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Market Wrap

Volatility Reigns!

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      07-25-2002           High     Low     Volume Advance/Decline
DJIA     8186.31 -  5.00  8309.39  7945.95 2.82 bln   1819/1368
NASDAQ   1240.08 - 50.20  1289.72  1220.93 2.32 bln   1550/1910
S&P 100   417.30 -  2.68   425.62   405.99   Totals   3369/3278
S&P 500   838.68 -  4.75   853.83   816.11 
RUS 2000  378.11 -  0.45   385.22   371.27 
DJ TRANS 2236.58 + 52.70  2250.16  2730.32   
VIX        44.65 -  0.64    47.88    43.11   
VXN        69.48 +  3.89    69.92    65.53 
Total Vol   5,501.0M
Total UpVol 1,499.4M
Total DnVol 3,735.9M
52wk Highs   31
52wk Lows   557
TRIN        1.63
PUT/CALL     .76

The Dow and Nasdaq headed in different directions early but despite the Nasdaq anchor the Dow managed to post a very strong day. The Dow opened with a -126 point drop followed by a wild ride of +210, -131, +157, -364, +287 point swings. Those point swings look more like a week of trading instead of a single day. The Nasdaq headed south at the open and never looked back until some short covering at the close. At one point the NDX futures were limit down with a -5% loss after Taiwan Semiconductor lowered estimates for the third quarter.

Chart of the S&P/Dow

Chart of the Nasdaq

The markets started off weak after Durable Goods Orders dropped an unexpected -3.8% when the consensus was for a gain of +0.4%. This wipes out all the gains made to date in 2002. Suddenly there was real evidence of a cutback in spending and a possibility of weaker times ahead. Computers and related equipment fell -7.1% and communications equipment fell a whopping -12.9%. Nondefense capital goods dropped -8.5%. If all this was not bad enough the positive +0.9% gain for May was revised down to +0.6%. The problem is being worsened by the stock market crash and the shutdown of the credit markets. This is limiting the amount of money available for companies to upgrade additional equipment and ramp up for new products. This is a lagging indicator because these numbers are for June and we are already deep into July and conditions are worsening.

The markets also reacted to an unexpected drop in existing home sales. The -11.7% drop pushed home sales to an eight month low and wiped out the +6.7% gains made last April. The much talked about housing bubble may be far from over for new homes but it is clear existing home owners are deciding not to sell or are having a much harder time finding buyers. The inventory levels are currently at a 4.9 month supply. Contrasting this drop in existing home sales was a slight increase in sales of new homes. The annual rate increased by 21,000 units over the consensus but definitely showed a slowing pattern over the +65,000 unit increase last month. These sales are being fueled by record low mortgage rates but if existing homes can no longer be sold then the pace of new home sales will slow as well.

Further indications of the slowing economic conditions was a warning from Taiwan Semiconductor this morning. They posted weaker than expected profits and surprised investors by saying things would get worse in the July-September quarter. TSM is the largest contract chip maker in the world and has the largest capital expenditure budget behind Intel. They are cutting capex spending by -$600 million. Their T$.49 earnings missed analyst's estimates of T$.56 cents. They said 3Q shipments would drop substantially and average selling prices by -5% due to competition. The CEO said he believed the recovery was coming but that the 3Q would show a pause until consumer confidence returned and capital markets loosened.

This warning hit the Nasdaq semiconductor and PC sectors very hard. Stocks that rallied strongly yesterday were down several dollars today. KLAC for instance was down to $36.55 intraday from yesterday's close of $42.30. The SOX dropped over -10% to a new 52-week low before short covering and some bargain hunting appeared at the close. This drastic drop by the semis dragged the Nasdaq futures to a limit down condition in early afternoon after an initial -5% drop. The Nasdaq finished down -50 points for the day but well off its -70 lows. Still this expanding worry over the future of tech stocks could continue to weigh on the tech sector.

