Option Investor
Market Wrap

The String is Broken!

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        WE 4-19          WE 4-12           WE 4-5          WE 3-29
DOW    10257.11 + 66.29 10190.82 - 80.82 10271.64 -132.30  - 23.73 
Nasdaq  1796.83 + 40.64  1756.19 - 13.84  1770.03 - 75.32  -  6.04 
S&P-100  559.79 +  6.05   553.74 - 10.28   564.02 - 13.85  -  2.22 
S&P-500 1125.17 + 14.16  1111.01 - 11.72  1122.73 - 24.66  -  1.31 
W5000  10635.05 +129.08 10505.97 - 45.46 10551.43 -224.31  -  1.12  
RUT      517.40 +  1.94   515.46 + 17.70   497.76 -  8.70  +  4.07 
TRAN    2796.87 - 78.16  2875.03 + 96.62  2778.41 -139.55  + 40.69 
VIX       20.30 -  1.79    22.09 +   .96    21.13 +  1.81  -  0.30 
VXN       39.35 -  3.46    42.81 +  1.96    40.85 +  4.57  -  1.28 
TRIN       1.18             1.03             1.67             0.84 
TICK       -492             +460             +341             +793    
Put/Call    .79              .99              .78              .79  

After a string of five weeks of losses the Dow and Nasdaq finally posted a small gain. It was nothing to write home about with only a +66 point gain for the Dow and +40 for the Nasdaq but traders were eager to take what they could get. After a week of earnings with headliners missing estimates, a flood of warnings, fears of another terrorist plane crash and a new threat at home, any positive gain is a surprise.

One of the biggest surprises of the week was the Microsoft results. Officially the company missed estimates by two cents and then warned for next quarter and the year. Traders however looked the other way and ignored the bad news and powered the stock to a gain on Friday. This brings to mind the story of a college girl coming home on vacation and when asked about her grades related the following. I have some bad news. I got a D in English and Math and a B in PhysEd, and I am pregnant. After the mother is picked up off the floor and revived the daughter tells her she was just kidding about the pregnant. In relief the mother says "that's great, a B in PhysEd! and she completely ignores the two Ds. This is how traders reacted to the fact that Microsoft earnings were not as bad as first thought. When the announcement included two special items around fifteen cents each analysts recoiled in horror that maybe Microsoft really missed earnings by seventeen cents and not just two. Surprise, just kidding about the charges, it is only a two cent miss and oh by the way, we are warning but its no big deal. Great, said the relieved analysts, lets buy Microsoft tomorrow! Merrill Lynch led the group and upgraded MSFT as a better value at the current price.

Remember the telecom rally from Tuesday? You can forget it again. Friday reality returned to the sector with a flurry of news events. Qwest started the decline with profit warnings for the year which echoed statements from BellSouth and SBC Communications. Qwest said it was going to seek a buyer for some of its assets in an effort to trim expenses and raise cash. After the bell on Friday Worldcom cut its full year 2002 earnings and revenue guidance, which dropped WCOM stock to less than $5 in after hours. All the telecom companies made remarks similar to the Nortel CEO on Thursday who said he expected continued weaker spending in the sector for 2002. Needless to say all the related companies like NT, LU, CSCO, JNPR and the communication chip companies finished lower.

Cautious comments came from many sectors this week despite 58% of the companies already reporting announcing results that beat the street. The problem is still the lowered estimates they beat. Some analysts point to this as a sign of promise but they are struggling to paddle up stream. The freight companies, notably the package shipping group, has been seen as a leading indicator of economic growth. This week the UPS CFO said they saw "no significant evidence of an economic recovery." The Consolidated Freightways (CNF) CEO said the "business upturn remained weak." Are investors fooling themselves that a recovery is underway because the alternative is too frightening?

