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Large caps say breakdown, while mid caps and small caps disagree

(April 21, 2002)

The Dow went out with a whimper last week, as options expiration activity took hold of the market towards the end of the week.  The Dow closed up 51.83 on Friday, after losing around 15 points on Thursday.

Friday's activity was highlighted by the amazing recovery of Microsoft in before-hours trading.  After the company warned on Thursday night, the stock fell to as much as below 52 at one point.  When the market opened, however, the stock was nearly at break-even level, and actually managed to close in positive territory (closing at 57.20).  That seemed to work well for options writers since there was a huge open interest on the April 55 puts for Microsoft.

Was last Monday indeed the bottom?  Let's take a look at the chart of the DJIA:

Current and Key Support Level of the Dow Jones Industrials (September 2001 to Present)

The Dow Industrials closed barely above its 50-day moving average (the red line) on Friday and it is still significantly below its up trend line from the September lows.

We believe last Monday's lows signal a breakdown in the Dow Industrials.  It is not a false move or a bottom, by any chance, since we believe the complacency during that Monday was too rampant to be characterized as a convincing bottom.  Moreover, we have not seen anyone else characterize last Monday's close as a breakdown, and because of this lack of acknowledgement, we are now as convinced as ever.

Meanwhile, both the S&P mid caps and the S&P small caps are still at or near their all-time highs.  We maintain the position that in a healthy bull market, the large caps lead, not the other way around.  We will continue to warn our readers to be careful while trading the mid and small caps since in a general market decline, the liquidity of those stocks will run out very quickly (that is, literally no buyers for some of those small cap stocks).

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