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Weakening Fundamentals

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       WE 06-15          WE 6-08          WE 6-01          WE 5-18
DOW    10623.64 -353.36 10977.00 - 13.41 10990.41 + 78.47  -296.37
Nasdaq  2028.43 -186.67  2215.10 + 65.66  2149.44 + 38.95  + 52.15
S&P-100  626.63 - 25.29   651.92 +  2.31   649.61 +  3.38  - 10.09
S&P-500 1214.36 - 50.60  1264.96 +  4.28  1260.67 +  4.85  - 14.07
W5000  11238.00 -498.70 11736.70 + 65.13 11671.40 + 61.20  - 73.63
RUT      495.13 - 16.51   511.64 +  9.92   501.72 +  5.22  +  2.34
TRAN    2693.62 -188.47  2882.09 -  4.96  2887.05 - 58.85  - 49.75
VIX       26.33 +  4.92    21.41 -  2.55    23.96 -  2.00  -  1.11
Put/Call    .73              .54              .53              

Weakening Fundamentals

I guess it was inevitable. The VIX readings near 20 were very indicative of a reversal of direction in the markets. Combine this factor with a handful of earnings warnings from former tech titans and end-of-quarter selling by major fund managers and you have the makings for a scenario that plays out exactly as did the previous 5 sessions. Adding fuel to the argument for a 50 basis point cut, instead of just 25 at the upcoming FOMC meeting later this month, were some weaker-than-expected economic reports, though some of the non-inflationary data were better than expected. Did I mention that the technical readings of the NDX, COMPX, and INDU, among others, also shows numbers which are firmly planted in bearish territory? It is UGLY with a capital U. It seems that the markets have given those who believed that we would snapback from recent economic and corporate weakness a healthy dose of reality.

How bad is it? Let's start with the technicals. After getting pummeled to the tune of 8.4% in the five sessions ending 6/15, led by stories of weakening profits, order flow and building inventories from the likes of JDS Uniphase, Nokia and Nortel Networks pushed the Nasdaq Composite firmly below the 50-dma (2106), at one point breaching the psychologically-important 2000-level.

Bulls (any left?) will make a table pounding argument that significant work was accomplished by closing back north of this benchmark, and I will give some credence to this. Unfortunately, the erratic nature of market action on triple witching Fridays really clouds one's ability to read true reaction of those in the market, considering the volume spikes and volatility that accompanies these quarterly events. I had discussed the 2032 -2016 levels as being important to close above in the COMPX, and we did manage to get this done. However, in order to fulfill the head and shoulders pattern that is playing out on the daily chart, we will need to fill the gap between 1923 and 2079, levels we have yet to visit. Others would conclude that the bottom of the pattern resides down at the 1825-1865 level, and this may well be the case. The bottom line is this: No technician or shorter-term market strategist would tell you that we go higher near term when looking at the chart of the Nasdaq. Ah yes, the bears are certainly back in full control, but this by no means says that traders cannot make money in this type of environment. Conversely, as traders, these are the times when some of the best profits can be achieved. You just have to be willing to turn off the eternal optimism bred in each of us and TRADE THE TREND.

For the week, the Dow Jones Industrial Average declined 353 points, or 3.2%, to 10623. The unexpected blocking of the proposed GE / Honeywell merger by European antitrust regulators put the nail in the coffin of an index already teetering on the crucial 11,000 mark, a level that has plagued the old school Dow 30 more or less since October 2000. This index too shows a very bearish technical snapshot, with MACD readings turning south, planted firmly in negative territory, and a settlement Friday below the all-important 200-dma at 10,632. A very impressive 150-point turn around was seen after a decline of 120 points early into the session, yet another case for those in the bull camp, but again, hard to judge due to options and futures expiration taking place. Support is likely to come into play in the DJIA near the 10,450-10,500 range. Oh, and the closing at 10,623 also lands the Dow at a negative 1.51% return for 2001, after being up a modest 5.11% year to date back on 5/29.

Looking to the economic picture for some guidance, Friday's benign CPI data could be the green light for the FOMC to again slash near term interest rates by 1/2 of a point. The headline CPI rose 0.4 percent in May. Excluding food and energy the index posted a benign 0.1 percent increase, the smallest since December, even with an outsized increase of 0.5 percent in a huge component like shelter, accounting for 30 percent of the CPI. Ah yes, those higher prices you are paying at the pump don't count, do they? We believe the Cleveland Federal Reserve's calculation of the median CPI tells a better tale, which rose by 0.3% in May, and its six-month trend is up by an annualized 3.9%. Those higher prices you're paying are real, believe it. To that end, while we may get more aggressive actions by the FOMC than were previously expected, it's not clear there will be much breathing room between the time a recovery takes hold and the time the Fed has to start raising rates.

The yield on the two-year Treasury note slipped decisively below 4 percent for the first time since the Asian scare in the fall of 1998. Sparking the rally in treasuries was a horrendous report on industrial production, which fell 0.8 percent in May. It was eighth consecutive monthly decline, putting the level of output 4.5 percent below that in September. Even in 1990-1991 recession, manufacturing output didn't fall so consistently without a bounce. For the week, Treasuries rallied across the board, signaling the expectation that the Fed will cut rates aggressively in its meeting this month. The yield on the benchmark 10-year Treasury note plunged to yield 5.24% Friday from 5.35% one week ago, and the 30-year bond went to 5.67% from 5.74%. The aforementioned fed-sensitive two-year note finished the week at 3.97% from 4.15 % a week earlier.

Next week will see a lightened economic calendar to give further guidance, with only housing starts, LEI and the treasury budget statement slated for release. Also, as was the case this week, much attention will be paid to the weekly unemployment claims figure, which comes out on Thursday.

The lack of data on the economic front coupled with the likelihood of continued earnings warnings from tech land should make for lower prices near term. Monday should be a better gauge than Friday, and continued selling on heavy participation would dictate a testing of key support points, if not recent lows, is in the cards. The fact that Oracle reports quarterly earnings should also make for interesting market action.

Influential analyst Rick Sherlund of Goldman Sachs recently asked a plethora of software company CEOs at a summit in California when they expected software sales would begin to pick up. According to his recent bearish report on the group, nobody in the mix even hinted at the 3rd quarter. One peek at the GSO.X (GSTI Software Index) and one can see the danger in being long stocks in the sector. Should Oracle be able to provide a report as upbeat as CEO "megabucks" Larry Ellison hinted at on CNBC Thursday evening, it could buoy the markets from the deep short term oversold conditions. However, expect selling to occur into any rally, and when this column is written next week, I expect the tech-riddled Nasdaq to have a 1900 handle on it, likely between the 1923 and 1961 levels. Without a pre-meeting fed cut (almost no chance), or a blowout quarter from ORCL (zero chance), there is simply no catalyst to take us higher. I wish the news were better. Not to leave without a bullish spin, a closing north of 2044 and obviously the 2100 mark would turn the tides, if at least momentarily. Unfortunately, the path of least resistance does not go in this direction.

Make sure to check out Eric Utley's Online Seminar this weekend. You can still sign up through the link below.

Derek E. Baltimore
Contributing Editor
www.Indexskybox.com

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