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Market Wrap

Watch Out For That Pothole Ahead

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      08-01-2002           High     Low     Volume Advance/Decline
DJIA     8506.62 -230.00  8734.31  8479.90 1.91 bln   1224/1954
NASDAQ   1280.00 - 48.30  1326.10  1276.88 1.47 bln   1259/2140
S&P 100   444.32 - 14.55   458.87   443.12   Totals   2483/4094
S&P 500   884.66 - 29.96   911.62   882.48 
RUS 2000  389.21 -  3.21   394.47   388.00 
DJ TRANS 2308.26 - 61.08  2371.74  2307.58   
VIX        41.49 +  6.28    41.80    36.70   
VXN        60.35 +  2.49    60.93    58.80 
Total Vol   3,595.9M
Total UpVol   671.2M
Total DnVol 2,836.1M
52wk Highs   48
52wk Lows   298
TRIN        2.26
PUT/CALL     .76

The day's economic reports produced more of the same in the form of slowing growth and rising unemployment. The airwaves were full of the arrest of WCOM executives and the promise of more in our future. After the close it was announced that the Tyco CFO and General Counsel were leaving the company. This may be the prelude to the markets as we approach the August 14th certifications. The economy is weakening and employees at risk are fleeing sinking ships.

Chart of the Dow

Chart of the Nasdaq

The big news this morning was the ISM report. This is one of the most watched report cards on the economy and the average grade today was a "D". Analysts were expecting a headline reading of 55.0 and got a 50.5 instead. This was down from 56.2 in June. All the internal numbers went the wrong way.

Table of ISM numbers

The numbers shaded represent weaker numbers than the month before. New Orders fell from 60.8 to 50.4. Only 0.4 away from shrinking instead of expanding. Order backlog did shrink to a declining number (over 50 expanding, under 50 declining) indicating that new orders have fallen below flat. These are recessionary levels. The only component up for the last six months is the prices paid component and this indicates that inflation is starting to creep into the economy.

Analysts were trying to spin this report as "economy still expanding" because the headline number was 0.5 over the flat line. Think about it. With all the warnings about falling sales and orders going forward does anybody really think the August numbers will be anything but negative? The 50.5 was the lowest number since January's 49.9 when we were just coming out of a recession.

Construction Spending was also reported on Thursday with a drop of -2.2% which followed last months -2% drop. This was well below the expected +0.3% increase. Nonresidential construction posted its fifth consecutive monthly decline and residential its third monthly decline. This report was seen as very negative as a drag in construction would also be a drag on future GDP. This was the lowest level in six years.

Together with the weeks already announced GDP, Beige Book and PMI, all showing declines, it is very hard to put bullish assumptions on the stock market. About the only positive data out this week was the auto sales today which showed a slight increase over last month. This increase in sales came with the resumption of zero percent financing and discounts as high as $7,000 per vehicle. You can sell anything if you give it away. Friday we will get the nonfarm payrolls and any reduction in jobs will be the final nail in the bullish coffin. Analysts are expecting 50,000 new jobs and an unemployment rate nearer 6.0%. A net loss of jobs will be very negative.

In stock news ADBE led the way with last nights warning that revenue would be -10% below previous estimates. The company lost -7.13 to 16.83 and took the rest of the software sector with it. They said software spending was still very constrained even for upgrades and sales had weakened in July.

After the close today Disney announced estimates that met street estimates but then warned of slowing bookings for the current quarter by -6% and -10% for the fourth quarter. This is a sure sign that the consumer is being more cautious and should be a leading indicator that the hibernation has begun.

National Semi (NSM) warned after the close that weaker than expected order rates for personal computer products and related accessories like monitors would impact their estimates. They did say orders for the following quarter were building now that the merged Compaq and HWP were placing orders again. This follows the NVDA warning earlier in the week and could mean problems for Intel before the quarter is out.

