Agora Outlook

Publisher Ken Davidson                                                                                                    Fax 250-860-2051
e-mail davidson@silk.net                                                                                        www.agoraoutlook.com

                                                                    September Expiration                     September 25th 1998

Davidson’s View

The market has completely discounted all the talk of a potential rate cut next week as evidenced by the bond market hitting a new record 5.12%. Investors have shifted their focus to the outcome of the FOMC meeting next Tuesday, and are trying to position themselves ahead of it. If the Fed doesn’t cut rates, we could see the start of a serious setback in the market. The Dow could go from 8000 to 7400 in days the way traders have been acting the past week.

Why might we see such a setback? For the first time since the 3rd quarter of 1991, S&P 500 companies could end up with negative earnings growth. Earnings estimates for S&P 500 companies continue to move lower. According to First Call, analysts expect profits for S&P 500 companies to fall 1.4% from the third quarter of last year. Last week, analysts were expecting profits to decline by 0.2% versus this week's loss of 1.4%. It is unbelievable how fast these estimates are coming down! Last quarter, actual earnings exceeded estimates by 1.9% and assuming actual earnings to exceed estimates by the same 1.9% margin this quarter, overall earnings growth in the 3rd quarter would be flat to negative relative to the 3rd quarter 1997. If that were to happen, it would be the fifth time since the 3rd quarter of 1991 that we have seen a loss. Profits rose 3.8% and 3.5%, respectively, in the first and second quarters of this year. Estimates are also coming down for the fourth quarter of this year and all of 1999. This does not look very good for the rest of 1998 and 1999. With overseas markets already in trouble it looks like the slowdown is coming home to roost!

The other factor to contend with is how much of a cut we will get on Tuesday. The debate is whether the Fed will lower rates by 25 or 50 basis points, and if they will reduce the discount rate as well. While many agree that the Fed may start with a cut of 25-basis points in the Feds funds rate, others see room for a 50-basis point reduction. Generally, the Federal Reserve tends to be cautious at the beginning and doesn’t want to raise people's expectations, so this suggests a probable rate cut of 25 basis points. The Fed will announce their decision at 2:15 p.m. est. on Tuesday. I can guarantee you that when the announcement comes, the market will initially move strongly either up or down and analysts will be immediately talking about the next rate cut about 33 seconds after the announcement! We have not placed any put trades because if there is no rate cut I believe as I mentioned above that the market will drop like a stone. I do believe that even if there is a rate cut, though, the markets will not rally that much because of the upcoming poor earnings showing. If anything, Tuesday is going to be a big day for the market and it is always wise to play it safe and be ready for the unexpected when it comes to a highly watched Fed meeting!!

Economic Effects

Thursday

Growth in the U.S. economy slowed sharply in the spring, marking the end, analysts believe, of a two-year stretch of vibrant growth and the start of a period of lackluster gains. The gross domestic product, the sum of all goods and services advanced at a 1.8% annual rate in the April-June period, after shooting up at a 5.5% rate during the first three months of the year. It was a bit better than the 1.6% rate estimated a month ago and the initial 1.4% estimate of two months ago. Still, it represented compelling evidence the economy has entered a new phase after growing rapidly at nearly a 4% rate through 1996 and 1997. Economists are expecting modest growth, around a 2% rate or a little higher, for the second half of the year. That would make the current recovery, which began at the end of the 1990-91 recession, the second longest in U.S. history, surpassing the boom of the 1980s but still falling short of the expansion of the 1960s. Economists blame two factors for the slowdown, one temporary and the other longer lasting. Businesses sharply slowed their production of goods for inventory and that alone subtracted 2.7% points from the second-quarter growth rate. The global economic slump, principally in Asia, showed up in the U.S. economy in the form of a drop in export sales, at a 7.7% annual rate, and an increase in imports at a 9.3% rate. Alan Greenspan told Congress Wednesday that he believed the U.S. economy would still be the strongest in the world six months from now. But he said he expected it would feel even more impact from global turmoil and signaled strongly that Fed policy-makers were prepared to cushion the impact by cutting short-term interest rates when they meet Tuesday. Despite the overall slowdown in the second quarter, growth remained brisk in many areas. Consumer spending grew at a 6.1% annual rate and housing construction at a 15% rate. Businesses increased investment in new equipment, including computers at an 18.8% rate. All three categories have been fueled by low interest rates, which have been for Americans the silver lining of the world’s financial problems.

Jobless Claims fell -8,000 in the latest week. Government figures showed 292,000 initial applications were filed for state jobless benefits, down from a revised 300,000 claims for the prior week. The drop brought the weekly average rate of new claims over the past four weeks, a more accurate measure of employment trends than the more volatile weekly numbers, to 302,500, down from 304,250 in the prior four week period.

Friday

Spending by consumers rebounded in August, after falling in July because of the GM strike. Growth in their incomes nearly kept up. Spending jumped 0.6% to a seasonally adjusted annual rate of $5.84 trillion after a rare 0.1% drop in July, the first in two years.

Personal income meanwhile, rose 0.5%, the most in six months, to a seasonally adjusted annual rate of $7.17 trillion. Incomes rose 0.4% in July and 0.3% in June; growth would have been more robust if not for the strike and related layoffs at GM suppliers. Taxes, interest payments and savings largely account for the difference between consumption spending and income. The figure suggests some are saving less to maintain their standard of living or still are spending some of the stock market gains they’ve accumulated over the past several years. Economic weakness overseas, principally in Asia, has slowed U.S. economic growth by slashing export sales and curbing the profits of U.S. corporations. Nevertheless, people continue to spend relatively freely and domestic demand remains strong, spurred by the lowest long-term interest rates in three decades.

The housing market, running hot through most of 1998, may be overheated and seeing some burnout judging by the level of existing home sales in August, economists said. Existing home sales dipped lower than market expectations, down 3.7% in August to an annualized rate of 4.73 million units. Economists polled by Reuters forecast, on average, an annualized sales pace of 4.81 million units in August, down from 4.93 million in July.

Data earlier in the week showed U.S. housing starts also declined in August, although that dip followed a month featuring the highest levels of starts in a decade. While the numbers are still strong, the housing market probably cannot sustain the powerful showing seen through most of this year. The declines in the equities markets will likely cause homeowners to be cautious. But this probably isn’t the start of a housing market burnout.

