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Market Wrap

Is This Deja vu or Vuja De?

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        08-20-2001        High      Low     Volume Advance/Decline
DJIA    10320.07 + 79.29 10320.07 10210.48  890 mln   1768/1336	
NASDAQ   1881.30 + 14.30  1881.62  1854.96 1.15 bln   1881/1809
S&P 100   599.00 +  5.13   599.00   593.00   totals   3674/3094
S&P 500  1171.41 +  9.44  1171.41  1160.94           
RUS 2000  478.87 +  3.22   478.88   473.74
DJ TRANS 2840.42 + 15.77  2840.72  2818.37
VIX        25.14 -  1.60    27.78    24.99
Put/Call Ratio      0.45

Is This Deja vu or Vuja De?

As expected, the broad markets saw rather light volume on Monday, with traders hesitant to place their bets ahead of tomorrow's FOMC meeting. With economic weakness continuing to intensify everywhere, Uncle Alan Greenspan looks likely to continue the recent pattern of cutting short term rates. But it looks like the old boy is being relegated to a position of impotence, at least where the markets are concerned.

Ahead of the Fed report, all the major indices managed decent gains on light volume, but it sure wasn't anything to get excited about. The DJIA pulled ahead by 79 points, regaining the 10,300 level, but 10,400 is looming overhead, a mere 80 points away. The S&P500 managed to regain the 1165 level, closing at 1171 and change, but the NASDAQ Composite is just snoozing along between the 1865 support level and formidable resistance at the 1950 level.

Consensus is calling for the Fed to drop rates by 25 basis points tomorrow, but after a total of 275 basis points since the first of the year and no real signs of economic recovery, how much of a difference is the marginal 25 points really going to have? And in my opinion, 25 points is the BEST thing he can do. He has to cut or investors are likely to revolt over not getting their expected candy, but cutting by 50 basis points again would put the Fed in a more aggressive stance again. Investors could very well view this as Greenspan seeing a new monster under the bed, and run for the exits. 25 points, 50 points or no cut. Those are the choices for investors to contemplate prior to the Fed's announcement at 2:15pm ET tomorrow.

Of course rampant bullishness is still a highly contagious disease, as evidenced by the parade of talking heads on CNBC. Even though all the indices were in the green today, I actually heard one of the guys on the NYSE trading floor say that no matter what Greenspan does, it will provide a catalyst for a sustained bullish move, due to the overwhelming negative sentiment in the market. I actually heard, "the only bad thing that could happen is if he were to raise rates". Excuse me?? If sentiment is so negative, then why is the VIX lurking around at a mere 25-27? Seems to me that it was rocketing north of 40 back in late March and early April. And if not for the intervention of the Fed back then to provide an inter-meeting rate cut and stem the bleeding, I see no reason why the Fear Index couldn't have topped the 50-55 range as it did back in late 1998.

Whether the VIX will revisit those peak levels is not really what I'm concerned with. It's the basic trend that is making me nervous. Over the past 3 weeks, the broad market indices have continued to deteriorate, falling to or even through significant support levels, while the VIX is refusing to head higher. Sure it is off of its lows near 22 early in August, but look at the VIX action today. After starting just below 28, the VIX fell to just above 25! And that was on a low volume, weak rally. A look at the chart below really highlights my concerns for the market as a whole.

If the broad markets are threatening to test the spring lows and investors are not showing their fear, what will happen with the next event that drives up their fear (Mid-East tensions, Argentina, worsening earnings picture, declining consumer spending, weakness in housing, etc.)? It seems like that could give us a pretty ugly drop in the markets in short order.

Providing further proof that the NASDAQ has been relegated to almost-irrelevant status, First Union Securities came out today stating that the tech index is once again overvalued, based on the current rate of earnings deterioration. Accordingly, the firm lowered their "Fair Value" for the NASDAQ from 1850 to 1550. Just for the record, that's where the Composite was finding support in 1997-1998. We may grouse that the DJIA has been rangebound for the past 2 years, but at least it isn't trading back in the 7500-8500 level (its 1997-1998 trading range). Until capital spending comes out of its suspended animation, it's going to be hard to make money in Techs. Just my opinion...take it for what it's worth.

Is it any wonder I look at the NASDAQ as a secondary market right now? On its most recent "rally", bulls couldn't even push it through the 2300 level. Another way of putting it is that NASDAQ bulls couldn't trade their way out of a wet paper bag! Although I haven't shown it, I did put a very long-term weekly chart of the NASDAQ composite up and drew a trendline through all the lows since late 1995 through the March 2001 lows. If that trend is going to hold, then the COMPX should find support in the vicinity of 1775. My concern with this trendline is the fact that all the prior lows occurred in the midst of a record bull market. We're now in a protracted bear market (in my never-to-be humble opinion) and I question whether there is any fundamental reason for the long-term bullish trend to prevail. Make no mistake...I'm hoping it does, but preparing for the possibility that it doesn't.

If the Fed doesn't matter (as I happen to believe, right now) then what does? That's right, it's still the economy and more importantly to us, earnings. Sad to say, there just isn't any great news to point to on that front and General Motors (NYSE:GM) vaulted to the head of that watch list this morning. On the heels of Ford's layoff announcement last week, Goldman Sachs cut their outlook for GM for 2001 and 2002 and the stock fell to $56 today on very heavy volume, negating all the gains the stock accrued since mid-May. Does the recent weakness in the Auto sector indicate that the almighty U.S. consumer is reeling in their wallets? If so, does that mean the capital spending recession is preparing to drag the rest of the economy into a full-blown recession.

This all brings me to the title of the Wrap tonight. It seems like we've been here before doesn't it? The markets are struggling under concerns about earnings continuing to weaken. All the major indices are resting above tenuous support levels that if broken, will open the door for a retest of the April lows. On one hand we have Alan Greenspan promising to "act aggressively" when necessary, while on the other hand we have corporate profits continue to atrophy, leading us closer and closer to the official definition of a recession.

But what if the markets are about to begin another downward leg? Then the situation we find ourselves is more akin to what comedian Robin Williams calls Vuja De, "The strange, unexplainable feeling that somehow none of this has happened before". Sure, similar market conditions have probably occurred in past market downturns. But for those of us that entered the investing world in the past decade, we truly are in unexplored territory. When venturing into unknown and possibly hostile territory, caution is the watchword.

Every pundit that can fog a mirror is busy telling us how the economy is going to rebound in the second half (ok, they've moved it to the first half of 2002, but the mantra is the same) and that investors should be buying stocks now. Does everything really look the darkest before the dawn? Yes, it probably does, but just because it is dark doesn't necessarily mean that the sun is about to rise. I wouldn't be a big fan of chasing these markets up with calls. until the DJIA clears 10,600 again and the NASDAQ clears 2100 ON STRONG VOLUME, the profitable trades are in Put plays. Just ask someone who has been trading the downside. I'll bet they will tell you they're making money. The time to trade calls and bet on the bulls will come again...hopefully soon. But that time is not now. Either take advantage of the opportunities to the downside (shorting the rallies) or sit on your hands. In the long run, your trading account will thank you.

Remember to trade only when the reward/risk ratio is in your favor.

Mark Phillips
Research Analyst

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