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Market Wrap

It's the Economy Stupid!

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        WE 8-02          WE 7-26          WE 7-19          WE 7-12
DOW     8313.13 + 48.74  8264.39 +245.13  8019.26 -665.27  -694.97 
Nasdaq  1247.92 - 14.20  1262.12 - 57.03  1319.15 - 54.35  - 74.86
S&P-100  434.05 +  7.12   426.93 +  3.83   423.10 - 35.81  - 33.75 
S&P-500  864.24 + 11.40   852.84 +  5.09   847.75 - 73.64  - 67.64
W5000   8186.56 + 94.93  8091.63 +  8.63  8083.00 -628.50  -601.90
RUT      376.45 -  5.81   382.26 -  3.94   386.20 - 27.08  - 27.64
TRAN    2202.03 - 52.76  2254.79 - 77.39  2332.18 -147.96  -172.50
VIX       45.39 +  4.95    40.44 -  3.01    43.45 +  5.12  +  8.12
VXN       65.44 -  3.58    69.02 +  7.85    61.17 -  4.83  +  9.72
TRIN       1.47             1.21             1.44             0.89 
Put/Call   0.93             0.70             1.14             0.64 

The Dow climbed back above 8300 at the close and managed to retain some of its gains for the week. The strength came in the techs at the close with the QQQ trading huge blocks as bulls/bears battled over direction. The Dow may have finished positive for the week but not without a black eye and bloody nose. The trend changed as blow after economic blow rained down on the markets.

Dow chart

Nasdaq Chart

Two dips please and I am not talking chocolate. That is the growing consensus of opinion after the barrage of bad economics reports this week. The Jobs Report was just another piece of the puzzle and it appears that the picture is turning ugly. The economy only created +6,000 jobs in July and that was far below estimates of 68,000-75,000 depending on who you asked. This was just a squeak above losing jobs and as some point out only a "revision" away from recessionary. Critical indications of weakness included a drop in the manufacturing work week, overtime hours and the average workweek. Without growth in these areas employers will not need to hire additional workers and a continued drop will prompt more layoffs.

The unemployment rate remained at 5.9% as more unemployed workers dropped off the unemployment rolls after exhausting benefits while others simply got tired of looking and stayed home or retired early. The aggregate weekly hours, which is a proxy for GDP growth, declined by -0.6% with the largest decline since October. Construction lost the most jobs with a -30,000 cut as construction spending fell as we saw earlier in the week. Employers kept their checkbooks shut tight as worries about slower orders kept a lid on hiring. With hours worked and take home wages dropping the consumer is not likely going to be a big spender over the next quarter.

The Factory Orders dropped in June by -2.4% which was the worst drop in the last seven months. Last months numbers were also revised down. With the economy apparently hitting a wall in July the trend here is very troubling. With the consumer going into hibernation it will require more business investment to jump start new orders and without sales it will not happen.

Al this dire economic news has led to multiple projections of a dramatic Fed move in our future. Goldman cut their estimates of 2002 GDP to 2.0% from 2.5% and lowered 2003 as well. They projected a Fed rate cut of another 75 basis points between now and year end. This would be unprecedented in recent history and would put the Fed funds rate at 1.00%. This would prompt an entirely new round of refinancing and new home loans and make saving practically worthless. With money market accounts earning interest below the inflation rate consumers would be prodded to spend or invest the money instead of let is sit. The hope would be to stimulate another wave of consumers withdrawing equity from real estate and seeing that money begin to circulate instead of being tied up in property. There is a real move in progress to drastically cut rates and increase government spending to avoid a Japanese style deflation spiral.

In a report that was glossed over in the media, semiconductor billings dropped for the first time in three months. The drop was only -0.2% but in a time when orders are supposed to be increasing the drop was troubling. Manufacturers have been plagued with order cancellations and delays as a lack of economic recovery delays plans to build inventory. Since computers account for about half of all chips made the slowing PC sales will continue to impact the actual delivery of current orders. You can order anything you want as long as you don't have to take delivery until you are ready. This puts a squeeze on manufacturers who want to use the slack time to build orders but not if those orders may be delayed or cancelled indefinitely. The SOX.X broke to a new low under 300 intraday.

Adding to the cautious comments from Disney with their earnings on Thursday was the Four Seasons hotel chain. They said they were seeing no pickup in U.S. business travel and no pickup in global lodging. Hilton, Marriott and Starwood all posted lower lodging rates this week as well. There was some pre-Sept 9/11 anniversary worries. It appears nobody wants to be traveling anywhere around the anniversary of the attack. Whether the risk is real or imagined it could seriously hamper the fragile recovery if consumers and business travelers are already blacking out their calendars for that period. The already troubled travel/transportation industry took another hit when UAL disclosed they had contracted a bankruptcy attorney and would be in serious financial trouble if they could not get a Federal loan guarantee for nearly $2 billion.

Stock news on Friday was basically a rehash of the weeks highlights. AOL disclosed on Friday that the SEC had broadened their probe of their accounting problems and were now looking at past dealings and acquisitions. AOL closed at $10.40 with a loss of -.71. Cisco traded down another 50 cents near 11.50 after more disclosures were made about the future resignation of the CFO. In an effort to blunt the selling the company said the CEO/CFO were planning to certify the financials but not with the current quarter. They would certify beginning in October. This brought increased selling as investors feared they would be flushing huge problems through this quarter to clean house. They also expect CSCO to report weak sales and flat guidance and possibly miss earnings. There is a fear that they will be pushed into expensing stock options along with the building tide to do so. Cisco currently has a PE of 23 based on 2003 estimated earnings but throwing options into the mix would push that forward PE to a whopping 39. Cisco announces earnings on Tuesday after the close and will be a drag on the tech sector until they do.

