Option Investor
Market Wrap

Window Dressing Ends With a Whimper!

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        WE 3-30          WE 3-23          WE 3-16           WE 3-9
DOW     9878.78 +374.00  9504.78 -318.63  9823.41 -207.87  -213.63
Nasdaq  1840.26 - 88.42  1928.68 + 37.77  1890.91 - 49.80  -115.95
S&P-100  605.58 + 24.87   580.71 -  7.28   587.99 - 12.72  - 18.06
S&P-500 1182.17 + 42.34  1139.83 - 10.70  1150.53 - 23.03  - 31.32
W5000  10645.85 +170.55 10475.30 - 84.07 10559.37 -223.31  -282.18
RUT      450.53 +  7.26   443.27 +  1.47   441.80 - 10.36  -  7.84
TRAN    2771.36 +126.02  2645.34 + 13.97  2631.37 - 71.64  - 75.12
VIX       33.82 -  1.09    34.91 -   .38    35.29 +  2.66  +  2.89
Put/Call    .76              .52             1.08              .83

The close on Friday was anticlimactic with the Nasdaq closing only slightly positive for the day but posting the worst quarter on record. The Dow attracted some end of quarter money as we expected and eased closer to 9900 again with a +79 point gain.

The main catalyst for the market on Friday was the Chicago PMI and the University of Michigan Consumer Sentiment reports. The Chicago PMI surprised investors with a reading of 35 and a drop of -8 points. It is the lowest level since 1982. This signals that the significant weakness in manufacturing in the Chicago region is intensifying. There is no recovery underway in Chicago! This report is a leading indicator for the NAPM report which will be released on Monday and is strongly valued by Greenspan and the Fed. A drop of this magnitude in the National Purchasing Managers report (NAPM) report on Monday would be met with a call for more aggressive rate cuts before the next Fed meeting. The Consumer Sentiment report actually rose slightly for the first time in three months to 91.5 but only slightly over the February 90.6.

The other major report Friday was the ECRI which lost -4.9% and puts it at levels near the end of 2000. The ECRI continued its weekly decline falling to 120.7. The six month rate is falling to a level not seen since the end of 1990. It means that there is a continued worsening of economic conditions. The Personal Income and Spending reports showed that consumers were experiencing income growth and they were spending this extra income at a rate which would be consistent with the Fed's claims that the economy is not as bad off as feared. If you weight these reports the PMI carries more weight with the Fed while the increased income and spending encouraged retail investors that there was light at the end of the tunnel.

The week of April 2nd will be pivotal in market direction. The economic calendar has several major releases which could drive the market. Monday has Construction Spending and the important NAPM Index. The next most important report for the week is the Nonfarm Payrolls on Friday. A strong employment report would mean a recovery is underway and a weak report would provide another stimulant for the Fed to cut rates. Either of these major reports could trigger an inter-meeting rate cut but the Fed is more likely to wait until the employment report as confirmation of any NAPM weakness.

Earnings warnings on Friday included PRI Automation, Nasdaq:PRIA, Semtech, Nasdaq: SMTC, Cirrus Logic, Nasdaq:CRUS, C-Cor.net, Nasdaq CCBL, Dendrite, Nasdaq:DRTE and several other companies announced slowing sales and layoffs. Ameritrade, Nasdaq:AMTD, cut 170 jobs due to lower trading volume. Gillette, Nyse:G, said they saw zero growth going forward. This is just a sample of the hundreds of warnings in our future over the next three weeks. The market will have a significant wall of worry to climb but that also builds strong bases.

Dell Computer, Nasdaq:Dell, has an analyst conference this week and many analysts expect a positive report. Dell is reinventing itself and I even heard one analyst say he expected Dell to beat estimates. Now that would be a trick! Dell stock has been slowly gaining ground since hitting a low of 16.25 in December. It is not burning up the charts but showing positive momentum. The buy the rumor, sell the news syndrome may be showing since Dell faded the last couple days of the week. Remember, they can also guide analysts lower as well.

The challenge for Dell as well as the rest of the PC and Chip sectors will be the continuing decrease in demand. The most telling indicator is the semi book to bill ratio which was .77 in February. It is still falling and analysts say that component inventory in all the channels was still very high with as much as three quarters of excess. MU finally announced a narrow than expected loss but inventory levels were much higher than expected. The claim of decreasing inventory and building for new orders was hard for analysts to believe. These same analysts point to the pricing levels as still in the second down phase of correction and until manufacturers cut prices substantially to convert inventory back to cash, the correction is not over. There is still too much bullish sentiment for a quick rebound and until that sentiment is gone and inventory flushed, semi stocks have farther to fall.

The SOX.X, which is viewed as the leading indicator of an economic recovery, has fallen back to its last level of support at 540. After a hopeful rally two weeks ago the index is poised only 30 points above a new low. The semi- conductor holders, AMEX:SMH, came within .06 of setting a new intraday low on Friday. While checking for possible plays on Friday there were more semi stocks heading for new lows than holding their ground. For the first time in 16 years, many analysts are predicting that the number of semiconductors sold worldwide in 2001 will drop. Bill McClean, of IC Insights, said last week the industry is caught in a perfect storm, too much inventory, too many factories and a severe economic slowdown. He is predicting a -7% drop in unit sales worldwide and he is an optimist. David Wu, analyst for ABN Ambro, is looking for chip sales to fall -20% this year from over $200 billion to $160 billion. Wu said in late 2000 makers of networking, telecommunications equipment and cell phones were ordering as much as four times the number of chips that they needed in order to prevent shortages in the supply line for 2001. When the economy screeched to a halt in December these companies had millions of chips on hand and nobody buying their finished products. This excess chip inventory could last 18 months according to some analysts because there is simply no product movement in these sectors.

