Ticking Towards Conviction
The holiday shortened trading week combined with a lack of significant earnings warnings led to drifty action in the tape today. Volume on the Nasdaq finished at roughly 1.4 billion and the trading activity on the NYSE was equally muted at roughly 995 million shares traded. To put the aforementioned volume figures into perspective, the 30-day average volume for the NYSE is about 1.25 billion and roughly 2 billion for the Nasdaq.
The unusually light volume Monday stemmed from the fact that market participants lacked conviction in placing bets on either direction. However, the bulls in this market might argue the fact that Monday's trading was constructive in light of the massive rally across the broader market averages last Thursday. The term "consolidation" comes to mind. Conversely, the bears in this market might point to the continued deterioration in fundamentals, especially in the tech sector, which I'll elaborate upon below. And the absence of deterioration on the fundamental front Monday led to an absence of the bears. However, we must remember that stock prices generally turn higher six to nine months ahead of a rebound in underlying fundamentals, which begs the question: Will fundamentals in tech rebound in the next six to nine months?
According to both Lehman Brothers and Salomon Smith Barney, the ultimate rebound in the chip sector may be years away. Dan Niles, of Lehman Brothers, opined this morning that calendar 2001 would be the worst year ever for semiconductor companies. Niles predicted a 20% decline in year-over-year revenues for the chip sector, which would be the most severe pullback in the semi business since 1985. Meanwhile, Jonathan Joseph of Salomon Smith Barney, who correctly predicted the downturn in the chip sector last summer, cut his sales estimates for both Intel (NASDAQ:INTC) and Advanced Micro Devices (NYSE:AMD). Joseph said that sales in flash and communication chips could have weakened more-than-expected during the quarter.
The cautious comments from Niles and Joseph concerning the broader chip business sent the Philadelphia Semiconductor Index (SOX.X) lower in Monday's session. Although my examination of the SOX may seem repetitive, I feel that it holds the key to any rebound in the broader tech sector and, indeed, the Nasdaq Composite (COMPX). Semiconductors have become omnipresent in both the commercial and consumer markets. Furthermore, the SOX correctly anticipated the downturn in the economy last year and, it's my opinion, that the SOX will forecast a recovery in the economy, hence my focus.
From a fundamental standpoint, the semi sector is in bad shape as noted by Niles and Joseph Monday. Additionally, the technical standing of the SOX is weak, at best. Although the SOX did rebound towards the end of trading Monday on what appeared to be short covering, it's floating just above its 52-week low at 453, which was traced last Wednesday. Aside from that level, the SOX doesn't have support until the 400 area. On the upside, resistance for the SOX is firmly located at the 500 and 525 levels. Although it's a big range, I think the best way to trade the SOX would a breakout above 500 or 525, or on a breakdown below 450.
Within the SOX, traders will want to monitor shares of Intel, AMD, Micron (NYSE:MU), Xilinx (NASDAQ:XLNX) and Broadcom (NASDAQ:BRCM). As far as the capital equipment makers go, keep an eye on Applied Materials (NASDAQ:AMAT), KLA - Tencor (NASDAQ:KLAC), Teradyne (NYSE:TER) and Novellus (NASDAQ:NVLS). Finally, traders interested in the chip sector will want to pay special attention to the Motorola (NYSE:MOT) earnings report after the bell Tuesday. The company has been the target of rumors in addition to an analyst upgrade Monday morning. Motorola's earnings report could be a telling metric insofar as the current conditions in the semi sector...stay tuned!
Away from the tech sector, the speculation of an inter-meeting rate cut resumed following last Friday's weaker-than-expected employment report, which revealed the economy lost 86,000 jobs during March. According to most economists, as well as the Federal Funds futures market, there exists about a 50% probability of an inter-meeting rate cut by the Fed. In my opinion, those odds might be a little higher in light of the continued deterioration in earnings and the bankruptcy debacle surrounding Pg&E (NYSE:PCG). But that's only speculation on my part and, indeed, the whole idea of an inter-meeting rate cut is just that: speculation. Having said that, the only way to trade an inter-meeting rate cut is after the fact. But, if the Fed does actually cut rates in the next week or two, traders can capitalize on the event by focusing on the most interest rate sensitive issues in the market, such as retail, cyclical and, of course, financial stocks following the cut.
