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Market Wrap

Another Rate Cut? Does Anyone Care?

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        10-01-2001        High      Low     Volume Advance/Decline
DJIA     8836.80 - 10.80  8850.70  8732.10 1.17 bln   1294/1856	
NASDAQ   1480.46 - 18.34  1491.45  1458.41 1.48 bln   1350/2293
S&P 100   533.40 +  0.30   534.34   526.88   totals   2644/4149
S&P 500  1038.55 -  2.39  1040.94  1026.76           
RUS 2000  397.60 -  7.27   404.87   393.00
DJ TRANS 2142.16 - 52.52  2196.33  2119.77
VIX        34.78 -  0.41    36.55    34.71
Put/Call Ratio      0.62

Another Rate Cut? Does Anyone Care?

With investors holding their breath ahead of Tuesday's FOMC meeting and anticipated rate cut, the important question is not whether they'll cut again or by how much. The real important question is how the cut and its size will be greeted by already shell-shocked investors. Based on the Fed Funds rate, the market is expecting a 50 basis point cut, so if they get it, it could be a non-event. But if the Fed is stingy and doles out a measly quarter-point cut, investors might sell in protest for not getting their anticipated dose of easy money.

So if a small cut isn't going to make investors happy, then what about a 75 or 100 basis point cut? Forget for a moment that a cut that large is unlikely. Investors would likely interpret it as a sign that the Fed is more worried than previously thought and would likely sell in response to such a dramatic move. So let's recap. The Fed is expected to cut by 50 points and that is factored into the market already. The increasing economic sickness demands continued aggressive action from the Fed and their continuing rate-cut inoculations are having progressively less and less impact on the direction of the markets. If the Fed deviates from investor expectations, by cutting more OR less than the expected 50 points, investors are likely to take the news badly and press the sell button. I'd sure hate to be in Alan Greenspan's shoes now. He's been firing his high-caliber weapons (rate cuts and increasing the money supply) for the past 9 months and there isn't even a hint that it has helped either the market or the economy. And he's running out of ammunition for the rate-cut gun, as short-term rates are drilling down to levels not seen for more than a decade.

Those looking for some excitement ahead of the FOMC meeting were sorely disappointed as all the broad indices sold off to their lows in the first 90 minutes of trading and then gradually clawed their way back to post small losses on the day. The DJIA lost less than 11 points, while the NASDAQ Composite shed just over 18 points. Both exchanges saw fairly light volume, with the NYSE coming in at 1.17 billion shares and the NASDAQ ending the day just below 1.5 billion shares. Internals certainly didn't cheer up the bulls with advancers outpacing decliners on the NYSE by a ratio of 13:18 and the NASDAQ was even worse with a ratio of 13:23.

The actual action was pretty dull today, as you can see from the charts of the DJIA and NASDAQ Composite. Both are battling in ever narrowing wedge formations, and we'll just have to wait and see which way things break. The Fed will be the likely catalyst, with more earnings data likely to add weight to the bearish side of the scale.

Die-hard Tech bulls got another dose of pessimism today as Lazard Freres downgraded Cisco Systems (NASDAQ:CSCO) to a rare Sell rating with a price target of $9, citing expectations for a further 30% revenue contraction in 2002. Proof that rational thinking does not come easily to analysts, the same firm upgraded Juniper Networks (NASDAQ:JNPR) from a Hold to a Buy. Reasons cited for the upgrade included 1)growth in IP router spending should resume within the next 12 months; 2)company is still well-positioned to compete with CSCO and 3)believes that the company is trading at an attractive valuation. While JNPR has come down to a PE of 23, I'm not sure I'd consider that a great deal in the current economic climate. Notice the recurring theme? Stocks are labeled as compelling values based on the revenue and earnings growth that is EXPECTED next year because we KNOW that the Tech sector will recover soon. I'd sure like a reliable definition of "soon" from one of these guys, as we've been hearing about the recovery that is just around the corner since the this time last year. I don't know about you, but I don't believe it anymore.

More evidence of the severity of the slowing economy came from the Food-Service sector today, and the wording of the warning is likely a hint of what we can expect from hundreds of other companies in the next couple weeks. The first warning came from Jack in the Box (NYSE:JBX), and "Jack" must have had quite a blame-storming session with the other executives to come up with this one. JBX warned that slower sales after the Sep 11 attacks will reduce 3Q EPS to $0.49 from prior guidance of $0.53-0.57. But the real zinger is the reduction of 2002 estimates from $2.47 to $2.18! While the company goes ahead and cites the usual list of excuses, from increased economic uncertainty, rising utility, minimum wage and occupancy costs, the fast-food chain is putting the fallout of the September 11th terrorist attack at the top of the list. Hmmm, and the restaurant chain is predominantly a western-U.S. operation, and they are telling us that the events on the east coast are responsible for an 8-18% shortfall in earnings for this quarter? This looks like a case of blaming the incident of 3 weeks ago for every evil that exists in the business and hoping that investors buy the deception.

And it isn't likely to end there. I'm expecting every unhealthy business to trot out the saddest face and confess earnings shortfalls in the next couple weeks. And at the head of their list of excuses will be the economic fallout of September 11th. Whatever skeletons were hidden in the closet will be dragged out and labeled as collateral damage of terrorism in hopes that investors will allow them to use the disaster as a "Get out of Jail FREE Card". The bottom line is that this earnings season is likely to be a fiasco, and smart CEOs will lump as much of the bad news into this quarter in hopes that things will look better (at least on a comparative basis) next quarter.

Markets are likely to be fairly quiet again tomorrow ahead of the announced results of the FOMC meeting, due to be released at 2:15pm ET. The prudent approach will be to wait for the volatility immediately following the announcement to die down before initiating any new positions, and then let the market's direction be your guide. Remember that the oversold condition has been largely alleviated, and with earnings warnings continuing to flow at a record pace, my money would be on puts following the Fed's decision.

Even though the VIX is still above 30 (actually 34.78), its daily chart is looking very oversold and due to reverse. I expect the associated market decline to initiate the process of completing a double bottom as we retest the lows of last month. Then we should have a decent base from which we can launch the next sustained bullish move. For eager bulls, I offer this advice -- Patience is a virtue!

Capital preservation is key in these uncertain markets, so trade only when the risk/reward ratio is in your favor.

Mark Phillips
Research Analyst

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