The airwaves were awash in negative sentiment about the worst quarter ever for the Nasdaq. The Nasdaq lost over -630 points or -25.5% in the first quarter and finished only +45 points from its 52-week low set last week. The low point for Friday was only +.06 above that low of 1974.21 set on March-22nd.

The Dow managed to continue its rebound from last weeks lows and posted a +363 point gain for the week. With tech stocks still under pressure fund managers parked money in blue chips like JPM, XOM, MRK, PG, SBC and IBM. The other tech components of the Dow did not fare as well. MSFT -.69, INTC -.25, UTX -1.25 and HWP +.63. The Dow also got a boost from speculation that Citigroup wants to buy American Express. This rumor has been around for years because the CEO used to work for AXP and would like to structure a huge merger before he retires. At least that is the rumor. AXP gained +2.34 on the news.

We need some rumors to build a fire under this market. The possibility that we will see literally hundreds of warnings over the next three weeks was boosted by GE CEO Jack Welch on CNBC. When asked if we were in a recession he responded that his business "was ugly and getting worse." If the CEO of the largest diversified company in America says his business is ugly and getting worse, we should probably believe him. When asked if we could expect a second half recovery as many analysts are predicting, he said "he would not count on it." He does not see the recovery that everyone wishes was happening. He said he had called Greenspan for the first time in two years last quarter and told him things were looking grim. Before you start looking for a window to jump out of we need to remember that Jack Welch may be past his prime. His appearances have been less than inspiring and he may be playing for dramatic impact. He could also be doing his John Chambers imitation and using his public appearances to talk down analyst expectations for GE. Of course that would mean that he needed to reduce estimates due to weak earnings.

There were some improvements in money flow this week. After seven consecutive weeks of outflows, tech funds managed to post a positive week. Before you get too excited they were only positive by $37 million. Considering the trillions of dollars lost in the last year, $37 million is pocket change. Equity funds in general posted a +$850 million gain compared to over -$6 billion outflows from last week. Not much to write home about. After seven weeks of cash outflows it is no wonder Ameritrade is cutting jobs and heading to penny stock status. Order flow and commissions have got to be shrinking daily.

Besides the NAPM and Non-farm payroll reports next week we have seven Fed officials making public speeches. Talk about a mine field! Two years ago there was a flurry of value funds that closed up because investors had abandoned that approach to investing. We have now come full circle and value is now a very much appreciated commodity. Unfortunately it is the previous growth stocks like CSCO and LU that are being singled out as value plays. There are compelling values in the market and this is going to be the driving force in powering the market this spring. Several asset allocation analysts have gone on record as saying the risk/reward ratio for equities is at a 20 year high. Repeat, A 20-YR HIGH. To qualify that they are comparing the possible return from equities with the return from bonds in the same period. They are not saying that equities cannot go lower. These are the same people who were saying the ratios were at a 10 year extreme just a few weeks ago. Hopefully they will not be claiming 30 year extremes anytime soon.

The coming quarter is historically a tough one. The first two weeks in April are historically up. Don't take that as a buy recommendation. They are up historically because earnings are expected to flow in quantity by mid month and these two weeks are the end of the pre-earnings run, historically! Reality may be different. Historically earnings are expected to be up. This year earnings are falling through the basement and expectations of profits have given way to fear of increased losses. Instead of holding over earnings and hoping for an upside surprise there is a good chance that investors will be heading for the sidelines instead. They will sit in cash and look for survivors after the smoke clears. I have said this before but over the last three years, good earnings years, the last two weeks of April have produced a market sell off. Once a historical trend is established the timing of that trend accelerates as more investors try to beat the rush in and out of the trend.

Another challenge for next week will be the window undressing period. This is when funds who were forced to invest cash to show pretty statements now move back to cash to wait for better targets. This really does happen and stocks that attracted money this week can suffer next week. Some of this is related to traders who anticipated the fund movement and took positions ahead of them. Next week they will take profits.

What does all this mean to us? It means volatility is still with us and we may see some huge swings as warnings and actual earnings duel for press coverage. Many tech companies have earnings cycles that are back end loaded. That means they try to cram as many sales into the last two weeks as possible and we will be hearing over the next two weeks if those companies hit their targets. With all economic indicators still pointing down it is doubtful that many were successful. This warnings period has already gone down as the worst in history since First Call started keeping records. That does not bode well for the next three weeks.

Those readers who are following my benchmark trading plan should still be flat. Currently I am only recommending that buy and hold option investors ONLY open new positions with a Nasdaq close over 2000. Last Sunday the Nasdaq was sitting at 1928 and most retail investors were looking for a strong rebound to 2500 over the next couple weeks. Don't look now but after struggling to close the gap between 1928 and 2000 for two days, the Nasdaq came within .06 of making another new low on Friday. If you had tried to enter the market (as a buy and holder) on Monday or Tuesday before waiting for that close over 2000 then you lost money last week. Traders who can jump in and out quickly can trade these huge swings but longer term investors should wait patiently for confirmation of a rally before going long. If you don't like this benchmark strategy then trade whatever plan you like. It may be boring but it beats broke. It is your money!

If you have not yet reserved a seat at the April Trading Expo in Denver this week then you are missing out on the opportunity of a lifetime. This group of speakers will never be offered again. Over a million investors have read their books and newsletters and heard them speak individually. Next weekend you can hear them all in one place with over 50 hours of in-depth options and stock trading education. Take a couple days off from the markets and learn how to win more and lose less.

Trade smart, enter passively, exit aggressively!

Jim Brown

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