The Pain Has Begun
The late-day rebound in the NASDAQ and triple digit gains in the Dow Jones Industrial Average gave the bulls a glimmer of hope near the close of trading. However, that hope was dashed after the market closed when two earnings warnings rocked the tech sector in the evening trading session.
The story is beginning to unfold. The broader market indices have been foreshadowing a slowdown in the US economy since late last summer. This morning, the Commerce Department reported downwardly revised third-quarter gross domestic product (GDP) figures and confirmed the market's suspicions. Third-quarter growth in domestic goods and services produced was lowered to 2.4% from the previously reported 2.7%. Take note that the 2.4% GDP growth recorded during the third-quarter is the lowest rate of growth since 1996. I hope Doc Greenspan is content with his work!
The effects of the slowing US economy were immediately reflected in the tech sector this evening. Gateway warned that revenue and profits for its fourth-quarter would fall well short of Wall Street's previous estimates. The PC maker cited weak consumer spending on personal computers thus far in the holiday shopping season. Even more detrimental, Gateway said it expected demand for its computers to remain weak for the next 12 to 18 months. Shares of Gateway were hammered in the evening session of trading. The stock finished regular trading at $29.02 - it was trading at $19.75 at time of writing.
It gets worse. Altera (ALTR), a leading maker of programmable chips, announced it would fall short of analysts' consensus estimates for revenues during its fourth-quarter. The chip company said that sales in November were soft across all of its business lines, which resulted from a slowdown in orders from its digital subscriber line (DSL) customers. Moreover, Altera reported that inventory among its customers had built up dramatically in the past months, which would result in slower sales in the coming quarters. Shares of Altera settled at $25.94 in the regular session. After the stock was released from its halt in after hours trading it fell to $18.50 at the time of writing. The warning from Altera will surely send a shock through the Philadelphia Semiconductor Index (SOX.X) tomorrow as nearly every leading chip stock fell in sympathy during after hours trading. The SOX recently broke below a significant support level at 600 and will most likely see more downside on the heels of Altera's warning.
To digress from the doom, not all earnings news was bearish after the close. The once-high flying Brocade (BRCD) reported bullish fourth-quarter numbers that edged past Wall Street's consensus estimates by two cents. The company said its business remained strong and provided solid guidance going forward. Despite the bullish tone to Brocade's conference call, the stock bounced around in after hours trading, dipping as low as $143, or $10 below its 4:00 EST close of $153.81. However, at time of writing, shares of Brocade had rebounded from its evening session lows and had stabilized near its closing price. Brocade could provide a lift to select pockets of tech tomorrow if, and only if, the bulls overpower the bears who have all but crushed the stock over the past two weeks. The fact is shares of Brocade are still richly valued and the current market environment is not favorable to such valuations.
Ahead of the earnings news this evening, the NASDAQ had an impressive rebound off its intraday lows around the 2650 level. Before the late-day rebound, the NASDAQ was inflicting increased amounts of pain across several sectors. A glance over several charts this afternoon revealed that momentum and tech investors are really beginning to feel the heat. Take a look at the charts of ITWO, CIEN, and VRTS. All three stocks lost over $10 today, and all three stocks share something in common: high valuations. These previous mentioned leaders of the COMPX are weighing heavily on the tech-infested index and will continue to drag it lower if the buyers don't step in soon. Historical support levels are giving way with increased frailty and the bottom of the COMPX has not yet been found. As much as I hate to write it, the path of least resistance is still lower for the COMPX.
The above chart presents three levels which are likely to provide support for the COMPX. Although the NASDAQ continues along its path of relative lows, it doesn't mean you can't trade the rallies off support. A word of caution though, if you're going to trade the upside in this market pick your trades with scrutiny and practice professional money management. That means defining potential reward and clearly defining risks by setting stop losses. It's clearly evident that the NASDAQ is in a bear market, and a common characteristic of bear markets are violent and massive rallies over the course of two or three days. To reiterate, there is potential to make money on the upside but it requires discipline.
While I'm on the topic of bear markets, it may behoove us to review a history of the Ursa. In the last century, the average bear market lasted roughly 400 days. The average bear market over the last 100 years typically eroded 27% of the market. The current bear in the NASDAQ is only 270 days old, but it has taken away nearly 50% of the gains from the index's March peak at 5132. Judging by past bear markets, the current Ursa is one of the most violent in recent times, and it's still relatively young. While much damage has already been done to the NASDAQ, it could still trade lower until all the bad news is discounted. If you're holding on to big losses in some of the bear targets remember that it's never too late to sell and preserve capital - and stay alive to play the game!
But enough with the bearish talk for a moment. There are select areas of the market which continue to trade higher in spite of the weakness in the broader markets. If you're searching for upside look no further than the drug and food sectors. The obvious defensive positioning resulting from a slowdown in the US economy has sent several big drug and food names to new 52-week highs recently. Among some of the notable names trading at new highs include shares of Abbot Labs, Merck, Schering-Plough, Hershey, Wendy's, and WM Wrigley. As long as the economy continues slowing and earnings warnings stream from the tech sector, the aforementioned groups of stocks should produce trading profits as they provide a safer place to put capital to work. Remember that there's still a lot of capital sitting on the sidelines in the form of money markets. Professional money managers will need to put that money to work before the end of the year in order not to upset shareholders with such large cash positions. With the tech sector teetering, that capital could continue to work its way in the drug and food stocks.
Speaking of money managers, the end of the month is upon us tomorrow, which generally coincides with new cash coming into funds. Again, that cash will need to be put to work. Furthermore, there exists the possibility for a window dressing induced rally tomorrow despite the warnings from Gateway and Altera. Fund managers might try to administer some damage control to their portfolios tomorrow by running stocks up and improving their performance for the end of November results sent to large shareholders. As contradictory as I might sound, it wouldn't be surprising to see a rally tomorrow as November comes to an end. Furthermore, the NASDAQ has fallen 300 points from its intraday high at 3000 Monday and it's just plain ugly out there. One of the bear market rallies I mentioned above might be in the mix in the coming days.
I know that our readers don't like hearing bearish commentary; I don't like writing bearish commentary. However, I must be realistic. The NASDAQ is hurting big time, US economy is slowing, FED has not yet provided any relief, election is still a mess, and fourth-quarter earnings warning season is upon us. The combination of these events is inflicting a lot of pain in the tech sector to those who have bought dips and fought the trend over the past 12 weeks (myself included). The strategy here is defensive, which has been witnessed in the food and drug sectors. In a bear market, the name of the game is survival and patience. A bull will return and when it does it's better to have capital than not.
While my bias is still obviously bearish, here are a few things for the remaining bulls to think about. The bottom-line for the NASDAQ is that the pessimism is getting pretty thick, which is a good thing. Only when the maximum amount of pain is inflicted in tech sector will the bull be ready to run again. It may be several more months before the sentiment in the tech sector shifts and the bears start feeling pain and lose the valuation debate. Then again, it could be next week. The key is to watch for climatic selling in which EVERY stock gets taken out and shot. A big whoosh down to the 2300 level for the NASDAQ could very well be the bottom. Also, pay heed to the levels of the CBOE Market Volatility Index (VIX.X). The VIX is commonly referred to as the fear gauge of market participants and is a good tool to use when attempting to spot the bottom. A spike in the VIX above 35 or higher to the 40 level could very well be indicative of a bottom in the NASDAQ. And while I hesitate to use the word bottom, the selling has got to stop somewhere. Doesn't it?