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Market Wrap

Confidence Crisis?

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        WE 1-18          WE 1-11           WE 1-4         WE 12-28 
DOW     9771.85 -215.68  9987.53 -272.21 10259.74 +122.75  +101.65
Nasdaq  1930.34 - 92.12  2022.46 - 36.92  2059.38 + 72.12  + 41.92
S&P-100  575.24 -  8.96   584.20 - 14.41   598.61 +  6.86  +  5.34
S&P-500 1127.58 - 18.02  1145.60 - 26.91  1172.51 + 11.49  + 16.13
W5000  10509.36 -188.86 10698.22 -234.10 10932.32 +113.75  +173.64
RUT      474.37 - 15.57   489.94 -  9.36   499.30 +  5.68  +  9.60
TRAN    2667.25 - 39.52  2706.77 -123.43  2830.20 +187.15  + 37.82
VIX       24.34 +   .36    23.98 +  1.96    22.02 -   .31  -   .96
VXN       48.89 +   .52    48.37 +  1.51    46.86 +   .92  -  5.02
TRIN       1.13             1.44              .94              .73  
TICK       +522             +290             +996            +1098 
Put/Call    .85              .68              .67              .69   

The markets followed though on the drop in futures from Thursday night and opened down with crushing losses on IBM and MSFT. Despite the positive comments by SunMicro and 3M before the open the die was already cast. Even a surprising rebound in consumer confidence failed to sway investor opinion.

IBM was the big tech loser of the day with a -5.65 loss after losing revenue for the third year in a row. The intraday low of $112.81 coincided closely with the bottom set in the last three weeks of November. Several analysts felt it was a buying opportunity but few traders took advantage of it.

Microsoft also took a hit with a -3.75 drop to close near the lows of the day. The warning about lower revenues in some products and higher costs in others (Xbox) weighed on investor consciousness. Microsoft went counter to the recent recovery sentiment by saying they were even move pessimistic now than in the past about the PC market. Investors did not like the message and over 53 million shares traded hands.

SunMicro bucked the negative trend with positive comments with their earnings announcement saying they expected revenues to rise slightly in the current quarter. They also said they expect to be profitable again by the June quarter. Revenues would be slightly above the $3.1 billion in the last quarter. The CFO for SUNW said they were still seeing "extreme levels of competition" among network computer makers and that could slow IT spending in the near term. SUNW dropped a quarter on the day to close near $12, a level where retail traders feel there is little risk. Over 77 million shares traded in SUNW.

Not to be left out of the tech free for all, Dell announced that they would beat revenue and profit estimates for last quarter. Dell issued a press release stating that sales would reach $8 billion and earnings 17 cents per share. They said sales in the holiday season were stronger than expected, thank you Steven. Dell said shipments would run +50% over the third quarter and revenue would increase +40%. Dell was the only computer systems company to attain year over year growth in global shipments both for Q4 and the year. Industry analysts rate Dell's market share in the U.S. between 27% and 30%. Investors did not exactly cheer the Dell announcement and the stock lost -.85 cents for the day. Any other time Dell and SUNW could have gained on their news but the negative outlook from IBM and MSFT was just too thick a cloud to pierce.

Intel lost another -1.05 on the IBM/MSFT outlook and continued an eight day slide. Adding to the negative outlook on the chip sector was an announcement from Taiwan Semiconductor that they were going to cut capital expenditures along the same guidelines as Intel. The chip equipment makers like AMAT, NVLS, KLAC all dropped to new lows along with the SOX.X which closed at the low for January, 523, and well below the 200 DMA at 553. How does that fairy tale go about the SOX leading any tech recovery?

IMCL got kicked again on Friday. Eric talked me out of making IMCL a put play on Thursday night but to be fair I also wanted to drop QCOM as a put because it would not break $46 and he talked me out of that also. QCOM dropped -2.35, IMCL fell -9.09. Of course nobody knew that IMCL would be halted around midday after it received a letter of inquiry from a house subcommittee about the drug Erbitux. The biotech sector just can't get a break recently appears headed for support at 480. There should be some real values there once the sector stabilizes.

