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Market Wrap

Big Changes in the Dow

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        10-26-99           High     Low    Volume Advances Decline
DOW    10302.10 -  47.80 10408.20 10300.90   878,370k 1,159  1,874
Nasdaq  2811.47 -   4.48  2859.92  2811.20 1,060,420k 1,896  2,057
S&P-100  678.67 -   3.71   689.28   678.51    Totals  3,055  3,931
S&P-500 1281.91 -  11.72  1303.44  1281.86            43.7%  56.3%
$RUT     415.79 -   1.97   420.22   415.70
$TRAN   2829.20 -  41.39  2879.70  2826.96
VIX       25.06 +   0.64    25.55    23.40
Put/Call Ratio       .54

Big Changes in the Dow

Tradition gave way a little today as the Dow Jones Company added two NASDAQ stocks to the Dow Jones Industrial Average. While many believe that the move to put Microsoft and Intel on the Dow is long overdue, the Granddaddy of market indices does not make changes often and when changes are made the new stocks typically come from the NYSE, where most big and well-established companies usually elect to list. The NYSE is probably at least a little disappointed by the change because this new development makes it even less likely that Microsoft and Intel will make the move to the Big Board and assume the M and I trading symbols that had been reserved for them.

The big changes did not just include the two tech bellwethers. Four stocks were dropped from the Dow, including Sears, who has been on the index since 1924. Goodyear Tire, Chevron, and Union Carbide are the other blue chips being dropped for younger but bigger companies. Union Carbide is being swallowed by Dow Chemical and needed to be replaced anyway. Chevron was a natural choice to be let go also, since Exxon is also in the Dow and with only 30 stocks, it probably is not necessary to have two large oil companies. Sears and Goodyear are doubtless disappointed about the decision, but not even they could assert that chain store retailing and tire making deserve more representation on the index than computer software and hardware. Technology stocks now make up almost 25% of the Dow, which is probably a better representation of where the economy is headed in this "Information Economy."

Notice in the graph above how three of the four losers have significantly underperformed the S&P 500. UK has done better than the SPX only because of a buyout by DOW chemical. In the chart below, you can see that the new additions to the Dow 30 have drastically outperformed the SPX with the exception of SBC.

There are still a lot of questions about what effect the changes will have on the Dow. Some believe it will make the index more volatile, and some critics say that it is just a move by the Dow to boost the performance of the index, which has lagged versus the NASDAQ, kind of like a fund manager arranges the fund's portfolio to try to improve performance. Others believe that the change will make Microsoft and Intel even bigger due to the popularity of indexing. These are all questions that will be answered over time but it is unlikely to create any real problems. Both Microsoft and Intel have steady earnings and are very well positioned. At this point of their existence, none of the new Dow stocks are much more volatile than other Dow stocks, and they help to make the index more interesting.

Home Depot and the Baby Bell SBC Communications were also added to the Dow, but were overshadowed by Microsoft and Intel. Home Depot is one of the great "American Dream" business stories of the past decade. It started trading in October 1988 at a split-adjusted price of about $1.25. Now it is over 70 and there are Home Depots everywhere.

The big announcement gave the market, particularly technology stocks, a big boost in the morning. The NASDAQ shot up about 44 points at one point, but like the other indexes, it had difficulty holding onto those gains. With the exception of a few days last week, today's action has been a recurring theme in the market. Stocks try to rally, but it met by selling because of interest rate fears, the weak dollar, comments by some economist or analyst, or some other worrisome factor. The markets are simply weak and it will take some strong catalyst, either a sharp sell-off followed by a rebound, or a quick drop in bond yields, or some other unforeseen event to get the market back to new highs.

The Dow was understandably weak today, due to the beating the stocks being expelled took. Since the changes to the Dow do not take effect until November 1, Goodyear, Sears, and Chevron will not be on anyone's must buy list until then. Goodyear suffered the most, dropping 8.6%, while Sears fell 6.3%, and Chevron fell 2.2%. Those losses along with a 4.8% decline for Wal-Mart made it very difficult for the Dow to generate any upward momentum. Union Carbide was not hurt very badly since their merger deal made their drop from the Dow inevitable. The Dow finished down 47.80, or .46%, at 10,302.13, which is more than 100 points off of the day's high.

