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Market Wrap

History Repeats Itself?

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        WE 8-23          WE 8-16          WE 8-09          WE 8-02  
DOW     8872.96 + 94.90  8778.06 + 32.61  8745.45 +432.32  + 48.74
Nasdaq  1380.57 + 19.56  1361.01 + 54.89  1306.12 + 58.20  - 14.20
S&P-100  474.50 +  6.06   468.44 +  9.62   458.82 + 24.77  +  7.12 
S&P-500  940.86 + 12.09   928.77 + 20.13   908.64 + 44.40  + 11.40 
W5000   8876.89 +106.61  8770.28 +198.41  8571.87 +385.31  + 94.93 
RUT      400.13 +  4.16   395.97 +  7.52   388.45 + 12.00  -  5.81 
TRAN    2394.32 + 54.92  2339.40 +  7.52  2351.65 +149.62  - 52.76 
VIX       32.81 -  0.01    32.82 -  6.54    39.36 -  6.03  +  4.95 
VXN       47.62 -  3.03    50.65 -  8.05    58.70 -  6.74  -  3.58 
TRIN       2.87             1.52             0.90             1.47 
Put/Call   0.80             0.51             0.69             0.93 

The "new bull market" as hyped by some media commentators on Thursday night, took a step back on Friday with a -180 point loss by the Dow. The major indexes still finished up for the week but not nearly as bullish as Thursday's close. The Nasdaq put together its first three week winning streak this year. Is Friday's drop just a prelude for history to repeat itself?

Chart of the Dow

Chart of the Nasdaq

The market was hit with a round of punches at the open on Friday and contrary to other days this week traders decided that enough was enough and headed to the sidelines. Leading the punch list was news that the NY atty general was expanding its probe of Citigroup and extending it to CEO Sandy Weill. The regulators are probing a suspicious upgrade of AT&T by Jack Grubman just a month before Salomon Smith Barney, the Citigroup investment banking arm, was awarded the AT&T Wireless IPO deal. SSB made nearly $50 million on the deal. Rumors are persisting that Weill leaned on Grubman to change his bearish position on AT&T in order to get the deal. Citigroup stock has fallen -30% while investigators follow leads into their dealings with Enron, WCOM and others.

Another high profile company, AOL, dropped another -10% after news that regulators would widen their probe yet again. The new probe concerns insider stock sales while those same insiders were making rosy earnings forecasts. The stock has dropped more than -60% after taking a -$54 billion charge for the Time Warner acquisition in January. Now they may be on the verge of taking another large charge due to the drop in their stock price, lack of end user growth and write off of unused high speed capacity. Covenants with their banks require them to maintain a market cap of at least $50 billion. With the shares down sharply and possibility of another $20-$30 billion charge they may be in deeper trouble than expected.

For the fifth time this week semi stocks were downgraded before the open. Bear Stearns downgraded estimates for Intel saying channel checks showed they were below previous estimates in sales for the quarter. INTC dropped -$1.19 on the news and it will increase the expectations for lowered mid quarter guidance when they host the conference call on September 5th. Intel is rumored to be ready to announce steep cuts in capital expenditures based on weak demand. Any bets?

Goldman Sachs said they were cutting chip equipment makers again after there were strong indications that Taiwan Semi would also announce significant cuts in capex spending soon. This was bearish for NVLS, AMAT, ASYT, VARI and others who depend on the big fabricators for cash flow. With plants and chip equipment becoming exponentially more expensive with each new breakthrough in technology and speed, the number of companies that can afford the equipment shrinks.

Banc America also cut estimates on chip equipment makers after their analyst Mark FitzGerald said he expected Intel to cut capex by another -20% for this year. He also used the first drop in sales in five months by TSM as an indication of the demand drop accelerating. Merrill Lynch said chip companies expecting a recovery in the 2H of this year ordered too many chips and they have either cancelled orders or are sitting on a depreciating inventory of chips they cannot sell. The prices of computer components continue to drop. I checked on the price of two Pentium4 2.2GHZ mother boards on Friday and one had dropped from $159 to $59 since I bought one two months ago. Another was $127 down from $259 for the best you can buy. Dell may be able to profit from this hardware component glut but all the manufacturers are dying a slow death with no demand and no pricing power.

