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Market Wrap

Market Under Attack On All Sides

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      02-19-2002           High     Low     Volume Advance/Decline
DJIA     9745.14 -157.90  9899.38  9734.90 1.19 bln   1017/2116
NASDAQ   1750.61 - 54.59  1791.01  1745.05 1.73 bln   1051/2498
S&P 100   549.22 - 10.43   559.65   548.85   Totals   2068/4614
S&P 500  1083.34 - 20.84  1104.18  1082.24             
RUS 2000  459.98 -  9.27   469.25   459.47
DJ TRANS 2672.40 - 11.83  2694.01  2671.82
VIX        26.21 +  2.12    26.37    25.32
VXN        47.23 +  2.24    47.58    46.01
TRIN        2.35 
PUT/CALL    0.84

The day started out bad and then got worse! Accounting concerns caused further drops in name brand issues like IBM but rumors were flying about numerous other stocks as well. The strong economic numbers failed to bouy investor confidence and worries over Japan continued to weigh on financial stocks. All these concerns caused the major averages to break critical support levels and accelerate into the close.

IBM started the day off by announcing plans to release details of financial income that it had previously recorded as offsets to its expenses. Defending its prior accounting the CFO said the company's practices had been correct under accounting guidelines but shareholders and analysts had been asking for more. They said they would provide more about intellectual-property income, the impact of gains and losses from investments, the effect of amortization of goodwill from acquisition, gains from sales of real estate and income from IBM's overfunded pension plan. The CFO said the disclosures would be in the annual report to the SEC due to be filed next month. Concerns on accounting have knocked -$10 off the price of IBM stock since last Thursday's high. Investors are afraid they will see much of the profits came from non-operating sources which would call into question their current valuation.

PNC Financial Services spooked the market again by saying they would have to restate their financials again, for the second time in four weeks, due to accounting errors. Great! How would you have liked to be that CFO who had to come to the board again after being responsible for a $10 stock drop in January only to tell them there was still more errors? Break out the Maalox!

Same with the management at JPM. The stock appears destined to break under $29 as worries about bad debt mount along with class action suits on Enron dealings. Add in Japan, Argentina, GX, TYC and scores of others and JPM suffering is far from over.

Circuit City has dropped almost -33% in the last four days as analysts continue their verbal debate. Scot Ciccarelli, an analyst at Gerad Klauer Mattison said in a research note that the costs to remodel the stores could exceed $700,000 each and significantly impact earnings over the next two years. An analyst at Bernstein said he has spoken with the company and they have not even made a decision on remodeling. This is all speculation on the part of Ciccarelli. Merrill Lynch said there was "no credence to this speculation" because Circuit City was very conservative and would never undertake a change of that magnitude if it would impact earnings. The battle continued with G.K.M. saying that CC was also at risk for its credit card loans. Other analysts quickly pointed out that they sold those loans and had almost no risk. Scot, what have you been shorting recently?

A management change at Honeywell also helped to accelerate the drop at the close. HON announced that it had named David Cote, formerly chairman and CEO of TRW as CEO of Honeywell effective immediately. Current HON CEO, Larry Bossidy, had returned to HON for a one year term after the failed GE/HON merger. The stock of Dow component HON fell nearly -$2 on the news but rebounded some to close down only $1. TRW however fell over -3.29 on the news.

King Pharma, KG, broke the cardinal rule of meeting estimates but not raising its guidance. Sound strange? KG has previously raised guidance almost every time it announced earnings but this quarter the trend changed. KG dropped -2.20 on the news and may have started a new down trend as traders used to bigger/faster face flatter/slower in the future.

Cienna went shopping for a fiber bargain and came up with ONIS which they picked up for a paltry $900 million in stock. Last year it would have cost them $11 billion for the same company. A bargain? What is Global Crossing worth? OOPS, unfair comparison. They said it would make them more competitive against NT and LU in the telecom sector. Isn't that the sector that is evaporating daily? With only 5% of the available fiber capacity being used and all the telecoms cutting jobs and services, why would you want to be more competitive in that sector? The market was under whelmed by the transaction which only carried a 12% premium for ONIS shareholders.

Wal-Mart continued its domination of the retail sector with a +6.9% increase in same store sales and a cool $2.19 billion profit in the last quarter. The nearly 4300 stores are slowly squeezing the life out of competitors near any of their locations. Their move into groceries has been a big plus and they are able to obtain better margins due to their size and buying power. They were aggressive in lowering their prices during the recession to attack buyers and gain market share and it appears to have worked. I shop at Wal-Mart at least once a week and the checker last Saturday was telling me that they were grossing $22 million an hour and the goal by year end was $25 million an hour. With Kmart filing bankruptcy and other retailers in trouble they could make it.

SUNW took another hit from SoundView which cut them to a hold citing a data center survey showing continued tight budgets and SUNW in the fifth position among enterprise vendors and also fifth in customer satisfaction. SUNW fell to $8.33 and close to a 52-week low.

The economic news was headlined by the Residential Construction Activity which soared +6.3% in January to an annualized rate of 1.678 million. The continued low mortgage rates have sparked demand to the point where some analysts fear a bubble is in progress. The flaw in this argument is the limited four-month supply in the pipeline. Should that supply start expanding rapidly it would be a sign that demand had weakened. Until then it is still a sellers market.

A sellers market was what we were seeing in the broader markets on Tuesday. The Dow has now dropped -300 points from the highs of 10050 last Thursday. The Nasdaq closed at a low not seen since early November. Neither are showing signs of a bottom. As I said last Thursday there was no confidence in the rally. It was just another bear trap which has now been sprung. The daily accounting problems along with downgrades and worry over the possibility of the recovery being delayed even farther have soured investors on the market. Normally after a big drop like we had today there is some glimmer of a bounce at the close. If it occurred today nobody saw it.

The Dow seems destined to test 9600 again but the real weakness is in tech stocks. The Nasdaq closed at 1750 and could easily test 1665 this week. The only positive factor we could find was the huge drop in tech stocks over the last two days. Look at almost any of the high flyers, QLGC, BRCD, NEWP, EBAY, NVDA as examples. Huge drops which could bring a short covering rally any day. This is why we did not add any PUTS in today's play section. They all appeared overdone for the time being. We expect a short covering rally in the next day of two and then another leg down. We opted instead for two stocks that turned in respectable performances despite the market.

The semiconductor book to bill number for January was .81 which represented a slight increase over December's revised .77 number. While this is encouraging it is not earth shaking. The majority of the gains came mathematically. Bookings only increased +$8.4 million from December but billings decreased $35.3 million. If your billings decrease four times the amount of the booking increase then your ratio will improve but your business will is still slowing. This number will be debated on Wednesday and investors will vote with their dollars.

As traders we need to be very leery of this current market dip. With the Nasdaq at three-month lows and falling the Dow could continue to be dragged down with it. Stay short or flat until this trend changes. Don't trust any bounce! That bounce could come when the S&P hits 1080, only 3 points away.

Enter very passively, exit aggressively!

Jim Brown

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