Option Queen Letter for July 13, 2008
Most market watchers want to know where the bottom of the market is, this is a difficult question to answer precisely. Very few of those who ask this question remember the bear markets of the past, most of these managers and whiz kids weren’t even alive at that time. Well kids, bear markets can last a long time. The previous “mini bear market” caused by the dot.com mania, didn’t last all that long, in terms of bear markets, and the current bear market isn’t that old. In Dow Jones terms, 10,683.32, 10,156.46 and 10,000 should offer some very good support. That said, support doesn’t mean reversal. It may only be a resting place where a bear market rally will begin. A bear market rally can take the market up 5% while remaining in a bear market. Some rallies can go even further. These rallies have to be studied to understand the value of that rally; is it a short covering affair or, are true buyers entering the market? In a bigger context, when looking at the extent of the bull market rally from 2002 to its peak in 2007, we have not yet even seen a 50% retracement of that rally. The retracement level is at around 10,728 or so, thus, we could trade back to that level, which is in a congestion area on the monthly chart.
On Friday, the small capitalization Russell 2000 rallied and closed positive on the day. This index was the only one of the indices that we follow, that had a positive close. Does this mean that we are going to rally from here? No. There are not a lot of financial stocks in this index and we believe that the Friday rally in this index demonstrated that, without financials, the market wanted to rally.
The S&P 500 chart shows some reason to believe that support will be found at 1229.2, 1172.0, 1135.9, 1088.1, and 1061.0. When we apply Fibonacci retracement numbers on the monthly chart from the low seen in 2002 to the high of 2007, we notice that the 50% line is at 11,789.50. With all the recent whining and crying heard in the media, and with absolutely dreadful economics, you would have thought that the market would be approaching the 2002 lows. In reality, the market remains above the 50% retracement level of the 2002 to 2007 bull market. Sadly, these charts show that there is more room to the downside. On the good news side of the chart, we are grossly oversold, but that information does not ensure a huge rally, rather we will see a relief rally, which can take this market back to 1340. To add to all the tumult in the market, be warned, this is an options expiration week, which can and will bring with it its own volatility spikes. Speaking of volatility, we haven’t seen the VIX trade back to the highs of March and that tells us that there is still room to the downside. Even if the VIX were to trade down to 23.75, it would continue to remain in a strong uptrend. The VIX is a good anxiety measure and we haven’t seen enough anxiety in this market to call even a short-term bottom. Sorry!
Fed Chairman Bernanke is under the gun on the “Hill” this week. In an election year we see a lot of jaw-boning and this week, we will see the Chairman take the brunt of these elected Senators and Congress-people’s anger. We have the Senate testimony on Tuesday and the House testimony on Wednesday, same speech different questions and answers. We will all be watching as the Chairman dodges the bullets of the question and answer periods. As a side view, the questions and answer period of this testimony shows us how little our elected officials really understand about the economy and the Fed.
Mutual funds are in denial of their eventual decline and classification of: investment relic. Why do we say that? This class of investment does not allow the investor the flexibility of selling intraday and forces all sales or buys to the close of the business day. This rule, especially in today’s markets, keeps the investor invested until the close of the market at 4:00. In today’s investment world we have other means of diversification without the time restrictions of the mutual fund industry. Yes, many investment plans, pension plans, retirement plans, 401K’s and the like, force employees to opt for mutual funds and that business will continue to remain steady, well until the liability of holding a sale until 4:00 becomes a legal problem brought on by infuriated investors. The individual investor or pension fund can get diversification similar to mutual funds by investing in ETF’s (exchange traded funds). These assets can be bought or sold in the market with no time limitation.
