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Positive CPI and Microsoft beat estimates but don't get out the party hats yet!

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        10-19-99           High     Low    Volume Advances Decline
DOW    10204.90 +  88.60 10335.40 10117.50   903,951k 1,611  1,401
Nasdaq  2688.18 -   0.97  2729.30  2845.20 1,093,110k 2,124  1,771
S&P-100  660.27 +   3.48   670.16   657.95    Totals  3,735  3,172
S&P-500 1261.32 +   7.19  1279.30  1255.60              54%    46%
$RUT     410.93 +   2.03   414.53   408.90            
$TRAN   2860.21 +  16.14  2907.76  2845.20
VIX       28.46 -   0.98    28.76    25.85
Put/Call Ratio       .50

Positive CPI and Microsoft beat estimates but don't get out the party hats yet!

While most investors breathed a sigh of relief this morning when the CPI came in as expected, the underlying fear is that the road ahead could still be rocky. I know you are sinking back in your chair with that "oh no, not again" feeling but it is better to be careful now. Even if the market continues up tomorrow there is still a good chance the worst is not over yet.

The CPI was benign and the markets reacted positively, almost. The Nasdaq jumped off to a big gain but quickly turned ugly again. After dropping well off the highs at the open, the big run over +200 points by the Dow held the Nasdaq in positive territory for some time but the weight of the PC sector was just too much to overcome. Also bonds started selling off around noon as investors realized that the CPI is a lagging indicator from the PPI and next month could be a real problem.

As you can see by the charts we had a nice bump today but we do not yet have a trend change. The advance/decline was positive today for its one day in five gulp for fresh air. It was only positive by about +500 stocks but we will take anything we can get. The Dow bounced off the 10300 ceiling and probably set us up for things to come. The close at -131 points off the high of the day was a let down for many traders. As you can see both charts rolled over midday and showed very little energy at the close. The most telling indicator was probably the 88 new highs compared to 730 new lows.

The PC sector was led downward by Dell's earnings warning last night. Dell suffered a memory loss after misplacing their just in time delivery model. Dell said that the memory shortage, which was caused by the earthquake in Taiwan, had more than doubled the cost of DRAM memory chips as buyers bid for the available supply. Dell is famous for offering computer systems with huge amounts of memory, much more than you will find on dept store shelves, but the quick change from feast to famine in the chip market has them rethinking their sales plan. They are now offering computers with less memory in an attempt to stretch the available chips. Another factor in the earnings warning is the corresponding jump in component prices. Most other components used also have memory in them as well. Instead of just having the main computer memory chips increase in price, all the components, which also use memory chips as well, also went up in price. While this is expected to be a temporary problem some analysts think this could drag into the next quarter and rob the PC vendors of the vital momentum going into the heavy retail selling season. The major losers today were GTW -4.63, Dell -2.75, MU -5.75, HWP -4.50. The winner here is still IBM which actually finished positive for the day. IBM announced today that they were going to quit selling PC equipment in retail stores and move more into the web strategy. I wonder if the Dell deals have some web consulting buried in there somewhere. Personally I think today was a tremendous buying opportunity for DELL and IBM. Dell traded as low as $37.38 and stopped dead. Strong support exists at $36 but short of another market disaster, Dell will not likely see that price soon. This is Dell's traditional low point before earnings. Investors are currently trading earnings on other stocks and ignoring Dell. After this weeks earnings are over then investors will start moving into stocks, like Dell, that announce in November. (Nov-11th) Secondly, the strong Microsoft earnings after the bell today will give all the PC makers a rebound tomorrow. Dell traded up to almost $40 after the MSFT announcement.

IBM has screeched to a dead stop at $106 and holding for the earnings announcement tomorrow afternoon. If IBM turns in a good performance then I think the bleeding is over. They have very low investor expectations after the rest of the sector has been beaten up so bad. This means that a good report will be greeted with a new round of buying.

Microsoft announced earnings of $.38 vs $.34 estimated and their CFO actually predicted that they would do better than the current estimates for the fourth quarter. This is very uncharacteristic for MSFT. They normally beat, then warn that the next quarter could be lower than analysts estimates. This constant "holding down" of the future estimates always dampens the outlook to some extent. Investors were jubilant and MSFT traded up over +$4 in after hours trading.

All this optimism from MSFT of course depends on PC makers being able to deliver computers. Since that process is in question the MSFT rally tomorrow could be short lived. The CPI, as I mentioned above, is a lagging indicator. The PPI which was so bad last week is the prices "producers" paid for raw materials. The products they are making with those materials have not made their way into consumers hands and when they do the CPI will also jump. The possibility of next months CPI looking like this months PPI is a real worry.

The next challenge is the Employment Cost Index Report on Thursday of next week. This is a critical piece of the Feds policy formulation and could be another nail in our coffin. According to the Fed Funds Futures there is a 100% certainty that the Fed will raise rates on Nov-16th. They will have the ECI and the Oct Jobs Report under their belts before they meet but the decision, some say, has already been made. The December FOMC meeting is expected to be a non-event due to Y2K but the February meeting is already a 50/50 bet for another rate hike. This rate worry drove the bonds down again to a yield of 6.35% and killed the brief flight to quality rally.

I think when we look back at today it will not be as the start of a fall rally but simply as a relief rally from the beating we have been taking the last two weeks. The Nasdaq Internet leaders rebounded today but there was no energy behind them. A bump at the open and then flat to down the rest of the day. Without the excitement of the Internet stocks the rest of the Nasdaq, with the exception of the biotech stocks, will simply fade away. All the leaders are failing to lead. CSCO, INTC, QCOM, WCOM all faded from the open to close negative or only slightly positive. There is no joy in Mudville after Dell struck out. The new batter, MSFT, came to the plate with two outs and got on base but many of the fans are already leaving the game. Microsoft is carrying a lot of baggage around the bases and could tire before it gets home. The judge in the antitrust case said he could announce a verdict as soon as Friday at 6:30PM. Could be some selling into the rally tomorrow as traders move to the sidelines before the decision. I also read a review that expected traders to move into MSFT because they expected a favorable decision?? A long shot may be the AOL earnings tomorrow. Not a Nasdaq stock but a leading Internet. A possible pinch hitter but I am afraid we will need more than a base hit to save the game.

S&P Futures are up +3.00 on the MSFT news but we have a lot of dark before morning. My best guess is a positive open with a fade to negative before the day is over. There is no reason to buy stocks yet. Earnings are here but some are not looking as good as expected. Y2K is cropping up as the scapegoat excuse in places you would not expect. If you are playing earnings runs, then you should be getting out about now. We all know that you don't want to hold over the announcement and after this week more than 750 of the leading companies will have already announced. Who is left to play? Not many that are worth while. So, why buy with all the uncertainty in the market? My point exactly!

Pick your entry points carefully and don't buy too soon.

Jim Brown

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