Next week’s Economic Indicators

On Tuesday we get consumer confidence but the important factor for the day will be the FOMC meeting. The market is expecting the Fed to lower interest rates and if they don’t the market could react negatively and sell off strongly. On Wednesday there is New Home Sales. Last week we actually saw sales of existing homes fall for the first time in a while so we could see a lower number today. Sales have been so strong of late the number will not likely affect the market at all. Thursday has Jobless Claims, Construction Spending, National Association of Purchasing Managers number and the Fed’s FOMC minutes for the 8/18/98 meeting. The NAPM number is the only indicator today that could rock the market and that is unlikely unless the prices paid component of the number is rising, indicating that inflation may be on the way. On Friday we get the all important unemployment report. The past few weeks have seen Jobless claims falling strongly so we could see a strong number. With people becoming worried about a slowdown, a strong number may be good to hold up confidence levels.

Technically

The market has now worked out of its oversold condition and is now approaching overbought levels. The put/call ratio has dropped to 50.8% versus its 30-day average of 86.3%. In the past whenever the daily P/C ratio drops under its 30-day moving average by 30%, its created a short-term sell signal. That 30% trigger happened on two straight days last week, Tuesday and Wednesday. This means that option traders who are rarely right all of a sudden turned bullish in the wake of Mr. Greenspan's comments about an interest rate cut. As the market is approaching overbought levels we are starting to see longer-term stochastics on the point of turning over but we should still have a little room to the upside. The Arms indicator is remaining in oversold territory and volatility is once again below 30, which is a good sign of stability. Of course, one must remember that a normal volatility level is 15 but when you’re hitting 45 plus, below 30 looks attractive.

The Dow has overhead resistance at 8150 and then at 8300 and is trying to close above its downtrending 25-day moving average. The current rally in the market is typical within a downtrend and given the poor profit outlook for many Dow companies, (read Davidson’s view for more information) it would be difficult to make a case for the market to rise substantially from these levels.

Mclellan Oscillator: +146 -100 oversold +100 overbought
Summation Index: -2060

Five day arms: 1.12 .80 and below, overbought 1.00 and above, oversold
Ten day arms: 1.10 .80 and below, overbought 1.00 and above, oversold

Bulls: 36.2 previous week 36.4 50% plus overbought/bearish
Bears: 45.7 previous week 47.5 50% plus oversold /bullish
Correction: 18.1 previous week 16.1

Five day Qvix: 28.88 Last week 41.93 10-15 bullish, low volatility 15-40 bearish, high volatility

MARKET CLOSES

Index

Last Week

This Week

Change

Percent

Dow Jones

7895.66

8028.77

+133.11

1.7

S & P 500

1020.09

1044.75

+24.66

2.4

S & P 100

495.18

506.27

+11.09

2.2

Nasdaq

1663.77

1743.59

+79.82

4.8

30 Year bond

5.15%

5.12%

Program Trades

We had a successful week in getting trades filled and so far they are looking great. The S&P 500 rose 11.09 points or 2.2% and our call trades premiums have fallen substantially, holding prices around the same level of what we placed them for. We’re set up now to finish filling the put side for this month after the FOMC meeting on Tuesday. After we watch the action on Monday and Tuesday we may send out an ALERT to trade the reaction.

Current Trades

Average Entry price

Bid

ask

last

800 sold SPX Put $5.00

Outright sell $5.00

1.13

1.25

1.25

1085 sold SPX Call $8.75

Long trade

9.00

9.25

9.25

1090 bought SPX Put $7.62

$1.13 spread

7.88

8.88

8.25

1120 sold SPX Call $3.00

Ultra Trade

2.00

2.50

2.32

1125 bought SPX Call $2.50

$.50

1.50

2.25

3.63

Futures Trades

High

Low

Close

Sold October 800 Put

$4.00

2.00

1.20

1.25

Sold October 1100 Call

$7.00

9.50

7.00

7.60

Copyright 1998. All rights reserved. The information contained in the AGORA OUTLOOK NEWSLETTER is based upon data that is believed to be accurate, but is not guaranteed, and subject to change without notice. All projections, forecasts, opinions, and track records cannot be guaranteed to equal our past performance. Persons reading this newsletter are responsible for their actions. Officers and employees of this publication may at times have a position in the securities mentioned, or related services.

Short Trades

Long Trades

Ultra Trades

Short Sales

1998

Current

17%

1998

Current

-03%

1998

Current

88%

1998 Current

48%

1997

108%

1997

188%

1997

82%

1996

163%

1996

169%

1996

99%

1995

93%

1995

76%

1994

79%

1994

89%

1993

177%

1993

long

1992

112%

1992

long

1991

162%

1991

long

1990

166%

1990

long

Agora Outlook

Publisher Ken Davidson                                                                                                    Fax 250-860-2051
e-mail davidson@silk.net                                                                                        www.agoraoutlook.com

                                                                  October Expiration                                   October 2nd 1998

Davidson’s View

The market is now giving signs that it is steering its boat in a new direction with consumer sentiment heading downwards. Consumer sentiment is important since consumer spending accounts for 2/3rds of the nation's overall economic activity. Confidence is currently at levels not seen since early 1966, 1987, and 1994. Two of these times were just before stock market slumps. We’re now in the middle of another correcting market and the stockmarket is usually a predictor of what may happen in the future. The economy is not likely to go into recession for a year. However, from these jacked up levels of confidence. If the stock market corrects at high confidence levels like these, it generally bounces right back. This raises the question of how long the current correction will last. It is possible that the market will bounce sometime in October, and continue up into 1999 but for the longer term it is even more likely that we have begun a long period of sideways action because of the valuation levels of stocks and lower earnings forecasts.