Whatever the reason the markets appeared amazingly resilient last week. After less than stellar guidance from many companies and warnings from many others the indexes finished with a gain. This came after a fear of another terrorist attack was news on Thursday with the plane crash in Milan. A -150 point Dow drop was quickly erased with the index closing within 15 points of zero. This was a significant event. It means there are buyers in the crowd and those buyers were quick to pick up shares others were dumping. The lack of a drop on the Microsoft warning shows that there are tech buyers at this level.

While there are buyers lurking below the bid there are no buyers willing to push stocks higher. Volume remains very weak and we are moving into the season where it will get even weaker. Nervous but resilient? How much longer will the resilience last? First Call is becoming more vocal about their doubts regarding tech companies hitting the current +140% increase in profits for the third quarter. Granted comparisons to 2001-Q3 should not be hard to beat but +140% improvement? As analysts come to grips with the fact that the economy may not be recovering as fast as they wish then estimates will start dropping rapidly. Doubtless there are many analysts scratching their heads and sharpening their pencils after this weeks earnings reports. The shrinking estimates will likely begin next week and as estimates drop so may stock prices.

Little was said about the jump in initial jobless claims over the last two weeks to the highest levels of the year. Analysts claim the numbers are not relative since it contains previous filers whose claims expired and are now allowed to file again for extended benefits. Still the continuing claims rose again to 3,839,000 which indicates continued weakening unemployment. I don't need Federal numbers to drive home the unemployment problem. I ran an ad in the local paper for a web developer last week and got over 200 resumes. Two years ago I was lucky to get ten for the same ad. After speaking to many of the applicants several admitted to sending out thousands of resumes around the country over the last several months with only a random call or a thank you for your submission letter. Several applicants, with 7-10 years of developer experience, had taken jobs as waiters and laborers just to make ends meet. Others, which were still employed said their companies were planning more cut backs before summer. I am sure Denver is not alone in this problem and when you multiply it nationwide you can see that the tech sector is having the same problem as telecom.

This brings us back to the markets. We all know that the markets are discounters of current and future events and investors typically focus six months in advance. That six month focus is expecting a +140% increase in profits for tech stocks. It is becoming increasingly apparent that this may not happen. As it sinks into investor consciousness there may be a tendency to lower those bids or withdraw them completely. The S&P is struggling to break resistance at 1130. To its credit it is holding its ground and fighting a valiant fight. The bounce off 1100 last week was very strong but it came to a screeching halt at the 1130 level. If you remember what powered that bounce it was short covering in chips and telecoms. The semiconductor index rolled over right at 615 resistance and we all know what happened to telecoms this week. Neither sector is likely to provide any help next week.

That puts us back to square one for next week. All the averages are struggling under resistance. Dow 10300, Nasdaq 1800 and S&P 1130. Without some strong positive news we appear stuck in this trading range. The news for this earnings cycle is already priced into the markets and has been unable to power us above resistance. We are five days into the April-15th to May-15th period which historically produces sell offs 80% of the time. The VIX closed at 20 on Friday but the put/call ratio and the TRIN suggest it will fall farther before it stops. My entry points for long plays continue to be 10350, 1850, 1130. You may notice I adjusted the Nasdaq number back to 1850 to bring it more inline with the other two indexes. My entry points for going short are Dow 10,000, Nasdaq 1725 and S&P 1100. If the markets are going to continue to trade in a range between those levels then attempting to make profitable trades will be very difficult for most investors. You are left buying bounces from the low side and selling into rallies on the top. It is easily done only if you are an active trader and comfortable with the risk.

Despite the gain for the week the markets are still in a downtrend. One positive week out of six does not change the trend it only equalizes the oversold pressure. Over half of the Dow has already announced and most of the remainder will announce next week. We can expect more of what we got this week, mixed results with cautious guidance. Nearly half of the S&P have already announced with another 25% due next week. After that the earnings news will dwindle and we will begin our drift into the summer doldrums. This is the period when we need to be especially careful about trying to force trades. Be very patient and wait for the entry points above.

Enter Very Passively, Exit Aggressively!

Jim Brown

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