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Market Wrap

Sentiment Implodes, Nobody Seems To Care?

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        WE 6-14          WE 6-07          WE 5-31          WE 5-24
DOW     9474.21 -115.46  9589.67 -335.58  9925.25 -179.01  -248.82  
Nasdaq  1504.74 - 30.74  1535.48 - 80.25  1615.73 - 45.76  - 79.90 
S&P-100  501.76 -  5.56   507.32 - 21.88   529.20 - 10.72  - 13.38 
S&P-500 1007.27 - 20.26  1027.53 - 39.61  1067.14 - 16.68  - 22.77 
W5000   9549.72 -202.97  9752.69 -353.80 10106.49 -144.15  -223.54  
RUT      459.07 - 11.44   470.51 - 16.96   487.47 -  6.17  - 15.30 
TRAN    2673.14 - 13.52  2686.66 - 62.60  2749.26 +  5.59  - 54.69 
VIX       29.93 +  3.28    26.65 +  3.75    22.90 +  1.64  +   .88 
VXN       55.67 +  3.43    52.24 +  6.29    45.95 +  3.09  -   .08 
TRIN       1.34             1.30             1.11             1.59       
Put/Call   1.15              .79              .73              .82       

Friday morning was almost an exact copy of last week. Intel did not warn again although others did. There were no bombs in Israel but Karachi Pakistan instead. What did happen other than earnings warnings was a drop in Industrial production to nearly flat and a collapse in Consumer Sentiment to 90.8 from 96. The feared "VV" recession or the second dip appears to be coming to pass.

The Industrial Production fell to only a +0.2% growth rate in May. This was continuing the fall from the high of +0.6% in Jan, a drop to 0.4 in Feb/Mar and 0.3 in April. If this drop continues we will be back to negative growth by July/August. After eighteen months of contraction the inventory rebuild cycle bumped the economy back into growth mode in January. It has slipped every month since. This is not the news investors wanted to hear with the market nearing September lows.

The Consumer Sentiment drop was even more drastic. Sentiment fell to 90.8 for the first half of June and wiped out all the gains from the last three months. This was a six-point drop. The current conditions component fell from 103.5 to 97.9 and the expectations component fell to 86.2 from 92.7. This was the lowest reading since December and shows that the recovery is slowly slipping away. Reasons for the drops include a lack of recovery in the job market and weak business confidence after the high profile corporate problems of late. Also impacting the numbers were the fears of a nuclear war in India and Pakistan and the "dirty bomb" scare. The stock market decline also sours consumer moods. A rising stock market is a visible "wellness indicator" for the public.

What these two reports emphasize in addition to others this week is that the Fed is not going to raise rates anytime soon. The fed funds futures are pointing to a 2.25% interest rate in December. It has almost completely ruled out any summer or fall rate hikes. This is good for the home builders as it extends the low mortgage rates through the typical summer home buying season. It also means businesses will have nearly six more months of ramp time. It is like pitting under a yellow flag during a car race. The longer the yellow is out the more cars can pit for quick repairs. The longer the Fed is dormant the longer the stealth economy can continue to heal and gain speed.

Microsoft resumed its rise upward on Friday after dropping back to $53 at the open. The stock closed with a +$1.03 gain at $55.27 as the rumor about better than expected results resurfaced. It seems that MSFT has been managing earnings for so long that it has built up a stash of off book profits that it is now going to be forced to claim. The SEC has been looking at companies that manage earnings and is forcing them to clean up their act. The rumor is that MSFT will flush those profits out of the books this quarter. Microsoft just settled a two year SEC investigation last week where they alledgely hid up to $900 million in past profits to use later. This is prompting the rumor that a "repentant" Microsoft might beat the estimates using real accounting. In other MSFT news oral arguments will be made on Wednesday by the states disputing the proposed settlement.

In the software sector all eyes will be on Oracle when they release earnings next Tuesday. Larry Ellison has already said they would meet or beat the $.12 cents analysts expect but he did not say how. Analysts will be looking at revenue numbers for real guidance instead of profits derived from cost cutting, restructuring or tax savings. Many analysts expected Oracle to miss estimates and were shocked last week when Ellison implied they would hit estimates. Since it is common knowledge that Oracle has been having trouble signing those big deals for hundreds of thousands of dollars they are wondering where the earnings will come from. They will be waiting impatiently Tuesday night chanting "show me the money." Other earnings this week will highlight brokers and retailers.

Genesis Microchip got taken to the cleaners after their warning on Thursday. The stock lost -25% of its value and closed at $9.05. The selling did not rub off on the rest of the chip stocks with the SOX losing only -.81 for the day. The bad news was taken as company specific even though it was due to a boycott in corporate spending.

Investors appear to be in denial. With the Industrial Production and Consumer Sentiment numbers both pointing to another recessionary drop they bought the market dip on Friday. Earnings warnings are flying but they bought the dip anyway. A common sign of a bottom is when bad news is no longer able to push the market down. Could we be nearing that point? Some say yes. Others say short covering by mini-hedge funds were responsible for the Friday bounce. I don't put much faith in the mini-hedge fund scenario. The volume just does not support it. The combined market volume was only 3.4 billion shares on Friday with down volume beating up volume 6:5. Considering the severity of the morning drop that was a pretty good ratio but not serious short covering.

I think the more plausible answer is simply investors can count and read charts and they see what they "think" will be a bottom just a few trading days away. (S&P September lows of 944 intraday, 965 close) If your investment time horizon is years then buying the dips this close to a perceived bottom is a good tactic whether you are an individual or a mutual fund. I think this is why the dip bottoms are quickly bought but not with enough volume to produce those rocket rebounds we have seen in the past. They are simply setting out there with limit orders under the market and they are not chasing stocks once they rise above those limits. They are being very patient as we get closer to the September lows. They are letting the market come to them. I think the real buying in volume will come once those lows have been hit and they have held! There are analysts out there calling for 600 on the S&P and 7000-8000 on the Dow. Even with a double dip recession I can't imagine those numbers in our current high tech world. Considering the Dow is now trading at Jan-1999 levels a lot of pain has already been factored in. The Nasdaq has time traveled back to July-1997 levels. Very few investors can vision a significant drop from here. Of course you would have had a hard time finding a group of investors who thought today's numbers were possible two years ago.

The bottom line here is I don't think we are done but we are getting very close to at least a temporary bottom. Temporary? Yes, it is entirely possible the first test will produce a bounce that fails and we will have to retest again just to convince those hardcore bears that it is time to hibernate. That second test could include a monster capitulation day. Market makers are getting hammered daily. With no buyers they are forced to continually dump stock only to turn around and get hit with another load on their screens. If the first bounce does not hold they may just step back and let the prices fall until volume buyers appear. Until that day they will always be looking over their shoulder wondering when the next flood of sell orders will appear. All the retail stop orders will be cleared and they will start with a clean slate.

Monday morning could be exciting as we enter an expiration week with loaded internals. The VIX closed right at 30 which is historically very bullish. It spiked to just over 33 intraday, a level it has not seen since Nov-2nd-2001. The TRIN was not as positive at the close at 1.34 but it also spiked to 4.68 intraday. A high not seen since September. The put/call ratio closed at 1.15, which is extremely bullish. From my Friday night viewpoint it looks like the open on Monday could be bullish. Expiration weeks recently have seen the market rise the prior week to be flat to down during expiration week itself. Nobody knows what this week will bring but you can bet that it will not be boring. With the wide intraday ranges coming back into the markets it is just one more piece of evidence that the bottom may be near. Could it be next week?

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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