Confidence appears to be in a topping action that is similar to 1968-1969. The unemployment rate is likely to hold steady around the 4.5% level during the rest of 1998 and some job loss may occur because of deflation coming from Asia. The international situation will probably keep domestic inflation low to nonexistent. The overall yield curve remains positively sloped, which suggests neither recession nor substantially rising rates in the near term but this current situation is potentially dangerous for our markets. Collapses in stocks occur as lower confidence levels in the economy usually push the economy into recession because buyers dry up. The U.S. economy has not been in a cyclical downturn since 1990-1991, seven long years, one of the longest cycles on record. The biggest problem is that consumers and the government are still heavily in debt. The next recession is still likely to originate in weak consumer demand, which is almost inevitable if consumers hold their money close to their chests because their confidence has been lowered. At the start of the year I felt we were moving into a sideways action pattern but I had thought we would see more of a decline at the beginning of the year and then a flat market. 1999 could turn out to be similar to 1993 which was one of the flattest years in some time and the perfect year for placing credit spreads!

Economic Effects

Tuesday

In its biggest monthly drop since January, consumer confidence fell for a third-straight month in September amid rising fears that global economic and political turmoil would soon slow the U.S. economy. The index of consumer confidence fell 7.1 points to 126 in September from a revised 133.1 in August. The index is down 12.2 points from its 29-year high in June. [Turbulent markets here and abroad and unsettling political developments in the U.S. have been major factors in curbing consumer confidence. Consumer sentiment is important because consumer spending accounts for 2/3rds of the nation’s overall economic activity. The report comes amid increasing signs that the U.S. economy is slowing as a result of the economic crises in Asia and Russia that now are threatening to spread to Latin America.] Consumers were most concerned about the outlook for the next six months, sending the index on consumers’ expectations down 10.9 points to 95.9. Fewer people said they would buy a car or a major appliance. One of the greatest concerns is the volatility in global stock markets. Also troubling to consumers is the uncertainty over President Clinton’s future. Although consumers are worried about future economic conditions, they remain somewhat confident about their current economic situation. The index that measures consumer sentiment only dropped 1.4 points to 171.2 in September. The consumer confidence index, started in 1967, is compiled from responses to questions sent to 5,000 households nationwide. The survey polls consumers on matters ranging from job prospects to buying plans. The index compares results to its base year, 1985, when it stood at 100. The number initially took the steam out of the market as confidence fell for the third-straight month. The biggest surprise that seemed to hurt the market though was the fact that consumers were most concerned about the outlook for the next six months. This could be the start of something bigger as we mentioned in this past week’s "Next week’s economic indicators" section of the newsletter. It would definitely be good to see stronger numbers now. This would help to lift the outlook for the future, which in turn will help heighten consumer confidence sentiment.

Wednesday
New-home sales fell for a second straight month in August after peaking in June. All the August sales drop occurred in one region, the South, but the supply of new homes on the market climbed to the highest in more than a year in a sign that demand was not as robust as earlier in the year. Interest rates have since fallen to historically low levels, which analysts say will help keep a floor under the housing sector as long as jobs remain ample and incomes are rising. Total sales declined 4.4% in August to a seasonally adjusted annual rate of 838,000, well below economists' forecasts for an 882,000-unit rate. Previously, the department said July sales were at a stronger annual rate of 886,000 but the revised figure was lower. The falloff in August new home sales followed a 4.9% sales decrease in July. The market showed little reaction to the home-sales data, preoccupied instead with declines in international stock prices and efforts to calm global economic turmoil. The 30-year bond was up strongly on the news that we could be seeing things slowdown. On Tuesday, the Fed cut interest rates a quarter percentage point, aiming to head off spillover from ailing overseas economies into the U.S, where a slow down likely would likely be felt early in homebuilding and sales.
The Index of Leading Indicators, a gauge of trends in the U.S. economy, was unchanged in August as a sharp fall in stock prices canceled positive factors. The flat reading, which was in line with forecasts, followed a revised 0.5% increase in July that was previously reported as up 0.4%. Five of the 10 leading indicators that make up the index rose in August, four were down and one was flat. Changes in the leading indicators index are used to predict shifts in the business cycle. A Reuter’s survey of U.S. economists had expected the August leading index to be unchanged. While stock prices were the most significant negative component, the money supply, average weekly initial jobless claims and manufacturers new orders for non-defense capital goods were the largest positive contributors last month. The report also said the index of coincident indicators, a measure of present economic conditions, rose 0.6% in August after being unchanged in July. The business research group said the rise resulted from a rebound following the recent strike by the United AutoWorkers union against GM.
 
Thursday

New applications for jobless claims fell unexpectedly last week to their lowest level in more than five months, showing the job market remains healthy. Initial claims declined by 5,000 to a seasonally adjusted 289,000 in the week ended Sept. 26. That was down from an upwardly revised 294,000 in the prior week, which was originally reported as 292,000. Economists in a Reuter’s poll had expected new jobless claims to rise to 302,000. The four-week claims average fell to 299,250 in the Sept. 26 week, the lowest since the Feb. 11 week in 1989 during the height of the last U.S. economic expansion. In the Sept. 19 week, the four-week claims average came in at 303,000. A consistently low level of jobless claims recently has surprised many economists because they have indicated the job market is holding its strength despite the global financial crisis, which has dealt a blow to some areas of the U.S. economy such as manufacturing.

The National Association of Purchasing Management (NAPM) said its index of manufacturing business conditions held steady at 49.4 in September. The index has read below 50 since June, a level suggesting contraction within the sector since June. The report's production component, however, managed a sizeable gain, jumping to 53.4 last month from 50.3 in August, due mainly to GM's rebound. Economists polled by Reuters had, on average, expected a weaker NAPM reading of 48.9. Without the surprise jump in production, they might have seen such a performance, analysts said. Measures of inventories, employment conditions, export orders and prices all suggested a slowing pace of manufacturing. The NAPM price index was particularly weak, marking its lowest level since July 1949 with a decline to 34.4 from August's 38.4. Product prices will continue to be under pressure and the manufacturing sector could be underwater for quite a while. Looking ahead, economists found in the data no signs of hope for a turnaround in the manufacturing sector. The dollar's continued strength amid widespread devaluations elsewhere actually may raise the level of competition U.S. factories face. The competition from abroad is only now starting to intensify. Since late spring, the NAPM index has pointed to steady but gradual slippage in the manufacturing sector. It has hovered very near the break-even point of 50 since June, and nothing in this latest report suggests a dramatic worsening of the situation, economists said. We've had four straight months of being around 49. Right at the moment it means we're dead in the water. Aside from manufacturing, the economy continues to move along. A NAPM reading above 43.6 historically has correlated with general economic growth. Recent manufacturing history recalls periods during the 1980s when the factory sector dove into recession but the broader economy remained afloat. The report didn’t appear to have much influence on the market. Stocks were down from the overnight declines of share prices on foreign exchanges and largely ignored the NAPM release

