It was fun while it lasted but if you look behind the Nasdaq loss of only -14 then you may see that the stealth rally may still be in progress. While all the Nasdaq big caps suffered minor losses for different reasons the smaller sector specific stocks continued to break out of their recent doldrums. The leaders INTC, CSCO, MSFT, DELL, ORCL, WCOM, SUNW all lost ground but sector leaders like BRCM, CIEN, HGSI, BMY, RBAK continued to add to their gains. The Dow however continued to suffer. Led down by UTX -3.19, PG -2.44, MMM -2.44, HWP -1.69, DD -1.81, C -1.88, INTC -1.25 and CAT -1.75 the index traded below 10500 again late in the afternoon but rallied at the close to 10525.
There were various reasons for the market weakness on Friday and most were unrelated. First there was the HWP profit warning which held the PC and software stocks down for the day. Most had been posting gains so normal profit taking was assisted by the warnings. Microsoft moved lower after the Justice Dept filed papers denying negative bias on the part of the judge. While this was not an earth moving event it did bring back into focus the fact that the case was still alive and well. SUNW was downgraded by Salomon Smith Barney to a price target of $30, which is where it closed, based on a view that even though SUNW has not warned it was facing a tough couple of quarters.
Other factors influencing the drop included the PPI and Retail Sales reports Friday morning. The PPI headline rate was unchanged compared with estimates of a +0.1% increase. The core rate was up +0.3% well over the +0.1% expected increase. The crude goods category increased +8.7% which was the largest increase since August 1990. Analysts fear these costs will ripple through the broader numbers once these goods make their way into the market. The fear, which shot through the markets like a lightning bolt, is that the Fed might pull back from their aggressive rate cut posture to see if inflation has suddenly reappeared. The hope of a -.50% rate cut was suddenly dashed and now the Fed funds futures are only indicating a -.25% drop. This concerns the markets since a slower drop in interest rates could delay a recovery for six months or more. Financial stocks fell on the worries as well as old economy stocks like DD, IP, UK, MMM etc. If the recovery was off to the races we now need to wait for the FOMC meeting on Jan-31st to see if we developed a flat tire. Retail Sales grew by +0.1% when the expectations were for a decline of -0.5%. The gains were in stronger than expected auto sales and should not impact any Fed decision.
William Hewlett who co-founded Hewlett-Packard in 1939 died Friday morning in California. The pair started HWP with $538 in a one car garage. The combined companies HWP and Agilent have over $61 billion in sales. Steve Jobs once worked for the pair in a summer job. Jobs said he used what he learned during that summer to build Apple Computer into a success. Well done Mr. Hewlett!
The AOL Time Warner merger is history. The final approval came through on Thursday and TWX ceased trading on Friday. The combined company faces many challenges going forward but is likely to be a force to be feared in the Internet world. The combined might of the two companies will usher in a new era of Internet marketing. The stock is on almost every buy list for 2001 as the 800 lb gorilla just got a lot bigger. AOL is my guess for inclusion into the Dow to replace HON.
Oil prices appear headed higher again. OPEC is going to meet Jan-17th on cutting production to maintain high prices for their products. The anticipated cuts will be 1.5 million bbls per day but with Iraq still playing tough and withholding 1.5 million bbls per day until he gets paid in Euros, Rubles, gold bars or ammo of his choosing, the impact will be 3 mil bbls per day. That could drive prices back over $30 per bbl and cause the energy related prices to soar again. Bush is applying pressure already to Saudi Arabia to hold the line. The first major crisis of his presidency will be seen as a yard stick of what to expect going forward. Good luck Mr. Bush!
The Nasdaq fell at the open as a result of the PC sector earnings warnings but rallied back to within a whisker of 2700 at 2699.87 before pulling back. The end of day bargain hunting never materialized with the traders deciding that going into the long three day weekend flat was better than taking a chance of another post close blockbuster warning. The warning did not happen but the positive sentiment from as late as Thursday appeared to be changing again. The volume was strong at almost 2.5 billion on the Nasdaq and 1.26 bil on the NYSE. BUT, and there is always a but, there was no movement. After a big move high volume with no movement is often a prelude to a drop. Investors still giddy with the bullishness from this week are rushing into the market while investors holding stock are selling into the rally.
The causes for the selling are the worry that the Fed will not cut as much as expected but of even more concern is the severity of the HWP and GTW forecasts. With earnings beginning in earnest next week investors are worried that there will be a flood of missed estimates and even worse a dire forecast from the big names. With the earnings list for next week reading like a who's who of the tech world any pattern of weakening forecasts could cause another sell off. Big names reporting next week include JNPR, AMCC, INTC, NVLS, RBAK, IBM, ITWO, EXTR, CMRC, EMLX, INKT, MUSE, TXN, ALTR, AMD, APPL, CTXS, LSCC, MSFT and SUNW to name just a few. If their forecasts are as dire as Hewlett-Packard's then there will be trouble on the street. Investors can ignore the HWP and GTW warnings as industry and/or company specific but if the entire tech sector starts repeating the same mantra then our fragile rally may self destruct.
The historical rally for last week came to pass for the Nasdaq but not the Dow. While historical trends are just that, trends, and not a sure thing, they are useful for planning for future events. Historically there is a dip after the first week of earnings in January. We should plan on that possibility and use any bounce Monday or Tuesday to position ourselves to take profits if the market follows past trends as the week draws to a close. The reason for the dip is combined profit taking after the earnings runs and/or bad earnings news. With the possibility for bad news very high the possibility for a dip is also very high. Many analysts feel the bad news is already priced into the market as evidenced by the lack of a material sell off on HWP -1.69 and GTW -1.81. By previous standards these companies could have easily lost a third or more of their stock price. The bright side is still the strong advance/decline ratios at 2:1 on the Nasdaq even though the index finished negative. This means investors are still bidding up stock prices on the broader market even though the big caps were weak. TrimTabs.com said equity inflows amounted to over +$15 billion for the week ended Jan-10th and more cash is on the way with retirement contributions on the way. While last week provided a good base from which to rally we will be at the mercy of earnings guidance.
Next week is options expiration week and that typically gives the market a bullish bias. It also provides a tremendous opportunity for aggressive traders. This is not for the faint of heart but buying slightly out of the money options can be very rewarding next week. An example would be ASYT and the Jan-17.50 call at only $.63. Only -$.69 out of the money and ASYT moved almost +$3 last week. Another $3 move would make the option worth $2.50. It is just an example but the reason I love expiration week. I will list some more possible plays in my Editor's Plays section today.
My recommendation for the week would be to keep your stops tight as we get closer to Friday. If you are in a trade on a stock that announces earnings this week PLEASE consider closing those trades the day before. Earnings bombs are very destructive. Remember ARBA last week. They announced a +625% increase in earnings and beat estimates by +150% but the stock dropped -$8.19 the next day. An obscure line in the financials showed they increased their allowance for doubtful accounts and they are changing the way they recognize income. This sent investors into a stampede to exit the stock. Good earnings are not enough to prevent a trade meltdown. We recommend exiting the trade the day before earnings are announced to prevent disasters. You give up the possibility of an explosive bounce but we have found that historically only occurs in about 2 of every 20 announcements. Are you willing to risk a 90% chance of a gap down the next morning to get that possible bounce?
Trade smart, enter passively, exit aggressively!