- A very quiet expiration Friday as the market ends in a dead heat. - Waiting on the FOMC interest rate decision. - Market is in a state of transition, but has not tipped its hand. - Subscriber Questions.
Anticlimactic end to the week.
Stocks traded in a narrow range as expiration Friday came without much of a fight. Nasdaq volume tailed off while NYSE volume rose. As far as price/volume action that was in keeping with the rally as Nasdaq finished lower while SP500 and DJ30 posted gains. The action was mostly downbeat with the indexes closing well off of their highs. They did not, however, break their near support at the 10 day MVA as they continue the pattern of intraday corrections in lieu of a more substantial pullback.
The DJ30 performed the best with 20 advancers to 10 declines, much better than the overall market breadth. After such a torrid advance from the market leaders, could the old economy stocks be ready to lead? That is almost a scary thought, placing the market in their hands. Doubt that will happen, but with many leaders extended and testing lower, there was some rotation occurring Friday, i.e., money moving into some blue chips.
Rotation is a good thing for the market as it is a sign that money is not leaving, just moving to new areas as gains are taken in others. Some profits are taken on leaders and the money is moved elsewhere. Those leaders then test back and test the 50 day MVA or slip into another base. The profits are put into other stocks.
In addition, money continues to flow into the market, and fund managers have to put that to work. $4.3B flowed into the market last week versus $2B the prior week. The 4-week average moved up to $4.9B per week. That is back to the April 2002 highs. That was no great shakes of a period for the market, but the point is that money is starting to move back in and it has to be put to work. That has kept the market rising in the afternoon session after dipping in the morning. That buying has kept stocks moving higher when gravity is trying to make them fall after such long runs. Thus the choppier action we have seen. The market is working hard right now to keep the gains. The only real question we have is what kind of consolidation finally takes shape.
THE ECONOMY
Waiting on the FOMC decision.
This week the Fed meets for a 2-day meeting to make decisions on where interest rates should be. A tremendous amount of time has been devoted to the subject of a 25 or 50 basis point cut. Some say the Fed does not want to be locked into expectations and thus 25 basis points and even no cut could happen. The other side talks of the Fed taking out an insurance policy against inflation. With what the Fed has been broadcasting the past two weeks, to us it is rather clear that it intends a 50 basis point cut in a final, grand statement against deflation and pro economic growth much as its 50 basis point hike in May 2000 was to put inflation fears to rest. It certainly did that, and we wish we were as confident that a last 50 basis point rate cut would restore the economy.
The Fed decision could be an important event for the market. Not because what it does, but because the market senses that the Fed, as far as rate cuts, has done just about all it can do and that the economy is basically on its own. With earnings just around the corner and no real sign of economic pickup yet, the market could get some cold feet if the Fed cuts 50 basis points or if it does not cut 50 basis points.
Interest rates starting to go their own way.
We have discussed in the past how interest rates are trying to rise on their own in spite of the Fed�s actions to keep them lower. More and more talk swirls about the Fed buying the long end of the curve (10 year treasuries) to keep rates lower and keep money in the economy. The Fed wants rates low to keep the consumer stimulated. It has lowered the Fed Funds rate, bought short term treasuries, and jawboned the 10 year down with its talk of �insurance policies� against inflation.
It worked for a few weeks as the bond market rallied and interest rates fell. Interest rates were trying to rise but they were being pushed lower by external forces. When non-market forces act to keep a market from moving where it wants, pressure builds. When the forces pushing against the market�s natural tendency finally lose the ability to hold the market back, the snapback can be strong. Friday the 10 year note jumped to 3.39, a rather dramatic move. The move was blamed on a WSJ story that stated the Fed may only cut rates by 25 basis points and that buying 10 year notes may not be as effective against deflation as some say. With the prospect of a lesser rate cut and questions about whether the Fed would buy more treasuries, bond holders started to sell.
The irony of it is, the WSJ story almost certifies that the Fed will cut 50 basis points simply because bonds are threatening to overturn the Fed�s careful jaw boning. If the bond market continues to slide the Fed is forced to cut, jawbone, and buy treasuries to keep rates lower. It may not be able to win the battle. If the 10 year gets to 3.55 and breaks higher, rates could really shoot higher. It has not made it there yet, and you can bet the Fed will do what it can to keep them from reaching that important level.
Thus the FOMC meeting will indeed be critical to the market. It won�t necessarily answer any questions for the market, but the market needs reassurance in the face of still lackluster economic numbers that there is additional stimulus in the till. The market may use the meeting as an inflection point. The underlying concern will be how treasuries react to the Fed action. If the Fed loses control of them and they rebound sharply, stock investors will be concerned about the economy. At the same time, however, there will be money leaving bonds. The question is will it move into stocks.
