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Market Wrap

Are we there yet?

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         WE 1-28          WE 1-20          WE 1-14         WE 1-07
DOW     10738.87 -512.84 11251.71 -471.20 11722.98 +200.42 + 25.44
Nasdaq   3887.07 -348.33  4235.40 +171.13  4064.27 +181.65 -186.66
S&P-100   738.04 - 41.74   779.78 - 17.74   797.52 + 14.03 -  9.34
S&P-500  1360.16 - 81.20  1441.36 - 23.79  1465.15 + 23.68 - 27.78
RUT       504.62 - 29.33   533.95 + 25.84   508.11 + 19.80 - 16.44
TRAN     2581.75 -169.74  2751.49 -140.14  2891.63 - 73.09 - 12.48
VIX        29.09 +  6.43    22.66 +   .53    22.13 -  1.07 -  3.51
Put/Call     .60              .47              .42             .50

Are we there yet?

How often have your heard that? Are we there yet becomes the refrain that every parent dreads on a long trip with a car full of expectant children. They continue to ask because they have no concept of time and distance. Parents compound this by answering "just a little while longer" or "almost" when there may be hours left in the trip. It is easier than explaining the correct answer and the 20 questions that follow. To those of you, that emailed me Friday at various times asking "are we there yet", I dedicate this commentary.

The buying opportunity today, for everyone in cash, was brought to you by the Goldilocks economy. The Employment Cost Index, which is closely watched by the Fed, posted a much stronger than expected gain of +1.1% compared to estimates of +0.9%. This equates to a +3.4% annual increase in employment costs. The GDP came in at a scorching rate of +5.8% when estimates were only +5.2%. The Fed would like to see a GDP in the range of +3.5%. At the rate we are increasing we could see +7% by the end of the year without any brakes on the growth. Almost twice the Fed's target rate. The University of Michigan Consumer Sentiment came in at much stronger than expected 112 vs the 105.4 posted in December. This and the GDP shows the American consumer is buying everything in sight and there is no letup. Business inventories doubled in the third and fourth quarters to supply this buying binge. Consumer spending is off the charts and is propelled by the tightest unemployment in decades and the billions of dollars in wealth pouring in from the runaway stock market. The government, if you believe Clinton, will have the trillions of dollars of national debt paid off in the next ten years or so based on the soaring tax receipts. Tax receipts based on the profits of the Internet economy and the profits from investing in the stock market. This windfall income stream could dry up in the blink of an eye if the Fed allows the economy and the stock market to run unchecked until it self destructed by itself. It would also dry up if the Fed turned up the heat too high. Either way the outlook would be grim. The key here is to let the economy and the markets continue to run but just slow them down slightly. Money will continue to flow, consumers will continue to buy and profits and taxes will continue to accrue.

Adding to the extremely negative economic reports Friday was a couple of high profile earnings challenges. Compaq, not a stranger to earnings warnings, did an about face. At an analyst meeting Friday morning Compaq blessed the future growth estimates of +15% to +17%. Later in the day, an analyst expressed concern about Compaq being able to grow at more than +10% to +11%. The company, when confronted with the concerns, agreed that the 10% to 11% numbers were actually closer to reality. That is a pretty good trick, lose 6% of your growth estimates, a billion dollars or so, in only a couple hours! The next bombshell was in the Internet sector. Amazon announced it was laying off 150 workers in a cost reduction move to slow their cash burn rate. Although this was only a small number of their 7500 employees it was seen as a warning of things to come. Amazon is rumored to be planning to float another $1 bln plus offering to raise cash to make it through fiscal 2000 and announcing a layoff three days before their earnings was a warning to investors that they would lose more than expected. This increasing cash burn and widening losses for one of the biggest E-commerce sites on the net prompted concerns for all Internet stocks. These worries are only amplified by the high high valuations of techs and the extreme bullishness in the market. Investor sentiment is at the highest point since July 1999. All the buyers were fully invested in spite of the impending Fed meeting.

The reasons for staying invested are almost gone. Earnings, have just about run their course and the February correction was just around the corner. Add to this mix a few margin calls and the Dow breaking under its 200 DMA and you have a recipe for trouble. Stir in some investor frustration with leaders YHOO, almost -40% from its recent high, and QCOM, -50% from its recent high, and many investors just decided to take their lumps and move to the sidelines. All of a sudden there are no buyers, even in a month where according to trimtabs.com $24 billion has come into mutual funds. Of this amount 25% went into global funds and the majority of the remaining $16 bln was earmarked for tech funds. $13 billion in additional funds were taken out of the general market and earmarked for the heavy IPO calendar. NYSE stocks were going begging for buyers. Funds were caught selling retail, manufacturing, cyclicals and basic material stocks as their customers moved into position to capitalize on the February weakness. Bonds were hot for a change with yields dropping into the 6.43% range. You can see where the cash was being parked until buying time is here again. The only sector positive for the day was drugs. Spared the "price control" for Medicare speech by Clinton on Thursday night investors breathed a sigh of relief and started moving back into this sector.