The markets are definitely experiencing mood swings and this is evidenced by the cash inflows into equity funds. In the five days ending Jan-17th U.S. equity funds saw +$2.3 billion flow into their accounts. However only two of those five days saw positive flows. The flood of retirement cash has turned into a trickle and the markets are reflecting this event.

This is contrary to the general consumer sentiment, which exploded in the University of Michigan report on Friday. The index shot up to 94.2 and the highest level in twelve months. This was the fourth month of improvement and the highest point since the 81.8 low in September. Consumers feel better off after purchasing a new home or consolidating debt with a low interest refinance. Gas prices are down, millions are driving new cars for zero interest and the terrorist problem at home appears to be under control. Jobless claims fell again this week as well as continuing claims leading some analysts to think that a broad based recovery is really beginning.

Despite the rising consumer confidence stocks got killed over the last two weeks. Investors have a good memory of the losses they sustained in 2000/2001 and are not rushing back into the markets just yet. When I started my research for today's commentary I was bearish. As I compiled all the facts and looked at hundreds of charts I am now cautiously bullish again. First, I know that a lot of readers will disagree with me. That is your choice however you pay me to interpret the signals and express my opinion. If it was always the same as yours we would both lose. Also, just because I am "cautiously" bullish it does not mean I think the markets will go up on Tuesday. Everyone interprets my comments as gospel and we all know that is not correct. Nobody can call exact tops and bottoms until after the fact and then some people still get it wrong. Now lets review the facts.

IBM and MSFT said there were still difficult times ahead BUT they would still make their numbers even if a recovery did not appear. GE is still projecting 17% growth WITHOUT a recovery. MMM is looking for 8% growth. SUNW said the bottom was behind them and they were expecting growth. Dell shipped 50% more computers in the fourth quarter than the prior year. Compaq likes their chances going forward. Corning is starting two plants back up to handle the expected 2H business. Do you see a common trend here? Warnings are slowing. Companies have cut to the bone and are prepared to be profitable with no recovery ahead. Inventory levels are dropping to critical levels with only consumer buying. Once corporate customers see daylight and start buying again the ramp to cover those orders will be huge. Companies will be even more profitable in the coming recovery than they were in the bubble days. They have lowered costs and dropped unprofitable businesses.

The IBM announcement was just another in a long line of "reduced revenue" excuses. Mainframe sales are giving way to servers and personal computers with a cheaper price tag. No problem for profits since the services business with its $100 billion order backlog has a much higher profit margin. I do believe the drop in IBM is a buying opportunity, once it firms. Microsoft on the other hand has an ulterior motive. Man, business was so good we don't know what to do with the money! Cha-ching! Regulators and class action lawyers just added another billion to the price tag for settlement. Microsoft was just managing expectations. Seventeen million installs on WindowsXP is not bad business. Microsoft said it was their best windows launch ever. Chalk up the Microsoft comments to damage control instead of global economic worry.

You want to see the real strength of the economy look at GE. CEO Immelt came close to saying things were recovering in his interview on Thursday. He stole a line from the Graduate and said "plastics" is where it is at. When his plastics business exhibits a growth spurt he will know the recovery is underway. Still he expects to grow +18% for the year. Not bad and the stock is cheap.

Much of the Dow drop over the last two weeks was due to asbestos worries. Several of the Dow companies came out this week and dismissed those claims as false. MMM said they were not material. DOW said they had plenty of reserves. DD, HON, UTX had all taken asbestos hits and now appear to be ready to move back up as those fears ease.

The Fed is making noises about another rate cut at the end of January as insurance to guarantee a solid recovery. Glad they care because most investors don't, at least not on the surface. Just remember that while we may not be excited about another quarter point cut now, that cut stretched out another year will have impact. That takes another monthly meeting cycle to retract each one which means it could be two years before the Fed gets back to the market killing rates we had just a short time ago. Take anything they give us and say thank you. There is also a rumor that Greenspan may have misspoke last week and gave a more negative view of the economy then he intended. The Washington Post has an article on this in the weekend edition. Does this mean he will correct this impression soon?

