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Back to the Future

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08-21-2002                High    Low     Volume Advance/Decl
DJIA     8957.23 + 85.16 8974.36  8798.89 1600 mln  1969/774
NASDAQ   1409.25 + 32.66 1410.88  1378.09 1609 mln  2241/1032
S&P 100   480.04 +  6.01  481.33  470.68   totals   4210/1806
S&P 500   949.36 + 11.93  951.59  931.32
RUS 2000  406.79 +  8.95  406.79  397.84
DJ TRANS 2432.21 + 84.49 2432.21  2347.43
VIX        31.63 -  0.93   34.02  30.62
VIXN       46.11  - 1.60   49.72  45.99
Put/Call Ratio 0.67

Back to the Future
by Steven Price

The Dow, S&P 500, Nasdaq Composite and NDX all broke through their 50 day moving averages on Monday. I addressed this point then, so I will not simply repeat the same information. For investors looking at whether we have now achieved a new level of support, let's examine what the indices have done since then.

On Tuesday, the broader markets took a step backward, which can be expected after a run of over 1400 Dow points since July 24. However, all of the averages finished the day above the 50-dmas, lending credence to the belief that we have established a new base from which to work higher. On Tuesday, the Dow traded below the 50-dma by 13 points, however rebounded to finish above it by 36.42. The S&P 500 came within 1.27 of the 50-dma, before finishing 6.84 above it. The NDX fell to just 5.11 above the 50- dma, eventually finishing the day 11.29 above this level. The Nasdaq Composite traded 2.04 points below the 50-dma, but closed 3.57 points above it. These amounts are not very large, and that is exactly the point. All of these indices found enough buyers to keep them just above the 50-dmas on a market pullback.

This morning, the market pulled back once again, with the Dow touching just below the 50-dma, the S&P 500 just above it, and the NDX just above it. Once again the buyers came in and pushed these averages back up and over the hump. The more supported pullbacks we see, the more impressive is this level.

Historically speaking, we may be seeing something even more significant. This past July, when the Dow traded as low as 7532.66, we saw the lowest levels in this index since the end of August 1998 and beginning of September 1998. When looking back at that time period, we see a double dip, with the first low in October of 1997, followed by an extended second dip in August- October of 1998, 10 months later. This is similar to the double dip we've seen with the market bottom in September of 2001, and again 10 months later in July 2002. While the impetus for the drops is different, the similarities are striking.

Chart of the Dow Double-Dip

The next similarity is the 50-dma crossover. In 1998, the 50-dma crossover appeared shortly (about a week and a half) after the October 1998 low. In 2002, we see the 50-dma crossover about three weeks after the July 24 low. In 1998 this crossover signaled the start of an extended rise, in which the Dow rode the 50-dma as support all the way up to 10,500. It crossed below, on occasion, during a consolidation period a few months later, however stuck very close to it during this 2-month period. It was not until June 1999 that the 50-dma was decisively broken to the downside, and even then the Dow saw a wide consolidation trading band, before moving higher.

Chart of The Dow 2002 50-dma Crossover

Chart of The Dow 1998 50-dma Crossover

The market does seem to be in consolidation at the moment, with the Dow first getting a little beat up this morning, showing a major turnaround and trading up over a hundred points at one time this afternoon, and then giving back to close at 8957.02, up 84.95 on the day.

The Nasdaq Composite, which also broke its 50-dma on Monday, and has held above it, crossed a significant barrier today as it passed the 1400 mark, to close at 1409.08, up 32.49 on the day. This is partially due to the strength of the semiconductor group. The Semiconductor Sector Index (SOX.X), which was unable to hold its 50-dma on Monday, and was turned back on Tuesday, has now broken the barrier, hanging on by a hair. Today's 16.12 point gain put the index at 361.80, just above the 50-dma of 360.48. If this group is able to hold the rally, in spite of a lack of IT spending, and lowered estimates for sales and revenue in 2003, it may be evidence that the valuations are now more reasonable. If the Semis, which have been a major drag on the Nasdaq indices, can find legs for even a mild run, that may be the catalyst for a continued rise in all of the major indices. The past several years the NDX has led the market, as was evidenced by its bullish percentage turning up ahead of the rest of the group prior to the most recent rally. If the semiconductors can spark a continued rally in the NDX, this may be the last piece to the recovery puzzle. I am skeptical, however, as we are still not seeing evidence of a turnaround in the PC market. In fact, Dell's recent prediction of single digit sales growth next year was considered a disappointment.