Spending on new U.S. construction projects edged up modestly in August as building activity cooled off from a frenzied pace earlier in the year. August construction spending rose 0.1% to $651.6 billion. That gain matched July's increase but both months were much slower than June's surge of 2.3%. U.S. economists in a Reuters survey had expected construction spending to rise by 0.4% in August. The small spending gain in August was driven entirely by the public sector, where construction spending for hospitals, schools, highways and other projects jumped 0.6% to $147.9 billion after a 0.2% rise in July. The housing market has had a great year in 1998 amid falling interest rates and a robust job market but activity has shown signs of some slowing recently.

Friday

The U.S. unemployment rate rose to 4.6% and job growth slumped to its lowest level in nearly three years in September, as the global economic crisis seemed to intensify. The rate, up from 4.5% during the three previous months, was the highest in six months. It had hit a 28-year low of 4.3% in April and May. There were 69,000 jobs added last month, down from 309,000 in August and the weakest figure since a blizzard in the Northeast forced businesses to cut payrolls in January 1996, the Labor Department said Friday. The relatively weak September growth reflects an unusually small increase in services and job losses in manufacturing and construction. Manufacturers cut payrolls by 16,000 jobs in September, the fifth decline in six months. During that period, factory employment increased in August only, reflecting a rebound following the GM strikes. Over the past six months the sector has lost 152,000 jobs. Recession in Asia has hurt U.S. factories on two fronts: It has slashed sales in what was once one of their best export markets and, because of steep currency de-valuations, forced them to compete against a flood of cheap imports pouring into the U.S. In another sign of softness, the average workweek fell to 34.4 hours from 34.6 hours in August. Average hourly earnings rose only 1 cent, to $12.86, but that followed a strong 6-cent gain the month before and wages are up 4% from a year earlier. The weakness in this number pulled the market out of its rally to see more large declines but as the day wore on the market rallied on positive comments by President Clinton about the overall economy.

New orders received by U.S. factories rose in August for the fifth time in the last six months, with transportation equipment makers leading the way following the end of a strike at GM. New orders rose 0.9% to a seasonally adjusted $337.7 billion, following a 1.1% July gain. Excluding transportation products and the impact of the resumption of output at GM, orders were down 1.2% in August after a 1.1% rise in July.

The University of Michigan's final September index of consumer sentiment fell to 100.9 from a reading of 104.4 for the final August index. The current conditions component fell to 111.7 in the final reading for September from 113.9 in the final August survey.

The consumer expectations index fell to 93.9 versus 98.3 for the final reading in August. The falling consumer sentiment indicators all seem to be moving in sync and this may become one of the most watched indicators in the future as sentiment plays a big role in the market when it is headed lower. The public now has the most money ever in mutual funds and if investors pull their money out of the market it could be very dangerous.

Next week’s Economic Indicators

This coming week has to be the slowest week of the year for indicators. Everything comes on Thursday and even those indicators are not likely to move the market very much. There are Jobless Claims, Overall Chain Store sales and finally Wholesale trade. Because of this the market will probably concentrate on technical factors all week.

Technically

The market has moved back into oversold territory. Shorter term, the market is deeply oversold but longer term, the market still looks as if it is going to go lower.

The weekly advance decline is one of the reasons for believing we're in a bear market downtrend of indeterminable length and should expect much lower prices. The line broke its 40-week average on July 31. It looks like we peaked again and have started to turn back down. The Arms index reveals that we are strongly oversold short term by the 5 and 10 day Arms Index but even there we may only see a bounce from lower levels as down volume is swamping up volume. Volatility has again begun to rise indicating we’ll likely see plus or minus 100 point Dow days for the next little while. Longer-term momentum has double-peaked and this topping process is being confirmed by put/call ratios as well as other consumer confidence survey readings. It has been steadily falling since the beginning of the year. Short term, though, momentum appears to be favoring the upside, as its uptrend was not broken this week. Stochastics were at overbought levels all week and with the fall Wednesday and Thursday, have now registered a sell signal. Overall technical indicators are mixed to lower, so it looks as though we could have another short term bounce but it is not likely to break past the previous rally levels of 1067.00 on the S&P 500.

Mclellan Oscillator: +59 -100 oversold +100 overbought
Summation Index: -1530

Five day arms: 1.33 .80 and below, overbought 1.00 and above, oversold
Ten day arms: 1.55 .80 and below, overbought 1.00 and above, oversold

Bulls: 37.6 previous week 36.2 50% plus overbought/bearish
Bears: 44.4 previous week 45.7 50% plus oversold /bullish
Correction: 18.0 previous week 18.1

Five day Qvix: 40.41 Last week 41.93 10-15 bullish, low volatility 15-40 bearish, high volatility

MARKET CLOSES

Index

Last Week

This Week

Change

Percent

Dow Jones

8028.77

7784.69

-244.08

3.0

S & P 500

1044.75

1002.60

-42.15

4.0

S & P 100

506.27

486.49

-19.78

3.9

Nasdaq

1743.59

1615.03

-128.56

7.3

30 Year bond

5.12%

4.84%

Program Trades

With the slide in the market this week our trades are looking very good. We have ran the numbers to see what the probability of our trades being successful this expiration cycle and we came up with incredible numbers. The cash S&P 500 1085/1090 calls had the lowest number but still came up with a 95% probability of expiring worthless on October 16th. The 1120/1125 cash calls gave a high 98% probability, which was not surprising. The futures 800 put and 1100 calls both gave a reading of 96% success. Hopefully the market will continue down at the start of the week so we can get some put trade fills to complete the Long and Ultra trades for the other side of this months trades.

