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Market Wrap

Not Convinced

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09-25-2002                High    Low     Volume Advance/Decl
DJIA     7841.82 + 158.69 7891.28 7665.66  1930 mln   1509/415
NASDAQ   1222.29 +  40.12 1209.72 1177.41  1684 mln   1438/213
S&P 100   417.38 +  6.52  1227.23 1184.12   totals    2947/628
S&P 500   839.66 + 20.37  844.22  818.46
RUS 2000  365.14 +  8.56  365.18  356.58
DJ TRANS 2167.08 + 69.91 2167.08  2097.65
VIX        42.41 -  2.97   46.23  41.84
VIXN       56.69 -  2.71   61.80  56.67
Put/Call Ratio 0.77

Not Convinced
by Steven Price

Have we found a bottom? This is the question on the minds of investors, OI readers and my own. It's going to take a lot more than a 158.69 point gain, after the Dow gave up over 1300 points over the last month, to convince me that we have found a bottom. That being said, all bear markets experience some bounces, and after a 1300-point drop, this bounce could still tack on a few hundred more points without changing my overall sentiment. That bounce could provide some great long opportunities, as well.

I looked back at recent head and shoulders reversal patterns in the Dow to see just how accurate the downside projections were. It was difficult to find a pattern that looked as textbook as the recent pattern, but I found a few that fit the description, nonetheless. It was surprising to see just how accurate the downside measuring objectives have been. The measuring objective is taken from the top of the head to the neckline, and then that distance is projected downward. Below is a copy of the chart I put in Monday's Market Wrap showing the minimum downside objective of the current pattern. It is followed by recent head and shoulders patterns in the Dow.

Chart of the Current Dow and Nasdaq Pattern

In the following charts, the distance between the head and neckline is in red, the neckline is in black and the projection downward is in blue.

The following chart follows a broad pattern from the end of last year to the beginning of this year. The minimum downside objective was achieved, and then some.

Chart of Dow H&S from 2001-2002

This chart from the end of 2000 to the beginning of 2001 is not as well defined, but still fits the H&S criteria. The downside objective is also achieved in this pattern.

Chart of Dow H&S from 2000-2001

If we go back a couple of months from this point, to July-October 2000, we see the pattern repeat itself. The market continues downward and bounces when it hits the downside measuring objective.

Chart of H&S from July-October 2000

Moving back to the summer and fall of 1999, once again the downside objective of a head and shoulders pattern is achieved, and provides a bounce point.

Chart of H&S from July to October 1999

By now you get the point. The recent consistency of the pattern suggests to me that today's rally was just a minor bounce on the way down. Tuesday's close brought the Dow down below the closing low of July 23(7702.34). On July 24, the Dow sank 170 points, to 7532, before staging a 658-point intraday turnaround. This bounce was the beginning of a rally that took the average back over 9000. If there was going to be a similar bounce, this double bottom point seemed like the logical place for it to happen. We did get a bounce, but I'm not sure it was terribly convincing, especially given the patterns highlighted above. Remember that the July low was achieved on the tail end of the 2000-2001 H&S pattern, shown above. A double bottom is usually portrayed with the second dip being higher than the first. It can be argued that yesterday's intraday low of 7666 was higher than the intraday low of 7532 on July 24. However, the other side of the argument is that yesterday's end of day close, 7683.13, was actually lower than that of 7702 on July 23.

Today's rebound did take out yesterday's resistance level of 7800. Intraday resistance had been appearing at successively lower round numbers over the last several days. Today broke that daily trend, but was turned back decisively below Monday's resistance level of 7900. While a recovery will most likely take place in small steps, today's bounce was hardly a reversal in the larger trend. However, it could be the first small step after finding support right around the July 23 closing low.

Chart of Dow resistance levels

Over the last several years, the techs have led the market. One of the sectors that has been dragging the Nasdaq down is the semiconductors. With constant warnings, and lower earnings and revenue guidance becoming almost a daily event, a look at the Semiconductor Index (SOX.X) provides quite a bit of insight as to where the broader markets are headed. Today the group rebounded, showing a gain of almost 7%. However, the index had lost 35% of its value in the month between August 21 and September 23. So while today's rally was nice, the sector still remains in a strong down trend. The only silver lining seems to be that the last two rebounds have come from the center of the descending channel, as opposed to the bottom. While I wouldn't call this bullish, it is an improvement from a technical standpoint. The 7% gain, however, has not broken the series of lower highs and lower lows.

