Market Bottom or Not? Lehman Bull Seems Cowed by Bearish Market

GuruVision: A Chink in the Armor

SAN FRANCISCO -- All was relatively quiet on the Wall Street front Monday -- the Dow Jones Industrial Average gained 0.5%, the S&P 500 rose a fraction and the Nasdaq Composite shed 0.8%.

Those betting and/or praying Friday's advance was the start of something real should be encouraged by the market's performance. Here's another reason: One of the most steadfastly optimistic strategists on Wall Street just blinked ... maybe.

"The current stock market correction may have more to run," Jeffery Applegate, chief investment strategist at Lehman Brothers wrote in his weekly market commentary, published today.

Applegate, whose longstanding bullishness has been reported here repeatedly, also wrote, "We could need to see higher volatility, higher put/call ratios, higher volume and more new lows" before a final bottom is established.

Applegate contends the S&P 500 is fundamentally undervalued but expressed concern about a potential war in the Middle East and the corresponding implication for oil prices, which fell 5.4% Monday. Higher oil prices could lead to additional price-to-earnings ratio compression and contribute to the Federal Reserve maintaining a tightening bias (or the modern variation thereof), he wrote.

Notably, Applegate was blase about oil prices just two weeks ago, just as he had been during much of oil's big rise in the past two years. Admittedly few, if any, experts predicted recent events in the Middle East. But it's a bit late to suddenly become concerned about the potential negatives associated with rising oil prices. Isn't it?

The strategist also warned that stocks that held up best during the preceding six weeks -- he cited BEA Systems (BEAS), EMC (EMC), Juniper (JNPR) and Network Appliance (NTAP) (all up again on Monday) -- "will be pummeled as the stock market makes its bottom." (Lehman has done underwriting for Network Appliance.)

In a follow-up call, Applegate backed away from any implication that this week's piece marks a reversal from his long-standing bullishness. Indeed, his year-end target for the S&P 500 of 1600 and overweighting in tech remain unchanged. Additionally, the strategist chuckled when I asked if he's recommending investors sell the aforementioned stocks in anticipation of a "pummeling" to come.

"Certainly not," he said. "We own them all [in Lehman's various recommended portfolios] and wouldn't want to market-time. I'm not inclined to sell them."

During our phone conversation, Applegate shied away from the significance of his "no-bottom" market call, suggesting the central point of his report is that "unless oil goes to $90, it's hard to make an argument we have a serious inflation or valuation problem."

Coulda fooled me. The report sure read like something indicating one of the Street's most bullish gurus has gotten the chills, something that might suggest the market really did bottom last week.

But I guess not.

Expiration Could Enliven Bulls

Merrill Lynch's equity derivatives team points out that as of Oct. 11, open interest on in-the-money puts for the S&P 500 totaled $14.2 billion vs. $1.4 billion in-the-money calls . For the Nasdaq 100, open interest on puts totaled $3.9 billion vs. $93 million for calls. Those dollar figures are not absolute -- they are "delta-adjusted," meaning the relationship between the price of the puts or calls and the price of their underlying futures has been taken into account.

The investment community's desire for puts over calls effectively means brokerages are short puts, notes Diane Garnick, equity derivatives strategist at Merrill. To hedge this position, they will sell index futures.

If the market moves up, brokers are forced to cover their hedges and buy back futures, she continues, noting this short covering has resulted in "positive expiry week returns in 11 out of the last 12 put imbalance expiries." For expiration weeks when the previous week was a down one (as last week was despite Friday's big advance), the average return has been 3.1% for the S&P 500 and 3.9% for the NDX, Merrill reported.

Garnick recommends buying either S&P Depositary Receipts (Spiders ) or Nasdaq 100 Trusts (QQQ) in anticipation of a similar performance this week, suggesting the short covering by brokers will continue to "support the market" through Thursday's close. But come Friday, "That support is gone," meaning it won't be until then that we have a clear view of where the market really is.

Rearguard Action

I'm overdue to respond to the big email reaction (thanks, as always) to last Wednesday's piece.

Most importantly (kidding), the answer to the cinematic reference was Nicholas Cage in Vampire's Kiss.

Regarding Bob Brinker, editor and publisher of Bob Brinker's Marketimer and host of ABC Radio's "MoneyTalk," several readers recalled a very different version of his Nasdaq 100 Trust recommendation in May.

Upon further review, here is what transpired, as best as I can ascertain:

• In his May 13-14 MoneyTalk show, Brinker told listeners to look for signs of "positive divergences."

• In the May 27-28 show, Brinker said those divergences had occurred during the previous week and that he had taken advantage by buying the QQQs (QQQ) at $74 on May 23. He predicted a 20% upside but cautioned that the trade was for "sophisticated traders" only.

• Inspired partially -- it seems -- by folks buying on Brinker's recommendation, the QQQs opened at $80 when trading resumed on Tuesday, May 30 and rose as high as $85.94.

• In the July 8-9 show, Brinker said he expected the QQQs to get beyond $100 later in the summer, but he did not explicitly recommend selling them at that level, as I originally reported (all apologies). Brinker said he would announce when it was time to sell at a later date, a pledge he repeated during the July 15-16 show.

• In the July 29-30 show -- with the QQQs back down to $86.88 -- Brinker recommended investors take profits if the shares dipped to $84, which they hit on Aug. 3.

There's obviously a lot of frustrations about this trade, judging from the emails. But here's my take: Could Brinker have done it better or differently, including his description of the events to this reporter? Yes, absolutely. But almost everyone who followed Brinker's recommendations profited, and I have a hard time feeling badly for anyone who profited on a trade, any trade -- especially this year.

More to the point, Brinker said explicitly the QQQ trade was for "sophisticated traders," and I don't know anyone who fits that description who waits breathlessly for someone else to tell them when (or what) to buy or sell. Furthermore, how much does Brinker's radio advice cost? If you want the right to complain, pony up and subscribe to his newsletter (and RealMoney.com), or hire a full-service broker.

Finally, none of this changes the fact Brinker's macromarket call this year has been spot on, which was the point of the story. If you've listened to him, you've made money or at least pared losses. Don't get upset because he didn't come over and mow your lawn, too.

Levity Break

Call National Discount Brokers (NDB) toll-free at 1-800-888-3999. After listening to all the options, choose No. 7.

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