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Market Wrap

"Mom! Dad! The monster under my bed is back!"

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        6-23-99          High     Low     Volume   Advances Decline
DOW    10666.86 - 54.77 10725.12 10616.84   729,060k  1,214   1,746
Nasdaq  2598.13 + 17.86  2598.13  2557.46   955,471k  1,796   2,030
S&P-100  678.60 -  1.98   680.58   674.82    Totals   3,010   3,776
S&P-500 1333.06 -  2.82  1335.87  1324.32             44.4%   55.6%
$RUT     447.04 -  0.29   447.33   444.79
$TRAN   3378.91 - 12.72  3391.63  3367.01
VIX       21.57 -  1.48    23.71    21.49
Put/Call Ratio      .59

"Mom! Dad! The monster under my bed is back!"

"Oh dear, now what?" you ask. Just like a child calling his parents for the second time in the same night about the proverbial monster under the bed, bond traders are wringing their hands again about inflation, as they fret over how large the interest rate increase is going to be following the FOMC meeting next week. "For crying out loud, get over it!" is the response we'd want to give to both kids and traders. Unfortunately, that kind of response won't win any converts, and forces the kid or the trader to defend a position rather than consider evidence. Besides, what if in the real and metaphoric sense, there are unexplained crumbs under the bed? Such was the backdrop for today's action.

Particularly interesting to us was "the sky is falling" mentality reported by CNBC correspondent, Bob Pisani, which referred to bond traders hallucinating (our word for an overactive imagination) that rates could be headed to 7% as the Fed might raise rates 3 times in the next 6 months, starting with a 50 basis point increase next week! Whoa! Back up the truck. . .did he say 7%? Yep, he did. Fortunately, the anchor desk was on the ball and completely dispelled that 50 bp hike by pointing out that it was a rumor started by "Shorty" exaggerating the contents of a think tank report. The report actually stated that a 25 bp hike was likely to be accompanied by a simultaneous bias shift back to a neutral stance. The general bearish mood also came in no small part from hawkish comments from New York Fed President, McDonough, that it is "time to be vigilant" to keep inflation in check. We've heard this before from the lips of Alphonso the Great last week, and got a rally. What's different? We can't say for sure, but here are a few crumbs from under the bed, which we referred to earlier.

First, gold is back up $6 from its low of $260 last week. Gold stocks actually did well today. Second, petroleum stockpiles showed a bigger decline than anticipated last week. Remember that oil is the economic engine driving the western world. We can't prosper without it no matter what the price. If the price goes up, it's reflected in the price of goods and services we buy, ala inflation. Third, the utility index, thought to behave like a bond, has been flat and slightly declining for the last 2 weeks. Fourth, the treasury auction today was dreary sending 30- year yields up to 6.13%. Because there is competition from corporate bond issues, the Treasury needs to provide a better rate to remain competitive. None of this means we're going back to the late 1970's and shouldn't affect your trading plan. It's just something to be aware of. Furthermore, if you follow our trend trading strategy, with bond yields increasing every day this week, they're about due to head the other direction anyway.

That said, with the general negative tone of the market, everybody seems to be back in a holding pattern until the Fed meets. If funds cash out now, and the Fed raises rates and changes its bias, they miss out on a likely rally. If they start buying now, and the bears are right (a theory we doubt strongly), they get pummeled in a sell-off, then have to explain it to investors while all along "the signs were there - what were you thinking?" The solution? Wait and do nothing. That explains the lower overall volume (at least until that buying surge late this afternoon).

Let's take a look at what again turned out to be the tale of 2 different markets.

The DOW began the day on the downhill after opening at 10,721. While rising slightly thereafter, it couldn't hold its gain and fell back to its low of 10,616, a triple digit loss, just after mid-day. A modest 50 point recovery ensued by the close, leaving the DOW to finish down 54 points at 10,666, with 729 mln. shares traded on NYSE. While the A/D line began to show some improvement by day's end, advancers trailed decliners by roughly a 2:3 ratio. Strong sectors included oil, paper, and gold (mentioned earlier). Surprisingly Philip Morris tacked on $1.06 thanks to a precedent setting judge's dismissal in a class action asbestos trial. The same rules will apply to tobacco liability.

