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Market Wrap

Outlook Too Bearish?

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        9-18-2001          High      Low     Volume Advance/Decline
DJIA     8897.24 - 17.30  9022.06  8861.05 1.67 bln   1228/1926	
NASDAQ   1554.50 - 24.47  1605.06  1548.85 1.83 bln   1440/2300
S&P 100   526.24 -  2.30   533.74   524.25   Totals   2668/4226
S&P 500  1031.95 -  6.03  1046.42  1029.25             
RUS 2000  411.03 -  6.01   419.25   410.18
DJ TRANS 2217.26 - 54.61  2296.21  2212.88
VIX        42.50 -  2.44    46.67    41.70 
VXN        74.74 +  1.48    75.32    72.28
TRIN        1.10 
Put/Call Ratio      1.13

Several readers thought I was too bearish on Monday night. I wonder if they still feel that way? The expected rebound/relief rally appeared right on schedule on Tuesday but the bounce only provided a new entry point for sellers as worries about the new world economy started hitting home. There was even a flurry of upside warnings, companies affirming their guidance, but there were simply no buyers.

There were persistent rumors that mutual funds were being forced to sell to meet redemption's after the big drop on Monday. That along with all the negative news convinced a new wave of investors to look for safety elsewhere. We will not get the fund flows from TrimTabs.com until Thursday but odds are good there will be a net outflow. This would be ironic since now is the time real investors should be scrounging up every dollar they can find to put into investments for the long term.

Hedge funds were also rumored to be jumping on the short bandwagon with brokers, airlines, hotels and semiconductor stocks being the targets. Several analysts said that we could see some airlines file for bankruptcy as early as next week. UAL and AMR remained positive as the likely winners in any industry shakeup but CAL continued to dive with another -2.33 loss. It is a shame the options on the airline index, XAL, were not more heavily traded because the sector is severely oversold and any government bailout is sure to provide a huge bounce. I checked out the options and the November 80 call, nine dollars out of the money, was quoted at $6.50x$9.50, a whopping $3 spread between bid and ask. To put this option in perspective the index was near $120 only a couple days ago and is now $71.66. I doubt any government solution would recover that drop because air travelers have simply cancelled their trips. The industry is losing -$350 million per day according to their estimates and the government has said that their help will not pay for past sins, only direct results of the disaster.

The new wave of business surveys is starting to show that business across America came to an abrupt halt last week. Not just in New York but all across America. The business community is just now starting to show a pulse. This is critical. The third quarter is the most critical for end of quarter weighting. Business is sold in the last three weeks for delivery before year end. Take out a complete week or more from this cycle and put a big cloud of uncertainty over the rest of the month and you have a recipe for ugly earnings.

Have you noticed that there were almost ZERO earnings warnings last week? There has only been a trickle this week. We all know that there was going to be hundreds due to the slowing U.S. and global economy that was inching towards recession. Nothing happened to stop that and one can only guess that corporations did not want to further depress the market last week and were hoping for a patriotic bounce this week. No bounce, now what? I can only speculate that there are dozens if not hundreds of companies that are faced with a shrinking time horizon for making a warning call for the third quarter. I would also suspect that any warning could be severe since they are likely to use the attack as an excuse to clean up their books as well as lower expectations going forward. If you are going to get beaten severely then at least make it worthwhile, right?

Based on the prior scenario, guidance, that was already weak at best, is likely to slow even more. SunMicro said they felt that the increased purchases spurred by the disaster could boost the tech sector. Many analysts disagreed. The expected boost from the Windows-XP launch is now in doubt. Consumers may not be buying computers until things are clearer and jobs are secure.

The disaster had other unexpected results as well. The "just in time" parts delivery standard that many companies have adopted, failed. The week long shutdown of airlines, longer and more difficult security checks and stringent import reviews have left many companies without inventory. Auto makers took it on the chin as NAFTA deliveries came to a complete stop for several days. Ford closed several plants for lack of supplies and S&P has placed the big three auto makers on credit watch. The double whammy of slowed production and nonexistent sales has and will cost them millions. Dell, the champion of just in time delivery of parts from overseas manufacturers has not made any negative comments but the week is still young. Electronics manufacturers not only had the WTC disaster to deal with but Typhoon Nari completely shut down traffic to and from Taiwan. Analysts in Taiwan estimated that at least 20% of the sales for the month were lost in a critical month.

