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Market Wrap

A Market Without Generals As Memorial Day Approaches

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 	WE 5-21           WE 5-14         WE 5-7           WE 4-30
DOW    10829.28 - 84.04 10913.32 -118.27 11031.59 +242.55  + 99.37  
Nasdaq  2520.14 -  7.72  2527.86 + 24.24  2503.62 - 39.23  - 47.84  
S&P-100  671.76 -  1.81   673.57 -  8.17   681.74 +  6.09  - 11.76  
S&P-500 1330.29 -  7.51  1337.80 -  7.30  1345.00 +  9.82  - 21.67  
RUT      449.14 +  6.01   443.13 +  7.02   436.11 +  3.30  +  1.08  
TRAN    3551.26 -115.08  3666.34 - 76.49  3742.83 + 95.54  + 57.61  
VIX       25.36            29.66            26.72            26.07
Put/Call    .64              .71              .61              .53

A Market Without Generals As Memorial Day Approaches

The market opened mixed on Friday and continued to wander without leadership throughout most of the morning. Many of the high tech issues remained under pressure from Thursday's closing sell-off and some of the leading equities that fell in the morning simply never recovered. A brief rally after 1:30 p.m. failed to hold and the major market indexes fell lower in the afternoon as the session turned listless. The fact that Friday was a double- witching option expiration day did little to help matters; it just created more volatility during the last hour of trading. Overall, there was a notable lack of confidence as indecision ruled the floor and institutional commitment failed to materialize. Trading volume remained moderate right up to the close but most of the heavy players were already heading out the door when the bell finally rang.

The breadth of the market was neutral with advancing shares edging decliners slightly by a 16-to-13 margin. The only good news was the renewed strength in the advance-decline line as it continues to reflect a broadening of the market. For the week, all of the major market averages closed in the red except for the small cap index; the Russell 2000, which climbed just over 1%.

Bonds rose almost one full point on continued optimism that the recent consumer price index report was a one-time event and the Federal Reserve will remain active in its pursuit of inflationary indicators. The Fed fired a successful warning shot last Tuesday when it announced that it may raise interest rates if further signs of inflation appear in the coming months. Higher interest rates can reduce corporate profits as borrowing costs rise and although most investors believe that a rate hike is not imminent, they continue to worry about the effect it could have on industry leaders. Top-tier technology and big-cap stocks are showing the effects of departing capital as fund managers rotate portfolios into lower priced issues and the less volatile sectors such as basic materials are becoming more attractive. It becomes obvious that investors are nervous when utilities start to participate in a rally and the Dow Utility Average closed in record territory for the second straight day.

There were no major announcements or activities to affect the overall market and other than some specific news driven issues, few sectors recorded significant price moves. The session was considered a non-event by those who participated and many investors just watched from the sidelines. Most Internet stocks continued their post-earnings lull and today's new IPO's met with less-than-overwhelming demand. Transports were travel weary as airline issues fell lower. Health care and drug stocks relapsed, retracing gains from yesterday's rally. Chip companies suffered substantial losses and financial stocks were also among the market's weaker groups. On the positive side, materials producers of aluminum, paper and chemicals moved higher and oil stocks rebounded as investors took advantage of the gains in crude futures.

Most of the major computer stocks fell today, including Dow workhorse IBM and the Nasdaq's most actively traded issues; Dell, Microsoft and Intel. A recent article described the problems inherent in the industry as sub-$1000 machines continue to flood the market. Many companies will be unable to increase revenues with future profit margins expected to be 10% or less and the only way PC makers can boost sales and earnings is by stealing customers from rivals. Industry leaders are now taking steps to avoid a complete disaster. Dell made agreements with IBM to build high-powered computers and data-storage devices. Compaq bought Digital Equipment to expand their main frame business and Intel bought into communications chips. Even Microsoft is looking for new avenues by developing software for servers that run the Internet and acquiring the right to install Microsoft software on set-top boxes that AT&T will use to offer TV and Internet access.

With the Dow showing signs of exhaustion after its record run to 11,000, many analysts think the market will be locked in a new trading range as we move into the summer months. There is little news to look forward to on the corporate calendar and the interest rate uncertainty is expected to deter any significant rallies. High P/E stocks that make up the market leadership are very sensitive to rising interest rates and the Federal Reserve has made it clear that if it inflation rears its ugly head, investors can expect higher interest rates. Even without Fed intervention, a notable rise in interest rates would cause bond prices to plunge and take the steam out of the stock market. This whole scenario is a self fulfilling prophecy now that policymakers believe that the balance of risks forward is leaning toward a decline in the value of money. Historians have been saying the economy is long overdue for a bout with inflation and the recent rise in consumer prices supports their case. The end result is that an interest rate increase is more likely to come sooner rather than later.