THE MARKET
Breakouts are fewer, intraday volatility is higher, some leaders are peeling back on volume, some distribution, intraday reversals, and as one reader pointed out, new highs have leveled out. On top of that there is a new tendency for stocks to sell on good news. Homebuilders were knocked around Friday after KBH (KB Homes) destroyed earnings estimates. A lot of expectations are built into stocks, but even when those expectations are met it does not satisfy expectations.
All of these are signs of an extended market where many stocks have posted 40% to 50% gains since March with some doubling or tripling in that time (e.g., SOHU, GRMN, SINA, MVL). No market, no stock, can keep up that pace. Indeed many leaders are already back to the 18 day MVA or the 50 day MVA in some pretty heavy selling this past week. The question ahead for the market is whether it consolidates laterally or corrects more substantially.
With the FOMC meeting ahead and earnings shortly thereafter, investors are more skittish. Intraday and day to day volatility has increased as the buyers take some profits and back off from entering new positions while a few sellers test the water. The market has traded higher on expectations of a better economy, helped by some bullish economists and Federal Reserve governors talking of a strong second half. The numbers have yet to really show that strength, and ahead of Q2 earnings there will be doubt. Again the issue is when it starts. Thus far the trend up the 10 day MVA has not even been broken as that extra money is still being put to work.
Market Sentiment
VIX: 21.09; -0.92 VXN: 32.34; -1.52
Put/Call Ratio (CBOE): 0.51; -0.03. Even the put/call ratio, holding in the .70 and higher range for months has started to fade significantly the past week as more action takes place in call options. That is yet another sign of increased bullishness and upside speculation in options. Historically options players are predominantly speculators, and when they get too bullish or bearish the market is ready to turn the other way for a bit.
Nasdaq
Volume fell back below average as techs stocks traded in a relatively narrow 20 point range, holding near the 10 day MVA on the low.
Stats: -3.92 points (-0.24%) to close at 1644.72 Volume: 1.797B (-8.29%). A very slow expiration session as volume fell to average on a small point loss. Surprisingly low.
Up Volume: 672M (+210M) Down Volume: 1.109B (-287M)
A/D and Hi/Lo: Decliners led 1.02 to 1. Breadth matched the action, basically confirming it was a slow session. Previous Session: Decliners led 1.91 to 1
New Highs: 122 (-44). A reader pointed out the steady decline in new highs as Nasdaq re-tests the early June intraday high. -24, -183, -34, and -44 to end the week. New Lows: 8 (+4). New lows are showing no appreciable expansion, but with this run that is hardly surprising. The focus has to be on the highs, and they are flattening out and starting to sag.
The Chart: (Click to view the chart)
After peaking at the early June high yet again on Thursday (1684), techs were flat. Given the alternative of continuing the Thursday selling, the action was quite good: Nasdaq once again was able to contain its losses, maintaining its move up the 10 day MVA (1644). It is holding the 10 day, but it also has made two quick tries at 1684, a point that has now become some resistance, and has fallen right back. Not heavy selling on the way down, but simply continuing to show some erosion in the strength of the move. If the 10 day MVA and 18 day MVA (1622) fail, we still look to the mid-May high (1550ish) and the 50 day MVA (1546) to provide some solid support.
S&P 500/NYSE
A short pullback and the large caps show a hammer doji on the 10 day MVA, looking ready to bounce again, but can they lead.
Stats: +0.99 points (+0.1%) to close at 995.69 NYSE Volume: 1.683B (+10.8%). Volume surged on the session but we attribute that to the expiration session more than buying or selling. The standoff in the market indicates it was more turnover and rolling out to next month than buying or selling.
Up Volume: 790M (+437M) Down Volume: 889M (-233M)
A/D and Hi/Lo: Decliners led 1.06 to 1. A dead heat. Previous Session: Decliners led 1.99 to 1
New Highs: 98 (-72) New Lows: 3 (-2)
The Chart: (Click to view the chart)
SP500 also continues its move up the 10 day MVA (995), testing back late in the week after an early surge. Friday it showed a slightly more bullish pattern, a tight hammer doji right on top of the 10 day MVA. That can signal a bounce upcoming. We won�t ignore the pattern, but we also are not betting on it necessarily leading to a big upside breakout. It has the advantage of not being nearly extended as Nasdaq, but again whether it can lead is another question.
