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When Greenspan's "Irrational Exuberance" meets investors' irrational fear.

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        5-17-99          High     Low     Volume   Advances Decline
DOW    10853.47 - 59.85 10910.57 10745.80  679,680k  1,040   1,995
Nasdaq  2561.84 + 33.98  2561.85  2494.51  793,404k  1,817   2,193 
S&P-100  675.06 +  1.49   675.86   665.27   Totals   2,857   4,188
S&P-500 1339.49 +  1.69  1339.95  1321.18            40.6%   59.4%
$RUT     441.35 -  1.78   443.13   436.94
$TRAN   3651.12 - 15.22  3667.17  3622.08
VIX       28.24 -  1.42    30.76    27.07
Put/Call Ratio      .60      

When Greenspan's "Irrational Exuberance" meets investors' irrational fear.

Today, no other news item could remain foremost in investors' minds quite as notably as tomorrow's FOMC meeting, scheduled for 9:00 a.m. Eastern time, after which the market's future will be determined by Alan Greenspan's comments (around 2:00 p.m.) It is expected by a majority of Fed watchers, analysts and pundits that only the bias towards tightening, and not the actual interest rates, will increase. While we discussed the anatomy of a rate hike in Sunday's Market Wrap with the full expectation of a bias toward tightening, there still exists a strong possibility that the Fed will do nothing. No shift in bias, a rate hike, no anything.

Here's why. Wages have been on a non-inflationary course; same for the Producers Price Index (PPI), released last Thursday showing only .1% increase in the core rate (excluding the energy component). The big surprise of course was the .4% rise in the CPI, which set the negative market tone Friday due to the presumption that we'd soon have economy-crippling interest rate hikes that would eat into corporate profits. Not so fast. When you add that +.4% spike to the previous monthly figures to date, annualized inflation is showing up at 2.3% - about the same rate as the past 2 years! This fact seems to be lost in all but the most levelheaded reporting. The Fed simply isn't going to make a policy decision based on a 1 month spike on only 1 of many indicators they regularly watch. In effect, instead of the Fed dictating rates, they are letting the bond market do its bidding by whipping up fevers that control rates via market pressure and expectation. While we're not saying that the Fed won't eventually tighten its bias, the likelihood of that happening tomorrow based on CPI data is much less than most think. Furthermore, an actual rate increase tomorrow is extremely remote.

We should mention a couple of other inflation/interest rate related items too. Gold is making new lows, around $275, its lowest price in 20 years. Also, particularly interesting to us is that the utilities index is moving up again. Utilities are generally reflective of interest rates and behave like bonds, traditionally - when interest rates drop, bonds go up. Might bonds be far behind? Finally, we just can't help repeatedly pointing out that OPEC members still cheat on oil production, which in our opinion will eventually cause oil prices to drop. No inflation signs here!

That said, let's see what today's action might be telling us about the rest of the week. Merger Monday struck again as 3 major mergers were announced. First, Global Crossing (GBLX), an international fiber network builder and US West (USW) agreed to a stock-swap merger valued at $37 bln. The combined entity would have revenues of about $15 bln., giving it better footing against competitors, AT&T (T) and MCIWorldcom (WCOM). Frontier (FRO), Global Crossing's other acquisition target has also blessed this union. Second, General Dynamics (GD) agreed to acquire Gulfstream Aerospace (GAC), makers of the world's most-preferred, "money-is-no-object" business jets in a stock swap worth $5.3 bln. Meanwhile, New Holland (NH), a European farm equipment manufacturer took its case to Case (CSE), a U.S.- based heavy equipment builder, by offering up $55 per share, or $4.3 bln. cash.

