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Earnings Disappointments Make for a Gloomy Day on Wall Street

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        07-26-2000        High      Low     Volume Advance/Decline
DJIA    10516.50 -183.50 10692.50 10516.50 1.18 bln   1364/1475
NASDAQ   3987.72 - 41.85  4002.70  3906.55 1.74 bln   1588/2366
S&P 100   791.19 - 11.25   800.94   791.19   totals   2952/3841   
S&P 500  1452.42 - 22.05  1472.08  1452.42           43.5%/56.5%
RUS 2000  513.81 -  0.52   514.33   503.92
DJ TRANS 2800.34 -  8.98  2817.10  2790.77
VIX        22.75 +  1.08    23.23    22.13
Put/Call Ratio       .51

Earnings Disappointments Make for a Gloomy Day on Wall Street

As earnings continue to hog the spotlight, we are seeing confirmation that investors are less concerned about the actual earnings numbers and are instead focusing on the forward-looking statements about revenue for the remainder of the year. XRX kicked this trend back into high gear this morning as they reported earnings a penny ahead of estimates, but cautioned that estimates for the rest of the year are too high.

Without so much as a whimper, the DJIA plunged through the tenuous 10700 support level this morning, and that was only the beginning. Although finding support above the 10500 level, the heavy selling volume (just under 1.2 billion shares) hit almost every sector and the Industrials gave up -183.49 to close at 10516.48. Nearly 70 points disappeared at the close as fund managers reshuffled their holdings to make room for their required acquisition of JDSU (see details below). Breadth was mixed with 1363 advancers outpaced by 1474 decliners, although new highs beat out new lows by 90 to 78.

Lest you think all was negative today, we did get one positive earnings surprise from Oxford Health (OXHP), as the company reported earnings of $0.36, blowing away estimates by 33%. The company was rewarded by a strong move, as investors snatched up shares and pushed the price up nearly 10% on triple the average daily volume.

The biggest bright spot at the NYSE came from the Insurance sector, as a number of brokerage firms came forward with positive comments and upgrades, indicating the sector's recent rally may have legs. Bear Stearns upgraded AON Corp. (AOC) from Attractive to Buy, while Merrill Lynch chimed in with a Buy rating, up from Accumulate. The St. Paul Companies (SPC), which is due to report earnings tomorrow morning, received a Salomon Smith Barney upgrade from Neutral to Buy, and the positive sentiment was palpable as buyers flocked to the sector like moths to a flame. Besides AOC (+2.94) and SPC (+2.38), other winners were AIG (+1.13), CB (+2.44), HIG (+3.06) and PGR (+3.88). Although the gains were not huge, anything that was in the green today was impressive, given the broad market weakness.

The small rally on the NASDAQ yesterday afternoon did indeed turn out to be a bear-trap rally as the index headed lower right from the open. Gapping below 4000 opened the door for a quick slide, as selling pushed the Composite down -120 points within the first 90 minutes of trading. Semiconductor and Internet weakness led the decline (see below for details), and fortunately support held at 3900. Although the NASDAQ spent most of the day recovering from its lows, it was unable to get back above 4000 before the close, and breadth was decidedly negative. 2368 declining stocks beat out 1591 advancing stocks and 133 new lows swamped a mere 43 new highs.

So much for the tenuous recovery in Semiconductor stocks. Providing belated vindication for Jonathan Joseph (remember his downgrade of the entire sector a couple weeks ago?), the entire sector bled heavily today. So what happened, you ask? LSI had a disappointing earnings report last night after the close, and the selling that took place in the after-hours session accelerated this morning, pushing the stock ever lower, closing at $31 for a 28% loss.

As if that wasn't enough to tank the sector, INTC decided to pick a fight with RMBS, announcing that it will release a chipset that serves as an intermediary between the processor and the rest of the computer components. This will allow PC makers to use standard, relatively inexpensive computer memory in Pentium 4 desktops. INTC is also investigating how to adopt the chipset to an enhanced version of standard memory called DDR DRAM that more directly competes with RMBS memory. This marks a significant departure from INTC's product roadmap, which officially contained only RMBS memory for its Pentium 4 chipsets. The impact on the sector could be significant and investors responded by slicing -$9.50 off the price of RMBS and -$1.88 from INTC. The negative sentiment bled into the entire Semiconductor sector, with virtually everything in the red. Some of the more notable losers were ALTR (-10.63), XLNX (-4.13), NSM (-4.13), and AMD (-3.44).

