Option Investor
Market Wrap

3M Giveth, IBM Taketh Away

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        WE 4-5           WE 3-29          WE 3-22          WE 3-15
DOW    10271.64 -132.30 10403.94 - 23.73 10427.67 -179.56  + 34.74
Nasdaq  1770.03 - 75.32  1845.35 -  6.04  1851.39 - 16.91  - 61.37
S&P-100  564.02 - 13.85   577.87 -  2.22   580.09 - 11.04  +  1.29
S&P-500 1122.73 - 24.66  1147.39 -  1.31  1148.70 - 17.46  +  1.85
W5000  10551.43 -224.31 10775.74 -  1.12 10776.86 -127.83  + 14.02
RUT      497.76 -  8.70   506.46 +  4.07   502.39 +  3.27  -   .73
TRAN    2778.41 -139.55  2917.96 + 40.69  2877.27 - 74.27  - 58.70
VIX       21.13 +  1.81    19.32 -  0.30    19.62 -  1.15  -  0.84
VXN       40.85 +  4.57    36.28 -  1.28    37.56 -  2.70  -  1.36
TRIN       1.67             0.84             1.12             0.56
TICK       +341             +793             +647             +855   
Put/Call    .78              .79              .66              .64 

Mix one positive earnings forecast with fear of another tech warning and you get the Dow picture for Friday. Too simple? Try this. 3M gained +7.81 points after saying that they would beat estimates of $1.16 with earnings of $1.20. That +7.81 gain equated to +60 Dow points. IBM however was hit with rumors that they would issue an earnings warning after the close on Friday. IBM dropped -3.59 points. Those -3.59 points equates to -24 Dow points. Add them up (60 - 24 = 36) and you get exactly the gain for the Dow on Friday. As you can see, without MMM holding the Dow in positive territory the final outcome might have been much different.

Pretty strong results by MMM beating the estimates so strongly, right? Wrong! If you read the reports you will see that MMM posted the gain in earnings purely from cost cutting and restructuring because sales were down about 5%. Their cost savings should amount to about $615 million for the full year. Strong performance but not strong business. There were several upgrades but the strong gains were clearly from short covering and should not last based on fundamentals.

As I mentioned above, IBM was rumored to warn after the close on Friday. It did not happen but they did announce they were laying off 600 customer engineers. Worries abound that IBM will miss their estimates when they announce on Wednesday the 17th. Recently they have been struggling to hit estimates due to lower sales and weak growth in their hardware division. They have been cutting costs and using billion dollar share buybacks to manage results. Eventually those tactics will fail and they will miss. Salomon Smith Barney took the unusual step of downgrading IBM late in the afternoon to an "avoid" based on failing technicals. IBM closed at $97.84.

Earnings warnings were far more prevalent than positive surprises with MCDT leading the list with their second warning for this quarter. According to the company its biggest customer, EMC, had drastically cut back on orders in March which could continue to weigh on EMC as well. Analysts say the market is moving to two gigabit switches, a product that MCDT has not yet shipped, and a market where Brocade is gaining share daily.

A downgrade to junk status of the Nortel debt hit the networking sector again. NT dropped to $3.76 and a level not seen since 1995. JNPR fell to $11.40 , GLW to $6.79 and CIEN to $8.09. You can buy those stocks for not much more than the price of an option but you better have a very long time horizon!

About the only other positive earnings news came from Dow component Alcoa which met analysts estimates. They did this with reduction in expenses to offset the weak demand for aluminum. Sound familiar? Alcoa also said the economic conditions were still very challenging and we must continue to focus on managing what is under our control. Read that as "more cost cutting" until a recovery appears.

Speaking of recovery, the nonfarm payrolls provided a mixed blessing Friday morning. The report showed that +58,000 jobs were added in March but the +66,000 gain in February was revised down to a -2,000 job loss. The disappearing jobs had the impact of canceling the recovery for February. Traders quickly questioned the +58,000 jobs for March and wondered if they would still be there this time next month. Ironically the unemployment rate rose to 5.7% from 5.5% in February and also shocked the recovery pundits. This was the highest rate since 1995.

The market rallied on the headline news and then sold off as the internal numbers became known. Ameritrade warned after the close that they would come in at the bottom of the range due to lower trading volume. No kidding! The Nasdaq is slowly sliding into oblivion on volume numbers that continually vie for the top three lowest days of the year. It is not any surprise that the Nasdaq is slipping after over 20 software stocks have warned so far this quarter. If software is not selling then computers, chips and networking are probably not selling either.

Still, despite the flurry of warnings this week the rate is well below the same period for last year. This would normally be bullish for earnings but many analysts feel that companies will just miss estimates and only be penalized once instead of twice with a warning too. They can do that if they are close to their guidance numbers. But, close only counts in horseshoes!

ETS and Qwest announced new SEC inquiries on Friday bringing the total to 49 for companies in the S&P undergoing scrutiny for their financial dealings. Not a solid investment environment when those companies announcing inline are doing it with cost savings and the quality of earnings on everybody else is still in question.

They say bear markets are built on the "slope of hope" and that appears to be what we have here. Almost every analyst on stock TV is predicting great things for the 3Q/4Q of this year. However, they cannot point to any reasons for this optimism other than the recovery is underway. It may be but the rising unemployment and slowing retail sales may be a symptom of a coming second dip. Even if it does not come the fear of it is keeping investors on the sidelines. We are only a week away from the historical spring selling season (April-15th to May-15th) and traders are hard pressed to find a reason to buy here.

Even the Fed may have to reconsider raising rates anytime soon. The bounce back may have just been inventory adjustments and until that is known for sure they cannot risk smothering the economy again. The Fed funds futures are dropping rapidly and are now only showing a 22% chance of a .25% rate hike by July. Any rate hike at the May meeting is only a very slim to non-existent chance. Mortgage companies like Washington Mutual (WM) have exploded this week on the chances of several more months of strong home sales. Their busy season is just ahead and with the Fed on the sidelines it should be a license to print money.

What is a trader to do? Probably not go long! With the S&P dangerously close to breaking support at 1120 it appears risky to be long. The Nasdaq is poised to break 1770 and could hit my intermediate support target of 1750 next week. The Dow would have likely closed under 10200 again without the short covering on MMM. All the short-term targets are down, not up. The moving averages on the TRIN (see the market sentiment section) are slowly moving up which indicates an oversold condition building. This will eventually lead to a bounce but probably a short one.

My long entry points remain 10500/1875/1155 respectively. I considered revising them downward this weekend but there is too much risk of a roll over just below those levels. We need to be patient and pick our long call entry points carefully. Besides, there are so many put opportunities right now that there is no need for traders to wait on the sidelines. Remember, my entry points for shorting were 1140 on the S&P and 1825 on the Nasdaq. If you are following my advice you should be very profitable already. Remember to exit at those levels as well should a rally break out!

Enter Passively, Exit Aggressively!

Jim Brown

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