After the bell Dow Jones reported that Tyco CFO Mark Swartz and General Counsel Irving Gutin are leaving the company. According to many analysts the CFO is the only one besides ex-CEO Dennis Kozlowski who really knew what is happening inside Tyco. Both men said they would remain at their posts until replacements were found. I am going to bet that this scene will be repeated many times in the near future as life in the hot seat becomes unbearable. With new criminal penalties for financial misstatements the running of multidivisional companies with far flung operations and having to certify the accounting for thousands of employees is suddenly not a highly sought after position. With officer salaries ready to plummet in a fresh wave of stockholder unrest, the risk- reward ratio is not what it used to be.

There is also the cloud of suspicion for everyone currently running a company until they certify. Tyco has already said it could be months before they can swear to their statements. A rumor that John Chambers, CEO of Cisco, was going to resign rather than certify statements caused CSCO to drop -1.13 on volume of 132 million shares on Thursday. There was also a rumor that the CFO Larry Carter had refused to certify their statements due to closet skeletons. Traders are also worried that CSCO will announce a huge house cleaning with their next earnings to dump some prior problems so they can certify for the next quarter. Cisco has a July 28th year-end so they don't have to certify until October. Cisco said it would not comment on the rumors. It is too early to tell is they will or won't but comments reportedly from the officers indicate they will probably sign. Of the 947 companies required to certify statements only 18 companies have said they would vouch for their books and the starting date is only 12 days away.

Tomorrow we will also get mutual fund flows and from the amazing resiliency of the markets this week I would think there was a slow down in withdrawals. Possibly even an small positive inflow. However after the negative economic news this week this is likely to be only a pause in the flood. Retail investors have had the double dip recession picture painted for them in almost every conceivable way and many of those not hopelessly mired in the "buy the dip until broke rut" are going to pull money out next week. The picture is clear. Despite the lowest interest rate in a decade and a Fed that is pumping money into the market by multiple billions every day the economy and the markets are still falling. According to the futures there is nearly a 50% chance of another Fed rate cut at the August meeting. Will this be a desperation cut because the economy is worse than we thought? Definitely! The Fed will try to spin it as an "insurance" cut but not many would be fooled. Is another -25 point cut really going to help now if an entire year of cuts has barely put the economy back onto life support? This is a cyclical thing and everyone has to get used to it. We had the longest bull market and economic expansion in recent history and now we are suffering through the obligatory bear market and recession. Just as our excessive highs were extreme our bottoms will be just as extreme. The current accounting nightmare is just another log on the fire.

How much farther can the market drop? Nobody knows. Merrill Lynch cut their 12-month target on the S&P to 960 today. Think about that. The S&P closed at 883 today. Do you think they are planning on a rebound to 1200 over the next 12 months and a return to 960? I don't think so! They are expecting the market to drop to lower levels (not stated) and return to 960 within 12 months. We all know that targets are rarely hit but the thought process that went behind this is critical. They had to analyze a lot of factors relating to the economy, earnings and the impact on stock prices before deciding to go public with another lowered estimate. This impacts the buying habits of tens of thousands of Merrill customers. In effect they are saying more bear market ahead, batten down the hatches. Their previous target was 1050 and they would have gotten considerably less grief by just sticking to that number.

Merrill's chief U.S. Strategist Richard Bernstein said his indicators were deep into "sell" territory in a note to clients. He said, "Even though investors are becoming increasingly aware of the problems confronting the stock market they remain far from the psychological state of capitulation that would signal a bottom. Also, stocks are not cheap when considering low interest rates and inflation. Investors are ignoring that the S&P earnings growth is the least predictable and the most variable as anytime in the last 60 years." Do I believe everything I see and hear? Heck no. However if only 25% of what we hear about the economy and current accounting crisis is true then there is a lower low ahead of us. I think these high profile warnings are overly extreme but they should prompt traders to be more cautious about buying this dip.

I have wandered too far astray tonight so I am not going to cover specific market levels. Leigh does an excellent job of that in his Index Wrap. (link below) I think the bulls have one last chance to attempt a rally with the nonfarm payrolls tomorrow morning. An upside surprise could cause just enough confusion to get one more bounce before the negative economic news from this week begins to weigh even heavier on the markets as investors withdraw even more money from mutual funds. The question remains, "Why buy", and until it can be answered convincingly our future is not bright.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
Editor

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