NASDAQ stocks gave back their early gains and finished lower on the day. After the initial boost from Microsoft and Intel, the NASDAQ spent the rest of the day slipping, closing near the low at 2,811.47, down 4.48, or .17%, after trading as high as 2859. Just as a note, it is usually a bearish sign to gap higher and finish at the low for the day. Microsoft and Intel gave back their early gains and finished near their lows. Microsoft closed down .07 and Intel was up .18. The S&P 500 also lost ground today, finishing at 1,281.91, down 11.72, or .91%.

Market internals were again weak, although volume was higher than yesterday. Declining stocks outdid improving stocks 18 to 11 on the NYSE and 16 to 15 on the NASDAQ. Volume on the NYSE came in at 862 million and over a billion traded on the NASDAQ, with over 5% of the NASDAQ's volume coming from Microsoft and Intel. The volume today was about 10% higher than yesterday.

In other big news, former Treasury Secretary Robert Rubin decided to join Citigroup as a kind of third chief executive. Rubin vows he will never be CEO, but the current dual CEO situation makes Citigroup one of the most unusual executive situations around. It would be more entertaining if Microsoft and Oracle merged and Bill Gates and Larry Ellison became co-CEOs. Now that would be a lot of fun. But let's get back to Citigroup. Rubin will have no real responsibilities but will undoubtedly generate deals for Citigroup since Rubin has very important contacts all over the world. Shares jumped in anticipation of the announcement, trading over 50, but finished the day at $48.61, up .75.

Aside from the volatile precious metals sector, the retailing sector weighed most heavily on the market. With Sears being booted off the Dow a lower than expected Consumer Confidence and retail sales figures, most retailing stocks had a rough day. The CBOE Retailing index fell 4% today. It was the same story with oil stocks and the reaction to the snub of Chevron. The Oil index fell 1.9% today. Drug stocks also suffered with the AMEX Pharmaceutical index falling 2.4% and the Biotech index losing 1.8%.

Technology stocks held up better than most stocks today, but finished well of their highs. The PHLX Boxmaker index rose .48% and the CBOE Software index rose 1.1%. Internet and Semiconductor stocks were not as fortunate, with TheStreet.com Internet index dropping 1.2% and the PHLX Semiconductor index shedding .54%.

On the earnings front Lucent Technologies announced earnings today, beating estimates by a penny and a 23% increase in revenues. They also announced they would split the company into four divisions in an effort to focus on the high-growth areas of optical networking, wireless communications, semiconductors and e-business. The stock was rewarded with a 5% rise in price. After the closing bell Compaq, Nortel Networks, eBay, and Anheuser Busche all announced earnings. Compaq beat their estimate by 2 cents, but their estimate had been revised downward several times. Nortel beat estimates as did eBay, but both were down in after-hours trading. As this report was being written, eBay was down over $10, which does not bode well for the Internet sector tomorrow.

In spite of a slipping Consumer Confidence Index, bonds slipped again, due in part to some somewhat hawkish comments by a few Fed governors. The 30-year Treasury bond dropped 13/32, which pushed the yield up to 6.39% Traders are still pessimistic about the outlook for bonds and nervous about Thursday's economic data. Without some interest rate relief it is hard to imagine a strong rally for stocks in the near future.

The weak close at or near the low for the day makes it likely that the market will at least open a little lower tomorrow. Most traders will probably be reticent to take substantial positions ahead of Thursday's data, so most of us are expecting a lackluster trading day. According to First Call's estimates, third quarter earnings to date have exceeded analysts' expectations by 3.2%. There are still quite a few earning announcements over the next few weeks, but certainly we can't be disappointed with the results. The problem is expectation, which is what drives markets. Most analysts expected spectacular earnings, and simply meeting expectations does not usually generate a round of back patting and rewards. It says something about the weakness and temerity of the market when earnings can be over 20% higher than a year ago and it is not enough to lift the market. The Dow remains 5% lower than it was a month ago.

Be careful going into Thursday. The indices might be in a trading range but individual issues are even worse off. Recent rallies have been narrow and declines have been broad. This is truly a stock- picker's market and its better to stay on the sideline or cut a loss short than to get into a position that within a week or two forces you to decide to either take a loss or hold a position indefinitely (if you are trading stocks) and to expire worthless if you are trading options. As today demonstrated, times are a - changin' and unless there are working crystal balls around, there are plenty of uncertainties.

Good luck and happy trading

Chad Poulson
Research Analyst

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