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Market Wrap

Short Covering Rally Right on Queue

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         WE 2-8           WE 2-1          WE 1-25          WE 1-18
DOW     9744.24 -163.02  9907.26 + 67.18  9840.08 + 68.23  -215.68
Nasdaq  1818.88 - 92.36  1911.24 - 26.46  1937.70 +  7.36  - 92.12
S&P-100  557.28 - 12.07   569.35 -  5.79   575.14 -   .10  -  8.96
S&P-500 1096.22 - 25.98  1122.20 - 11.08  1133.28 +  5.70  - 18.02
W5000  10249.32 -240.85 10490.17 - 86.35 10576.52 + 67.16  -188.86
RUT      466.67 - 13.37   480.04 +   .69   479.35 +  4.98  - 15.57
TRAN    2659.94 - 99.39  2759.33 - 20.59  2779.92 +112.67  - 39.52
VIX       25.47 +  2.60    22.87 +   .94    21.93 -  2.41  +   .36
VXN       49.28 +  6.20    43.08 -  2.59    45.67 -  3.22  +   .52
TRIN        .64             1.44              .82             1.13
TICK       +957             +652             +885             +522 
Put/Call    .73              .67              .68              .85  

The five session losing streak was snapped when stocks rebounded from several high level news stories. The markets sold off again in the morning as rumors flew on Honeywell, Qualcomm and Global Crossing. Volume was light however and the gains only powered the averages right back to prior resistance levels. The Dow may have closed the day with a +118 point gain but it finished the week with a -163 point loss. The Nasdaq ended the week at 1818 with a -92 point loss for the week.

Friday was another news driven day with rumors and accusations flying everywhere. Leading the list was Qualcomm, which fell to a new low after Maryland based Center for Financial Research and Analysis cited accounting irregularities and potential conflicts of interest between the board and auditors as well as family members working at the company. CFRA was responsible for wiping out nearly $3 billion in market cap at the lows of the day and all their complaints were really already known. The family members had been there for 15 years according to some commentators reports. The "revenue in exchange for non-cash consideration" claims amounted to only $30 million and was previously disclosed in their published accounting papers. The Qualcomm COO complained that they took old data out of context and attempted to create a news event to capitalize on the current accounting witch hunt. QCOM dropped from $40 to $34.60 on the initial report but rebounded to close at $37.46.

Honeywell came under attack just before lunch after news broke that a verdict had been rendered in New York in an asbestos case against 36 companies. The jury award was $53 million and the Honeywell portion only $1.1 million. The stock dropped -$4.30 on the initial news even though Honeywell has $2 billion in insurance to cover potential claims. A clear case of investor fright and over reaction. HON recovered from the intraday dip to close down only -1.21. In other asbestos news the major automakers lost their bid to transfer thousands of nationwide cases into one case for ease of processing. Thirty-one companies had asked for some 15,000-20,000 cases to be combined but the District Court Judge ruled that he did not have jurisdiction to make the move.

Whirlpool stock lost -$10 over the last two days after rumors of accounting problems were leaked. CEO David Whitwam said on Friday they know the source of the rumor and that it was malicious and they were considering legal action. This type of comment has been rampant over the last two weeks and nearly caused the worst week for the Dow since last September.

Tyco, the accounting target of choice for the last week is fighting back. The CEO said on CNBC that they had no problems and no accounting issues. He said they had $4 billion cash in the bank which could grow to $5 billion by quarter end. The company has been the target of several aggressive attacks by short sellers and hedge funds. The stock has dropped from $60 to under $25 in just a month and we think the selling has been way over done. We are initiating TYC as a call play this weekend. Once institutions are convinced there are no problems this $40 billion company will be a buying target.

Global Crossing was the target of the alphabet soup groups on Friday with the FBI and SEC announcing investigations of their accounting practices. It appears there is the possibility they deceived investors intentionally with accounting for some bandwidth swaps in the last several quarters. The way I understand it they would swap $100 million in bandwidth across their network for $100 million across other networks. They would book the $100 million as immediate income for the bandwidth they would receive but booked the identical bandwidth they were giving away over much longer periods. They did 13 of these swaps in order to meet earnings estimates on paper even though it was an even swap and no cash changed hands. (details are from news reports believed to be accurate) Their auditors, Arthur Anderson, blessed these "Lazy Susan" deals it appears.

On a better note AOL has put together a string of gains for three whole days. The gains came on the news that Steve Case had purchased one million shares in the market in the $24 range bringing his total owned to around eleven million shares. In a prepared statement Case said he had been a net seller of AOL in the past in order to diversify his holdings but as of last week he became a buyer again based on the confidence he has in AOL and its growth prospects. I tried to get the OIN team to make AOL a call play this weekend but Eric was steadfast in his refusal. Even Jeff Bailey likes AOL on a pullback to $26. If AOL is up next week you can pick on Eric in the Market Monitor. If it is down, Jeff and I want you to forget this paragraph!!

Dell was one of the few stocks not to participate in the end of day rally. The reason was a note from Lehman that the 4Q gains were really one time gains and not repeatable. Dan Niles thinks current estimates of 17 cents per share are too high. He also expects that guidance will be as much as $400 million below the fourth quarter or about $7.6 billion. He thinks there is a high likelihood Dell will forecast sequentially down revenue when they report on Feb-14th.