DJ30:
Similar to SP500, the blue chips tacked up a hammer doji right on top of the 10 day MVA (9171) as volume surged. Again, the volume was most likely attributable to the expiration session, but many blue chips are moving laterally in a tight range, consolidating. As money moves from extended techs, it appears to be moving into some blue chips. Perhaps they will lead, but the gains on these tend to be rather stodgy outside perhaps the financials. Cannot complain about the pattern at all as DJ30 was the last index to clear its August high and break the string of lower highs and it still has a lot of upside ahead of it for the older economy stocks to rally.
The Chart: (Click to view the chart)
THIS WEEK
The week�s focus is on the FOMC meeting Tuesday and Wednesday with the announcement coming at 2:15ET. We anticipate some further nervous trade ahead of that decision as speculation about the size of the cut swirls based on opposing stories from the NY Times and WSJ. That has roiled the bond market, but we doubt that any money coming out of bonds will automatically be pushed into equities in the near term.
With the market still in the process of trying to correct intraday to keep the uptrend alive but still showing signs of erosion, we are going to take a cautious approach, looking at both upside and some downside positions. Downside are forming up more as the market is getting disappointed by even good news now. At the same time we are really intrigued by some of the recent leaders that have fallen back to test toward the 50 day MVA and then showed nice action Friday off of that test. At the same time other stocks are still forming bullish patterns, including a few blue chips.
We would prefer to see a nice, steady pullback and consolidation. We have continued to take gain on positions and have moved up stop loss points; we would prefer to take the gain and lock it in given the uncertainty the market is showing. We will continue to take gains when targets are hit and used trailing stops to lock in remaining gains on stocks that start to falter in their trends.
The market has put in quite a run. It can certainly move higher, but we also have to look at the probabilities. After a 32% run on Nasdaq since the March low, the probability is that Nasdaq will have to undergo a more sustained consolidation than just a dip to the 18 day MVA. Again whether it is a lateral move or a deeper pullback to 1550 is an issue; the latter seems more likely to us. The question is timing, and with money chasing stocks higher and stocks still acting quite well overall, we are not about to outguess the market. Thus we will continue to look at the plays that present themselves. That is taking what the market is giving, and that is what our method of investing is all about.
Support and Resistance
Nasdaq: Closed at 1644.72 - Resistance: 1685 (June intraday high) remains hanging over the index. 1700 (Feb 2002 low). - Support: The 10 day MVA at 1644. The 18 day MVA (1623). 1595 (June 2002 closing high). 1573 (May 2002 closing low). The May high (1554) is what we are watching as a primary support level. The exponential 50 day MVA (1546) is the next primary support point. The December intraday high (1522). The January high (1467).
S&P 500: Closed at 995.69 - Resistance: 1007. Then 1050. - Support: The 10 day MVA (995). 975 (December 1997 peak). The 18 day MVA (984). 965 (August 2002 peak). The 50 day MVA (948) and the mid-May high (948). 935 (November and January peaks).
Dow: Closed at 9200.75 - Resistance: 9500 (June 2002 lows). - Support: The 10 day MVA (9171). The August high (9077) and the December high (9044) may act as some support. The 18 day MVA (9069). January high (8870). November high (8800). The 50 day MVA (8770). 8522 and 8520, the March and April twin peaks.
Economic Calendar
6-16-03 - NY PMI, June (8:00): 26.8 actual, 8.8 expected, 10.6 May.
Q: You always point out the delta when buying an option. Is it better to have a high delta or a low one? Thank you for your help.
A: An option delta measures approximately the change in the option price for every $1 change in the underlying stock price. For example, if a call option has a delta of 50 (it can also be shown as 0.50), for every $1 the underlying stock moves up or down, the option will move, all other things equal, 50 cents. A put option delta is designated as a negative; if the stock moves up it moves down and vice versa. Typically the deeper in the money and the closer to expiration, the higher the delta.
As the delta represents the percentage the option will move in relation to the stock, the higher the delta the better the move. We prefer higher deltas for various reaons. One of the primary reasons is that the option will move better when the stock moves and that makes us a better profit on the play. Getting a higher delta, however, has to be balanced with the cost of getting that delta. If the cost is high the precentage gain may be less even though the higher delta option increases in value more rapidly.
We always look at the available options to see if it is a better value to buy a closer to the money option than a deeper in the money option (e.g., a $12.50 strike call option on a $13 stock as opposed to a $10 strike call option) even though that deeper in the money option has a higher delta. The idea is to get the best value for the price that will deliver the best return. As a general rule we like a higher delta, but we always then run the numbers to see what the anticipated profit will be given the anticipated move in the stock.
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