The 800lb tech gorilla, MSFT, held an analyst meeting on Thursday and admitted they had made some expensive mistakes. They are planning to increase the size of their work force by 10% (5,000) and increase their R&D budget nearly +$1 billion to $5.2 billion in this fiscal year. Analysts and investors were not excited by the lackluster business summary and outlook. The stock traded down -3.41 on the day to $42.85.

The biggest impact to the markets during the day was a repeat of a news story that the SEC was investigating Citigroup and JPM. The key point appeared to be that there was a "clear attempt to mislead investors" and several analysts say the companies could be subject to severe civil and criminal penalties. Moody's downgraded their outlook on JPM to negative from stable saying their reputation and credibility could sustain serious damage. This type of downgrade is normally a prelude to a major cut on a companies debt ratings. The companies fought back in the afternoon saying that this was old news and they did nothing wrong and the stocks recovered slightly.

After the close today QCOM beat estimates and raised guidance saying orders were picking up for its CDMA technology. This bullishness was surprising after Telecom Italia dropped plans to implement the 3G technology in Europe. QCOM was trading up +1.63 in after hours.

JDSU also announced a loss of nearly $1 billion and said the meltdown in the communication sector was continuing and the outlook had dimmed for its fiber optic components. They said economic conditions continued to impact the sector and business was not going to improve and sales would continue to drop in the current quarter.

AOL fell to a low of 8.63 intraday after reporting results that disappointed analysts and investors. This is a five year low and was prompted by news that the SEC was investigating numerous factors relating to their accounting. Many examples were given today but AOL and their accountants defended them all. Essentially they booked large volumes of special items as ad revenue when they were really other types of gains. AOL wanted to pump ad revenue to support their business model and shifted one time events into ad sales to inflate these numbers according to news reports. It is almost certain that AOL will now be spun off from Time-Warner as the fortunes of AOL continue to decline. Ironic how quickly things change.

Thursday was the fifth day in a row that the NYSE has traded over two billion shares. Volume was very strong at 2.82B on the NYSE and 2.32B on the Nasdaq but the advance/decline was flat with an even mix of advancers to decliners. While this may sound good on the surface the down volume was 3.7B to only 1.49B of up volume. There was a lot of stock traded but despite the remarkable rebound by the Dow it was still a negative day. Many have remarked that Wednesday was a capitulation day. Sorry but that does not compute. One yardstick for a capitulation is strong advance/decline imbalances at the bottom followed by strong imbalances in the opposite direction on the way back up. The advance/decline ratio yesterday was only 4:3 in favor of the advances. Far from a strong imbalance! The new lows yesterday were a very high 1746 but today's action also produced 573 more new lows. If we had seen a bottom yesterday those lows would have been minimal.

Despite the previous paragraph I saw some bullish signs today. The rumor that Tyco was going to file bankruptcy had no impact on the market. The dip on the Citigroup/JPM/SEC news was met with strong buying and C finished positive on the day. The TSM warning tanked the semi sector but buyers appeared at days end. The AOL news impacted the Internet sector but was largely ignored other than the drop in AOL stock. The Durable Goods and Existing Home Sales both dropped much more than expected. Even after all these negatives the Dow rebounded +287 points off its low to close flat and retain nearly all the monster gains from yesterday. This is very bullish. The bears were unable to sell off the end of day rally and there were several strong buy programs instead. Is this a sign we have seen the bottom? I doubt it but it is a sign that there are still buyers with money on the sidelines.

The Wednesday bounce and the intraday recovery on Thursday may only be a strong trading rally but it is a definite change in the trend. This leads me to expect a positive open on Friday and possibly only a minor sell off around lunchtime on profit taking. The wild card here is the Consumer Sentiment number due out at 9:45. This will be the second update for July and with the huge market drop over the last two weeks I expect it to fall again. The magnitude of this fall will determine our direction tomorrow.

The bottom line? About the only thing we can guarantee is that volatility will continue to reign and there is a great possibility of another triple digit move. Fortunately the Sentiment Report is early and that could give us the directional signal for the day. Earnings are beginning to dwindle and despite the bullish signs I pointed out above there is still no overwhelming reason to buy and hold stocks. Until there is any rally is doomed to fail.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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