Will Enron ever go away? With CEO Ken Lay scheduled to testify on Tuesday we will get to see trading come to a halt again as curiosity draws investors to live TV. What they will see is a "baked Lay" as the heat for the entire Enron debacle comes to bear on him. The lights, cameras and lack of action, unless you count watching him sweat, will be anticlimactic to the hype that has gone before. Does anybody really expect him to say anything important? Do they expect him to incriminate himself on national TV? I think they will take the opportunity to flog him verbally and try to win votes for the next election as opposed to actually get information they can use. That comes from real discovery and court proceedings not TV proceedings.

If you left your PC/TV at 1:45 on Friday with the Dow at 9580 and heading down, you would have been really surprised to hear that the close was +164 points higher at nearly 9750. Same with the Nasdaq which was trading at 1772 but closed +46 points higher. This is the same Nasdaq that has been on a steep dive since entering February. Advances/decline ratios reversed to 2:1 positive for the first time in ages. So what happened?

Multiple events caused the reversal. First the day started out flat to bullish as short sellers tried to decide which way the market was going. When the attacks on HON and QCOM came just before lunch the shorts smelled blood and piled on their positions. When both those companies and others came out and violently denied any problems the shorts got caught going the wrong way down a one way street. Immediately the volume picked up and 90% of it was up volume as those shorts scrambled to cover positions. Not only new positions but when faced with rising volume and sentiment, positions from the entire down week as well. I said Thursday we should expect short covering into the close but the news conditions accelerated this much more than I expected.

It did not hurt that several tech stocks received bullish upgrades as well. SUNW, TXN received bullish comments. TQNT beat the street and raised its guidance. Corning said it will meet estimates and that the 1Q will be the bottom in the fiber sector. Even financials struggled back into the green after MER was upgraded to "strong buy" at CSFB. Euphoria, although the weakened version, was breaking out all over. However the $64 question is will it hold. When the markets were dropping like a rock all week it was on high volume. 1.7 bil on the NYSE and 2.0 bil on the Nasdaq. Friday's volume was much weaker at 1.3/1.7 bil respectively. It would have been much less without the HON/QCOM induced volatility. As such we cannot assume the trend has changed.

The best example of support holding was the S&P with 1080 holding the line for the last three days. The low on Friday was 1079.91. Talk about a line in the sand! The S&P was probably responsible for the strength of the rally with heavy volume in the futures every time 1080 was hit. Also impacting the rally was the influx of 457 pension money which normally hits on the 10th of the month. Analysts suspect that hedge funds and floor traders were buying in anticipation of selling into this cash influx on Monday.

In deciding what will happen next week we need to decide what is different. Corning called a bottom but after missing every call for the last two years are you going to believe them? Dell, AMAT, NTAP and NVDA will announce earnings and traders are likely to avoid those stocks/sectors until after the announcements. No help there. Biotechs rallied from an extreme oversold position with huge short covering gains. They are not likely to repeat this performance. IDPH +5.44, GENZ +4.19, SEPR +3.67, AFFX +3.63, CEPH +3.51, ENZN +3.26.

In reality nothing really changed. Stocks are still counting on a 2H recovery that has not come. Accounting problems and suspicions are still with us and will be at the forefront of investors minds next week with the Ken Lay flogging. The economic calendar is light until Thr/Fri where the deck is stacked against us. The bottom line is nothing changed and nobody knows which way the market will move. With two months before the next earnings cycle there are likely more worries than positives. Many analysts are now saying that 1Q earnings could actually be worse than expected due to a drop in activity that began in late January. Great, just something else to worry about.

As traders we need to play the trend until the trend changes. The trend as I see it is to watch for another bout of selling if the gains from Friday fail to carry through on Monday. The sell the rally crowd have got to be drooling with excitement after Friday's bounce. The S&P has resistance at 1100, the Dow at 9775. The Nasdaq has resistance at about every 20 point increment between here and 1960. There is no yellow brick road in front of the bulls. They will have to fight for every inch of ground they take. The road ahead is rocky and fraught with negative accounting news. Volume will be light as many traders will be focused on the testimony and the Olympics instead. However, light volume tended to work in the bulls favor on Friday.

Despite what I said above about the possibility of another rally failure there is another scenario. The very strong short covering rally on Friday is a symptom of the underlying market. Short interest is very high and for good reason. Should a flood of 457 pension money hit the markets on Monday it could ignite another bout of covering which could ignite another bout, etc. Am I conjuring up too bullish a picture for you? We can dream can't we? The most positive event for me last week was the S&P holding support at 1080. I would venture a guess that if the S&P can break over 1125 again next week there would be a lot of bears deciding to change sides. 1140 would be the last real hurdle and decision point for the bears.

I have painted both sides of the market Olympics above and just like the real Olympics starting this weekend we will not know who wins until the finish line is crossed. The lines we should cross as investors seem pretty clear cut today. I am changing them from past recommendations based on Friday's market action. I would go long above Dow 9775, Nasdaq 1870 and S&P 1100. Use those same levels as stops once long positions are open. Unfortunately these three levels may not coincide with each other. When in doubt use the S&P first, Nasdaq and then the Dow simply because of the number of stocks in each. If the markets move down from here I would go flat/short if the S&P breaks 1080 or the Nasdaq breaks 1775. Hope that is clear enough!

Enter Very Passively, Exit Aggressively!

Jim Brown
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