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Market Wrap

No Recovery in Sight

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       1-22-2002           High     Low     Volume Advance/Decline
DJIA     9713.80 - 58.05  9842.84  9696.57  1.3 bln   1374/1758
NASDAQ   1882.53 - 47.81  1947.41  1882.14  1.8 bln   1333/2306
S&P 100   570.63 -  4.61   579.22   569.68   Totals   2707/4054
S&P 500  1119.31 -  8.27  1135.26  1117.91
RUS 2000  469.43 -  4.94   476.96   469.42
DJ TRANS 2659.70 -  7.55  2684.04  2652.40
VIX        25.10 +  0.76    25.24    23.97
VXN        50.37 +  1.48    50.76    49.31
TRIN        1.33
Put/Call Ratio       .65

The markets gave up early gains with a quick sell off after the underlying earnings trend was reinforced by many different companies. "There is no recovery in sight" clause is becoming a common theme and analysts are claiming the stocks they loved last month are too over valued to support the current prices. Add to that unfavorable refrain the news of a Kmart bankruptcy and further problems in the drug sector and investors decided to move back to the sidelines.

The news that Kmart filed chapter 11 bankruptcy sent ripples through the retail sector as other chains came under scrutiny. Wal-Mart and Target both spiked higher on prospects of gains in market share. Kmart is the biggest bankruptcy in retail history. They are currently, even in their depressed state, the seventh largest retailer in the country. At the beginning of 1990 they were bigger than Wal-Mart but the aggressive growth policy and marketing strategies of Wal-Mart propelled them to six times the size of Kmart today. Problems with the bankruptcy include non-payment of huge sums to some suppliers. A food supplier could suffer nearly $100 million in losses from unpaid bills. Landlords could stand to lose billions in broken leases for the more than 500 stores that will be closed outright and possible hundreds more that will eventually be phased out. Many suppliers depend on Kmart for up to 20% of their demand. Much of that demand will move to other chains in areas where stores are closed but that same demand could be absorbed by other brands. The results of this bankruptcy will take years to unfold but could be played out in the market prices of their suppliers over the next two weeks.

Tyco announced today that they were going to split up into four publicly traded companies to unlock shareholder value and put an end to rumors that have been plaguing the stock over the last several weeks. Tyco denied any rumors of accounting problems such as those which took down Enron. The company said its health care, fire protection and control and financial services businesses would be taken public through initial public offerings. The security and electronics businesses would be combined as a fourth public company. The company estimated that there could be an upside of 50% in the current stock price based on valuations of each of the new companies.

Bigger news than Kmart and Tyco was the earnings announcement from Amazon. For the first time in that companies history they posted a profit. Not a pro forma profit but a real GAAP profit! Under the pro forma rules they netted $35 million or nine cents a share but under the more stringent GAAP rules they still managed a $5 million profit. This was a significant event for Amazon, which posted record sales of $1.12 billion in the last quarter. AMZN appears destined to take on EBAY with an emphasis on its Amazon Marketplace where used items are sold along with new products. 15% of all orders were place for used items in the 4Q. They are adding new products from third parties as well. AMZN produced a 15% gain in revenue in the 4Q and ended the year with $1 billion in cash. They are extending their partnerships with Circuit City, Target and will have a new venture with AOL later this year. Now that there is an "E" in their PE it will become a yardstick for future stock prices. What is a stock worth, which makes $30 million a year in profits (their 2002 guidance) and has 400 million shares outstanding? KKD, another high-flyer with a PE of 100, will net about $30 million this year but only has 50+ million shares outstanding. Their closing price on Tuesday was $37+.

Microsoft was slapped with another antitrust suit by AOL, buyer of Netscape, the other browser people. The trust claims damages by Microsoft because they used their monopolistic power to harm Netscape by giving away their Internet Explorer browser and bundling it with their operating system. They are seeking $12 billion in damages and remedies to prevent MSFT from continuing the practice. Investors don't appear worried as MSFT only dropped -.20 in after hours.

In economic news the Conference Board's Index of Leading Indicators rose +1.2% in December to 111.4. This was the largest increase since February 1996. This was the third straight month of improvement and beat estimates by +0.8%. This is yet another sign that a recovery is on the horizon but as yet not seen in earnings. Eight of the ten indicators rose in December. The board indicators are volatile and could be impacted in January by any drop in the S&P.

In earnings news after the bell there was a large number of firms beating the estimates but the consensus was the same. Companies that beat and the amount they exceeded estimates included EMLX +.04, VTSS +.01, ALTR +.01, NVLS +.01, MERQ +.02, SLAB +.04, CDWC +.01. Announcing inline with estimates were FCS, MOT and AMCC. Motorola posted its fourth quarterly loss in a row and predicted two more but hoped to return to profitability by the end of 2002. They said that "baring any unforeseen political or economic disruptions" they would be profitable for the full year.

Still the consensus for most of the companies announcing today was the same. "No evidence of a recovery in sight" was the common thread. Most expect business to pickup in the third or fourth quarter but only a couple firms had positive comments about the current quarter. This is causing investors which bought on the hopes of an immediate recovery to rethink their decision.

The tech sector has gone from rational exuberance to irrational depression in the space of only nine days. This is not however an uncommon occurrence. Earnings typically have this type of impact on the markets even in times of growth. This is called an "earnings run" and many investors have forgotten that expectations seldom equal reality. Their expectations of a "V" bottom did not materialize what we are seeing is reality returning to the markets. This is not a bad thing but it is something we need to work through. The reality is that everyone now expects the economy to recover in the third and fourth quarter. More and more companies are pointing to signs of an economic bottom as being behind us. Yes, we still have a couple of questionable quarters ahead of us but many of the chip stocks (leaders in any tech rebound) are saying that the worst is behind them. Even Motorola is projecting a rebound!

Where does that put us today? Waiting! If you are invested in puts then you have been making money the last two weeks. If you want to play calls then you should still be waiting for the "market rebound" which precedes an economic rebound by about six months. Now if you have been following the economic commentary and can count then you could be saying, "rebound in 3Q-4Q, minus six months, equals Jan-Mar as the historical market rebound months. I say historic since "most" rebounds look this way in retrospect. Does this mean buy tomorrow? Of course not.

On Sunday I theorized that a rebound was coming soon as we approached certain critical support areas. 9700 is critical for the Dow just like 1880 is critical for the Nasdaq. (See the traders corner from Buzz tonight on Dow 9712, it is excellent). On Sunday I showed how the Nasdaq could hit 1880 (1882 today) but it would take a major event to push it below that level. Boys and girls that comment will be tested tomorrow. Every major index is showing severely oversold but is sitting EXACTLY on support I quoted on Sunday. S&P 1118 and it closed today at 1119.31. Dow 9700, closed today 9715. Nasdaq at 1880, it closed today at 1882. The line has been drawn in the sand and the battle is underway. These support levels may not be the final bottom in this leg down. This may just be a resting point. One thing for sure, if this level fails we could see a substantial drop for the major indexes. (9550/1800/1085 respectively.) Use any bounce from the current levels as an entry for a short term trade only and stay flat or go short below it. Tuesday's levels are a clear-cut entry and exit point. Repeat, long above, short below today's levels.

Enter very passively, exit aggressively!

Jim Brown
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