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Mid-East Violence Prompts Profit Taking

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        12-03-2001        High      Low     Volume Advance/Decline
DJIA     9764.00 - 87.60  9848.90  9703.90 1.20 bln   1272/1870	
NASDAQ   1904.90 - 25.60  1925.35  1898.98 1.48 bln   1324/2282
S&P 100   578.66 -  6.14   584.80   576.77   totals   2596/4152
S&P 500  1129.90 -  9.55  1139.45  1125.78           
RUS 2000  457.03 -  3.75   460.79   455.51
DJ TRANS 2483.06 - 28.72  2512.68  2471.24
VIX        26.00 -  0.14    27.04    25.82
Put/Call Ratio      0.62

Mid-East Violence Prompts Profit Taking

On the heels of another suicide-bombing attack in Israel over the weekend, Israel retaliated by launching rockets at Yasser Arafat's headquarters in the Gaza Strip and on the West Bank city of Jenin. Laying the blame at Arafat's doorstep, Israeli Prime Minister Ariel Sharon likened his country's reprisal to the United States' efforts to root out terrorism wherever it exists.

Fears that the ongoing Middle East conflict could spiral out of control sent the broad markets spiraling lower at the opening bell, a decline from which they never recovered. Despite several attempts throughout the day, there was no conviction in the bullish camp, keeping the DJIA below the 9800 level all day, while the NASDAQ Composite meandered in a tight range between 1900-1925.

This was in spite of potentially positive economic data out this morning in the form of Consumer Spending. Exceeding the consensus expectations of +2.3%, the actual report showed continued strong spending completely offset the September decline with at rise of +2.9%. Given the previously released strong Retail Sales report, the sharp rise in Consumer Spending was likely already factored into the market, making the Middle East violence the dominant factor as the markets opened. Half an hour after the open, the NAPM numbers came out (44.5% vs. 42% expected), but the potential bullish effect of that report was shrugged off as light trade saw a modest downward move by the end of the day.

By the closing bell, the DJIA had trimmed its losses to a little over 87 points, while the NASDAQ Comp. ended the session with a 25 point loss. Volume was moderate on the Big Board and downright anemic over at the NASDAQ, with decliners solidly trouncing advancers throughout the day on both exchanges. While it would be natural to blame the weakness on the Mid-East situation, I tend to think that isn't the case, given the light trade.

Let's face it, there were some more significant developments in the business world, and that is before we even consider the approach of earnings warning season. Starting in the Automotive sector, the news just keeps getting worse over at Ford (NYSE:F). Despite strong sales due to the zero-percent financing promotion, the car maker announced cutbacks in retirement and health benefits for 45,000 white-collar workers along with plans to lay off an additional 630 workers. The CEO said these cuts probably won't be the last as the firm seeks to return to financial health.

The meltdown of Enron (NYSE:ENE) continued with the firm formally filing bankruptcy and suing former merger partner Dynegy (NYSE:DYN) in the amount of $10 billion for terminating the proposed buyout/merger that was widely viewed as ENE's last chance to avoid bankruptcy. DYN responded with its own counter-suit, showing that the demise of once mighty ENE will not be a simple matter. But the markets have largely discounted this process, and it is likely not going to have a significant effect going forward until investors can see what the collateral damage is to other market participants, most notably in the Financial sector.

Widely viewed as a leading indicator for the broad Technology market, the Semiconductor sector had several notable news items on Monday, starting with the Semiconductor Industry Association's (SIA) data showing that the 38% year-over-year decline in orders was worse than the September decline of 29%. While still better than the low in August, these data suggest that there will not be a V-shaped recovery in Semiconductors.

Lehman analyst Dan Niles, commenting on this data suggested that buying stocks at the bottom for year/year declines in orders might not work this time like it did in 1986 and 1991. Seemingly in contrast to this view, Niles raised his price target on shares of Compaq Computer (NYSE:CPQ), due to the firm having a strong October and November. He cited that the consumer market has bounced back since the September terrorist attacks and that corporate customers have stuck with the firm despite the uncertainty of the pending merger with Hewlett-Packard (NYSE:HWP), which he still gives a 75 percent chance of success.

Weighing in ahead of the chip giant's mid-quarter update on Thursday, Jonathan Joseph of Salomon Smith Barney made bullish comments on Intel (NASDAQ:INTC) Monday. Citing market acceptance of the new P4 chip, and anticipated recovery in the microprocessor market. Mr. Joseph expects INTC to be at the high end or exceed their $6.2-6.8 billion revenue target for the current quarter. INTC ended the session down 62 cents at $32.04.

In the Biotechnology arena, MedImmune (NASDAQ:MEDI) agreed to acquire Aviron (NASDAQ:AVIR), the maker of a promising nasal-spray flu vaccine. The $1.5 stock deal values AVIR at a 13% premium to Friday's closing price of $37. Shares of MEDI dropped nearly 12% to $38.83, while AVIR rose to $41.42.

One other interesting development while we're talking about individual equities is the recent price action in shares of General Electric (NYSE:GE). Largely regarded as a proxy for the broad market due to its participation in virtually every sector of the market, the stock has been trading particularly poorly over the past week. After the breakout over $40, GE began weakening considerably last week and has lost more than 10% in just the past 4 days. That brings the stock very close to major support near $36, and should it break down below that level, it could be a leading indication of pending broad-market weakness. GE will be updating their outlook at their mid-quarter update on December 17th.

Speaking of the broad market, I think it is worthwhile to re-examine some of the sectors that have been leading the recent rally to try to divine where the broader market may be headed from here. We have looked at each of these in recent weeks, so I'll keep my comments brief. I think you'll see the emerging theme, with very little comment necessary. Each of these sectors, Biotechnology (BTK.X), Internets (INX.X), Networking (NWX.X), Semiconductors (SOX.X) and Software (GSO.X) have been tracing a solid and reliable uptrend over the past 2 months. That picture has been changing somewhat over the past few sessions, as can be seen most clearly in the daily charts below.

GSO and NWX indices:

SOX and BTK indices:

The one remaining sector of technology that has not yet violated its ascending trendline is the Internet sector, but we are seeing signs of weakness here too.

After falling back from the double-top near $145, also the site of the 38% retracement from the May highs (not shown). This could just be a healthy pullback (ideally to the $120 support level), before the sector continues to recover, but judging by the 4 other Technology sectors shown above, bullish traders need to proceed with caution here. All of the above sectors, as well as the broad market indices have seen strong advances off their September lows, largely on hopes that the worst of the economic weakness is in the past. Whether that is the case remains to be seen, but with earnings warning season looming large in the viewscreen, prudence demands that the bulls exercise caution.

The DJIA spent all day today below the bullish trigger level (9800) that Jim listed over the weekend, while the NASDAQ and S&P500 spent the session above their respective triggers, 1900 and 1125. Continue to use those levels as your first-level filter for staying long. Then use the behavior of the sector index related to your trade, to determine whether the risk is weighted to heavily to the downside. If everything is lining up against your bullish bias, it just might be time to switch to puts. Afterall, that approach has worked for every rally we have seen for the past year, and that is a formidable pattern to bet against.

Preserve your capital by keeping a market-neutral bias. Remember, the market is neither good, nor bad. It just is.

Mark Phillips
Research Analyst

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