Current Trades

Average Entry price

Bid

ask

last

800 sold SPX Put $5.00

Outright sell $5.00

.75

.93

1.25

1085 sold SPX Call $8.75

Long trade

1.32

1.75

1.75

1090 bought SPX Put $7.62

$1.13 spread

1.32

1.75

1.50

1120 sold SPX Call $3.00

Ultra Trade

.25

.75

.38

1125 bought SPX Call $2.50

$.50

.06

.93

.25

Futures Trades

High

Low

Close

Sold October 800 Put

$4.00

2.00

.85

.85

Sold October 1100 Call

$7.00

1.50

.80

1.35

Agora Outlook

Publisher Ken Davidson                                                                                                    Fax 250-860-2051
e-mail davidson@silk.net                                                                                        www.agoraoutlook.com

                                                                  October Expiration                                   October 7th 1998

Davidson’s View

So are we starting to move into a deflationary cycle? Deflation can lead to terrible economic conditions because it produces falling prices, falling profits and cutbacks in employment. The last deflationary period we suffered through was during the Great Depression, a decade-long economic bust that began in 1929. A manufacturing company needs to buy supplies and pay wages in order to produce its products. It might take several weeks or months to get those supplies and put that product together. During a period of falling prices a manufacturer can be faced with a no win situation. By the time you get the products to market you would lose money in selling them. When that happens, manufacturers cut back and that puts people out of work. Even the most productive workers are no match for deflation. Next Friday’s release of Industrial Production could prove to be an important number right now. Devastating deflation is now occurring in many parts of the world, especially where basic commodities such as oil and agricultural goods are affected. So far, we have benefited from falling prices. Deflation elsewhere is only serving to ease inflation pressures in the U.S. but if these other countries begin to dump their goods here we could begin to see a downward spiral of prices. The Fed has now reduced interest rates on worries of a global slowdown but I’m sure they don’t want to be stimulating the economy too much, as our economy is still very strong. The good thing about lower rates is that if interest rates continue to drop that will encourage people to borrow and spend even more money. If that happens, that would keep businesses humming and keep people employed and keep positive pressure on prices.

But until then…

J.P. Morgan has forecast a recession in 1999, becoming the first major U.S. bank or investment house to predict a downturn in the U.S. economy next year. The nation's fourth-biggest commercial bank said in its quarterly forecast that it expected the economy to stall in the first quarter of 1999 and then fall to a 2% annual rate in the second quarter and a 1% rate in the third quarter. Growth would resume at a 1.5% pace in the fourth quarter they said. It’s not surprising to see a business slowdown develop now or next year since the extraordinary high upside momentum has probably ended and it is only a matter of time before what’s happening overseas begins to hurt us. The negative is that slower business justifies lower stocks prices on a fundamental basis. But there is also a possibility that for very long-term investors the run up from the 1982 low (or the 1987 low) is somehow over and they might as well take long-term profits. This raises the likelihood that we will see a decline based simply on long term profit all on top of a poorer business outlook.

On the other hand, there are often completely new and unexpected opportunities arising out of change and it might be a good idea to keep an eye out for any new emerging investment themes that might seem to be gaining at the expense of those stocks that have done well over the last 20 years. Like maybe, credit spread trading!! Even so, we have plenty of time to look for any emerging new investment theme and the Internet might make the search task easier and more practical. None of this means the market is about to collapse into a 1929 type decline. However, I would say there are many warning signals. While there is no direct implication of a very serious long-term decline for the years ahead, this similarity could mean that risks for the long term are much higher than most investors think right now. The high rate of returns investors have become used to over the last 15 years are not likely to continue for the years ahead. Since the 1962 correction low, strong bull market advances have eventually seen corrections of 50% (plus or minus) of their run up. If the 1991 to 1998 run up was to see a 50% correction, the downside objective would be just under 6000 on the Dow.

With the Federal Reserve just now moving into a reduction mode, I expect the market to at least remain sideways to down, as it will be worried about how deep the slowdown may be. After the Fed cuts rates for the third time, it will then be time to say the market will move into another bull leg. In the past, the market has always started to rally after the 3rd move by the Fed since analysts then know that their stimulus should start to work through the economy (as we talked about above).

A sideways market is great for high volatility in option premiums and perfect for trading credit spreads on both sides of the market with greater safety as bulls and bears are equally matched. Hopefully for stock traders it won’t be like the sideways market that lasted from 1965-1982! We would be in heaven if that happened.

Economic Effects

Thursday

The number of jobless claims rose by 11,000 in the week ended Oct. 3, but remains at levels indicative of a robust labor market. Initial jobless claims rose to 300,000, up from 289,000 in the prior week. Economists had estimated a more modest increase to 297,000. However, claims will not likely stay this low and could start moving toward the 350,000 mark in the next few months. Job losses in the manufacturing sector and some in the service sector will heavily weight them as well. The four-week jobless average, viewed as a more accurate indicator of longer-term labor conditions, fell to 295,750 in the week ended Oct. 3, down from 299,250 in the prior week and continued a pattern of gradual declines begun four weeks ago.

Stocks of unsold goods on U.S. wholesalers' shelves rose more than expected in August as sales took their biggest drop in more than five years. Wholesale inventories rose 0.9% in August to a seasonally adjusted $280 billion after being unchanged in July. Economists had expected August inventories to rise only 0.2%. Wholesale sales fell 1.2% in August to $211.59 billion, the biggest monthly drop since June 1993 when sales dropped by 1.3%. In July, sales rose a slim 0.2%. The inventories-to-sales ratio for wholesale goods, a measure of the amount of time needed to sell stored goods at the current sales rate, rose to 1.32 months' worth in August from 1.30 in July. The increase lifted the ratio to its highest level since October 1995 when it was also 1.32 months' worth. It appears that the economy is starting to slow down but this indicator had little effect on the market as it was already dealing with a plunging dollar.

Next week’s Economic Indicators

On Wednesday we get Retail Sales and Import & Export Prices. Analysts will be watching closely to see if this number is indicating a continued slowdown. Import and Export numbers are not a significant indicator but with the dollar falling strongly against the Yen, prices may be watched closely. On Thursday we get Jobless Claims, Producer Price Index, and Business Inventories. All of these indicators are important and capable of moving the market. The PPI number will probably be ignored, as inflation is already low. Business Inventories will be closely watched for a build up in goods representing a coming slowdown. Friday gives the Consumer Price Index and Industrial Production. The production number could be important, as analysts will be watching to see if worker productivity is holding up to rising wage costs.