Today's market swings may be the result of investors digesting the comments of three Federal Reserve Presidents, who gave comments regarding the economy today. The first to speak was Philadelphia Fed President Anthony Santomero, who is a voting member of the FOMC committee, which sets interest rates. There is a rotation that determines which bank presidents vote each year. Santomero admitted to reduced forecasts for economic growth, but stated that he thought consumer spending would help bring the economy out of its rut. He is relying on the equity people have built up in their homes, and the continued rise in real income, to fuel this growth. In a statement indicating there may not be an interest rate cut at the September 24th FOMC meeting, he said, "The Fed's current monetary policy stance is appropriately supportive of the recovery process... At some point, prudence will dictate that we begin moving monetary policy back toward a more neutral stance." This statement can be viewed as confirmation of revelations contained in the minutes of the June FOMC meeting. Those minutes revealed that there was more talk of when the Fed would need to raise rates, rather than when to lower them further.

Comments from Chicago Fed president Michael Moskow echoed the same sentiment, when he said he also was convinced the economy is strengthening. The October Fed funds futures are now showing less than a 30% chance for a rate cut on September 24th. The current rate stands at 1.75%, which has not changed since December 2001

Oil prices remained over $29 a barrel today, in spite of a surprise increase in last week's inventories. After the inventory announcement last night, it looked as though crude oil would be giving back some of its recent gains. However, as tensions continue with Iraq, oil prices are likely to remain high.

The first domino in the Enron prosecution seems to have fallen. Michael Kopper, former managing director of Enron's global finance department, plead guilty to criminal conspiracy charges to commit wire fraud and money laundering. He also agreed to pay a $12 million fine, which the SEC intends to eventually distribute to Enron shareholders. Kooper worked with former CFO Andrew Fastow, in illegally managing off-balance-sheet partnerships used to artificially inflate Enron's financial results. More importantly, Kopper has now turned stool pigeon, agreeing to co-operate with prosecutors. Ever since prosecutors took down Arthur Andersen, investors have been wondering when the Enron executives would follow. Most federal prosecutions rely on a series of witnesses rolling over on one another. Once the first defendant agrees to testify against others, the sense of "all for one and one for all" is gone. The dominos usually fall quickly, as no one wants to be the last one standing without a chair when the music stops. With each successive co-operating witness, information flows geometrically and the picture of what really happened grows much brighter. Expect the pace of prosecutions in this case to speed up now, and keep an eye on the companies that had close ties to Enron, such as J.P. Morgan and Citigroup. I'm not predicting anything specific about these companies, just the possibility that if there is information out there that hasn't yet been discovered, it will probably be coming out in the near future.

On a similar note, Congress may be looking deeper into the relationship between Citigroup and Global Crossing. J.P. Morgan may be looking at a debt downgrade from Moody's, which placed the long-term ratings of J.P. Morgan and its subsidiaries on review for possible downgrade. Moody's cited current and prospective profitability, earnings volatility, weak operating margins and rising credit losses.

The U.S. posted a budget deficit of $29.2 billion for July, according to a treasury report today. This contrasted with last year's surplus in the same period. The deficit was less than the $32 billion predicted by the Congressional Budget Office, but year-to-date the U.S. is running a deficit of $147.2 billion, compared to a surplus of $172 billion at the same point last year. This deficit has been blamed on defense spending and lack of capital gains taxes, since the stock market has not produced many. The lack of income tax, due to unemployment, has also figured into the equation.

The mortgage market is still going strong, with the MBA mortgage index hitting a new high last week. However, the Dow Jones Home Construction Index experienced a decline of 5.34 points today, as it ran into converging 200 and 50-dmas. While the record number of mortgages, combined with low interest rates, would seem to have led to a gain in the sector, a closer look at the index shows that re-financing is near a record high, however purchase activity, while strong, is slightly off from the second quarter. This may be the reason for today's sell-off of the home builders.

As we head into the end of summer, we shouldn't expect Earth shattering activity in the stock market. Summer is traditionally the slow time of the year, when investment bankers head to the Hamptons and traders leave the trading floors by noon. Of course, this summer has been anything but boring. Volumes have fallen off in both the NYSE and Nasdaq recently, and investors may grow squeemish as we head toward the September 11 anniversary. Keep an eye on the 50-dmas for signs of overall weakness. I seem to become more bullish with each market wrap, however we still haven't seen a change in basic fundamentals. The technicals are, however, looking much stronger than they have recently. The fact that the market was up on a day when the Fed Presidents seemed to hint at no rate cut in September, is also encouraging. As the market continues its upward pace, the chances of another cut grow slimmer. The Fed successfully held onto its bullets, and now has more ammunition in case a cut is needed. Of course if we are trading much higher a month from now, there won't be many calls for another cut anyway.

Steve Price

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