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MARKET > Commentary Wednesday, March 14, 2001
by: Eric Utley
Contributing Editor

Parabolic Fear

The Dow Jones Industrial Average (INDU) has lost roughly 885 points in the last four trading sessions. Meanwhile, the Nasdaq Composite (COMPX) fell below the psychologically significant 2000 level.

With fear running rampant on Wall Street, the threat of that emotion spilling over into Main Street America is a cause for great concern. Many economists and market watchers have opined recently that the plunge in stock prices, particularly the Nasdaq, could negatively impact consumer sentiment and ultimately reduce spending. And as Alan Greenspan has made it clear during recent testimonies, the American consumer holds the key to fending off a recession in the United States economy. We'll know more about the recent decline in stock prices and the impact on consumers with the preliminary Michigan Consumer Sentiment report set for release Friday morning, in conjunction with the producer price index.

In the meantime, we must set aside emotions in the form of fear and instead defer to objectivity. For the investor types among my readers, with longer time horizons than traders, the game is growing more and more difficult. Up until the recent blowup in the INDU, sectors such as retail, finance and cyclical had been working higher. But, the growing concerns in international markets, particularly Japan, has confounded matters in the aforementioned groups of stocks. However, I continue to think these groups of stocks will work higher in the second half of 2001, If the U.S. economy doesn't slip into a recession. Moreover, by positioning in finance, retail and cyclical, investors can take advantage of a dramatic move by the Fed. And by dramatic, I mean a cut in interest rates that the market has not yet discounted.

In fact, rumors hit trading desks Wednesday that the Fed could possibly cut interest rates Thursday, similar to what they did in 1998, which was a day before an options expiration. In addition, the Fed Funds Futures discounted a 68 percent probability of the FOMC cutting by 75 basis points next Tuesday. Whether or not either of the two scenarios plays out over the coming trading sessions remains to be seen. Nonetheless, both traders and investors should be aware that there exists an increasing probability of the Fed drastically cutting interest rates in the near future to snuff out the fear which is spreading across global capital markets, particularly if inflation remains subdued.

The fear that I've been alluding to has been exacerbated in recent days by the debacle in Japan. About two weeks ago, Standard & Poor's downgraded their credit rating on Japanese debt, which was seen as pivotal. This morning, another debt rating agency, Fitch, placed 19 Japanese banks on 'Rating Watch Negative.' In essence, the downgrade by Fitch heightened fears of broad risk among global financial institutions. The concerns over defaults in Japan are very real for leading money center U.S. banks such as Citgroup (NYSE:C) and JP Morgan Chase (NYSE:JPM) judging by the price action in their shares Wednesday. While I still believe the financials will outperform in the latter half of this year if the Fed cuts rates drastically, the market may continue to punish shares of the larger banks with exposure to Japan. That's why investors may shun the larger, global banks for smaller, regional concerns in the U.S. such as Washington Mutual (NYSE:WM).

The breakdown in the financial sector played the leading role in the demise of the INDU Wednesday. We may see a rebound on short covering Thursday in the INDU, but it appears the old economy index wants to trade lower. Of course, that could change with the market's perception of what the Fed will do next week. Nevertheless, I consulted my astute colleague, Jeff Bailey, for a downside target on the INDU using his point and figure charting. Jeff's charts revealed that the bearish price objective for the INDU is 9400. Now we don't expect the INDU to trade in a straight line down to 9400, but it does give a reference to the downside. Furthermore, resistance for the INDU now solidly sits at the 10,250 level. What that means, in the near-term, is the INDU could bounce back up to that level and rollover. This is just an idea and a few levels to reference in the INDU over the coming week or two to keep in mind for a TRADE.

Meanwhile, the COMPX continues to work lower and the trend is obviously down. And that's why I'll reiterate that buying puts on weak tech stocks should continue to make money until the market tells us we're wrong (read: losses) in betting on lower stock prices. Our recent put play on shares of Broadcom (NASDAQ:BRCM) represents a good argument. We've captured about $13 on the downside in the Broadcom play.

The 1500 level has been popularized among technicians lately as a possible downside target for the COMPX. And there is a growing belief that the COMPX is headed to that level. Here again with the COMPX, I'm simply setting forth a reference point for traders.

Going into Thursday's session, there are a couple of things to keep in my mind. There exists the possibility of Fed-related rumors circulating again, which may induce short covering in both the INDU and COMPX. What's more, we'll want to pay special attention to the news and action overnight in the global markets, especially Japan.

In addition, Oracle (NASDAQ:ORCL) is set to report earnings after the close Thursday. In short, keep in mind the possible impact of the Oracle report when planning trades, especially if you plan on holding positions overnight. I have no insight into the Oracle report, so I won't give a bias going into their numbers.

What's more, Friday marks triple witching for equity and index options along with futures contracts. Expiration may lend a brief bid to the tape in conjunction with anticipation of the Fed meeting next Tuesday.

Finally, Friday morning will bring two key economic releases: preliminary consumer sentiment numbers and the producer price index (PPI). Both are very crucial! The market would like to see a weak PPI to prove that inflation remains subdued. Furthermore, the market might actually like a VERY weak sentiment number which may induce the Fed to move more aggressively than the market expects.

On a final note, in light of the rampant pain and fear in the broader market averages, I'd like to share a random thought. The biggest advantage that retail traders/investors have over professionals is that the former don't HAVE to operate in the market every day. Institutional traders/investors are required to put money to work EVERY day, whereas retail market participants are not. I would urge my readers to consider that thought before every trade that may not present favorable risk to reward characteristics. This market is one of the most difficult to gauge in recent history and it's blowing up professionals and individuals alike. But, for those who make it through this difficult period, I'm sure they will prosper and make a ton of money when the market gets easier. And I unequivocally believe the market will get easier after the pain has passed!

Eric Utley
Contributing Editor


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