As to insurance companies and their products, we cast a jaundice eye on these products as well. The concern isn’t so much with the trade investment time restrictions, but rather the portfolios which, if not already publicized, could be under water. We have always had a problem with this asset class and the very heavy commissions charged to the buyers of their products. Not only are their life policies chock full of heavy commissions, but their annuities share that same heavy handed commission base. These portfolios do have bonds in them, yes, some are in trouble, but nobody is looking or taking about it. One day we will awake to an insurance company in big trouble. Yes, they can use the term guaranteed on their annuity products, we have seen this act before in the eighties when several insurance companies failed leaving these “guaranteed annuity” holders holding the bag. Many were paid 20 cents on the dollar and those were the lucky ones.
What happens to the US Dollar should the government opt to bail out Freddy and Fanny? Would the government print money to cover these costs? Either way, the value of the US Dollar has to be under stress with the additional stress of a possible bail-out for Freddy Mac and Fanny Mae. Should the government take on that 5 trillion dollar debt (by the way, the government is you meaning that we American’s foot the bills with our and corporate tax receipts). This maneuver will double the national debt! It is thought, that when pen comes to paper the loss will only be in the neighborhood of 100 billion dollars, about the same cost of the savings and loan bail-out of the 80’s. The share-holders should remember what happened to the value of Bear Stearns stock when that company was put on life-support, by the Fed. Freddy and Fanny can go to zero, but remain viable. How is that, well, the share-holders will be left holding the bag on both Freddy and Fanny while the bond-holders will be fine. Should these stocks enter bankruptcy, the share-holders are the losers, which includes the preferreds as well. Some foreign entities long US Dollars or pegged to the US Dollar, can’t be too happy with these developments. Doubling the national debt and printing money to bail-out Freddy and Fanny can’t be good for the value of the US Dollar. The problem is that with the US Dollar becoming ever weaker, commodity prices, priced in US Dollars become stronger. We can feel the noose tightening.
Tuesday: June PPI and June retail sales are both released at 8:30, May business inventories are released at 10:00 and Fed Chairman Bernanke testifies on the “Hill.”
Wednesday: Dr Bernanke testifies again this time in the House, the minutes of the FOMC June meeting are released at 2:00, June CPI is released at 8:30, June industrial production and capacity utilization are released at 9:15, and Kansas City Fed President Hoenig speaks.
Thursday: June housing starts are released at 8:30 and July Philadelphia Fed Survey is released at 10:00, Merrill Lynch, JP Morgan Chase, Microsoft, IBM yadda yadda report earnings.
The US Dollar index is making historic lows, true; the low of April continues to hold the low record, which was 71.05. We note that the indicators are all oversold but all continue to issue a uniform sell-signal. The 5-period moving average is at 72.853. The top of the Bollinger band is at 74.213 and the lower edge is seen at 72.123. On the Market Profile chart we notice that below 72.20, we are in “watch out below” territory. On the upside a move above 73.265 should spark some interest in the US Dollar index taking it back to its previous comfort zone of 73.91 and even to 74.195. The good news on the US Dollar index is that we haven’t crumbled further, given all the bad economic news that the market has been given. The weekly chart looks as though the price of the US Dollar index is trying to consolidate. If long, use the previous low of 71.05 as a bail-out level. The Bollinger bands, on the weekly chart are contracting telling us that we will see another surge in volatility in the US Dollar index, perhaps in a week or two.
The Euro seems to be going for the “highs” of 159.840, seen on April 22, 2008. All the indicators that we follow herein are pointing higher, all are overbought. The 5-period moving average is at 157.178. The top of the Bollinger band is at 158.85 and the lower edge is seen at 153.554. The short-term daily uptrend line for the Monday session is at 156.60. The weekly chart looks as though the market is probing to the upside.