Technically

The pessimism in the stock market was rampant on Thursday, with the CBOE put/call ratio surging to 127%, and the equity put/call ratio moved to the highest level in its relatively short 10-year history of 108% which means we may have hit a short term bottom.

It is a negative for the market that the Advance-Decline Line is weaker than the price index. This suggests the a/d Line will remain weak for some more months and therefore we are more inclined to believe the current state of weakness is probably sustainable longer term. As long as the a/d Line is working lower or sideways there will always be the risk that the final phase of the downtrend will be a climatic washout which is very damaging. Since anything could happen, it is also possible to see a very short duration rally as the market is oversold. Therefore we must continue to watch the daily advance/decline Line closely. The McClellan oscillator has moved to -73 from an oversold level of -150 and the summation index has risen to -1845 so a continued bounce is probable. The 5 day arms index is now in overbought territory but the 10 day is solidly in oversold territory so we have a divergence. This means we could have a small correction but then a quick turnaround to the upside as they come back into sync. Stochastics have started to turn up and momentum and relative strength are flattening out but not yet turning lower. As a result, we may still see higher moves with overall indicators oversold.

Mclellan Oscillator: -73 -100 oversold +100 overbought
Summation Index: -1845

Five day arms: .80 .80 and below, overbought 1.00 and above, oversold
Ten day arms: 1.17 .80 and below, overbought 1.00 and above, oversold

Bulls: 38.5 previous week 37.6 50% plus overbought/bearish
Bears: 42.7 previous week 44.4 50% plus oversold /bullish
Correction: 18.8 previous week 18.0

Five day Qvix: 46.17 Last week 40.41 10-15 bullish, low volatility 15-40 bearish, high volatility

MARKET CLOSES

Index

Last Week

This Week

Change

Percent

Dow Jones

7784.69

7899.52

+114.83

1.4

S & P 500

1002.60

984.39

-18.21

1.8

S & P 100

486.49

483.73

-2.76

0.5

Nasdaq

1615.03

1493.23

-121.80

7.5

30 Year bond

4.84%

5.12%

Program Trades

We’re looking very good going into expiration next week. We have run the numbers to see what the probability of our trades being successful this expiration cycle and we came up with solid numbers. The cash S&P 500 1085/1090 calls came up with a 98% probability of expiring worthless on October 16th. The 1120/1125 cash calls gave a high 99% probability, which was not surprising. The futures 800 put and 1100 calls both gave a reading of 99% success. We were able to get into the Long 950/940 cash and futures put trades on Wednesday of this week. With the strong close on Friday the probability of the S&P 500 staying above the 950 level for expiration is looking pretty good with a 89% probability for cash and 87% for the futures 950/940 puts.

Current Trades

Average Entry price

Bid

ask

last

800 sold SPX Put $5.00

Outright sell $5.00

.25

.50

.25

1085 sold SPX Call $8.75

Long trade

.13

.50

.25

1090 bought SPX Put $7.62

$1.13 spread

.13

.50

.38

950 sold SPX Put $21.50

Long trade

8.75

9.00

8.50

940 bought SPX Put $18.50

$3.00 spread

6.25

7.00

6.13

1120 sold SPX Call $3.00

Ultra Trade

0

.50

8.00

1125 bought SPX Call $2.50

$.50

0

.13

.13

Futures Trades

High

Low

Close

Sold October 800 Put

$4.00

.70

.35

.35

Sold October 1100 Call

$7.00

.20

.15

.15

950 sold SPX Put

Long trade

19.00

8.00

8.00

940 bought SPX Put

$4.50pread

16.50

6.30

6.50

Agora Outlook

Publisher Ken Davidson                                                                                                    Fax 250-860-2051
e-mail davidson@silk.net                                                                                        www.agoraoutlook.com

 

                                                                 October Expiration                                October 16 th 1998

Davidson’s View

Every year when the October expiration cycle is finished my thoughts go back to October 16th 1987, the Friday before Black Monday. (This year Friday even has the same date.) That year it had already been a rough week. The market had fallen 4.5% going into expiration Friday and the day of expiration alone saw a 5% loss. I was glad I had already moved to a full cash position on Wednesday (I traded stocks back then) because of many factors pointing to a big fall and the sudden drop off of psychology and internal sentiment becoming very negative. You could tell there were a lot of nervous put sellers around, as the market kept moving lower into the October expiration. Back then very few people actually protected their sold puts because no one thought the market would ever crash again like it did in 1929. Boy, were they in for a surprise! None-the-less the October expiration saved the day in the same way it did for the short call sellers today.

October 16th 1987 expiration was finished! October puts were now done and finished and most traders would just take the weekend off and soak in their sorrows until Monday. They could then redeem themselves with selling the November Puts because they figured the market wouldn’t see any more selling! Surprise surprise, they were able to sit back and watch on Monday morning as the market started melting before it even opened! For the first time, "households" learned about the Nikkei average because Japan’s stocks had collapsed overnight and Wall Street was set to open with a massive loss with futures already down big time. You know the rest of the story….

What happened with the Fed rate decrease yesterday was similar to that one day save just before the crash. If the Fed would have lowered rates earlier in the day the S&P 500 could have moved much higher creating call sellers to even see bigger losses. The move may have then even came close to our sold call trades! But, only the most daring, or should I say "gambler"call option sellers were caught in the final 45 minutes of trading as they scrambled to cover positions in case the market continued moving upward Friday morning. The benefit for us was that time ran out just like the one day before the crash. Our program covered us beautifully since its numbers predicted, we could see this kind of move happening sometime this month thus we were further out than normal and got through unscathed.

As I mentioned Thursday night, I didn’t think the market would move much Friday since it had the air of hesitation and Friday’s trading did turn out lackluster but higher. The rate decrease was good but it was almost a negative for the market because it came in-between Fed meetings indicating that things could be worse then expected and maybe fourth quarter earnings are going to be worse than thought and even slower in 1999. This is why the market seems hesitant and thus we need to sit and wait; a perfect setup for spread trading. Most analysts believe that if the Federal Reserve cuts rates 3 times a new bull market has arrived. We may see that 3rd cut in November but, maybe it will just be a calf market this time around!!

