Option Investor
Market Wrap

Close But No Cigar!

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       WE 11-30         WE 11-23         WE 11-16         WE 11-11
DOW     9851.56 -108.15  9959.71 + 92.72  9866.99 +258.99  +284.46
Nasdaq  1930.58 + 27.39  1903.19 +  4.61  1898.58 + 70.10  + 82.75
S&P-100  584.80 -  8.47   593.27 +  5.20   588.07 + 10.08  + 18.00
S&P-500 1139.45 - 10.89  1150.34 + 11.69  1138.65 + 18.34  + 33.11
W5000  10531.45 - 64.95 10596.40 +109.73 10486.67 +189.46  +280.40
RUT      460.78 +  2.36   458.42 +  7.11   451.31 + 13.21  +  5.03
TRAN    2511.78 - 23.12  2534.90 + 37.53  2497.37 +176.68  + 74.03
VIX       26.14 +  1.36    24.78 -  2.39    27.17 -  1.59  -  3.64
VXN       48.45 -  2.36    50.81 -  4.23    55.04 -  3.55  -  2.60
TRIN       1.19             0.70             0.99             0.90
TICK       +852             +976             +750             +784
Put/Call    .63              .61              .50              .74

I think I can, I think I can, well maybe not. The Dow struggled back from another visit to 9800 at the open and tried valiantly to reach the high ground again but was unsuccessful. The Nasdaq traded on both sides of negative as well but even positive comments from Greenspan could not keep it in the green. For the week the Dow lost -108 points and the Nasdaq gained +27 but the Friday numbers showed just how troubled the markets are becoming.

The Dow posted the best November since 1962 with a +8%, +775 point gain. The Nasdaq posted the best November ever and the sixth best month overall with a +14%, +240 point gain. While this may be a good running start into historically the best month of the year, the battle still lies ahead. In order to close the year where we started 2001 the Dow will have to gain +900 points and the Nasdaq +540 points in December. Now that would be a record December that we could all celebrate! Any bettors out there that feel this will happen?

The CSFB tech conference last week gave us plenty of positive news and the Nasdaq ended the week flat. Dell, Cisco, Intel, Palm, Brocade, Siebel, Xilinx and several others affirmed earnings guidance and stocks still had trouble moving ahead. Next week we get more in-depth guidance from tech big caps INTC, SUNW, CSCO and ORCL but a warning from Novellus on Thursday may have poisoned the air.

Granted the majority of the weakness we saw last week was due to the Enron destruction but any confirmation of a longer recovery period than previously expected could be equally disastrous. On Friday the 3Q GDP was restated at -1.1% from a previously estimated -0.4% and investors were not happy. Everyone expected the number to be revised downward but consumer consumption was cut by more than half to only a +1.1% rate. The only positive aspect was a big decrease in business inventories by -$60 billion which would give hope to a bottom soon. When the recovery begins the steeper the prior inventory drop the steeper the rebound according to economists. If anything this report again cements another Fed rate cut on Dec. 11th and possibly again in January. The GDP number was the worst in a decade.

Adding to the gloom was the Chicago PMI which fell in Nov to 41.1 from 46.2 in October. Any number under 50 represents a contraction in manufacturing. After two months of rebound to the 46 level the drop back to the lowest level since July's 38 brought doubts about the bottom being behind us. The employment index lost five points to 37.2% in November indicating that jobs are continuing to be lost. This is the 15th consecutive month of declines in the PMI and the drop after two months at higher levels did not help stock prices. There were 1,816 mass layoffs (more than 50 employees) in October with more than 200,000 workers fired.