The Wall Street Journal said Lucent was about to announce another 10,000 job cuts due to slowing demand and lack of a recovery. Lucent had 155,000 employees at the high and has cut -105,000 so far. An additional -10,000 would put them at only 40,000 and around 25% of their original strength. Riverstone Networks issued an earnings warning and said they were going to cut -30% of their workforce and predicted sales would be flat. They estimated their operating loss would be twice as large as previously expected. Things are tough all over and getting tougher.

The Nasdaq put together three weeks of gains. Great! The Dow and S&P stretched their gains to five weeks. Awesome! All of them are running full speed towards the August crash. The drop today was just a hint. Historically the last week of August is a nightmare that turns into a double feature after Labor Day. This historical trend has turned the NYSE trading floor into a ghost town. Next week is the biggest vacation week of the summer as traders stretch vacations into the Labor Day weekend. Historically the last week of August and first two weeks of September are very negative. Traders know this, institutions know this and they plan accordingly.

If you wanted to add some IBM stock to your portfolio (now $80) but you were hoping to buy it on a pull back you could put in a good till cancelled order at $75 or $72 or even $65. That GTC order goes into the market makers order book. If the stock drops to your entry point you get filled and everybody is happy. Most market makers have several million shares of orders in their book everywhere from just under the current price to ridiculous prices $10 to $20 lower. This is how they determine the "depth" of the market. They can tell at a glance how many shares they can buy or sell at a given price. The problem today is the books are blank. Not just lighter than usual but nearly empty. There are always a few orders lingering around but the breadth (amount of stock to buy at a given price like $70) and the depth (amount of stock to buy at any price) has gone to near zero on the buy side.

Whether it is fear of the August dip, the post Labor Day drop or the anniversary of the attack, volume buyers have pulled their bids. Retail buyers who are not aware of historical trends provided a slight cushion late in the afternoon on Friday but volume was only 1.4 billion on the Nasdaq and 1.3 billion on the NYSE. The more amazing numbers which really tell the tale were the ratios. Down volume on the NYSE was 1.09 billion compared to up volume of only 195 million. Better than 4:1 in favor of the decliners. The Nasdaq was the same. Commentators chalked it up to profit taking, which it was, but even more so it was getting out of the way. With no orders to act as a brake any serious volume, like we could see from hedge funds next week, the market makers will stand aside and let them drop until buyers appear. I think the wild card here is the 9/11 fear. Institutional traders who would normally have buy orders placed at ridiculous fire sale prices don't know what might happen with the convergence of the August dip, September slide, 9/11 anniversary, weakening economy and earnings warnings. Are we going to Dow 8500 or 7500? Is IBM going to be $75 or $55 by October. How bad is Intel going to lower guidance on the 5th? The problem is a huge number of unknown factors all coming to pass over the next three weeks. Did I mention a 20% gain from the July lows that needs to be taken off the table?

The good news is that there may be a bounce on Monday. The VIX at 32.81 is not near as high as it will be soon but still in that high volatility range. The TRIN closed at 2.87 which is showing as fairly oversold. The put/call ratio closed at .80 which indicates rising fear on the part of traders and a mildly bullish signal. Bulls were probably not really interested in buying the dip before the weekend but they may buy the Monday open depending on the weekend news. Based on the conditions I described above I would not try to buy a ticket on that bus. Based on historical trends and converging news events this would be the week to plan on staying flat or going short but not going long. If you want to buy stocks for long term capital appreciation then I would bet on lower prices over the next three weeks. There is no need to buy bargains on Monday.

I posted this chart in my Swing Trade wrap on Thursday night. It is the comparison of the Aug/Sept results for the last four years. While history may not repeat itself, you be the judge if you want to bet against it.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
Editor

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