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Economy over Earnings

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        07-02-2001        High      Low     Volume Advance/Decline
DJIA    10593.75 + 91.32 10638.87 10467.38 1.11 bln   1600/1471	
NASDAQ   2148.72 - 11.82  2181.05  2140.65 1.51 bln   1555/2234
S&P 100   639.96 +  7.94   642.08   632.02   totals   3155/3705
S&P 500  1236.72 + 12.34  1239.78  1224.03           46.0%/54.0%
RUS 2000  498.39 - 14.25   513.28   498.25
DJ TRANS 2806.50 - 27.06  2836.63  2802.80
VIX        20.29 -  1.34    21.58    20.26
Put/Call Ratio      0.60

Economy over Earnings

Is this a new dynamic? Positive economic news trumps negative corporate earnings news?

About two weeks ago, I wrote about the market's rally off of positive data from the Conference Board, specifically its leading economic indicators. A similar situation developed Monday morning, when the National Association of Purchasing Managers released its index of manufacturing. The index rose to 44.7 during the month of June, from its May reading of 42.1. Estimates had the June reading pegged at 42.9, so market participants were pleasantly surprised this morning with the better-than-expected number. Still, a reading below 50 suggests that manufacturing is in recession - the index has been below 50 for 11 straight months ended June.

Although manufacturing remains in somewhat of a slump, the recent rebound in the NAPM's index suggests that the worst may be over and better times lie ahead. In addition, the Commerce Department reported that consumer spending rose by 0.5 percent during April and May, which like the NAPM number, bested estimates. Fortunately, the dual dose of positive economic data overshadowed another major earnings warning.

Minnesota Mining & Manufacturing (NYSE:MMM) guided second-quarter earnings estimates lower Monday morning, blaming its shortfall on weakness in the U.S. economy, overseas economies and the strength of the U.S. dollar. But, like many other companies that have warned recently, shares of 3M rallied throughout the day Monday, following its gap lower. In fact, the stock staged an $8 rebound from its opening lows and actually finished over $3 higher on the day.

After the bell, further warnings surfaced in both the old and new economy. DuPont (NYSE:DD) issued a warning predicated upon the same issues as 3M had reported: weak domestic and foreign economies and the strong dollar. Although under illiquid conditions, shares were off by about $1 in the after hours session.

The blow-up of the day belongs to Internet Security Systems (NASDAQ:ISSX), who issued a horrific earnings warning judging by the market's reaction in after hours trading. The company reported that it would sustain a loss of 2 cents per share from operations during its current quarter, while previous estimates had called for a profit of 15 cents. Shares of Internet Security shed about $17 in the after hours session, and its warning rippled across to its competitors, including Check Point Software (NASDAQ:CHKP) and Verisign (NASDAQ:VRSN).

Additionally and unfortunately, Rational Software (NASDAQ:RATL) issued a warning, although it was not nearly as negative. The company reported that its earnings would fall to the low-end of estimates and that revenues would fall short by about $10 million. Shares of Rational slipped by about $3 in the after hours session.

The slew of earnings warnings so far this week could keep the resistance in place across the major market averages. For its part, the Nasdaq Composite (COMPX) is having difficulty clearing the 2150 - 2180 range. Recall the head-and-shoulders pattern I had written about in early June, and it's clear why the COMPX is having trouble clearing that range. The neckline of that pattern had served as meaningful support prior to the COMPX's breakdown, and now that neckline becomes resistance.

Should the COMPX decidedly advance above its current resistance range, it could retest its staunch resistance around the 2250 area. Traders can use any advance above the COMPX's intraday high around 2180 to confirm a rally attempt, as that level has served as very short-term resistance last Friday and again Monday. In terms of support, the COMPX has psychological help at the 2100 level, with technical support lower near 2060.

The S&P 500 (SPX.X) is having trouble advancing above the 1240 level as evidenced by Monday's three failed attempts to clear that area. In fact, the S&P has attempted to clear 1240 on four separate occasions over the past three weeks, but each time it has failed. Of course, a breakout above 1240 would certainly be a positive development for the broader market and may help the COMPX clear is resistance.

On the downside, the S&P continues to gyrate around the 1225 level, which was its intraday low Monday and may continue to serve as support over the short-term. Below that level, however, the S&P has meaningful technical support at the 1210 level, which is reinforced by the equally significant 1200 level. We'll want to keep a close watch on the S&P's support levels this week.

Meanwhile, the Dow Jones Industrial Average (INDU) is having problems hurdling resistance around the 10,650 level. Of course above that level lies the 10,700 level. But, the Dow continues to find support around the 10,500 level, where buyers continue to step in.

As we turn to future, short-term price action, I'd like to opine that Monday's light volume pullback in the Nasdaq is not out of the ordinary in light of its substantial run over the last two weeks. In fact, it wouldn't be surprising to see the COMPX fall further this week to consolidate its recent gains, which wouldn't be all that disconcerting, at least from where I sit.

What we don't want to see is the major market averages drift lower and subsequently break below key support levels, such as the S&P 500 and its support at the 1200 - 1210 range. If earnings warnings start to impact the broader market in a negative way, and support levels are taken out, we may witness a retest of relative lows, or even see a further pullback across the broader market averages. But earnings warnings haven't had much of an impact on price action recently, so that variable remains somewhat of a mystery.

While I desperately want to have conviction one way or the other to better position my readers for profits, I must concede that it's difficult to definitively say which way the market is headed over the short-term. That's because several of the indicators I follow are telling conflicting stories. On one hand, the Nasdaq-100 is a few ticks away from a bull confirmed signal on the bullish percent chart. Should it be issued, I think that metric would add credence to the COMPX retesting the 2250 level in the short-term. Furthermore, the economic data recently released is showing signs of improvement, which has in turn discounted the myriad earnings warnings across the broader market.

On the other hand, there are warning signals being flashed. I personally received an inbox full of e-mails this morning concerning the low level of the CBOE Market Volatility Index (VIX.X). For those who don't know, the VIX is a measure of fear among market participants, hence the "fear gauge." Typically, the lower the level of the VIX, the lower the level of fear among market participants. And when viewed contrarily, a low reading in the VIX suggests that market participants have grown complacent and portends a correction in the broader market averages.

The two-year chart of the VIX below depicts that it's approaching historically low levels. And if readers juxtapose a broader market average, say the S&P 500, over each of the VIX's relative lows over the last several years a disturbing pattern develops. (Note the timing of each low.)

I'm not smart enough to know whether or not the complacency displayed by the VIX is forecasting a correction in the broader markets. If history is any guide, however, that may very well be the case. But we must also remember that the VIX can always go lower if the broader markets work higher in the short-term.

I think that the extreme reading of the VIX is a cause for concern, but it shouldn't be the final answer. Instead, I think the prudent approach is to incorporate it into your trading thesis.

Finally, the markets will close early Tuesday, at 1:00 p.m. EST. And I hope all of our readers have a happy and very safe Fourth of July holiday Wednesday.

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Eric Utley
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