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Merck Knocks -100 Points Off Dow, Another Entry Point?

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       12-11-2001           High     Low    Volume Advance/Decline
DJIA     9888.37 - 33.08 10015.90  9866.85  1.3 bln   1557/1564
NASDAQ   2001.93 +  9.81  2032.63  1995.09  1.9 bln   1948/1703
S&P 100   579.32 -  1.92   587.42   577.93   Totals   3505/3267
S&P 500  1136.76 -  3.17  1150.89  1134.32
RUS 2000  474.77 +  0.59   478.19   473.43
DJ TRANS 3586.59 - 12.51  2602.70  2573.79
VIX        25.69 -  0.31    26.27    24.96
VXN        50.73 -  1.39    52.10    49.49
TRIN        1.35
Put/Call Ratio       .73

For those who wanted another buying opportunity Dow component Merck (NYSE:MRK) provided it with a strategically released earnings warning for 2002. Shortly after the markets rallied on the eleventh Fed rate cut to 10015/2032 Merck warned that earnings would be flat for 2002 due to expiring patents and slowing sales of VIOXX. The Dow dropped instantly even though MRK was halted from trading but when MRK reopened it got ugly. Merck's high for the day before the announcement was 67.55 and it traded as low as $59.81 when trading was restarted. After being up +97 points post Fed the Dow closed down -33 at 9885.

The Merck announcement caught everyone off guard and deflated the optimistic sentiment in the market at the time. Most analysts see this as company specific. The pipeline has dried up for new drugs and their blockbuster drug Prilosec is coming off patent. Vioxx sales are slowing. The company has new drugs coming, just not soon enough for 2002 profits.

Proctor and Gamble fired a return volley after the close by announcing that their earnings would beat analyst's estimates by two to three cents due to better than expected sales and additional external income. Outstanding PG, not that it can help the Dow after the close but it should help to offset the impact on Wednesday.

Other market news included CMVT which announced earnings inline with estimates after the close but said they were feeling the pressure from the hard business climate and would cut 900 jobs or 15% of its workforce. CMVT lost about a dollar in after hours.

XLNX rose after saying sales would come in at the low end of the prior estimates. The affirmation of only a -5% drop in sales held up the semiconductor sector most of the day and helped the Nasdaq remain positive after the Merck news tanked the indexes.

IBM set the tone for the tech market as it traded up to $122.74 and a new 52-week high. The blue chip tech (and current play) just refuses to stay down and should be an indication of investor expectations. Buying Cisco at $20 does not require as much faith or commitment as IBM at $120. Obviously this is also a good place for funds to park money with little risk and still appear to be invested in the market.

Nokia also made news today saying they were gaining market share worldwide. When the current economic downturn began cell phones were one of the first items hit. After the WTC attack sales soared and inventory shrank. This reduced the price war impact and provided a consumer driven inventory direction. Nokia which makes one third of all the phones in the world said they would gain significant market share this quarter as consumers upgraded to faster phones with more features. Nokia said they expected earnings to be at or above the high end of expectations this quarter. While most cell phone sales are upgrades the market still has plenty of depth in non-phone users. Only 45% of U.S. residents have phones and in some other countries cell phones are more prevalent than land lines. It is easier to add cell towers than phone lines. The positive comments from Nokia also helped the chip stocks which supply components.

EBAY was also a major factor in keeping the Nasdaq positive. W.R. Hambrecht analyst, Derek Brown, issued a research report on Tuesday saying the company was performing well despite the poor economic environment. They reiterated a strong buy on the stock and said the company was on track to beat his 4Q estimates of twelve cents per share. EBAY had fallen from a 52-week high of $72.74 set just last week but the stock rallied +3.10 today and to close at $70.10. I do not know what valuation model the analyst uses but he said EBAY is trading at a 20% discount to a broad group of "technology bellwethers." He said there was no justification for this valuation discrepancy. How about a PE well over 200 Derek?

The economic news was bleak again with the Richmond Fed Manufacturing Survey showing a drop in manufacturing yet again. The biggest drop came in the new orders index which fell -17 points to a -16. This report is from the Fifth Fed District which is possibly the worst area with North Carolina responsible for half of all jobs lost.

The biggest news of the day was of course the 11th rate cut by the Fed to 1.75%. This is a forty-year low. The Fed said economic conditions still were weighted toward softness. They saw the weakness in demand abating somewhat but called it "preliminary and tentative." With their language they left the door open for yet another cut in January. They really don't have many bullets left in their gun at this point. With rates at a 40yr low of 1.75% we are already at the "who cares" point. The difference between 6.5% and 1.75% is huge but another quarter point or two will not make that much long term difference. They said inflation was still low and likely to move lower and they remained ready to act as needed.

So what now? The Nasdaq closed slightly above 2000 again and the Dow could have closed over 10000 had it not been for Merck. Is this another buying opportunity or a new down trend evidenced by the lowest close since December 5th? Let's see. The Dow has support at 9800 which is only 85 points away. The Nasdaq closed above yesterday's low but still has a huge gap up from the 5th which is totally unsupported. That support is around 1950 and rising. On the surface it would appear that the downside risk is minimal. However we are, as shown by Merck today, in the twilight zone of December earnings warnings. Also, tax selling has not really caused much trouble but could with any more major warnings.

One of the wild cards we are facing is the huge amount of debt and new IPOs coming to market in December. Literally billions of dollars of new supply which must be absorbed. Liquidity is there to fill the need, IF owners wanted to use it. There is an estimated $4.5 trillion in cash on the sidelines and the excess cash drain over the next two weeks could easily go unnoticed if those owners wanted it. There is the drag. If stock bargains have failed to pull that cash off the sidelines over the last three weeks then why would new unproven issues be more attractive?

Don't get me wrong. I am still B-U-L-L-I-S-H. (sometimes I have to spell it out for people) Bonds yields are so low that any possibility of a gain in stocks is better than the sure yield in bonds. We are just not entirely out of the woods yet. I would buy this dip. I think we should see another run at breaking out to new highs again before Christmas. Almost everyone is still projecting a recovery soon although the second half of 2002 is quoted more and more frequently. That is fine for investors, just as long as it is coming. The administration is applying pressure for another stimulus package and that should also give the markets another boost.

My bullishness wanes when the Dow reaches 10150. Strong resistance begins there and continues for several hundred points. 2100 on the Nasdaq begins strong resistance as well. The S&P faces the same problem between 1173-1250. Despite the bullishness in the markets and an expected Santa Claus rally there will need to be strong conviction to power the markets over those hurdles. We have not seen ANY of that conviction yet. As traders we need to be ready to move to the sidelines if the markets exhibit any weakness when those levels are reached. I have repeatedly said "buy the dips" since November 1st. I still suggest that tactic (actually buy the rebounds) and think that this tactic will continue working as investors fight through this overhead resistance. I think we will see a "MRK" rebound in the markets at Wednesday's open. Not MRK itself but stocks that sold off on the MRK scare. Look for direction after that bounce and trade accordingly. My levels to go flat are 9800/1950/1125. Above those, "buy the dips."

Enter very passively, exit aggressively!

Jim Brown
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