Prior to the Intel conference next week Dan Niles raised earnings estimates and many analysts speculated aloud that they expected Intel to do the same. That would be a real shock. Intel is one of the companies that manages earnings about as well as IBM. If they did have a windfall profit they would shift some of that profit into the next quarter or book a write down somewhere else to avoid a premature bullish announcement. With all this said you could also believe that if Intel did raise guidance then things are going very well and they could not hide it all. We need to hope that they raise guidance or at least perform better than analysts expect in order for the tech rally to continue. After the Fall bounce the tech big caps are trading at very high PE multiples compared with 2001 earnings. For instance, Intel's PE is 61, Cisco 146 and SunMicro 476. Sound like Internet stocks again? The reason for the high PE is not a huge rebound in stock prices but a crushing drop in earnings over the last year. The recent thought process was a recovery from a September bottom into 2Q of 2002. That recovery would spike earnings back up into more recent 2000 levels and drive the PE ratios back down. If those earnings do not return soon then PE compression and a drop in stock prices is inevitable.

The 4Q earnings warnings period begins in earnest next week but there is some good news in that event. The ratio of negative to positive warnings so far in the fourth quarter has been better than anytime earlier this year. There has been a flurry of affirmed estimates and even some raised guidance. Actual warnings have been fewer but then next week will tell the tale. AVCI beat the rush after the close on Friday saying they would cut another -12% of their workforce and cut costs further in light of current conditions. They said they expected the Internet router market to remain flat through the first HALF of 2002. When companies have been warning this is the predominant excuse, "No recovery THROUGH the second half of 2002." Hopefully the analyst conferences for the big four (ORCL, INTC, CSCO, SUNW) will overshadow any negative news we receive from earnings. Of course, negative news at any of those meetings could be very bad for the market.

From a technical standpoint it would appear we are in trouble. Historically December is normally the best month of the year for the markets followed by January as second best. However we are not normally coming out of a +25% Dow gain off the September lows or a +39% gain for the Nasdaq. Those gains will be tempered by tax selling as the residue of the great Tech Wreck is flushed by disappointed investors. The bottom line, December should be very interesting. Dow 10,000 may happen but 10,200, 10,300, 10,500 may be very tough to hit. The same with the Nasdaq. We have stalled at resistance just below the 200DMA at 1954. Should we break through this level the next 300 points will be very hard to conquer. There is very strong resistance from 2000 to 2300. There may not be any sustained drive but a daily battle for each point.

The Fed is not going to be a factor even if they cut rates again in January. Greenspan said on Friday that productivity should rise unscathed in the fourth quarter. That provided a small bounce but it evaporated at the close. There was some strong market on close orders across multiple sectors but it was attributed to a rebalancing of the Morgan Stanley Indexes. That rebalancing does not explain a three day drop in GE which closed at the low of the day on Friday. Banks, a critical component to any sustained rally, are flat to down. The big banks are under pressure due to concerns about Enron loans or loans to others who may suffer from an Enron bankruptcy. Were it not for Home Depot posting a +2.63 gain the Dow could have closed in negative territory. While it sounds like I am painting a very negative picture there are some bright spots. Intel is $.34 away from breaking a nine month high and is looking very strong. All that could of course change with their analyst meeting next week. Dell is just a few cents away from hitting highs not seen since July and April. Cisco is right at its high from the summer. Again, conference this week. SUNW is at a three month high. Conference this week! The other big caps MSFT, WCOM, QCOM and ORCL are not look healthy. The leaders can extend their lead with positive comments or shoot themselves and the market in the foot with cautionary statements.

I would be very cautious about opening any new long call positions this week. We need to remain objective and unbiased, (despite what I said above), and only trade when it is profitable to trade. I would use 9800/1900/1125 as my triggers to go flat. (Note that I have modified those slightly from Thursday's 9800/1925/1150.) Should any of these indexes fall below those levels I would move to the sidelines until they trade above them again. This makes the "should I" or "shouldn't I" trade decision painless. Open new positions on any rebound from BELOW those numbers. If you are currently flat and the market moves up from here I would not open new positions until we pass 10000/1955/1165. Why open positions below those numbers if each has produced a solid top over the last several weeks? If the market is going to rally there will be plenty of time for profits. If it is going to fail again then you don't want to be long. Right? Trade what the market gives you or don't trade at all!

Enter very passively, Exit aggressively!

Jim Brown
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