ET
http://www.schaeffersresearch.com/c...s.aspx?ID=10704

Much has been made in recent weeks of the fact that the market has this year been trapped in a very narrow trading range. I've commented on this myself, and I've attributed much of it to heavy selling of option premium and its strangling effect on market volatility. I still believe this, but I also believe there may be more at work at the low end of the range than mechanical buying of shares to hedge long put positions by those on the other side of the premium selling trade.

Yesterday morning, the market was greeted with a dollop of unpleasant news, including a tepid durable goods number and an across-the-board downgrade of chip companies by a major firm. But per the chart below of the Diamonds Trust (DIA) - an exchange traded fund that represents the Dow 30 and is priced at about 10 percent of the Dow Jones Industrial Average (DJIA) - we opened very strongly on big volume. Odd.

We then drifted lower till very early in the afternoon, with the DJIA showing a 91-point loss to 9994 at its low. Suddenly, in the midst of typically one of the sleepiest hours of a market session, big volume in the DIA showed up to stem the decline. Odd. And in an odd replication of Monday afternoon's "miracle rally" after a dip below DJIA 10,000, the market exploded to the upside in a magical final hour of trading.

Why do I deem the action at the low end of the trading range to be "odd?"

1. In addition to being keyed to important round-number price levels, the rallies are often initiated at specific "round number" times of the day - most frequently (all times Eastern) at 10:00 a.m., 2:00 p.m., and 3:00 p.m. It's difficult to imagine that such impeccably timed buying is random and diffuse.

2. The volume spikes are most heavily pronounced in the DIA exchange-traded fund. The DIA moves the "headline index" DJIA - the index that the vast majority view as indicative of the health of the market. And the DJIA's relatively modest capitalization (at least compared to the S&P) and its odd price-weighted calculation render it extremely malleable.

3. The buying will often begin at a time when the market is in freefall. It is odd that a rational, profit-motivated buyer would be willing, time and time again, to step up and "catch the falling knife."

4. The buying occurs as part of huge "buy program" operations, which have an immediate and substantial impact on market psychology, as in "let's get out of the way of this freight train." Note the huge spikes yesterday afternoon in the NYSE "net ticks," which spent a good deal of time above the "+1000" level. We've traditionally gone for days at a time without a "+1000" tick reading, but when the buying begins at the low end of the range there will be multiple +1000 tick readings in a very concentrated time period.

Remember the so-called "Greenspan put?" In the late-1990s, investors assumed that Greenspan would always come to the stock market's rescue at critical junctures, so downside risk was given scant consideration. One of the results of the Greenspan put was the market's plunge from the peak of the bubble, as the legions of those who believed in the put panicked on the realization that the market was no longer going to be held together.

And right at this moment, we seem to have a "DJIA 10,000" put, which allows wise-guy trader types to make a quick buck with little risk by stepping up and buying on these pullbacks and which freezes any major selling from the institutional behemoths, who even in own their slow, plodding way can't help but notice the "impregnability" of DJIA 10,000 (see chart below). As a result, many investors are now comfortable in maintaining a much greater exposure to the market than may otherwise be warranted. And when the support breaks - as I believe it ultimately must - a panic market plunge (instead of a much more gentle market decline) is almost guaranteed.

John Q. Investor was painfully fooled in the bubble but he gamely came back for more. If he experiences "déjà vu all over again" in terms of an accelerated market plunge below a bogus "support level," we can forget about him participating in the market for many years to come.