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Market Wrap

What Rally?

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      07-09-2002           High     Low     Volume Advance/Decline
DJIA     9096.09 -178.80  9318.10  9081.96 1.31 bln   1113/1845
NASDAQ   1381.12 - 24.50  1415.31  1379.57 1.65 bln   1511/2016
S&P 100   475.24 - 11.05   488.75   474.33   Totals   2624/3861
S&P 500   952.83 - 24.15   979.63   951.71 
RUS 2000  429.25 -  4.36   435.19   428.61 
DJ TRANS 2576.57 - 39.20  2647.63  2575.43   
VIX        33.92 +  2.39    34.23    31.15   
VXN        62.12 +  2.83    62.25    60.05
Total UpVol   650.7M
Total DnVol 2,343.2M
52wk Highs  137
52wk Lows   324
TRIN        2.72
PUT/CALL     .87

The Dow came within 34 points of retracing the entire +323 point gain from Friday. The SPX, OEX and Nasdaq all hit their July-3rd closing levels or broke them. The "Rally" is now history for all practical purposes and we are back to "earnings" as usual. Those earnings will highlight INTC, IBM and MSFT beginning next Tuesday.

Chart of the Nasdaq

Chart of the Dow

The morning started off good despite the multiple downgrades of the chip sector. The markets actually traded in positive territory numerous times both before and after the presidents speech. The bulls continued to be in denial that the rally on Friday was just short covering and those that were long lost their lunch money. The bears began loading up around 1:30 and the ugliness continued right into the close.

Merrill Lynch began the morning with a downgrade of 13 chip equipment stocks citing a dramatic slowing in orders over the last several weeks. They hit companies like AMAT, KLAC, LRCX and NVLS. They cut ratings, 2002 and 2003 earnings and sales estimates and told clients they believe there will be a pause in new orders over the second half of 2002. Pretty negative! As if they knew about the Merrill downgrade, Deutsche Bank cut its earnings and price targets on 8 chip equipment makers as well. They cut 2003 growth estimates to +15% from +30% and said stock prices will likely remain under pressure for the near term. To put this in perspective the chip market was $230 billion last year and they are struggling to hit $140 billion this year.

Surprisingly, despite the chip sector downgrade the Nasdaq did not immediately crash. There were other tech problems as software companies RETK, CTXS, CAMZ and IONA warned of lower earnings. They joined JDAS, OPWV and ITWO which had already warned. Breaking out of the pack was Microsoft which posted a $.29 cent gain despite the loss in the broader markets. Bernstein said they thought MSFT would beat current estimates due to last minute orders ahead of the change in enterprise licensing agreements. They cut their 2003 estimates slightly to $2.09 but are still well ahead of the $1.92 consensus. They said the .NET uptake was slower than expected but set a price target of $70.

Dell announced they were reaffirming their earnings of $.18 cents for the quarter but the COO said they were seeing no increase in demand for personal computers. Rollins said that any glimmer of hope that demand was increasing was just not happening yet. They said they were able to maintain their earnings estimates due to reduced costs and gains in market share. Dell finished flat for the day.

Techs were not the only sectors in trouble. Wyeth said this morning that the a study of its HRT product was terminated early after it was found to increase the chances for heart attacks and breast cancer. The study was terminated early after it was not determined to not have any long term benefit to offset the dangers. The Prempro product is a huge money maker for WYE at something like $2.5 billion a year. According to estimates over six million women take the two drugs in the product, estrogen and progestin, to offset the symptoms of menopause. WYE dropped nearly -$12 or -25% on the news. The news rippled through the industry as it caused concerns about other products in the pipeline. NOVN, which also sells hormone replacement therapies for women, dropped -5.62 or -27% on the news. The BTK.X fell to close at 301 and its lowest level since Dec-1999.

Tiffany, TIF, warned that slower consumer sales would impact earnings for the rest of the year. This news hit TIF stock for nearly a -10% loss but the impact was broader than just TIF. This is another clue that consumers are starting to reduce their spending and beginning to worry that a second recessionary dip is approaching. This is likely to be shown in the next installment of the consumer sentiment due out Friday. We will also get Retail Sales on Friday, which could be another nail in the recovery coffin despite a couple of positive early reports.

IBM issued some financial guidance after the close. No it was not a warning but it was a reduction in earnings. They are taking a -$515 million charge for selling their disk drive operations. The "restatement" was to take the earning/losses/revenue of this unit out of the statements. IBM has been criticized for not breaking out details of its internal units and accused of hiding costs and storing profits to manage earnings. This restatement is the first step but they also announced they would lay out next week a $2.5 billion pre-tax charge for the disk drive business and closing some electronics manufacturing operations. The stock did not fall in after hours trading as investors have nothing to compare the restatement with. There will doubtless be some second-guessing and possibly some downgrades before the week is out. I cannot conceive of any scenario where IBM will beat estimates unless the massive book losses put them into a different tax bracket. This story is not over yet.

Now that the retracement of the Friday's gains is complete we are free of the technical baggage of an unfilled gap. The markets are now at the mercy of earnings again but based on the Nasdaq strength today that may not be bad. Despite the multiple downgrade of the chip/software sectors the Nasdaq did not crash until the S&P, the weakest index today, pulled it kicking and screaming under water. The Nasdaq struggled to hold 1400 and a -5 point loss all day and was successful until 2:PM. This was remarkable in the face of the downgrades. The major indexes closed right at support from last week and pushing them lower would take some doing. The S&P is just 8 points above the 944 post 9/11 low which held on a closing basis last week. The OEX is only 10 points away from its lows from last week.

Granted, if the markets are bent on setting new lows these levels will just be speed bumps on the way. However, buyers who missed the boat on last week's rally are being given a second chance. If we are going to bounce the S&P-944 level is a highly visible number that can easily be rationalized as a double bottom buy signal. I would not attempt to call a bottom here but I would buy any bounce from these levels as tradable. My overall outlook is still bearish but there was enough underpinnings of sentiment this morning to make me think there could be a long trade on the horizon. With the VIX at 34.05, VXN at 62.08 and TRIN at 2.72 the markets have gone full circle again. Extremely overbought to extremely oversold in only two sessions. This is a recipe for a bounce, probably another bear trap, but still a bounce.

In late news S&P announced some major changes to the S&P-500. They are kicking out seven non-U.S. firms and replacing them with U.S. companies. The deletions are RD, UN, NT, AL, ABX, PDG and N. The additions are UPS, GS, PRU, EBAY, PFG, ERTS, SDS. As always the deletions will be dumped by all the index funds and the additions will be bought in volume. Considering the size of many of the new companies there will be some shuffling to balance market caps. The change will be effective as of the close on July-19th.

Enter Very Passively, Exit Aggressively!

Jim Brown

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