Option Investor
Market Wrap

Back in the Red Again!

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        WE 7-12          WE 7-05          WE 6-28          WE 6-21  
DOW     8684.53 -694.97  9379.50 +136.24  9243.26 - 10.53  -220.42  
Nasdaq  1373.50 - 74.86  1448.36 - 16.58  1464.96 + 24.01  - 63.79 
S&P-100  458.91 - 33.75   492.66 +  2.54   490.12 +   .70  - 12.34 
S&P-500  921.39 - 67.64   989.03 -   .79   989.82 +   .69  - 18.14 
W5000   8711.50 -601.90  9313.40 - 70.63  9384.03 -  5.95  -159.74 
RUT      413.28 - 27.64   440.92 - 21.74   462.66 +  1.59  +  2.00 
TRAN    2480.14 -172.50  2652.64 - 77.68  2730.32 - 25.32  + 82.50 
VIX       38.33 +  8.12    30.21 +  1.08    29.13 -  2.15  +  1.35 
VXN       66.00 +  9.72    56.28 -  1.67    57.95 -  1.35  +  3.63 
TRIN       0.89             0.28             1.18             2.01 
Put/Call   0.64              .77              .66             1.27

After a one week pause the Dow resumed it downward trend with the worst performance since the week after 9/11 The spectacular +323 point gain from last Friday was wiped out with a huge -694 point drop for the week. (-6.8%) The Nasdaq, although more resilient, also dropped another -74 points. This was the worst showing for both indexes in some time. The bad news still remains more downside risk ahead.

Chart of the Dow

Chart of the Nasdaq

After the Dell guidance on Thursday and JNPR beating estimates, GE announced earnings on Friday and met street estimates on the surface. GE affirmed estimates going forward but cautioned that the good times had not yet returned. Analysts were quick to point out that GE earnings only increased +5.5% after special items were discounted. Not the +14% headline number, which was reported. The opening bounce was blunted by the Retail Sales report, which beat the consensus on the surface with a +1.1% gain but a closer look revealed that ex-autos it was only +0.4%. This is still good but left spoiled traders wanting more.

The big rally blunting news was the Consumer Sentiment report which showed a drop to 86.5 from Junes 92.4. June had also dropped from 96.9 to 92.4. This represents a -10.4 drop in the last two months. The expectations component dropped a spectacular -9.4 points in the first half of July alone. The 78.5 reading is the lowest since last November. Analysts blamed the markets, worries over corporate finance and continued rises in unemployment as the reasons. The drop in sentiment is a leading indicator for a drop in consumer spending and analysts fear an indicator of the coming second dip. Economists swear a double dip recession is not probable but the signs are creeping back into the economy.

Corporate problems were again in the headlines. Duke Energy and El Paso Energy acknowledged that they were under investigation for energy trading schemes. This tanked the energy sector again and helped push the Dow utilities close to a new low.

News reports repeated the claim that Ebbers knew about the fraudulent transaction for at least a year and the SEC announced they had issued dozens of restraining orders and asset seizures. They said they are also pursuing vigorously and quickly to prosecute the guilty corporate officers. Expect the WCOM officers to be on the top of that list. Investigators said that there was absolutely no doubt that many more people at WCOM were aware of the problems. While the news is good long term for the market the short term impact was psychologically negative. 25 banks filed suit against WCOM on Friday for defrauding them of $2.5 billion six weeks before disclosing the $3.6 billion scam.

After the bell the Wall street Journal reported that Qwest was going to restate their 2001 results and erase more than $1 billion in revenue from transactions under investigation by the SEC. The "swap" transactions were used by several telecom firms to inflate revenues when there was actually no financial benefit. Qwest has $26 billion in debt and its credit rating has been cut to junk. This may not be the end and it is seen as a preemptive event but one that the SEC could see as not strong enough.

In an effort to avoid investor flight FNM and FRE decided to register their stock with the SEC but the agreement stopped short of requiring them to register their debt and mortgage bonds with the government. FNM CEO said it has not issued stock since the 1980s but makes 1,500 debt issuances and more than 40,000 mortgage backed security releases annually. SEC chief Pitt endorsed the arrangement in lieu of proposed legislation that would repeal their exemptions from reporting to the SEC. FRE and FNM have more then $1.3 trillion in debt and Congress had introduced legislation to cancel their exemptions in reporting on that debt. The companies have resisted calls for normal mandatory disclosure requirements. Wonder why they are so strongly against it? Enquiring minds want to know.