Economic Effects

Wednesday

A rebound in auto sales following the GM strike helped produce a modest 0.3% increase in retail sales in September, but spending fell for furniture and clothing stores. Overall, sales rose to a seasonally adjusted $224.9 billion after remaining nearly unchanged. Auto sales shot up 0.9% in September, the best gain in four months, following decreases of 0.1% in August and 4.3% in July. Excluding autos, sales crept just 0.1% higher in September, the same as the increase the month before.

The report suggests consumers may have turned a bit cautious following the sharp late August drop in the stock market. Also, Hurricane George temporarily battered sales in parts of the South and unseasonable warmth curbed spending on fall merchandise. Sales at clothing and accessory stores, for instance, dropped 1.3%, the worst decline in a year and a half. Spending at furniture stores edged down by 0.2%, the weakest performance in five months. Hurt by falling gasoline prices, sales at service stations decreased 0.8%. For the third quarter, they’re off 5.7% from a year earlier. Reports from big retail chains last week showed consumers favored value-oriented stores such as Wal-Mart and K-mart over more expensive department stores. A boom in home sales, fueled by low mortgage rates, has supported sales of building materials and hardware. The third-quarter sales level was 9.7% higher than last year. Overall, retail sales, which account for roughly a third of the nation’s economic output, were 4.1% higher in the July-September period than a year earlier. Analysts are watching sales trends anxiously to see if the market’s troubles will slow sales during the all-important holiday shopping season.

Thursday

Prices charged by factories, farms and other producers jumped 0.3% in September, the largest rise in a year, pulled higher by big increases for fruit and vegetables and home-heating oil. In August it fell 0.4%. The closely watched core index, which strips out more volatile food and energy costs, rose 0.4% after a 0.1% fall in August. Analysts polled by Reuters had expected the overall index to be unchanged and a more moderate 0.1% increase in the core number. Up to September, wholesale prices were still down 0.9%, suggesting that overall inflation pressures in the world's top economy remain low despite the uptick in the monthly number. The report painted a mixed picture of wholesale prices across different sectors. Energy costs inched down 0.1% as gasoline prices dropped 2.0%, but heating oil prices rose 6.6%, the biggest gain in almost a year.

Prices for passenger cars rose 2.2%, the biggest increase since a 3.0% gain recorded eight years ago. Food prices gained 0.4%, propelled by a 12.4% increase in prices for fresh and dry vegetables, reversing last month's 0.4% decline.

Jobless Claims edged up by 2,000 last week. There were 303,000 new applications for benefits throughout the country from a revised 301,000 a week earlier, matching private economist’s forecast of 303,000. Claims have risen for the second straight week. The four-week claims average reached 297,000 in the week ended Oct. 10, up from a revised 296,250 the week prior. Claims are likely to worsen in the months ahead as workers lose jobs in manufacturing as well as in the service sector. Some economists have forecast a rise in first time applications to 350,000 by the end of the year.

Friday

Inflation disappeared in September thanks to falling prices for gasoline, clothing and vegetables. The seasonally adjusted Consumer Price Index was saw the best performance in six months. That brought the inflation rate for the first nine months of the year to just 1.4, even better than the 11-year low of 1.7% recorded for all of 1997! But the good news for consumers translated into a disappointing cost of living raise for those recieving Social Security checks. Their benefits will increase just 1.3% next year, the smallest raise since 1987. Based on the movement in a special price index for urban wage earners, the average monthly check for retirees will rise by $9 to $779. Generally, there were few signs of price pressures in September that could cause the Federal Reserve to pause in its efforts to boost the U.S. economy against the world slump by cutting interest rates. Yesterday the PPI jumped 0.3%, the worst in a year. But economists dismissed it as a fluke, caused largely by the failure of seasonal adjustments to capture a change in the timing of auto sales incentives. Today’s report shows the rise didn’t carry through to the consumer. Energy prices in September fell 1.3%, pulled down by a 2% drop for gasoline and smaller declines for fuel oil, electricity and natural gas. In fact, gasoline prices have fallen at an 18.8% annual rate this year. Though analysts don’t expect a big increase anytime soon because of falling world demand for energy, they don’t expect prices to fall much more either. Food prices were unchanged last month, but are up at a 2.1% rate year to date. Excluding volatile food and energy costs, core prices rose 0.2% in September and are up a 2.4% annual rate this year, compared with 2.2% for all of last year.

Industrial Production dropped unexpectedly by 0.3% in September, wrapping up the weakest quarterly performance for production in seven and a half years. The Fed said total output by the nation's mines, factories and utilities was flat during the July-September third quarter following a 1.7% second-quarter rise. The third quarter was the weakest three-month period since an 8.3% drop in industrial output in the first quarter of 1991, amid the last recession. Economists had forecast a 0.1% rise in September industrial output. According to the Fed, U.S. factories, mines and utilities operated at 81.1% of capacity last month. Economists had expected 81.5%, against 81.6% in August. The September weakness in overall industrial production followed a 1.6% jump in August, when strikers returned to work at GM plants, boosting output. The declines were widespread in durable manufacturing, with larger drops in steel and motor vehicles and parts. Manufacturing output fell 0.4% last month after a 1.8% jump in August. Production by mines was down 0.5% after a 0.8% August drop.

Real average weekly earnings, after adjusting for inflation and seasonal factors, fell 0.6% in September, the largest drop in more than two years. The numbers were good news for bonds but they were ignored as traders were more concerned with the falling dollar.

The September fall followed a revised 0.4% gain in August real average weekly earnings previously reported as a 0.5% gain. Labor said this month's decrease was the largest fall since a matching 0.6% drop in July 1996. The September drop resulted from a 0.6% fall in average weekly hours and a 0.1% rise in the Consumer Price Index for urban wage earners and clerical workers. It was partially offset by a 0.1% rise in average hourly earnings. Real average weekly earnings in September were up 1.1% from September last year. In current dollars, weekly earnings averaged a seasonally adjusted $442.38 in September, compared to $444.61 in August and $428.00 in September of last year.