The financial stocks, as measured by the KBW Bank Sector Index (BKX.X), did find a bid Monday in the wake of the Fed speculation, but we didn't see participation by the bellwethers of the group. Shares of both Citigroup (NYSE:C) and J.P. Morgan Chase (NYSE:JPM) finished higher by only a few cents each. We NEED to see this group advance if the broader market is going to work higher. I believe that continued weakness in the BKX will lead to aggressive selling in the broader market, including tech. The BKX is still working lower in its two month descending trend and now needs to breakout above roughly 860 to break trend. It just doesn't make sense to me that the BKX is in a descending trend following a 150 basis point reduction in interest rates. The weakness in the BKX is disconcerting from where I sit. This chart is similar to the one I put up last week, but the pivot point is moving lower as is the trend.
Along with the BKX, the S&P 500 (SPX.X) continues to work lower in its descending wedge, with a bottom in place at 1100. Last week, I mentioned that the double bottom at 1100 could've been the retest of its relative lows following the spike in the ARMS Index to extreme oversold levels. I can't say unequivocally if 1100 is the intermediate bottom for the SPX, especially with the weakness in the BKX. But, what I can say is that traders should follow the break in the SPX when it occurs, no matter the direction.
If 1100 gives way in the coming week or two, I think it would be most prudent to short stocks or buy puts. Conversely, if the SPX breaks out of its descending trend, I think the most prudent strategy would be to cautiously pursue quality stocks from the long side. And by quality stocks, I'm referring to those companies who are most likely to rally near the beginning of a benign monetary policy such as cylicals and retailers. Examples of two quality companies in terms of earnings and quality stocks in terms of price are Alcoa (NYSE:AA) and Christopher & Banks (NASDAQ:CHBS). The former is a classic cyclical and the latter is a young retailer (CHBS announces earnings on Wednesday). I'm not recommending my readers to go out and buy these stocks. Rather, my aim is to reinforce that if traders are going to approach this market from the long side, I think it's most prudent to find quality companies and stocks in retail and cyclical sectors for both trading and investing purposes.
Away from the technical metrics in the SOX, BKX and SPX that I mentioned above, I'd like to turn my focus to the forthcoming fundamental metrics in the form of earnings. This week kicks off first-quarter earnings season, with a big report due from Motorola Tuesday after the bell. Wednesday, we'll get guidance from Yahoo (NASDAQ:YHOO) and Redback Networks (NASDAQ:RBAK). And Thursday, we'll hear from Dow Jones (NYSE:DJ), Elantec Semiconductor (NASDAQ:ELNT), First Data Corp. (NYSE:FDC) and Rambus (NASDAQ:RMBS), among many others. The market has been awaiting guidance from both the old and new economy companies, and we're going to get that guidance in the coming weeks. What the market wants to hear is that companies, especially in tech, are beginning to gain visibility into their coming quarters. That is, companies are regaining to ability to forecast future sales and earnings. Furthermore, the market wants to hear that the inventory correction, which started in the chip companies, is reaching bottom. This earnings season is likely to be telling and could be a pivotal point. Make sure to tune into Jim's analysis of the companies that report earnings this week.
On a final note, I'd like to revisit last Thursday's big rally across the major market averages. Last Thursday's advance was obviously an initial rally attempt as it came on relatively heavy volume, and surging prices. If, in fact, that rally marked a near-term bottom in the major market averages (such as the SPX at 1100) we need to see a follow- through rally in the coming days. I think the follow-through, if it comes, needs to have price action at least equal to what we witnessed last Thursday. But, in terms of volume, I think the follow-through rally will need to exceed the trading activity we saw last Thursday. And so you know, trading on the NYSE totaled 1.33 billion and on the Nasdaq, 2.27 billion last Thursday. If we get the right catalyst (possibly an earnings report) this week, we could see a follow-through day, but just make sure that volume is exceptional before committing capital to the long side. I don't count Monday's advance in the broader market averages as a follow-through day, per se, as volume was weak, and price action lacked conviction.
Conversely, if the earnings reports this week disappoint, and we get technical failures in the aforementioned technical metrics (SOX, BKX, SOX), I think the path of least resistance still favors the downside for the majority of the market. As much as I dislike that idea, it's my opinion.
On a quick tangent, I'd like to personally thank each and every attendee at this past weekend's seminar here in Denver. I had the pleasure to meet many people from around the world, and received myriad insights into the market, trading, investing and life in general.