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2/10/01 Technical Traders Report
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Technical Traders Subscribers:

TONIGHT:
- Indexes get right back to where they started from.
- Nasdaq declines on rising volume again, while Dow and S&P 500 sink on lower trade.
- Nasdaq going to test the down trendline?
- Gloomy economic outlooks now abundant.
- Subscriber Questions
- Team Trades

Haven't we been here before?

Flashback: Early January, the indexes are in real trouble with the Nasdaq hitting a 52-week low. Then came the Fed and rallied the market. The Nasdaq and S&P 500 even broke their down trendlines, something they had fought since Labor Day. Even with a second rate cut the indexes are stalling. They have not taken out the previous lows and they have not yet broken back below the down trendlines. Indeed the sectors you would expect to perform well when the Fed steps in, retailers and financials to name two, are doing just that. But even these sectors are showing cracks as of last week. Is this a preparation for another swoop down to test the lows and beyond, or is it just a pause to test the break of the trendline in an otherwise new uptrend?

Many elements at work.

The Fed has cut rates twice, and that is historically been the medicine the markets needed to get back on track. Thus far they are not off track, but the Nasdaq and the S&P 500 are threatening. There is a pervading sense of gloom for the economy and the market that was really manifested on Friday in most all financial stations we tuned in. As discussed below, there is reason for concern but also reason for optimism; to us it appears the hype overplays the actual situation. Then there is a relatively new group of fund managers in charge of trillions of dollars, many more funds and dollars than were in the market in 1991, the time of the last recession. They have never experienced a protracted bear market, and we feel that is contributing to the remarkable volatility and sharp rotation in the market as they grope for some direction or conviction.

Regardless of the cause, we have to look at what the market is showing us now and base our investment decisions accordingly. We will go through what the market is saying right now and give you are conclusions. In a nutshell, the Nasdaq and S&P 500 are very threatening but have not yet completely broken down their rally moves. They are threatening enough to keep us from playing many stocks for more than short term moves (other than those demonstrating strong breakouts), but not to turn us into full-time bears because the moves for the most part are still in tact and even with Fed rate cuts the markets still range up and down even as they trend higher.

Signs from the Nasdaq.

The Nasdaq is an index for concern. It is still above its lows for the year, and it is still above the down trendline it broke back on January 17, but it is showing bad signs. First, even though it is still above its down trendline, we have to remember that down trendlines trend down. If a test of a break over a down trendline does not come relatively quickly, it is a long drop to the trendline. Indeed, if the Nasdaq's down trendline is right at the 2290-2300 level right now. That is another 7% from Friday's close, and that puts the index almost at 52-week lows (2251.71 intraday on January 3 when the Fed cut rates the first time). So, the fact that the Nasdaq has not broken below the down trendline again provides little comfort as doing so would require it to revisit its 52-week low.

That may be what is needed, and it appears that the Nasdaq could do that. Friday the Nasdaq suffered its third distribution day in eight sessions. A distribution day is one where an index sells on higher volume than the previous session. They are particularly important after a rally has started and when they occur on the highest relative volume in the rally. The first day occurred on January 31 when the Fed cut rates the second time. That was the highest volume in a week. The next occurred on February 7 on substantially higher volume than the market had been showing. The third was Friday; volume was not much more than the previous session, but it was higher on selling. When you get a quick series of three or more distribution days, that often signals the end of a rally as institutions are no longer buying but instead are selling stocks in large quantities. It is very difficult for a rally to survive in such an onslaught of supply.

Next look at the stocks that were helping lead the rally. These were the leaders from all previous rally attempts such as JNPR, BRCM, BRCD, EMC, SEBL, etc. These stocks have not only sold back with the index, they are now leading it down with several below the point where the Fed rally started while others are at that level or approaching at breakneck speed. This can be viewed as good or bad. On the positive side, perhaps these stocks were leading the index down and have now hit bottom at the previous lows or just below. Indeed, many of these stocks showed doji's on Friday with minimal losses or even gains while the overall index almost logged a triple digit loss. A heavy down session but the stocks that had been taking the brunt of the damage held their ground. Maybe they are ready to make a stand. On the negative side, These leaders to the upside are already slicing into new low territory, many on higher volume, and that signals a further drop for the index as it follows those leaders down.