The University of Michigan's preliminary October index of consumer sentiment fell to 98.9 from a reading of 100.9 for the final September index. The current conditions component rose to 115.4 in the preliminary reading for October, from 111.7 in the final reading for September which was good news. The consumer expectations index fell to 88.2 versus 93.9 in the final reading for September which means that consumers are getting worried about the future and this number actually pulled the market off of its rally highs as sentiment is currently optimistic about future economic growth.

Next week’s Economic Indicators

We thought we saw the quietest week of the year for indicators a couple of weeks ago but actually this week is going to be even quieter. On Tuesday we get International trade figures. This number is likely to be ignored unless the deficit sees another huge increase. On Wednesday we get Housing Starts. We have started to see a slippage here and another down number may be bad for the market as this is usually the first area that slows in the economy. On Thursday all we get is Jobless Claims and there is no reason to see this number move the market.

Technically

The Volatility Index went past the 60 level at one point last week, reaching its highest level since October 1987. Normally, this kind of extreme high in the VIX represents panicking put buyers seeking protection at any cost. This seemed to be the case as the market had been up since that reading came out and with the interest rate reduction market rally the timing couldn’t have been more perfect! The put/call ratio turned into extremely bullish territory this past week but the McClellan oscillator has become overbought once again short term. Stochastics still have quite a ways to go before they are overbought and relative strength is holding its own. The one downside is that momentum did not move as strong as this rally so the steam could be starting to slow. The 5-day Arms indicator has remained in overbought territory and now the 10-day is also. With momentum low, Arms overbought, we could see the market continue higher but it may not leap ahead at the start of the week. The important thing though is that since the S&P 500 went through resistance on Thursday with the Fed rate cut it will now fight with resistance at the 1080 level. The Dow has its first band of resistance right here, but the more significant resistance is awaiting it in the 8550 to 8800 range.

This strong week indicates that the recent rally has made short-term technical indicators overbought, but they can remain overbought for an extended period of time during rallies, just like when they remained oversold for long periods of times during the sell-off in July-August. Market tends to become overbought or oversold during important market moves. If the current overbought reading stays in this territory for some time, it would indicate that this rally could continue. When a market tends to change direction it will then refuse to react to overbought/oversold situations.

Another good long term indicator similar to our Investors Intelligence Bull/Bear report is data from Market Vane, another bullish/bearish polling company.

The percent of their survey expressing bullish sentiment last week fell to the lowest level in the last ten years so we may have seen a bottom put in place.

Mclellan Oscillator: +188 -100 oversold +100 overbought
Summation Index: -1465

Five day arms: .85 .80 and below, overbought 1.00 and above, oversold
Ten day arms: .82 .80 and below, overbought 1.00 and above, oversold

Bulls: 41.0 previous week 38.5 50% plus overbought/bearish
Bears: 42.0 previous week 42.7 50% plus oversold /bullish
Correction: 17.0 previous week 18.8

Five day Qvix: 39.93 Last week 40.41 10-15 bullish, low volatility 15-40 bearish, high volatility

MARKET CLOSES

Index

Last Week

This Week

Change

Percent

Dow Jones

7899.52

8416.76

+517.24

6.5

S & P 500

984.39

1056.42

+72.03

7.3

S & P 100

483.73

520.95

+37.22

6.3

Nasdaq

1493.23

1620.95

+127.72

8.6

30 Year bond

5.12%

4.97%

Program Trades

We had full profits again this month and our newly added Futures trade section started off with a bang. We didn't place any short trades this month as momentum and volatility were such that we couldn’t get any solid indications of a turn in the market. Long trades for calls were fully profitable, giving a 23% return. Once again we only displayed half of the percentage gains on the Long Put trades since we are still in Crash Alert Mode and not applying much capital to put trades. We still received a 15% return none the less. We were only able to get into one Ultra Conservative trade this month since there were few options available to trade. No one wanted to supply any options with volatility so high. We still made a 10% profit on the one Ultra Trade this month. Our Outright Sell trade saw another good month. The 800 put level has seemed to attract people even though the odds of hitting that level are high. Surprisingly, for the second month in a row they were expensive and so we made another 5% this month there. Our first Futures trades month turned out well. The first trade was a Sell strangle which gave us a 22% return. The big winner was a Long put trade that brought in a 45% profit. That was the trade winner of the month!! The coming month should be exciting since November is usually a mixed month.

Current Trades

Average Entry price

Bid

ask

last

800 sold SPX Put $5.00

Outright sell $5.00

0

0

0

1085 sold SPX Call $8.75

Long trade

0

0

0

1090 bought SPX Put $7.62

$1.13 spread

0

0

0

950 sold SPX Put $21.50

Long trade

0

0

0

940 bought SPX Put $18.50

$3.00 spread

0

0

0

1120 sold SPX Call $3.00

Ultra Trade

0

0

0

1125 bought SPX Call $2.50

$.50

0

0

0

Futures Trades

High

Low

Close

Sold October 800 Put

$4.00

0

0

0

Sold October 1100 Call

$6.50. bought back for $.50

0

0

0

950 sold SPX Put

Long trade

0

0

0

940 bought SPX Put

$4.50 spread

0

0

0

Copyright 1998. All rights reserved. The information contained in the AGORA OUTLOOK NEWSLETTER is based upon data that is believed to be accurate, but is not guaranteed, and subject to change without notice. All projections, forecasts, opinions, and track records cannot be guaranteed to equal our past performance. Persons reading this newsletter are responsible for their actions. Officers and employees of this publication may at times have a position in the securities mentioned, or related services.

Cash Trades

Short Trades

Long Trades

Ultra Trades

Short Sales

1998

Current

17%

1998

Current

35%

1998

Current

98%

1998 Current

53%

1997

108%

1997

188%

1997

82%

1996

163%

1996

169%

1996

99%

1995

93%

1995

76%

1994

79%

1994

89%

1993

177%

1993

long

1992

112%

1992

long

1991

162%

1991

long

1990

166%

1990

long

Futures Trades

Outright Sells

Long Trades

1998 Current

22%

1998 Current

45%