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Capitulation

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      08-22-2002           High     Low     Volume Advance/Decline
DJIA     9053.64 + 96.40  9077.01  8926.92 1.71 bln   2042/1136
NASDAQ   1422.95 + 13.70  1426.76  1398.83 1.82 bln   1978/1442
S&P 100   485.95 +  5.91   487.42   478.73   Totals   4020/2578
S&P 500   962.70 + 13.34   965.00   946.43 
RUS 2000  409.67 +  2.88   410.92   404.86 
DJ TRANS 2463.96 + 31.80  2469.91  2412.64   
VIX        30.96 -  0.67    32.54    30.44   
VXN        45.00 -  1.11    47.70    58.70 
Total Vol   3,726M
Total UpVol 2,705M
Total DnVol   909M
52wk Highs   92
52wk Lows   137
TRIN        0.51
PUT/CALL     .55

Bears are being converted daily and I am so close I can feel the horns starting to grow. This is probably a leading indicator of the next market crash. Bears are turning bullish and bulls are positively giddy with exuberance. The media is bubbling with excitement about the new bull market and yet another round of cautious comments about banks and techs failed to crash the market.

Chart of the Dow

Chart of the Nasdaq

The morning started off with continued concerns about Moody's possible downgrade of JPM's credit rating. They are worried about current and prospective profitability and potential liabilities. With the capital markets screeching to a halt and Enron discovery heating up again Moody's was concerned about their $42 billion in debt. Last week S&P placed JPM, LEH and MWD on credit watch with negative implications due to the deteriorating profitability of the investment banking community. Merrill Lynch also lowered profit estimates on GS, LEH and MWD due to difficult credit markets. Despite this action the Financial Index (NF.x) closed with a gain of +5 points. Go figure.

Merrill Lynch also issued comments that the tech recovery may not occur until 2004 or 2005. Whoa! That was the longest date I have heard yet. If this tunnel gets any longer we will lose sight of the light. It did not seem to hamper the Nasdaq as it added +14 points. The semiconductor index fell only -4 points despite some negative news.

I reported on Tuesday that the book-to-bill number was not really 1.16 as reported but was probably below .95 due to the reporting method. The semiconductor group only reports the number as a three month average which distorts the current environment. VLSI, an independent research firm, reported today that the real global number was only .77 for July on orders of $1.85 billion. Of course the market ignored this obvious sign of a serious problem brewing. VLSI claims any hopes for a 4Q recovery or spike in demand, as most earnings estimates are built on, are looking very slim. They feel the earliest hope for any recovery to begin is mid-2003.

After the bell ADCT reported earnings that fell -60% and warned that the timing and rate of the recovery remains uncertain. The said they would cut more workers and attempt to reduce costs even further in an effort to hit breakeven in the current economy. They posted a -$629 million loss on revenues of only $235 million. Definitely something wrong with that picture. They expected 4Q revenue to fall to only $200 million.

The monthly mass layoffs continued to climb with 2,041 for July as reported today. The number of new workers laid off in July was 245,457. The manufacturing sector was still the hardest hit as demand continues to drop. This was 83,000 higher than the 161,928 employees laid off in June. More bad news for the market ignored.

I reported yesterday in the Swing Trade wrap about the comments from three Fed presidents that were clear indications that the Fed was not going to cut rates any time soon. That message has filtered through the futures markets and the Fed fund futures are now factoring in only a 32% chance of a cut at the Sept-24th meeting compared to the over 80% chance just last week.

Let's see if I have this right. Merrill says no tech recovery until 2004-2005. The global book-to-bill has fallen to .77 and nearly a quarter of a million workers lost their jobs in mass layoffs in July. The Fed is not going to cut rates as expected and companies are continuing to guide lower for the current quarter. The markets digested this information and the Dow gained nearly +100 points at the close. What is wrong with this picture?

Nothing. When markets bottom investors are barraged with bad news and the bottoming process is the discounting of all this news. Once investors decide the news is priced in any more news is simply ignored. This is the stage we are in now. Everyone thinks the bottom is behind us and therefore nothing matters but buying stocks for the new bull market. CNBC was touting all afternoon the +20% gain by the S&P off the July lows as evidence we have exited the bear and entered a new bull market. (Obviously a prime contrarian indicator)

I have no trouble buying into the concept as long as everyone remembers that September and October are known for setting market lows as earnings warnings for the weak 3Q appear. Go long, set stops and be prepared to go long again on any bottom. Sound investment principle as long as you adhere to it. My only challenge today is the +20% gain off the July lows. It is begging for another bout of selling as those institutions with 20% profits and a fear of the coming calendar take those profits off the table. Until that profit taking appears I am seen as a bear crying wolf. After losing a sizeable amount of money over the last week betting on every dip being the "big one" I have decided to switch sides for the next week. Obviously this is a clear contrarian top indicator and a warning to traders already long.

A last word of caution. August of 2000 was an identical copy of this August. Traders ignored bearish news and threw money at the market thinking the bottom was behind them in July.

Dow Chart August 2000

When earnings warning season heated up and everyone finally realized that estimates were too high they started selling those stocks. With the current environment no different it would probably help to see what September looked like as well.

Dow Chart Sept 2000

While comparisons to Sept-2001 are impossible, investors have probably forgotten that the Dow had sold off nearly -950 points between 8/27 and 9/10.

Dow chart Aug/Sept 2001

I am not going to promise that this year will be a duplicate of prior years but September has been the worst month for the Dow and S&P for the last 51 years according to the Stock Traders Almanac. I will leave you with this quote from the almanac:

August is a good month to go on vacation
Trading stocks likely will lead to frustration

September is when leaves and stocks tend to fall
For blue chips it is the worst month of all

Enter Very Passively, Exit Very Aggressively!

Jim Brown
Editor

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