Even if the index is able to find bottom at a re-test of the previous lows to some degree, that is still a substantial drop as shown above, and will completely eliminate any gains on the rally. Other than turning back up from here, however, that is about the best-case scenario at this point. That means the Nasdaq is trending down for now until it does test that support or something happens to reverse its course.

There are two things to consider at this point, however. First, the Nasdaq is very oversold right now and in the midst of gloom. They were laying it on pretty thick Friday. That gives us the very probable chance of an oversold bounce after some more early selling on Monday. The big-name techs have been hammered and were showing little damage Friday even as the index overall burned. That could give a two-day run that would be playable if you get in, take a few points on some options or shares and get out. If the volumes are heavy on the upside, then it is worth letting plays run, but utilize trailing stop losses, either mental or mechanical to get you out if trouble develops again.

Second, consumer sentiment has Greenspan on edge. If it falls any further, his hope of heading off a technical recession further fades. Right now consumer sentiment is closely tied to the stock market; Greenspan said so himself when addressing the Senate two weeks ago. We thus feel that the Fed is going to attempt to set some type of bottom in the market above where it stepped in on January 3. We believe that the Fed feels it would be disastrous for the consumer psyche if the market fell to new lows even after the Fed has stepped in twice. Things may prove to be so bad in the economy that even more intervention won't work, but we do not believe that to be the case. Things are not economically great, but we have been watching that coming for over 5 months. Much of what we are hearing about how bad things are today is from those who have just made the switch to the dark side. That usually it means things are overblown. In any event, we may be totally out of step, but we feel the Fed is going to attempt, without ever admitting to it, to be the floor for the market. If Greenspan's gambit is going to work, the market has to start finding traction.

Signs from the S&P 500.

The big cap index has held up a bit better than the Nasdaq, but it also reversed course recently after it bounced down from resistance at the 1375 level. It has suffered just two distribution days since the second Fed rate cut, and its last two declines have been on lower and lower volume. Moreover, Friday it tapped at its down trendline that it broke on January 18 and moved up to the close. With the lighter volume on the selling, the big caps could indeed find support here that keeps the rally alive and gives the index a boost higher. There is not much in the way of positive sentiment to move the index higher, but support levels tend to work hold or not regardless of sentiment. Why? Because that is where institutions are willing to make their bets or not regardless of what the feeling is in the market. They either believe in it or they don't; thus, they will either buy or they won't. As the selling pressure was not increasing on the move down, it could very well find bottom here. A Nasdaq bounce, whether the real thing or merely an oversold bounce, would help it get back on track.

THE ECONOMY

What is the real state of the economy?

We never seem to know just how bad or good things are until after the fact. Most recessions are suspected but never confirmed until they are over. Only in the protracted ones do we know one is going on while we are in it, and then as we saw in 1991, we are usually out of them before the media and most of the public pick up on the economic upturn. Thus the 1991 recession was styled as the worst since the Great Depression, but that was nowhere near the case. Indeed, it was one of the mildest on record. Confusion rules the day as various interest groups argue about how bad or good the economy is.

Today is no exception. Just a few months ago prominent economists were prognosticating another 100 basis points in rate hikes but are now saying recession is inevitable. We get overwhelmed each week with economic reports that are as lengthy as arcane. Last week saw the rhetoric ratchet even higher as CSCO reported earnings and said that what it earned this year would be based on how the softening economy performed. Suddenly the talk of a second half recovery became talk of a continued slowdown through the second half of 2001. Apparently the fact that CSCO took a practical outlook and admitted it was not economically omniscient leads to the conclusion that things must truly be worse than anyone expected.

There is also the question of the daily announced layoffs. Motorola has announced 9,000 layoffs; AMZN 1300; Chrysler 26,000. Lechter's is closing 166 stores and laying off 30% of its workforce. JC Penney is closing 53 stores. CMOS is laying off 14%, Electrolux 2.3%, and even Land Rover is axing 250 in the UK. Now there are rumors Dell is about to announce layoffs as it announces earnings next week. There are more, but the point is made. The Fed wanted higher unemployment, and it is getting it. We don't think it is as bad as the raw numbers state because of reasons we have previously stated, e.g., continued job creation, employee's leaving the workforce, and significant reassignments. Still, there are more and more unemployed with each passing day.