With Memorial Day weekend fast approaching, the question is; what can traders focus on that will soothe their fears of inflation and the future interest rate hike. The overall outlook for bonds is negative but a short term technical bounce is currently underway and that may ease nerves this week. The problem is the new downward momentum for all three major market averages. The S&P500 and the NASDAQ both violated their respective 30 dma's and they are fast approaching their 50's.

The DOW may be bouncing off recent support around 10800 but it is still trending down as the mass exodus from the big-cap issues continues.

Do we find any help in the transports? No, they are also leading the DOW lower, having already violated their own 30 dma.

And that is the key; leadership, or the lack of it. Maybe the soldiers are just to tired to be lead. In contrast, the small caps are trying to catch up from a year of lagging. The Russell 2000 is in fact at a "key moment" as a failure to move above the recent May high would be another negative inicator; just look at what happened after the short term double top in January.

The recent cycle this week in the DOW has been one day up followed by three down with Friday being a second down day. With May and June having a negative bias for the DOW to begin with, we would expect the current trend to continue this week as traders take profits and go on vacation. Just looking through a the list of charts for the 30 DOW stocks; there are very few positive signs. Many of the recent winners appear to be consolidating after their parabolic climbs (AA, CAT, IP, EK) and IBM may be growing weary from its metoric climb. From my viewpoint, it looks quite stormy on the horizon.

More about market trends...THE DOW THEORY

With the recent interest rate uncertainty, many of the prominent technicians and historians have come forward, offering their expert opinions on the outlook for the U.S. economy. These experts use technical analysis of the various indicators to predict changes in the market cycle. Even if you aren't a well known analyst, it's important to understand the current trends and make your own decisions about the future direction of the stock market.

While it may be less effective in these days of atmospheric valuations, one of the oldest (and still widely discussed) market indicators is the Dow theory. Before we move further, it must be said that the stock market today is vastly different from that in the early 1900s when Dow formulated his ideas. Today's thirty large companies do not provide a true picture of the broad, technologically oriented 'Corporate America' and the transportation average is far less representative of the economy than it was in the past. To most investors, the value of the Dow theory is that it represents a sound fundamental method that can benefit those who devote time and effort to gaining a basic understanding of the principals involved.

Charles H. Dow was one of the founders of Dow Jones & Company. Dow believed the stock market to be a barometer of business and he was convinced that through the proper analysis, accurate signals could be used identify the beginning and end of bull and bear markets. The purpose of his theory was to predict these turns in the market and to forecast the business cycle or longer movements of depression or prosperity. His idea was based on the belief that stock prices cannot be forecast accurately by fundamental analysis, but that trends, indicated by price movements and volume, can be used successfully to predict future market movements. These trends or cycles can be recorded, tracked, and interpreted because the market itself prolongs movements.

Dow and his disciples saw the stock market as made up of "waves"; the primary wave, which is a bull or bear market cycle of serval years' duration, and the secondary (or intermediary) wave, which lasts from a few weeks to a few months. The theory basically states that once a trend of the Dow Jones Industrial Average (DJIA) has been established, it tends to move in that direction until it is canceled by both the Industrial and Transporation Averages. It relies on similar action by these two averages, which may vary in strength but not in direction. As an example; a 'primary bull market' is indicated by a pattern of broad movement, interrupted by secondary reactions averaging atleast 24 months, where successive rallies penetrate high points with ensuing declines terminating above preceding low points; and stock prices advance on demand by investors who start buying when business conditions improve; and continue to climb as rampant speculation drives the market higher. The key idea is that a new primary trend is not confirmed until the DJIA and DJTA penetrate their previous positions and the trend remains in progress as long as each new intermediate rise goes higher than the peak of the previous intermediate advance and each new intermediate decline stops above the bottom of the previous one.

Next time you are analyzing charts, take a look at the relationship between these averages and you might find that the ageless theory has some relevance after all...

Good Luck
Ray Cummins
Assistant Editor

P.S. Thanks to all of you who sent such kind remarks about Thursday's market wrap. I am sorry I could not respond personally to each one of your requests but I hope you will all profit from the information on option pricing tools that I provided...and don't worry, Jim will be back in the hot seat on Monday!

Ray Cummins
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