Brokerage stocks in particular have not reacted well to the fear of an interest rate hike. In what could be titled a case against holding through earnings, Goldman Sachs (GS) blew away their first quarter of reported earnings since going public a month ago with $1.30 per share, while the Street expected only $1.07. Party hats and horns, right? Nope. GS lost $3 to close at $65. The same happened to Lehman Bros., who dropped $3 yesterday, as they reported $2.12 vs. an expected $1.68. Anybody see a trend here? That's why we rarely if ever recommend holding through earnings. Just so you know, Morgan Stanley Dean Witter reports tomorrow. The same will likely happen. The trend is your friend. Don't fight the tape. Don't fight the Fed. . .all trite expressions, but extremely valuable. Save your capital. It's not worth the risk. "What if I buy a put?" you say. Answer: remember IBM last quarter. It shot up like a rocket, knocking the stuffing out of put buyers.

Back to the market. . .3com (COMS) also reported earnings with similar results. They came in a "penny ahead" and were punished $4, thanks to an unfavorable revenue outlook.

How 'bout that NASDAQ? Glad you asked. It started looking like a merger Monday as buyout rumors (and some confirmations) started flying through the market. Take a peek. QWST came back to the table looking to best GBLX's $42 bln. offer for USW/FRO with a $44 bln offer of its own. Metromedia Fiber Network (MFNX) agreed to buy Abovenet (ABOV), a high-speed data network for $1.37 bln. in stock.

Three other biggies to consider too. First, CMGI is rumored to in discussion with CPQ to acquire its Internet properties, including Alta Vista search engine. No word yet on whether or not that includes some lesser-known units, Millicent and Shopping.com. Second, GTW is reported to be in discussion to acquire Earthlink (ELNK), an ISP, the theory being that it could bundle the service and reduce the price of the box. Third, AMZN is rumored to be interested in Beyond.com (BYND), a software e- tailer. Lookout Egghead!

All this Internet activity brings up an important point. One group of analysts we follow point out that the Internet is now moving into Phase II of it growth pattern: Consolidation. It's being driven by pressure to generate revenue, and a general tendency to have 1-3 dominant players in a particular sector. It happened with cars and computers. Now it's the Internet's turn. While all the speculation has jacked up short-term prices, we are still 30-50% off previous highs as earnings approach. We simply are not seeing the froth we used to. Consolidation picks may be the next trend. Tuck this tidbit into your own trading arsenal. With the exception of the occasional IPO gift like we had today with Ariba and Globespan, we are not likely to see 1000% annual share price gains soon, if ever again, from the Internet.

(By the way, Ariba (ARBA), an e-commerce software company, rose $61 to close at $90 in its first day of trading. Globespan (GSPN), developer of DSL circuitry shot up $27 to close at $42 its first day.)

Anyway, the spotlight on Internets got the NASDAQ dancing as the day wore on. NASDAQ, in contrast to the DOW, traded in a 40 point range most of the day. It hit the low of 2557 within the first hour, then seesawed the rest of the day to finish at 2598, up 17 points. Volume was pretty good at 955 mln. shares, but again decliners edged advancers by a narrow 10:9 margin. We are just 95 point away from the high again, but don't expect much until the pessimists drown in the optimists' half full glass. Likely that won't happen until the Fed meets next week.

Let's review. Pessimistic bond traders are keeping a lid on stock trading volume, and thus upward price pressure. Like the returning scent of a skunk, inflation talk again fills the air. With any luck though, we may see a temporary pullout in the next day, as 4 days of downward pressure on bonds may ease a bit. However, don't expect any huge rally until the Fed meets. We seem to back in a holding pattern with chopiness as our not so welcome companion. Be selective in your plays, sticking with sectors you are familiar with. Or just sit out if your risk profile isn't predisposed to this kind of movement. Of course, confirm market direction and sell too soon. Good luck!

Buzz Lynn
Research Analyst

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