The S&P 500 is grossly oversold but not as oversold as it was on July 2nd. We see some divergence in that the market is trading lower while the indicators are not as oversold as the were at the previous forays lower. All the indicators that we follow herein are pointing lower. The chart shows a picture of a very organized downtrend. Resistance will be found at 1263.01, 1281.57, and 1303.23. The 5-period moving average is at 1253.56. The top of the Bollinger band is at 1374.95 and the lower edge is seen at 1220.61. We are getting a buy-signal on all but the RSI for the weekly time-frame. We would expect to see the market rally this coming week. We believe that the rally will be strong enough take us to 1320 and change before the sellers appear. Should the market trade above 1254.60 it will rally back to 1275. The monthly chart shows a continued liability to the downside. Enjoy the dead-cat bounce and take this opportunity to rid your account of the pound puppies living in your portfolio.
The NASDAQ 100 remains well above the March lows. All the indicators that we follow herein are issuing a uniform sell-signal with room to the downside. The 5-period moving average is at 1839.40. The top of the Bollinger band is at 2007.02 and the lower edge is seen at 1766.77. If we were to find a place to hide, it would be in either the Russell 2000 or the NASDAQ 100 which seem to be doing better than the S&P 500. The S&P 500 weekly chart gave us a buy-signal however, the NASDAQ 100 weekly chart, although close, has not given us a buy-signal. The monthly chart shows an index which remains in a trading band, with nothing remarkable about this monthly chart. We continue to see liability to the downside for the monthly time-frame.
The Russell 2000 was the winner of the Friday session closing up 2.60 on the day. All the indicators that we follow herein are issuing a continued buy-signal for the daily time-frame; none of the indicators are in oversold territory. The 5-period moving average is at 669.66. The top of the Bollinger band is at 751.43 and the lower edge is seen at 641.57. If this index can get above 673.20, it should easily trade up to 682.80 and above 690.30 you will see a move to 709.80. The weekly chart shows that this past week’s low was a high low and the third attempt to take out the March low. That attempt was not successful leaving another higher low on the weekly chart. The stochastic indicator, our own indicator and the RSI are all issuing a buy-signal for the weekly time-frame. The Thomas DeMark Expert indicator continues to issue a sell-signal at oversold levels. The monthly chart continues to show a downside liability. The bottom line is that we will bounce on a short-term, but that bounce may be all that we will get.
The Continuous Commodity Index continued the three day rally into the Friday session. All the indicators that we follow herein are issuing a continued buy-signal. The 5-period moving average is at 589.38. The top of the Bollinger band is at 614.46 and the lower edge is seen at 570.03. We are grossly overbought on the weekly and the monthly chart and find the most of the indicators are issuing a sell-signal. However, until or unless we break below 581.40 we will remain upward bound. On the other hand should we trade below 581.40 we could see a very fast whoosh to 554.20! Fasten you seat-belts!
Crude oil bingo continues, and will continue to react this week Tuesday with OPEC’s monthly report. We felt and saw the new high printed in the Friday session. The indicators have room to the upside and are not at overbought levels as yet. The indicators continue to issue a buy-signal. The 5-period moving average is at 140.038. The top of the Bollinger band is at 146.35 and the lower edge is seen at 131.37. There is not doubt that this market is extended on the upside. We continue to look for 150 to 155 as a resting place for crude oil. Naturally, as we print new highs, buy-stops become elected and poof, we go higher. Much of the poof is from those who continue to try to short crude and find themselves covering those shorts at new highs. On the downside, if crude oil can trade below 131.20 we will find support at 123.20. Below 121.60 we have support at116.80. We are getting a sell-signal on the weekly chart. Before you go and celebrate this signal, we have seen it before and it has not produced more than a few dollars on the downside therefore; we do not trust the signal. The weekly chart does tell us that we need to stay above 134.10 or risk more downside action.
Gold is overbought, but continues to point to higher levels. Now that we broke above the resistance of 950 and 940, we have opened the door to the March highs. The 5-period moving average is at 936.60. The top of the Bollinger band is at 964.38 and the lower edge is seen at 871.18. Should we continue to trade above 966 we will see a swift acceleration to 996 and the old highs. The weekly chart looks very positive. We believe that we will remove the March highs with the next few runs to the upside.
Have a good trading week, see you next Sunday.