The sell off of the last two weeks was expected. Nobody should be alarmed or worried because of it. The post 9/11 drop pushed the already falling markets into severe oversold territory. Once the initial bounce was over the 4Q earnings run began as dozens of analysts predicted a V bottom recovery. The euphoria grew as traders, feeling like the worst was behind them, took positions expecting better earnings than anybody should have. When those earnings came in at the estimates and without glowing guidance those investors raced to take profits.

Heated investor expectations met the cold light of reality and we got almost a -600 point Dow drop. Add in the asbestos problems, Enron, Kmart and a couple cautious outlooks and suddenly Nasdaq 2000 was a lot closer then 3000. Where we go from here may not be as bad as many expect. The not so dire warnings from IBM and MSFT failed to push the Dow back to Wednesday's support lows. The Nasdaq broke support at 1950 and fell below the 200 DMA at 1933 but only barely. Many of the hundreds of charts I looked at on Friday night finished well off their lows BUT many also finished at the lows of the day. This means that the selling may not yet be over.

We do not know where it will stop but I think it is close. The Dow has strong support just above 9700 and without a significant Dow event I think that may hold. Any major earnings miss or warning could break that support but if IBM/MSFT/INTC could not break it, who can? The Nasdaq is weaker due to the triple whammy of Chips, Software and Biotech. I did not include the PC sector since the Compaq, Dell and SUNW comments appear to have put a bottom under it. Still the Nasdaq could easily trade between here at 1930 and bottom support at 1880, a 50 point range. In order to break support at 1880 the majority of the biggest Nasdaq components would have to break their next support levels. The following graphic shows where those stocks are and where their next support levels would be.

Of those nine stocks only two are showing a probable chance of breaking that support, AMGN and QCOM. Four are showing only a possibility, INTC, CSCO, SUNW, MXIM. While ORCL, MSFT and DELL are not likely to break support levels. This means that we could see a further sell off to 1880 but it would take another major change in sentiment to push below it. Anything is possible but as Austin says, we are looking at higher odds that 1880 will hold if tested. For the S&P-500 at 1127 the next support is at 1118 and not far away. This is pretty decent support from the middle of December and should at least provide an interim bounce.

Despite what traders believe the markets have moved exactly sideways for the last two months. The Dow is exactly where it was trading on November-13th. The Nov/Dec gains have vanished in a puff of profit taking smoke. The "earnings" anticipation gains are gone and we are back to trading on reality as scary as that may be.

The internal indicators were ugly on the surface with decliners beating advancers substantially on both major averages. The down volume was 2:1 over up volume. However those internals produced some positives as well. The put/call ratio is the most bullish it has been in the last four Fridays at .85. It is normally a decent indicator. The Arms Index (TRIN) 5 & 10 DMA are both above 1.50 which is also somewhat bullish. Both the put/call ratio and the TRIN are indicators of oversold conditions. The VIX is hovering in the 25 range, which while not bullish it is not bearish either.

The bottom line here is a possible change in the trend coming soon. I am not confident enough to say it will be Tuesday morning since there are still negatives in play but it could easily come any day. The trick here is to play what we see not what we believe.

Just because my screen of the available facts suggests there may be a bounce in our future does not mean we should ignore market direction. The market is oversold but can get more oversold. There is no trigger on the trading floor that sets off the "buy alarm" when a certain level is reached. It is all subjective and without buyer conviction of better earnings ahead the prices can just keep falling. The instructions for Tuesday are play the trend. If the trend continues down be aware of the support levels mentioned above as possible exits for bearish plays. If you are looking for the bounce then wait until after amateur hour for confirmation of any upward moves. Gentlemen choose your weapons, it should be an interesting week! (Gentlewomen also!)

Enter Passively, Exit Aggressively!

Jim Brown
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