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Market Wrap

Bear Trap Rally or Spring Preview?

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       1-31-2002           High     Low     Volume Advance/Decline
DJIA     9920.00 +157.14  9922.49  9763.20  1.5 bln   2093/ 998
NASDAQ   1934.03 + 20.59  1935.17  1906.90  1.7 bln   2117/1461
S&P 100   573.49 +  9.11   573.49   564.38   Totals   4210/2459
S&P 500  1130.20 + 16.63  1130.21  1113.30
RUS 2000  483.10 +  3.38   483.10   478.51
DJ TRANS 2797.83 + 35.72  2797.83  2756.32
VIX        22.91 -  1.96    25.27    22.77
VXN        42.82 -  1.85    45.34    42.46
TRIN        0.75
Put/Call Ratio       .67

Bear Trap Rally or Spring Preview?

After a slow start the markets gained steam as the day progressed but was it investor optimism or more short covering? Thursday was the last day of the month and there was a strong move to dress up portfolios to prevent further cash drain on funds. Many of the big gains were in blue chips and big caps but few tech stocks took part. The deep V drop and rebound on Wednesday provided an excellent opportunity to cover shorts which many did. Those who were hoping for another leg down were disappointed with Thursday's action and could have been convinced to cover before averages moved even higher. Resistance has not disappeared however and could show itself again on Friday.

The day began with a worse than expected jobless claims report and a jump of +30,000 claims to 390,000. Bulls tried to spin the news by calling it the fourth week under 400,000 but next week will tell the tale. The current level of claims is consistent with the level from last January before the recession began. Continuing claims rose again and the number from the prior week was revised upward as well.

The Employment Cost Index showed costs continuing to rise as the costs of benefits grew. This growth is slowing and should equal 3.3% by year-end compared with 3.7% at the end of 2001. Rising benefit costs could impact employers ability to add employees as the recovery progresses. Still there is no inflation evident in the wage numbers.

While labor costs are rising Personal Income was also soaring. The December number came in twice what analysts expected at +0.4%. This shows that the labor markets are stabilizing with that being the largest increase since Feb-2001 at +0.6%. However personal consumption fell by -0.2% as durable goods suffered in the fourth quarter. The increased defense spending and increased government employment as a result of the September attacks should continue to power the personal income numbers. Even the manufacturing sector saw a bottoming in December as consumers continued to spend while businesses kept their wallets closed. Another indicator that the labor markets are firming was the first improvement in twelve months in the Help Wanted Index to 46. Advertising volume is increasing slightly but could take a year to become healthy again warned analysts.

The Chicago PMI report showed an improvement but was still in contraction stages at 45.1. Anything below 50 represents a contraction. The index hit a low of 38 last July and has been staggering in the low 40s since. The slight increase from 41.5 in December could be a sign that the recession is really ending. Many analysts expressed doubt that the +0.2 GDP number from Wednesday was a clear sign that the recession was over. There are far too many indicators that forecast no rebound until the 2H of 2002. This means the 1Q GDP could be negative again and that has worried investors. Greenspan has alluded to another dip in our future as well. The Fed kept its "bias toward easing" position in this weeks meeting even though the current 1.75% rate is the lowest in 40 years. They kept the bias to ease because of the risk of a financial crisis rising out of the Enron accounting problems. Should investors sit on their wallets until the worries are flushed out of the system the markets could continue downward and force the Fed to act again.

Friday will highlight the January Jobs Report, which is expected to show another loss of -60,000 jobs. The University of Michigan Consumer Confidence report for January will be released again as well. Continuing confidence will be key to any future recovery and market rally.

In stock news Procter & Gamble soared +3.37 after posting a +9% gain in net income and the first sales increase in more than a year. They have cut jobs and restructured to better reflect the current business environment and global recession. Investors rewarded their results with a huge bout of short covering as the shorts were betting on an earnings miss.

AOL was the third most active stock on the NYSE after posting earnings of only $.12. Several analysts expressed concern over the weak performance and Holly Becker from Lehman said she saw no reason to buy the stock at this time. AOL closed down -.09 at $26.30 and showed no indications of a bounce in the future.

