Here they come! What precedes earnings warnings? Analyst downgrades! It does their reputation no good to downgrade a stock that has already warned so if they want to garner publicity they have to go out on a limb in advance of warning season. Ashok Kumar fired the first salvo today with a downgrade on Intel and the tech market reacted with a big drop. Great timing for the maximum press exposure. Everyone is thinking rally and you manage to take out 25% of the leaders with one announcement. The Dow managed to rally back to plus territory after Coke said they were comfortable with estimates going forward but this just proves the fallacy of looking at the Dow as a market indicator. The Dow rebound was a fluke with every other index except the transports dropping. The broader market S&P-500 lost -13.69 and the Wilshire-5000 lost -128.
How to crater a rally, Step 1. Downgrade a major component of the Nasdaq. The ensuing drop of that component will take others in the index with it. Step 2. Phrase your downgrade on weakness in the sector not specific problems with the company in question. By saying that PC sales are weakening you can kill chip makers, INTC, AMD, MU, ATML, ALTR and others along with PC box makers Dell, CPQ, HWP, IBM and GTW. Guilt by association then drags in software makers MSFT, ADBE, SYMC and friends. If PC growth is weak then Internet network companies sales could slow and that hits CSCO, NT, NTAP, TERN, EXDS, FDRY, AKAM, RFMD and on and on. Every layer below the actual PC box and its impact on Internet and networking suffers. It is like that ad for weed killer Roundup. "Kill the roots, kill the weed." Kill the PC sales forecast and kill tech market. Thank you Ashok Kumar!
The downgrade on Intel was from "strong buy" to "buy" but the killer language was the downgrade on growth estimates, a warning about an imminent over supply of chips and a warning that chip pricing was likely to turn into a price war. Ashok said he expected Intel growth to be only mid single digits. This was much lower than the +15%-17% prior estimates. Saying the PC rally was failing and third quarter was going to be disappointing was like saying "man to the lifeboats" on a cruise ship. Traders back from vacation and trying to decide what to buy were suddenly trying to decide what PC stocks they needed to unload instead.
Add to the PC sector unrest the fear that neither presidential candidate is looking very drug friendly and suddenly another sector is looking grim. The new Bush Medicare plan was not viewed as positively as was hoped and Banc America's analyst Leonard Yaffe downgraded the entire sector to market perform. With the Gore plan seen as allowing Medicare to implement price controls on drugs and the Bush plan only slightly better, drug companies are facing possible lower profits once these plans are implemented. Lower profits mean lower stock prices and traders started moving out of the sector today.
If these problems were not enough CIEN investors got an unpleasant surprise. A major customer of Ciena filed for bankruptcy and CIEN is not likely to receive payment for $28 million of optical equipment. This will result in a charge of $.06 to their fourth quarter earnings. CIEN dropped $14 even though the revenue was already accounted for in the doubtful accounts category. The charge and loss of the customer will have no impact on CIEN going forward according to CIEN. Buying opportunity? Looks good to me but wait for a new trend to appear. CIEN has a 2:1 split on Sept 18th only two weeks away!
The Nasdaq posted a loss after five winning sessions in a row. Does that surprise anyone? The slightest scare of earnings or sales prompted the flight reflex as fears of lost profits overcame the greed compulsion. I want to spend a couple minutes exploring the shock loss syndrome. Remember the Emulex hoax from two weeks ago? The stock was rocketing from the mid $40s the first week of August to a high of almost $120 before the hoax on August 24th. Since the hoax the stock has fallen to only $100 even though the press release was bogus. The company is still exactly the same as it was when the stock was soaring but the stock is now falling. What changed? Profit shock. This is the term used to describe the feeling of seeing a $120 stock trading at $50 and you are still holding an open position. This is of course extreme but you get the picture. Investors who had been counting their paper profits of better than 100% were suddenly back to zero or at a loss depending on how long they had owned the stock.
Once the hoax was over every investor that survived the heart attack was determined to take profits. It is called getting out alive, the second chance that many of us don't ever see. Once the opportunity presents itself to sell, traders not seeing a continuation of the rapid gains, quietly sell into rallies and count themselves very lucky. The profit shock impacts not only investors in EMLX and stocks in the same sector like QLGC, but other stocks that have run up fast as well. Watching someone else take a bath in a news disaster will make you consider windfall profits you may have in your portfolio. Lightning can and does strike twice and once hit you are forever shy. For everyone that woke up this morning expecting a continued rally and found a tech sector nightmare instead, the prospect of losing the profits from the last three weeks was suddenly crystal clear. Investor sentiment changed in the blink of a press release and +550 points of profit in the Nasdaq since August 11th were on the verge of disappearing faster than a politicians promise on November 8th.
Which way from here? Like I said on Sunday, "just because everyone expects the market to do something does not mean it will," the drop today proved that millions of investors hoping for a rally cannot make it happen. The only thing that will cause a rally is buying, not hoping. Hoping is done by people with open positions and no money. Traders with money vote for rallies by buying something and their votes move the market. Volume was good today (1.6B) and that was a bad sign. Good volume on a down day causes more down days. The possibility that the PC sector analysis by Ashok Kumar may be accurate could cause more problems. Traders are beginning to be more concerned that the earnings warnings which start next week may be stronger than normal after today's tech downgrade. This COULD impact the rest of this week. There are no important economic reports this week but next week is loaded. The Nasdaq is now showing a failed rally at the 4250 resistance from Friday. The lack of a follow through today and the sector downgrade could be the one-two punch that knocks us into next weeks decline several days early. Light support is at 4100 and then 4000. With September the worst month on record in the last 49 years, even worse than October, and the four day post Labor Day rally now in doubt, I would be VERY cautious about starting new positions. There is still a ton of cash on the sidelines and this could be the buying opportunity they have been waiting for. Still, I would be careful. We blinked and sentiment changed. I hate it when that happens!
Good luck and sell too soon.
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