We are not saying that any of this is good news, and things are not as rosy as FOMC voting member Poole stated on Friday when he said that there were no "traditional" signs of a recession. Well, as we discussed last week, we already are in a relative recession, and that is the cause of a lot of the pain. In other words, it sure feels like a recession whether or not it is a textbook one or not. But let's put it into perspective. We started at a very high output level when things started to crumble. Moreover, the housing market remains exceptionally robust; job creation in the fourth quarter was much greater than expected; jobless claims continue to increase the past two weeks after starting to fade, but they are still holding well below the 400,000 to 500,000 level we saw in the last recession; and retail sales have remained surprisingly strong for the weak consumer sentiment, though we will know much more about that this Tuesday when the retail sales figures for January are released.

So, things are not all bleak. All we hear, however, is recession-talk from those who had no doubt the economy would continue to expand, and when it did start slowing (or more accurately by the time they admitted to what the numbers had been showing all along), they were sure it would be a 'soft landing' ('In Alan we trust'). As the predictably bad economic data rolled in these folks became full-fledged recession converts. We wish they would have been more honest with themselves or the rest of us when the numbers were showing trouble as perhaps the public pressure could have helped call the Fed more to the table.

As with most conversions, the metamorphosis has been complete. Just as they ignored signs of the economic weakness and overstated the economy's strength, they now ignore the signs of strength and emphasize the weakness. Just as with a reformed smoker, drinker, or other compulsive/addictive behavior, the transformation is from no problem at all to a mania against the former behavior.

THE MARKETS

Overall market stats:

VIX: 25.15; +1.06. Volatility is climbing, but barely on the selling. The Nasdaq is 200 points or so from its 52-week low. When it was near those levels in late 2000, the VIX was spiking to 37. As this latest rally has stalled and rolled over, volatility has barely budged. Still lots of complacency in the market even as the gloom is talked up in the press.

Put/Call ratio: 0.73; +0.02. Put buyers barely edged higher on Friday's selling, another sign that investors are not all that upset about what was going on Friday.

NASDAQ:

Falling on higher volume with the big names leading the way, closing right at where it ended 2001. As we said above, it is set up for a reflex bounce or a further plunge toward 2300.

Stats: Down 91.10 points (-3.6%) to close at 2470.96.
Volume: 1.882 billion shares (+1.7%). 1.537 billion shares to the downside versus 306 million to the upside. As noted, the third distribution day in 8 sessions, and that can spell doom for this rally as institutions are selling more tech shares than they are buying.
A/D and Hi/Lo: Declining issues jumped higher to 1.75 to 1 (1.22 to 1 Thursday). New highs fell to 80 (-7) while new lows rose to 60 (+24).

The Chart: http://www.investmenthouse.com/cd/$compq.html

The Nasdaq did not hang onto 2500; it did not even make much of an attempt at it. Selling on higher volume Friday again, but the stocks that had been hit the hardest of late were not dropping much. That indicates an oversold bounce is possible after some more selling to start the session Monday. As noted above, that can give us a rally for a couple of sessions. What we have to look for again is volume on any moves. Renewed buy volume will indicate the start of something positive, but as we know, a few institutions can prop things up for a session or two. What we will look for is a rally higher on stronger volume, some lighter volume selling, and then renewed buying on volume. That will show us the buyers winning the battle. It may come on the relief bounce, it may come after a further test of the previous lows.

Dow/NYSE: Suffered another bout of selling on Friday, but on lighter volume and tapped support on the low before moving up slightly to close.

Stats: Down 99.10 points (-0.9%) to close at 10,781.45.
Volume: NYSE volume eased again to 1.075 billion shares (-2.9%). That is what we prefer on selling, and the Dow avoided a day of distribution Friday. It has showed two such days since the second Fed rate cut, a reason to be wary but not a red flag at this point. Price/volume action has been less than stellar the past two weeks, but it has not been damaging. Down shares topped up volume 649 million to 396 million Friday.
A/D and Hi/Lo: NYSE decliners continued to lead 1.2 to 1 (1.15 to 1 Thursday). New highs held steady at 155 while new lows rose to 16 (+1).

The Chart: http://www.investmenthouse.com/cd/$dja.html

The Dow continued to pull back as expected, and the lower volume was key to us given the Nasdaq's selling on higher volume once again. We were looking for 10,750 to hold as support, and so far that has worked well as it tapped 10,754.96 on its low and recovered to close. The lighter volume selling indicates there is not a lot of share dumping going on, so it has a better chance of holding support for another move up at 11,020.