Chart of the SOX

The International Monetary Fund (IMF) has dialed down its expectations for global growth. It had projected global growth at 4% in 2003 just 6 months ago. It now predicts growth of only 2.8% in 2002 and 3.7% in 2003. The outlook stated, "Concerns about the pace and sustainability of the recovery have risen significantly... The recovery is still expected to continue, but global growth in the second half of 2002 and in 2003 will be weaker than earlier expected and the risks to the outlook are primarily on the downside." These numbers are still an improvement from the 2.2% growth in 2001, but that came during a U.S. recession. Chief IMF economist Kenneth Rogoff cited problems in Iraq, uncertainty about when investment will recover and investor risk tolerance as the major unknowns. The IMF also reduced its growth targets for the U.S. from 2.3% to 2.2% in 2002 and from 3.4% to 2.6% for 2003. One of the big problems facing the world economy is still Japan, whose economy is expected to shrink 0.5% this year, its third recession in the last decade. The IMF also said falling equity prices in the advanced nations would have negative effects on the global economy and should cut spending in the U.S. by about 1% over the year, negating the stimulating effects of the weaker dollar and lower interest rates.

In another bearish sign, the housing market is continuing its cool down. One of the props holding up consumer spending is the ability to refinance and lower mortgage payments. While mortgage applications and refinancings are still high historically, home resales did fall 1.7% in August, in spite of interest rates still heading lower. The August resale rate was also down 3.8% from a year ago. The rates were reported by the National Association of Realtors, whose chief economist said, "It's still a very healthy pace, but certainly we are winding down from the boom." With mortgage foreclosures at an all time high, and housing starts dropping, I can't help but feel like the housing bubble isn't so much bursting, as developing a slow leak.

Some positive news came after the bell from Bed, Bath and Beyond (BBBY). The past few days have brought cautious comments from Wal-Mart, Target and Federated, indicating that we are seeing a slowdown in consumer spending. However, Bed, Bath and Beyond beat estimates by 0.02 and posted a 39% increase over the year ago quarter. The company said same store sales were up 10.4%, after a 4.6% gain a year ago. This may be a result of the strength over the last few months of the housing market, as the company focuses on home furnishings. The slowdown in home sales, however, could affect them negatively in the future. Still, a retailer that beats the street is a positive sign.

Qualcomm said last week that it expects strong chip demand in its current fourth quarter and upped their shipping estimates from 19 million phone chips to 20 million. Today after the bell, they reiterated those expectations and said that they are also seeing an increase in fourth quarter bookings, which is a positive for a sector that has seen its book-to-bill ratio slide for the past few months. However, Qualcomm has failed to raise earnings guidance along with either of these announcements. One of the problems plaguing the chipmakers has been falling prices; so increased production does not necessarily mean they will be increasing earnings projections.

Ford also had some good news. After claiming recently that the market was undervaluing its earnings potential, Chairman Bill Ford said the company would be raising production in the fourth quarter. Since vehicles are booked as sold when shipped to dealers, this increase may help Ford turn a profit for the year. This would be a change from their losses of a year ago.

General Electric (GE) came out and reaffirmed their guidance for the quarter. This was one of today's market catalysts. However, I found interesting Jim Brown's Market Monitor comment that a reader emailed him with information that employees at a plant in Bangor, Maine were told this week that 50-75 workers would be cut by Christmas if business did not pick up.

Former WorldCom controller David Myers has agreed to plea guilty to two felony counts. Expect the case against WorldCom to heat up now that one of the high-ranking executives has apparently agreed to provide information to the prosecution.

This quarter, with the Dow and S&P 500 down 15% and the Nasdaq down 16%, is shaping up as the worst quarter since the fourth quarter of 1987. Today's bounce from the July lows may be the first step in another rally. However, it seems that expectations have been dialed down so dramatically that we have a long way to go, as far as consumer and capital spending, before we can consider ourselves healthy again. A CFO survey released today showed that the boys/girls in charge are not yet convinced. Their level of optimism has dropped, due to concerns about consumer spending, business capital spending and global unrest. If they are less convinced that things might turn around, then my feeling that the worst is not yet over seems justified. Of course, the cliché that "it always seems darkest before the dawn" usually applies to the stock market, as well.

Since we are now into earnings warning season, we can expect the market to be extremely jittery, as we have also hit critical support levels. Today's rally eased fears a little, but the market Volatility Index (VIX.X) still remains over 40, which is considered high. For the moment I am very cautious about short positions, as a bear market rally could still have some room to run. However, until we see signs of the pace of economic recovery picking up, I still think above outlined downside measuring objectives in the Dow and Nasdaq have a good chance of being tested.

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