Somebody is not very confident in our rally potential. They accumulated a 50,000 contract position in the Oct-80 DJX puts at around $5 today. This is a huge $25 million bet that the Dow will be below 8000 by expiration in October. This bet could just be that it will drop below 8000 sometime soon or at anytime between now and October 18th. I could not find any offsetting strikes so it does not appear to be a spread. Those contracts traded as high as $7 as recently as last week when the Dow dropped to 7532. A drop to retest those lows would be very profitable and with the negative sentiment from this week the odds are good we will see numbers lower than that before October. There is also the possibility this is a portfolio protection play where an institution/fund with hundreds of millions in market exposure is hedging their long bets. Probably Jeff Bailey expanding his trading horizons! (grin)

The buyer above is not the only one who expects the market to drop. Morgan Stanley went on record as saying the economy was "on the brink" of a double dip. This puts current high valuations for stocks into question and suggests further market dips over the next quarter. Lipper said the value of U.S, equity funds dropped -9.3% in July and investor unrest was growing. AMG Data and TrimTabs.com were strangely silent on Friday and neither released any numbers for the week. Both indicated that the month of July accounted for something in the -$50 billion net outflow category. This was the worst monthly outflow ever. With the very negative economic news the odds of record withdrawals next week are good.

There was a strong move to close the Dow over last Friday's close. A positive result for the week would be less damaging to investor sentiment and could convince some that the rebound was still underway. They fought it hard with huge block orders being triggered when the Dow dipped below the 8264 level. They were successful and while the Dow finished -193 for the day it was up +48 for the week. This fact will be highlighted in all the weekly news recaps for weekend consumption. Will it be successful in slowing the markets fall? We will not know until this time next week. The big money could be funds trying to stem withdrawals or defend portfolios already in danger of further losses. The Nasdaq was the weakest member of the group and despite block trades in million share lots in the QQQ they could not push it back over 1250 and it closed the week with a -14 point loss.

The drop on Friday was on much lighter volume than the gains earlier in the week. The NYSE only traded 1.5 billion shares and the Nasdaq 1.4 billion. While this is small consolation to those that lost money on Friday it does mean there was no real conviction in the drop. That conviction could increase next week. The VIX has rebounded from its low of 33.35 on Monday to a high of 48.97 on Friday before falling back to close at 45.39. Many of the past VIX extremes were followed by repeats over the next 7-12 days. If this is going to repeat then next week could see another reading in the 50+ range. This spike could be matched with another drop in the major averages back to the Dow 7500 range again. I am not predicting it just suggesting the road map has been laid out in front of us with the various economic reports.

We entered the week thinking that the recession had been very weak and lasting only one quarter and the recovery was well underway. It had been prompted in part by the 9/11 attacks. We exited the week knowing that the recession had lasted three quarters and was well under way before the attacks. We learned that the economy hit a wall in July and the current 3Q was not looking any better and could be the start of the feared double dip. Employment down, consumer spending down, business spending at a standstill, travel down and expectations down. This turn of events gave bullish investors a case of indigestion but they continued to try and buy the dips. This is exactly what prompted many analysts to predict lower lows ahead due to the lack of capitulation that many had thought was at hand. Buying in the face of bad news has long been seen as a prudent investor strategy. Buy stocks when nobody else wants them. This is not to be confused with the strategy of buying every bear market rally until you are broke.

The +1200 point bounce between last week's lows and this week's highs was too good to be true. It was begging for some profit taking regardless of the economic news. The -430 point loss over the last two days equates to about one third of that bounce. The vigorous buying at Friday's close was due to shorts covering and bulls anticipating a rebound after a 30% retracement. I am amazed that anyone could buy anything except to cover on a Friday after the news week we had. Especially with the odds of several financial certifications blowing up over the next two weeks. Still, that is what makes a market. Bulls see the glass half full of a wine aged to perfection and bears see the same glass half empty of sour grape juice.

Next week could see a positive follow though on Monday as bulls try to press their bets. They will be pinning their hopes on the non-manufacturing ISM report on Monday in hopes that it will show something entirely different than this weeks report. With Cisco earnings on Tuesday any positive news on Monday will be met with caution the next day. Wednesday has Wholesale Inventories, Thursday PPI and Friday Productivity. I would not be surprised to see that higher VIX number next week as economic worries hit home and the consumer hibernation process spreads to investments until the outlook is better. Even in good years August and September are not kind to investors and this year is not shaping up any better. The Dow just posted its first consecutive four month loss in 20 years. The Nasdaq has lost ground for 6 of the last 7 months. The yield on the two year note fell below 2% on Friday for the first time ever. Are we having fun yet?

The "Guess the Dow" contest was won by Tom Million with a guess of 8311.10. He wins a high end dual monitor video card to aid in his trading. The average of all guesses, which ranged from 9999 to 6750, was 8291. This was only 20 points away from where the Dow closed! We could be on to something here! Maybe we can predict the Dow and trade accordingly based on the consensus of several thousand readers. (joke) Let's see how this week plays out. The contest has been reactivated and you can now enter your guess for the Dow close on Friday August 9th. We we will give you a dual monitor video card if you are the winner. Click here:

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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