Are we there yet? As you can see by the charts, there was some serious damage done this week. The Dow is now down -962 points from the record closing high on Jan-14th of 11731. Support at 11000 is long past and if needed the next level is around 10640, almost -130 points lower. The Nasdaq was even worse in percentage terms. The -152 point drop today, the second largest point drop in Nasdaq history, brought the total for the week to -415 points from the intraday high just last Monday. The two major averages were not the only place there was blood on the floor. The Russell-2000 was hammered for -12 points to bring the loss for the week to -36 points. The S&P-500 suffered its 7th largest point drop ever and is now trading at levels not seen since last November. As I said on Thursday, if we broke support it would get ugly. Ugly was an understatement. There was almost no bounce at the close and the "order on close" volume was all on the sell side.

In just five days the Nasdaq has gone from record high to correction levels and the Fed has not even raised the rates yet. The Nasdaq broke the -10% intraday level of 3872 Friday and came within 9 points of touching the -10% level based on the previous record closing high of 4274. That is close enough in my book. The Dow however is still 130 points above its -10% correction level. The Nasdaq has now traded five straight days with over a 100 point spread. The highest volatility in Nasdaq history. Stocks with great earnings are being applauded on the announcement and then executed. Take SNDK who blew away estimates and announced a split. They gained +$33 Thursday and lost -$23 Friday. VIGN, great earnings, -$22 etc, etc.

If we are not there, we are at least at a rest stop. As you can see by the combination chart above the VIX is almost exactly where it was when we corrected on the Dow the first week of January. Remember the Dow dropped back to 11000 in that event. The VIX has only reached this level five times in the last six months and each time it was a market bottom. Can it get worse? Sure but it is very rare. If the VIX reached 32 it would equate to the same severity drop as the drops in August and October last year. Memorable occasions but the cash flow into the market this time of year is much stronger and therefore harder to hold down.

No analysis of the market next week would be complete without an analysis of the pending Fed meeting. I think there is no doubt in anybody's mind that there will be at least a +.25% rate increase. After the economic reports this morning there is a great number of analysts that think Greenspan could raise rates a full +.50%. Here is where the problem lies. In reality a +.50% increase is already priced into the market but there is still the uncertainty. It is like being summoned by the boss after being late three times in one week. You know you are in trouble, you just don't know how much until you get the lecture. The economy is in trouble, we just do not know how much. Chairman Greenspan is weighing the punishment. Here is my guess:

They will only raise +.25%. Why? Greenspan is an incrementalist. He raised +.50 before and the market cratered. Different time, different factors but still it cratered. This is an election year and you can bet some higher ups do not want to have a market event during their last year in office. They would like to get their boy elected and it is going to be a tough road without additional challenges. They also do not want to trip up the cash machine that is paying down the debt and contributing to election campaigns. The market drop before the meeting has taken the pressure off the committee to "control" the runaway market. If we were pushing 12000 on the Dow it would be a tougher call. Under 11000, with "valuation" concerns making the rounds, some steam has been let out of the boiler. If they only raise +.25% now they can raise +.25% again in March and again in May and again in June, etc. They do not even have to wait for a meeting. If they see a blowout report, they can raise at any time. Therefore, they do not have to rock the boat with a +.50% hike now. At the March meeting they will have the complete economic data from January and February and they will be better able to tell if the hot economy cooled after the holidays or accelerated.

My forecast for the week looks like this. Monday morning is a toss up. We could see a follow through of selling from Friday but I think it will be much more reserved. If anything we could see a drop at the open to the Nasdaq -10% level again and then a bargain hunter bounce. Cooler heads should prevail and many traders will be looking to buy some of these tech stocks before they rocket back up again. The weekend is a long time for traders itching to put their money back to work in stocks -20% to -30% off their highs. I am expecting a relief rally on Monday with a flat day Tuesday until after the meeting. Unfortunately we have January Non-farm payrolls on Friday so some traders will still be cautious.

The wall of worry is vertical at this point and the market performs best under pressure. The downdraft will have taken some of the wind out of the bulls sails and made them more cautious. The good news in my mind is the drop. We have been expecting a drop in February for a month. Because of the huge gains from the October lows traders sold early in an attempt to beat the rush. We are now strongly oversold and the chance of a continued drop in February is now lessened quite a bit. A convincing case could be made now for a slow recovery over the next two weeks and then a rally in March as we near April earnings. So by taking our medicine early and in large doses we may have vaccinated ourselves against the February correction. Regardless of investor sentiment the markets are oversold and poised for a relief rally, soon. Nothing ever goes straight up or straight down. Any dip on Monday morning could be another buying opportunity for aggressive traders. Cautious traders should wait for the conclusion of the Fed meeting and confirmation that the drop is over.

A week like we just finished sure makes you appreciate stop losses! You did use them? Didn't you? Don't you wish you had?

Something funny happened this week. I did not get any emails complaining about my bearish outlook the last two weeks. I can't imagine why?

Trade smart, sell too soon.

Jim Brown

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