Reporting better than expected earnings last night (5 cents vs estimates of 3 cents) wasn't enough to prop up shares of EBAY, and the online auction leader gave up -$3.56 today to close at $52.69. Further pressuring the Internet sector was a downgrade for AMZN ahead of their earnings announcement tonight after the close. Holly Becker of Lehman Brothers said she was "throwing in the towel on Amazon" cutting her rating from Buy to Neutral. This came on the heels of Tuesday's downgrade by Tom Courtney of Banc of America Securities. Courtney cut his rating on the company from Strong Buy to Buy and withdrew his price target of $80, saying he would revise it after the company's earnings estimate. AMZN gave up -$1.56 in the regular session and despite posting a smaller than expected loss (-$0.33 vs. estimates of -$0.35), traded below $34 in the after-hours session.

Ok, let's get to the big story of the day, JDS Uniphase (JDSU). As we have reported recently, the company went into the S&P 500 after the close today, replacing Rite Aid (RAD). Anticipation of the move has kept the volume very high on JDSU for the past week, and the price had been bouncing between $130 and $140. Today saw new levels of interest as nearly 120 million shares traded hands in the regular session ahead of earnings to be reported after the close.

As promised, the company beat even the high end of estimates, posting $0.14 vs. the consensus of $0.12, and followed up with a bullish conference call. Revenues increased 33% quarter-to- quarter, and 173% year-over-year, and management stated that the only limitation on their revenue growth is how fast they can make and sell their red-hot Optical products. The frantic pace didn't slow down after the close either, as JDSU traded over 87 million shares (no, I didn't leave out a decimal point) in the after-hours session, for a total daily volume of more than 200 million shares. JDSU closed the regular session at $135.94, but traded down after hours.

The collateral damage from this heavy action was felt in the S&P 500 as fund managers sold other index components to make room for shares of JDSU. The reason for this impact is that the market capitalization of JDSU is fully 100 times that of RAD, and since the index is market-cap weighted, literally all of the other 499 components had to be reshuffled to keep the index balanced.

Market weakness continues, and it is looking more and more like we have already had our summer rally. Even companies that are releasing stellar earnings are seeing shares of their stocks being sold on the news, while failing to meet earnings AND revenue growth estimates has become the cardinal sin. Take a look at RMDY - they announced earnings 4 cents above the street estimate last night, but their revenues were disappointing (notice the common theme, here?) and the stock shed nearly 50% of its value today to close at $22.38.

The VIX continues to lurk around 22, and the slight move up to 22.27 at the close tonight isn't nearly enough to get us out of the danger zone. As earnings season winds down, we can see that even the host of strong reports hasn't been enough to incite anything approaching a wild summer rally. Investors' focus seems to be shifting back to the economy in the near term, with the Employment Cost Index (ECI) report taking center stage tomorrow morning. Forecast to come in unchanged at 1.4%, anything stronger than this may re-ignite concerns that the Fed could throw one more rate hike at the market at its August meeting. This type of nervousness, coupled with the normal summer slowdown as investors and fund managers alike go on vacation, makes it look increasingly unlikely that the markets will have sufficient motive to move higher over the next 5 weeks.

Although it is starting to sound like a broken record, I feel compelled to echo Jim's cautionary statements from last night's Wrap. Use extreme caution in opening any new long positions and tighten up your stops on open positions. It is unclear which way the markets will move for the balance of the week, but today's downward bias confirmed the recent trading ranges for both the DJIA and the NASDAQ. The incentive to drive this market higher is rapidly evaporating as earnings wind down, so don't assume that every dip will be met with a bounce.

We need to pay attention to the market and trade the trend. If you don't see it, there is no shame in sitting out and hanging onto your cash.

Mark Phillips
Research Analyst

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