Consumer confidence is dropping like a rock. Retail sales for last week dropped -3.5% even as consumers were cleaning out store shelves of batteries, water, can goods, gas cans and blankets. The constant repetition of how long and difficult the "war" may be has locked wallets on the home front. The peace dividend we have been enjoying over the last ten years has ceased. The check is not only not in the mail, the last one may bounce! Consumers have no interest in air travel at any price. Online travel firms say business has dropped to only 30% to 40% of normal. Tales of tragedy on the ill fated airliners are hitting the TV news shows and each feature makes more people take the "no fly" pledge. Even visitors to Las Vegas, which many people would classify as "risk takers", have fallen dramatically. 45,000 visitors cancelled reservations for the last two weeks and the convention bureau estimated $55 million in revenue was lost already. Streets were deserted and casino analysts said drops in bookings would cause a -20% to -50% drop in earnings for stocks like PPE and MGM. Park Place Entertainment said it will postpone construction of a new $475 million hotel in Vegas due to the drop in bookings from last weeks attacks and may cut workers also.

The only bright side for the consumer is the outlook for gas prices. With refineries expecting a -30% to -35% drop in the demand for jet fuel they have already started switching to more gasoline, heating oil and other distillates. The constant tanker convoy from the middle east has to be offloaded regardless of what the need is on this side of the pond. Until the prior orders for crude can be worked off the oil companies have to convert it to something they can sell. This means that consumer supplies of gasoline are going to rocket higher and to burn off these supplies they will lower prices drastically. This puts the oil companies on a slippery slope and stock prices are starting to show the results. Phillips, Chevron, BP, and Shell were all lower.

Bulls are being slaughtered daily. Salomon Smith Barney strategist Tobias Levkovich lowered his forecast for the S&P for the end of year to 1200 from 1400. He also lowered his 2002 estimates to 1350 from 1500. Can Abbey Cohen be next? Even Joe Battapaglia was far from bullish when interviewed on Monday. Is hell freezing over yet?

The volume on Tuesday was much lower than Monday with the NYSE only posting 1.6 bln and 1.8 bln on the Nasdaq. Repeatedly commentators remarked that both Monday and Tuesday were very orderly. That the selling was very "orderly and reserved" was a constant refrain. This is bad news. Even with the big drop on Monday, there was no capitulation! The relief rally today was met with more sellers including short sellers. The consensus is still down and while the Dow closed slightly off the lows of the day it was due to a little short covering in the last 10 min. The Nasdaq closed only six points off the lows and the semiconductor sector led the drop. Demand estimates are falling and investors are fleeing the sector. Market internals are simply still negative and without a successful patriotic rally the outlook grew worse.

The VXN, or Nasdaq volatility index, rose to 74.74 while the VIX fell to -2.44 to 42.50. The Dow has lost over -700 points this week and it is only Tuesday. I could go on but you get the idea. While everyone wants to see a rally, it requires a lot of people spending real cash and as yet we have not seen it. Retail investors are fighting margin calls and selling winners to raise cash. Some brokers are selling stocks to raise cash as well. Not a recipe for a rally. There is still plenty of institutional cash on the sidelines but they are not spending it.

It may be heresy but the market may actually be supported by the new buyback rules which expire on Friday. Volume in Cisco was over 80 million shares and the artificial bottom we had been seeing collapsed at 2:PM with almost 30 million shares traded between 2 and 4. That is almost $500 million in CSCO stock in two hours of trading. 194 million shares of CSCO have traded this week which amounts to almost $3 billion. The entire buyback for CSCO was $3 billion and while nobody expects that they spent it all, they could have spent all they could afford for this week. Multiply this by the more than 75 companies that announced buybacks and you can see the problem. The rest of this week could be very exciting or frustrating depending on which side of the market you are on. Trade what you see and not what you believe. Belief is for long term investing where you are buying the promise of larger earnings and prosperous outlooks years down the road. For investors this is a great buying opportunity. Otherwise, trade the trend or don't trade at all!

Definitely, enter passively, exit aggressively!

Jim Brown

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