An era passed into history on Friday. Investment banker Robertson Stevens closed their doors for the last time. It was announced 15 min after the market closed that Fleet Boston had given up on trying to sell the company and issued the order to close the it. Tough times when well known and highly reputable companies with over 850 remaining employees are shut down due to lack of interest. Fleet paid $700 million for RS in 1998 to capitalize on the technology boom and the IPO frenzy. They anticipate a charge of nearly $500 million for the shutdown. I wonder if they are going to auction off the 2,000 flat panel monitors they were showing in their trading room? Give me a dozen at $250 please!

TrimTabs.com reported that nearly $6.3 billion flowed out of equity funds in the holiday shortened week ended Wednesday. While this compares favorable on the surface with the $10 and $9 billion prior weeks we need to remember it was really only three days. The bottom line is that investor sentiment has not changed and with the huge drop in the markets this week the number next Friday could be significantly higher. However, we are reaching the law of diminishing returns. $1 billion withdrawn from the markets a month ago was when stocks were selling at much higher levels. $1 billion next week could actually represent $1.25 billion the prior week and even $1.5 billion a couple weeks earlier. With new lows far outpacing new highs every day the loser stocks are getting much cheaper. An average of 436 stocks made new lows every day last week. How much does every billion withdrawn from equity funds next week really represent when it was first invested? Something to think about.

First Call went on record again with the prediction that earnings for the second half could be rocky and analysts estimates are far too aggressive. I have mentioned this before so I will be brief. They claim the economic possibilities are far too grim for the current optimistic projections for the last two quarters. When analysts estimated earnings for the full year back in late 2001 they were operating on the assumption that the recovery would be stronger than it has been. Therefore the expectations are too optimistic. They have been too slow to revise them in hopes they would not have to look like idiots to the public. The closer we get to the 3Q the more drastically they will have to reduce them. To put it bluntly, after the reduced expectations are seen in the current earnings cycle the forecast for 3Q/4Q will drop quickly and with it the stock prices.

This earnings estimate inflation and the possibility of negative disclosures does not bode well for the earnings cycle that moves into full speed next week. With the push to prosecute, freeze, confiscate assets, fire and ride executives out of town on a rail in full view of the press, the urge to "under report" and "over disclose" will be strong. What good is it to report pumped up earnings if you only have to restate when pressured by the SEC and investor watchdogs? It is a self defeating prospect and everyone will think twice before doing it this quarter. This is the primary reason the markets are in free fall. Fear of the unknown! They can no longer count on the estimated earnings being right or even close and the only protection is to move to cash until the smoke clears.

This week we have Intel leading the way on Tuesday. Widely expected to guide lower their guidance will be critical for techs. Should they miss estimates the blow would be even worse. IBM follows on Wednesday and you know I expect trouble there. IBM not only may miss estimates but could rock the markets by disclosing any number of negative events. Nobody will want to be long the market when they announce. Microsoft will announce on Thursday and could actually beat estimates if the switch to a new licensing scheme produced a buying rush before it took effect on July-1st. All three of these are Dow components and a drop to disaster levels by the first two announcements could see a rebound on positive Microsoft news. If MSFT were to guide lower I do not even want to consider the result. Sound bearish enough? I am just trying to be realistic and paint the picture graphically enough for everyone to understand the complications.

The Dow may have dropped -694 points for the week but there are those technical analysts that are predicting much worse. There are numerous "experts" now pointing out their version of a head and shoulders top and predicting dire results. While I do not give the very long term theory much credence and would rather base my assumptions on current events I feel the need to point out this projection.

For more information on this pattern click here;
http://www.stockcharts.com/education/What/ChartAnalysis/headShouldersTop.html Personally I think the earnings event risk from next week coupled with a desire to stand aside until the September bottom is tested by the Dow is a strong enough reason to expect something in the 8100 range soon regardless of what technical pattern you lay over it. Technicians have a habit of ignoring news events and assuming their chart patterns will lead them. I agree to some extent but the charts don't know who will confess next or how bad IBM will miss earnings. Real investors are standing aside because they are fed up with the current situation and fear the future. The charts are the speedometer which indicates the speed of the crash and will tell us later how bad it was. The bottom line to me is "why buy?"

If you are an investor today you may be thinking about picking up some "cheap" stocks for the eventual recovery. The problem is still cheap by what yardstick? Price, PE, historical valuations? What if, like WCOM, they admit they falsified $3.6 billion in earnings over the last two years? Can they suddenly become overpriced? The point of course is that literally millions of investors are considering the risk of being in the market today and deciding cash looks better every day. Before I scare you out of being an investor completely just remember that when the smoke clears over the next 90 days the real bargains will appear. Those that are patient will profit handsomely. The market is NOT going to run away from us over the next week or two. Despite any short-term relief rallies the mother of all call opportunities will still be in our future.

Be sure to check out the Traders Corner by Mike Parnos today. http://www.OptionInvestor.com/indexes/traderscorner.asp

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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