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Waiting On The Fed? Or Was It Cisco?

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        11-05-2001        High      Low     Volume Advance/Decline
DJIA     9441.00 +117.50  9476.40  9326.20 1.19 bln   2045/1074	
NASDAQ   1793.60 + 47.90  1801.55  1768.29 1.70 bln   2131/1408
S&P 100   566.68 +  6.69   569.77   559.99   totals   4176/2483
S&P 500  1102.84 + 15.64  1106.72  1087.20           
RUS 2000  437.54 +  4.47   438.24   433.07
DJ TRANS 2284.72 + 38.06  2291.78  2245.49
VIX        32.09 -  0.31    32.94    31.20
Put/Call Ratio      0.42

Waiting On The Fed? Or Was It Cisco?

After the world made it through another weekend without any meaningful developments on the war front (either good or bad), market participants decided to continue the bullish move that began last week. The major indices moved higher at the open and after stagnating in the middle of the day, rallied a bit more in the afternoon session. As has been the pattern recently, Technology stocks led the charge in hope that Cisco Systems (NASDAQ:CSCO) would have glowing things to say in their earnings report due out tonight after the close. We'll get into that subject below, but first let's take a look at the broader market action.

The Industrials staged another triple-digit gain on moderate volume, moving in for another attempt to break out of the recent range. This will make the fourth attempt to break out to the upside, and if the bulls can't pull it off this time, it will be hard to find the necessary catalyst to get the job done. In addition to the pending CSCO news, the markets are fixated on tomorrow's FOMC meeting. The Fed will announce their next move on interest rates at 2:15pm ET, and given the recent slew of abysmal economic reports, many participants are expecting another 50-bp cut to go along with the other 9 cuts already in place this year. Could it be that the 10th time will be the charm? More than a few traders are clearly betting that is the case, as shown by the solid gains posted over the past 3 days.

While volume was only moderate on the NYSE, the internals were decidedly positive, coming in at a 2:1 ratio and bringing the Dow Jones Industrials within range of a breakout over the 9550 resistance level. The solid bullish move is particularly impressive considering that the day started off with another poor economic report. The NAPM Services report came in at 40.6% vs. the 47% consensus, and the markets rallied out of the gate. Banking and Utility stocks led the charge outside of the Technology sector and the outcome of this upward push would seem to hinge on the outcome of the FOMC meeting tomorrow. Traders are hoping for a 50-bp cut as an aggressive antidote for the worsening economic climate. And waiting in the wings is the economic stimulus plan, currently being debated in Congress. Some of the reported issues (capital gains tax cut and repeal of the alternative minimum tax) being debated could have an even stronger positive effect on the business community than anything the Fed can do. It will take time to approve and then find its way into the economy, but anticipation of this package could be adding to the current bullish bias.

Over on the NASDAQ, Networking stocks led the charge higher with a nearly 6% gain in the NWX index. But the rally continued to be broad-based, with Internet (+5.86%), Biotech (+4.55%) and Semiconductor (+2.78%) stocks all posting solid gains. Decent volume and internals drove the Composite right up to the 1800 resistance level, but a mild pullback at the close kept the bulls from posting a close over this formidable level. But there is no denying that the bulls managed a solid victory by closing at a new post-attack high.

Getting back to the biggest factor in Monday's trading, let's take a look at what CSCO had to report tonight. Beating the consensus estimates of 2 cents, the Networking giant managed to deliver double that number, so on the surface it looked like a great report. But more than half the profits reported came from interest and other income. Don't you just love those pro-forma results?

Visibility is still murky (at best) for the current quarter, with things improving slightly as we move into next year. Judging by the nearly $1 gain in the after-hours session, this is what traders were focusing on in the conference call. CNBC characterized the report as the "first solid positive news from the Technology sector". I think Briefing.com does a better job of reporting the news and providing some rational commentary, so I'm going to quote their interpretation of what CSCO had to say tonight.

"Using the company's assumptions, we can put together a Q2 model as follows: revenues up 2.5% (company: flat-low single digits), gross margins of 54% (company: mid-50s), operating expenses down 1% (company: flat to slightly down), other income flat (company: flat), tax rate steady at 28% (company:28%), share count +70 mln (company: +60-80 mln). Using those assumptions, Briefing.com comes up with a Jan qtr EPS estimate of $0.05 vs. the current consensus of $0.03."

What that means in plain English is that the worst is behind for this member of the Networking sector and that expectation (along with hope for similar data from other leading Networkers) is reflected in the recent trading of the NWX index. Leading the NASDAQ higher on Monday, the NWX cleared the $290 level for the first time since the disaster in September and is now closing in on strong resistance at $310.

No matter how you slice it, we're going to need to see continued strength in the leading NASDAQ sectors (Networking, Semiconductors and Biotechs) tomorrow if we are going to clear the 1800 level and HOLD IT. I would expect a positive open in the morning due to the CSCO effect, but then the markets will probably churn sideways until the FOMC speculation becomes news. Then we'll see where investors line up, and that will be our cue to take action. Odds are good that there will be a dip after the announcement, and the strength of that dip will determine whether it is another bullish entry point or a warning that the current rally is over. Keep in mind that this may be the last bullish factor to drive the market upwards for awhile.

My personal trigger levels will be 1735 on the NASDAQ Composite and 9200 on the Industrials. I would consider new bullish entries on any solid bounce from above these levels after the announcement. Either that, or we'll need to see a volume-backed rally through the 1830 level on the NASDAQ and 9600 on the Dow before sharpening our bullish horns. Remember that the markets have had quite a run since the September lows, and without an additional bullish catalyst, we may be due for some post-announcement weakness.

On the other hand, if the rally fizzles near resistance, that could be your signal to shift back over to the bear camp. There is a nice selection of Put plays on the playlist that could provide some attractive entries if the broad markets fail to follow through.

Regardless of your personal bias, make the markets prove their intentions before committing to new positions.

Mark Phillips
Research Analyst

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