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Market Wrap

What Puts Are For

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        08-05-2002        High      Low     Volume Advance/Decline
DJIA     8043.63 -269.50  8312.92  8030.82 1668 mln   751/2400
NASDAQ   1206.01 - 41.91  1247.84  1205.68 1341 mln   954/2348
S&P 100   418.56 - 15.49   434.05   417.78   totals   1705/4748
S&P 500   834.60 - 29.64   864.24   833.44
RUS 2000  367.12 -  9.33   376.77   367.12
DJ TRANS 2132.27 - 69.76  2203.38  2127.70
VIX        49.31 +  3.92    49.83    45.46
VIXN       67.52 +  2.08    68.58    65.67
Put/Call Ratio      0.87

What Puts Are For

The "dead cat bounce" some had predicted, after last week's precipitous fall on Thursday and Friday, never materialized this morning. Instead we opened down, and kept going. The Dow ended the day down 269.50, for a loss of 3.24%. The S&P 500 fell by a similar percentage, losing 29.64, to finish at 834.60. The Nasdaq lost 41.91 to close at 1206.01. The non-manufacturing ISM indicated a slowdown in the service sector, as the index fell from 57.2% in June to 53.1% in July. Anything over 50% indicates growth, but we are getting closer and closer to contraction. The reading for new orders also declined from 56.9% to 52.6%. This was on top of last week's economic numbers showing manufacturing ISM at 50.5% and GDP at 1.1%. The prevailing discussion of a double dip recession is gaining steam. Last week's revisions of 2001 GDP quarterly results indicated we were in a definite recession, which we pulled out of in the fourth quarter. Although GDP has shown positive growth in the first two quarters of 2002, the second quarter was only positive by the same amount which was revised off of the first quarter numbers. Overall, things continue to get worse, not better.

The large banks led today's drop, with Lehman cutting price targets on both J.P. Morgan and Citigroup. Lehman cited a difficult business environment, "headline risk," a reference to the bad news that continues to flow regarding these two institutions, and economic uncertainty. There is also concern over deteriorating economies in Brazil and Argentina, and the exposure these banks carry in those areas. J.P. Morgan was down over 6% and Citigroup down over 7%. J.P. Morgan seems to receive nothing but bad news lately, with Lehman also reducing its 2002 and 2003 EPS estimates on J.P. Morgan based on expectations of weak trading results, continued losses in private equity and lower revenues in the structured finance business. This is on the heels of last week's revelations that the two banks may have helped Enron raise $1 billion by making loans to subsidiary pipelines, which illegally funneled the money to their parent, Enron, just before its bankruptcy filing. In addition, a watchdog group called GATA (Gold Anti-Trust Action Committee) has now alleged that Morgan failed to report $45 billion in gold derivatives to the SEC.

Speaking of Enron, federal prosecutors are now looking into whether the company bribed foreign government officials to win contracts for its abroad operations.

There was much talk of the Dow bouncing from its 50% retracement level. This level was calculated using the July 24 low of 7532.66, before the market took off on its 1200 point rally, culminating on July 31 with a high of 8736.73. This level meant little to the Dow today, as it blew right through it, heading for the next significant retracement level of 61.8%. The next level would put the Dow back under 8000, what could be been thought of as a significant support level. Of course the Dow shed almost 300 points again today, and with 8000 only 43 points away, we could have no problem reaching this level on the open tomorrow.

Chart of the Dow Jones

The Nasdaq has been on a much quicker pace toward its July 24 low, closing within 14 points of this number today. The tech sector has been leading the market for the last several years, and this indication is not good for the broader indices. The Nasdaq closed at a new 52-week closing low today. The low on July 24 was established in the morning, before it began its ascent along with the Dow on a day when the Dow gained almost 500 points. The tech sector, however, has experienced a wave of warnings for both the rest of 2002 and into 2003. The sector has been hit hard, and in spite of its recent rally, ending on July 31, has remained mostly within the downward channel begun back in May. The bottom of this channel falls below 1200, and could foreshadow continuing weakness before we see a rebound

Chart of the Nasdaq Composite

This decline has been led by the semiconductor stocks, which have seen better days. Weak demand for PC sales has hurt not only the chip makers, but chip equipment makers and any other company that sells to these companies. The warnings from the sector have been open-ended, without a target as to when the market will get better. As a result, the Semiconductor Index (SOX.X) is now trading at new 52-week lows almost each day. The index flirted with 300 and looked poised for a real rebound, only to watch the floor fall out from under it, culminating in today's drop of almost 6%, leaving 300 in the rear-view mirror. While this may feel oversold for the sector, the SOX is still near the center of its descending channel, with more room to the downside before a rebound appears likely. Bargain hunting investors may want to wait a little longer before jumping in long. Of course, that's what puts are for.

The Federal Open market Committee meets next week, and many analysts are expecting an interest rate cut. It is debatable whether a cut will rally the market, or put more fear into it, as investors may see this as confirmation of the seriousness of the shrinking economy. Goldman Sachs predicted possible rate cuts of up to 75 basis points by the end of the year. They said that the risk of not doing so outweighed the risk of the cuts. They also recommended an initial cut of 50 basis points, followed by 25, in addition to moving up tax cuts scheduled to take effect in 2004 & 2006.

Tomorrow's earnings release from Cisco Systems (CSCO) should have a pronounced effect on the tech sector. The stock was downgraded today by Lehman, and has announced that it will not expense its stock options. This practice would have erased $1.7 billion from Cisco's bottom line in 2001. Cisco lost $0.53 today to close at $11.36

The good news today was that corporate layoffs fell 15% in July to a 14 month low of 80.966. So far, layoffs are down 17% for the first seven months of the year, as compared to 2001. While last week's employment numbers showed far fewer jobs created than hoped for, weekly claims have fallen to about 386,00 from their peak of 500,000.

Today's ratio of 10 down shares to one up share does not foreshadow a significant bounce tomorrow. While we may see some bargain hunting at the open, we are more likely to take out 8000 in the Dow and 1200 in the Nasdaq quickly if Cisco does not have a pleasant surprise up its sleeve. Below 8000, we could be looking at a re-test in the 7500 range before the end of the week. After tomorrow, we have wholesale inventories on August 7, PPI on August 8, and Productivity on Aug 9. The big number we are waiting for won't be until next week, when the Fed announces its interest rate decision. If we manage to hold above 8000 tomorrow, expect some sideways movement ahead of the announcement. Although the market has moved considerably lately and the Volatility Index (VIX) spiked back to 49.31, this is considered to be a slow trading week, as many market movers are on vacation. This is evidenced by today's volume of 1.6 billion shares on the NYSE, which is light compared to the 2 billion share days we have experienced lately on days when we have seen triple digit moves in the Dow. Don't be to anxious to buy a bounce tomorrow. The last time we tested these levels, prior to 2002, was 1998. At that time we did, in fact, double dip. After the first test, the Dow traded back over 9000, before falling again. The second bounce resulted in a market which traded over 11,500. if we break 8000, wait for the next buying opportunity a few hundred points lower. If the market does find a real bottom here, and climbs for the next 10 years, a few minute wait won't hurt that much. Of course, as I mentioned earlier, down moves are what puts are for.

Steven Price
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