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Software stocks were moving higher Monday after Peoplesoft (PSFT) said its third quarter earnings would top previous forecasts.  As a result, the GSTI Software Index ($GSO) was helping lead technology stocks to the upside.  The index has skyrocketed nearly 80% during the past year and is now fast approaching 15-month highs.  Investors are buying software stocks on the notion that a recovery in information technology spending will translate into rising prices throughout the sector.  However, before the bullish trend continues, the software index faces a major barrier going forward.  Whether or not it can leap above that hurdle could provide clues regarding the outlook for, not just software stocks, but the technology sector as a whole.

The computer software index was headed higher early Monday following upbeat comments from software maker Peoplesoft.  The software maker told investors that it expects third quarter sales, earnings, and software sales to surpass previous estimates.  Although Peoplesoft did not specify to what extent their final results would exceed its previous target, the company said last month it anticipated earnings of 10 cents to 11 cents a share on revenue of between $575 million and $590 million.  Analysts were calling for earnings of 11 cents on $587 million in revenues.   

Shares of Peoplesoft rose 3.1% to $20.43 on the news.  The rise in the stock price deals a blow to Oracle (ORCL), which has recently made a $19.50 a share hostile takeover bid for the company.  Now, the software giant will be forced to raise the takeover bid or abandon the merger plans altogether.  In any event, investors seemed pleased with the latest developments.  Shares of both Oracle and Peoplesoft moved higher on Monday.  Meanwhile, call activity in the two stocks was busy.  For example, the November 22.5 PSFT calls were active.   More than 3,000 of these out of the money calls traded hands, compared to open interest of 4,757.


Figure 1: Daily Chart, GSO

The GSTI Computer Software index also moved higher Monday.  The index measures the performance of more than forty different software companies.  As we can see from Figure 2, the GSO has performed well during the past year.  In October 2002, the index fell below 80.  Last month, it rose above 145.  The eleven month 81% move was followed by a brief dip in late-September.  However, the software index is showing strength again and is up more than 4% so far in October.  The earnings news from Peoplesoft helped support the index in an otherwise dreary trading session Monday.  The Dow Jones Industrial Average ($INDU) finished the day up only 22 points, or .22%.  

As we can see, however, the software index faces a major resistance area near 145.  The index attempted to break above that level two times during the month of September, but failed.  In addition, as we can see from Figure 2, the 145-150 area has been an important technical area in the past.  For example, that level served as support in April 2001 and March 2002.  It became a source of resistance in April of last year.  While the software index is approaching a major resistance zone, the chart pattern (Figure 1) hints at the possible formation of a triple top, which would be a bearish technical formation ahead of a significant move lower.  

Going forward, technical traders will want to watch the 145-150 area on the GSO chart carefully.  If the index can break above that level and move higher, the bullish trend in the software sector is still alive and well.  However, if the GSTI Computer Software Index fails to break above that key resistance point in the near future, it could be a sign that software stocks are set to give back some of the large percentage gains recorded since the October 2002 bottom.   Therefore, the performance of the GSO is worth watching going forward.  It can serve as an important indicator regarding trends in software stocks and the technology sector.


Figure 2: Weekly Chart, GSO

Traders will probably not want to bet on the software sector using the GSTI Computer Software Index.  While the index is a useful tool for viewing the action of software stocks, it is not an attractive trading vehicle.  The main problem stems from the lack of trading activity and volume.  The options are not liquid.  An alternative way of playing the trends within the software sector is the ML Computer Software HOLDRS (SWH), which is an exchange-traded fund that holds a basket of twenty leading software companies.  Unlike the GSO, the options see steady trading activity and therefore offer enough liquidity to those strategists looking for a vehicle for trading the trends in the software sector.


Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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