Intel gave the semiconductor sector a boost after Merrill Lynch upgraded them to a "strong buy." The firm said investors are underestimating the potential of its new processor line. INTC stock jumped +1.18 and came to rest exactly on resistance at $35. Chip equipment makers like AMAT, KLAC, NVLS all rose and extended their bounce from the Jan-22nd lows.

Oracle tried to lift the software sector when the CFO said there were signs that the industries fortunes would reverse by spring. Prudential raised its rating to a "buy" from "hold" and the stock bounced to close exactly on resistance at $17.25.

Juniper fell to a four month low of $15.31 as rumors surfaced about insider selling and increasing market share by Cisco. CSCO rallied on the news but closed only .20 cents below resistance at $20. Lucent, Corning and Cienna also finished lower for the day. The sector cannot get a break with MCLD filing for bankruptcy with a plan to erase $3 billion in debt. MCLD was the fourth largest company in the U.S. telecom sector. Over the last four years over $90 billion has been spent building out fiber-optic networks in the U.S. which now has over 39 million miles of glass fiber. HOWEVER, because of the tremendous drop in cost for transmitting voice and data over those networks only 5% of that 39 million miles is active. The rest is dormant and lacking the switches and amplifiers to actually transmit information. Can you say a decade of glut ahead? No wonder the telecom companies are filing bankruptcy after spending billons for networks that are currently just lifeless buried cables.

The defense sector was the leader today after two days of rousing calls for increased defense spending along the lines of $48 billion. These companies have got to be working 24 hrs a day trying to come up with new high tech weapons and justifications for those weapons to present to the Defense Dept. NOC, LMT, GD, RTN and ATK were all up strongly with RTN up +20% in the last six days. GD has gained +$15 since mid January. We keep looking for an entry point but these stocks are riding the rockets they produce.

If you are a believer in the January barometer then we are in trouble. In the last 51 years the indicator has been correct 84% of the time with 42 years following the January lead. The Dow finished down -1.2%, S&P -1.9% and the Nasdaq an even -1% for January. That would seem to indicate that we only have a 16% chance of finishing 2002 higher than we are today. Personally I think the events of last September probably threw a kink in the indicator and the chances of a recovery from the 4Q lows will cause us to fall into that 14% error category. It just may not start next week!

The rally from the last two days was encouraging BUT it only brought us back to current resistance levels that had previously caused problems. The S&P has a strong top at 1140, only 11 points away and which is not likely to be broken on Friday. The top on the Nasdaq is just above 1950 and only 17 points away. The Dow actually closed at 9920 and +20 points ABOVE strong resistance but is now in a congested area that may limit future gains.

In the comments above I noted that INTC, CSCO and ORCL closed right at resistance. Not mentioned were MSFT, DELL, SUNW and QCOM, which are also showing no signs of help. There is not a lot of life in the tech sector. Any gains in this market will need to be very broad based and not depend on the Nasdaq big caps for help. The Dow components were very strong with only three closing negative, DIS, EK and KO. This two-day winning streak could see profit taking on Friday. I would expect the Nasdaq, which traded negative most of the morning, to be even weaker if the Dow rolls over from here.

The VIX soared from a low of 21.69 on Monday to a high of 29.92 on Wednesday only to collapse back to 22.91 today. Historically, 22 has been a sell signal brought on by overbought complacency. The Nasdaq VXN closed at an all time low of 42.82 today. Granted the VXN has not been around long, Jan-2001, but an all time low should be a cause for concern, especially when techs don't look that hot. Remember, we had a buying binge brought on by portfolio window dressing and a couple positive economic reports. This was not a tide of sentiment change. According to TrimTabs.com there was a -$500 million outflow of cash from funds in the week ended yesterday compared to outflows of $2.6 billion the prior week. Funds are bleeding cash and are not likely to make big bets until more economic news is known. That news will be in the form of the Jobs Report on Friday. A positive surprise could work in our favor if there are net jobs created instead of lost. Either way, we are at resistance and moving up from here could be a struggle.

Enter very passively, exit aggressively!

Jim Brown

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