S&P 500: The S&P 500 is a step ahead of Nasdaq, though its pattern is not nearly as dour. It is not great, but it is not horrid. Friday it sold back on lighter NYSE volume, indicating that the heavy selling that occurred Wednesday is backing off. Hand-in-hand is the fact that the index tapped its down trendline on its low (1309.98) and bounced up to close. That was key as it allowed the index to hold above support at 1300 and it kept the rally in tact. Low-volume tests of a previously broken trendline are good as it indicates fewer sellers as it approaches that potential support level. We want to see the trendline (now at 1305) hold for a higher volume move back up.

Stats: Down 17.77 points (-1.3%) to close at 1314.76.
Volume: NYSE volume fell on the selling to 1.075 billion shares (-2.9%).

The Chart: http://www.investmenthouse.com/cd/$spx.html

THIS WEEK

Thursday we said we would have to be very patient in this market. It is frustrating to see the Fed move in yet the market still stalls after a move up. Remember how a week into the rally there was talk on the financial stations that fund managers and others were afraid they had missed the bottom? We labeled that 'crazy talk' at the time and warned that might spell trouble in the short run. When there is a rush to get in for fear of missing out, the jig is up in many cases. We thought the rally, because it was so new, might be able to fend off that mindset. It has sold back, and now the risks are to the downside to borrow the Fed's phraseology. The market is indeed testing everyone's patience.

We have to continue with patience at this point until the market can show us just what it is going to do: rally from here or sell down to test the earlier lows. The S&P 500 is holding just above its down trendline and used that as support on Friday, a perfect point to rally from if it is going to do so. Indeed, we would expect it to do so if there is any life in this market. The Nasdaq is not helping it, however, as its big boys are taking a licking. While the Nasdaq was down 3.6% Friday, the Nasdaq 100 was down 4%. The new crop of Nasdaq powerhouses could be ready to make a stand, but there is nothing at this point to make us bite deeply on any move until we see some continued positive action as discussed above. Again we are looking at those Nasdaq powerhouses to see if they hold at their 52-week lows and start to move up on stronger volume. Not holding our breath, but watching.

We will be interested in playing these stocks if they start a run back up as they can give large moves and quick gains. AT this time we will not be looking for more out of them other than making some money on an oversold bounce. We will follow the moves with trailing stop losses and if we see any weakening in the move, we will be history. These stocks are ripe for a bounce and we will participate and hit some easy singles and move on if it does not last.

We are also interested in the continuing string of solid stocks that are breaking out of patterns and moving well such as SDS, NATI, ASD, EDS, and FRED. Each day we see a few more break out of the good patterns we are tracking. In this market keep the best patterns on the screen. Other than an oversold bounce and a run by the beaten up big techs, strong patterns give you the edge you need on the market, especially in times such as these. When a stock breaks out of a solid pattern on strong volume in this market, that is a sign that it has some strength. It does not relieve us of taking care of positions with stop losses whether mental or mechanical, but it gives us more confidence in the trade. When other stocks are tanking we keep following the strong patterns. Not all will break out; that is a fact of the market. The ones that do on strong volume, however, are the ones we get into.

This week we also have some important economic numbers. Retail sales come out on Tuesday. Greenspan gives the second part of his testimony on the economy on Wednesday. The PPI is out Friday. Another busy week of economic news that could have potential impact on the stock markets, but the question is which way. If retail sales come out stronger than expected, will that cause market selling for fear of no further rate cuts in the near future? Again, that is simply foolish, and the market will at some point wake up to the idea that now that the economy is really slowing and the Fed is alarmed, good economic news is actually good for the economy and good for the market. Greenspan most likely won't give us any new clues as to what is going on in his mind, but he will reiterate that the Fed stands ready and he may indicate the need to protect consumer confidence, indicating that the Fed will step in to help the market if need be. That will never be admitted, but Greenspan said as much already. Again, at some point fund managers will recognize that better economic news or at least no longer weakening economic news means that earnings will improve faster than now believed and the markets will start climbing again, repairing the damage of the past year.

Support and Resistance Levels

Nasdaq: Closed at 2470.97.
Resistance: 2650. 2890 to 2900 is next before the 3000 level.
Support: 2300.

S&P 500: Closed at 1314.76
Resistance: 1360 to 1375.
Support: Down trendline at 1300 to 1305.

Dow: Closed at 10,781.45.
Resistance: 11,020 - 11,028. After that, 11,400.
Support: 10,750. Then 10,650.

End Part 1 of 2

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