One would suppose that his might set the tone for a strong Monday rally on the merger news. Nope! Just the opposite happened as the "I" word (inflation) gripped the major markets with fear right from the open. The DOW opened at 10,910, then began a steady descent below 10,800 (previous short-term support) all the way to 10,750 before making a late recovery where it finished at 10,853, down -57 points on the day. Breadth was lousy with 1 stock up for every 2 down. It didn't help that Morgan Stanley down-graded the auto sector (inflation fears), including GM, which coupled with price drops in UTX and JNJ, accounted for -50 points on the DOW. We have to tip our hat to the mid-day recovery even though volume of 670 mln. shares was nearly the lowest this year. It kind of lends credence to the "old-timers" theory of "never short a dull market".

Just for the record, the S&P closed at 1339, up less than 2 points. The small-cap Russell 2000 closed at 441, down less than 2 points

NASDAQ too, couldn't escape this mornings down-draft as it gapped down to 2517, then sank below 2500 to 2494 (inflation fear again) before making a strong mid-day recovery all the way to the close at 2561 (an amazing 67 point rise off the low!), up +34 points. Breadth was much better here with advancers trailing decliners by a narrower margin of 18 to 22. This time, volume of just 793 mln. shares was a new record low for the year. Again, "never short a dull market". No kidding!

What lit the candle for NASDAQ as opposed to the DOW? In short, technology made a strong recovery today with the 5 largest components, Microsoft (79.13, +2.25), Intel (59.44, +1.44), Cisco (116.44, +1), MCIWorldcom (88.63, +2.25) and Dell (43.13, +1.94) leading the charge. While not a NASDAQ stock, Hewlett Packard (HWP, 84.38, +4.56) garnered inordinate investor attention too, as they were to report earnings after the bell today. When they did, beating the Street estimates of $0.80 with an actual $0.88, traders went nuts, bidding HWP up another $2.50 in after-hours trading, a new all-time high. Though sales came in right on target at $12.4 bln., the PC and computer divisions reported lightness in hardware (read that PC/computer) revenue. Nonetheless, HWP's success won't go un-noticed tomorrow as anther tech heavyweight reports earnings.

That's right. Tomorrow it's Dell's turn to capture the spotlight. Investors are expecting Dell to report $0.16 versus $0.11 a year ago. Watch the top-line revenue too. Any percentage revenue growth that exceeds 40% will be considered extremely bullish, since most everyone expects the now familiar 38%. Michael Dell continues to remind us that Dell is firing on all cylinders and they are experiencing no declines that seemed to specific to Compaq only. As we've said in the past, if Dell hits the numbers, particularly revenue, they could pull the whole tech sector and thus the NASDAQ up with them. A word of caution though: some wags are going hoarse "whispering" that Dell may surprise by a penny or two. Remember, Dell has a huge float that makes that kind of a surprise difficult to obtain. Keep your fingers crossed.

And how about those Internet stocks? On a DLJ upgrade to their "top pick" list today, AOL tacked on $10.88 to close at $136, dragging the rest of the Internets with it. Gains were as follows: EBAY (198.44, +12.56), CMGI (248.38, +18.81) and YHOO (161.81, +4.44). Really surprising was AMZN (137.63, +6.13) despite announcing price cuts in the price of books on the New York Times best-seller list, rose along with them after a big dip this morning on that news.

Now, to circle the wagons, inflation fears are a bit overblown in our opinion. One month of a spiked CPI index does not negate other empirical evidence, like low gold prices, increased utility index price, OPEC overproduction (or under-reporting), good core PPI numbers, etc. While we are comfortable that the Fed won't raise rates tomorrow, there is a chance, though smaller than most think, that the Fed will change its bias to tightening. Either way, we think the news is already priced in, given the amount of fear over the issue. If the Fed opts to tighten its bias toward a hike, the market won't take this badly since investors already expect it. If the Fed leaves rates alone or at worst, speaks again of "irrational exuberance" and still does nothing, look for a relief rally.

While we make no promises, our fearless forecast for tomorrow is choppy until the FOMC meeting, then up the rest of the week. Dell could help the cause too.

Wait for an acceptable entry, then sell too soon.

Buzz Lynn
Research Analyst

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