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Market Wrap


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      10-01-2002           High     Low     Volume Advance/Decline
DJIA     7938.79 +346.90  7940.59  7593.04 2.03 bln   2200/1009
NASDAQ   1213.72 + 41.70  1214.01  1160.71 1.67 bln   1881/1525
S&P 100   425.74 + 18.49   425.74   406.57   Totals   4081/2634 
S&P 500   847.91 + 32.63   847.93   812.82 
RUS 2000  368.09 +  5.82   368.09   357.15 
DJ TRANS 2225.18 + 74.10  2225.18  2138.98   
VIX        40.13 -  4.44    45.32    39.77   
VXN        57.24 -  1.11    62.01    57.07
Total Vol   3,947M
Total UpVol 3,008M
Total DnVol   850M
52wk Highs   150 
52wk Lows    538
TRIN        0.61
PUT/CALL    0.87

By Jim Brown

The markets started off slow but finished with a bang. The Dow opened marginally positive and traded sideways until 12:15 and then exploded on the Iraq headlines. Actually exploded is the wrong term, it was more like built into a bonfire after being started by a smoldering cigarette. The biggest winners were the big caps as the safest ports in a storm. The overall take is one day does not an October make.

Dow Chart

Nasdaq Chart

Everybody has heard the adage. Toss a frog in boiling water and he will jump out. Put it in a pan of cold water and turn up the heat and it will not jump and be boiled alive. I have never tried this but it is exactly how many investors felt after the close. The markets smoldered with an underlying bid and a slow building of higher lows until about 12:15. Shorts were starting to get uneasy as the Dow moved from 7600 to 7700 but after multiple attempts at that level most expected just another failed attempt and a roll over into an October decline.

Just before 1:PM the 7700 gate broke but it did so slowly with a steady move into the close. The move had a couple plateaus about 50 points apart which worked to convince bears that the momentum move was over. Thus stops got nudged again and again and shorts found themselves looking at a +300 point Dow and wondering how the water got so hot.

The reasoning given for the bounce was the Iraq news but it was squashed several minutes after the announcement as nothing new. Still with news channels reporting it over and over I could see where some retail traders would decide to bail out or some positions. In reality I believe it was the lack of major earnings warnings that sparked the market. Two days without bad news makes bears weak. We also saw some asset allocation in progress. Add the positive ISM numbers and suddenly the bulls are thinking rally.

Did I say "positive" ISM numbers? The headline number fell below expectations for the third consecutive month and fell below 50 to 49.5. This indicates a shrinking economy instead of a growing economy. Had it been a stand alone number we would likely be much lower tonight. Instead there were some signs of progress in the internal numbers. New orders rose to 50.2 from 49.7 last month. Deliveries increased from 53.4 to 55.7. Inventories fell from 45.2 to 43.6. After seven months of growth the economy is falling back into recession but only very slightly as indicated by the internals. The key number dragging down the average was production which fell to 50.9 from 55.9 last month. Despite the small decline in the headline number the last three months have been basically flat with an average of 50.1. Definitely not expanding but bulls are claiming no decline either. More on this later.

Chain Store sales fell again -0.8% for the week ended 9/21. Year over year growth fell to only +2.0% from +3.7% in early September. Most chain stores, including the discounters have warned of falling sales and decreasing consumer traffic for the last four weeks. The back to school season was miserable and according to current surveys the holiday season will also be miserable. One survey showed 57% of consumers were planning to spend less money this year than last. When you consider that the periods now being compared against were the weeks immediately after the 9/11 attack when retail was almost zero you can see how bad these numbers really are. There is really an implied decline when you consider that year ago period. We also have the dock strike/lock out on the west coast. The news reporters have been quick to point out multiple times a day that it is costing the U.S. $1 billion a day in lost GDP. Whether it is true or not the 3Q GDP is only estimated to be $29 billion. Take a few billion off here and there and suddenly you have a real recession. I happen to believe the goods on the ships will be delivered in time for the holidays but nobody will be there to buy them anyway.

Zero percent is generating zero interest. Auto sales dropped to an annual rate of 16.3 million units from 18.7 million units last month. With zero percent interest for up to five years, added sales incentives and a new model year the pace of sales still slowed. This suggests that those who wanted to buy a car already have and we could be slamming up against the slow holiday season with higher inventories and no buyers. GM sales fell sharply from 5.5 million to 4.1 million units. They had been leading the league in performance and now led in the sales drop.

Construction Spending fell -0.4% and posted the fourth consecutive month of decline. Commercial spending fell the hardest at -2.0% with office construction down -4.6%. This puts commercial spending down -18.6% from last years levels. New residential construction is also slowing with single family dropping -0.7% and the third monthly drop. With the commercial and residential construction drop accelerating it is evident that the economy is moving into rougher times. At least evident to me.

Good news today came in the slower pace of layoffs for September. The Challenger report showed only -70,057 workers laid off compared to -118,000 in August. While the rate of layoff is decreasing there is still no hiring. Businesses are down to the bare bones staff and would be hard pressed to keep up the layoff pace of -100K a month that was posted in early 2002. However, remember there have been several high profile cuts announced over the last couple weeks for execution in the 4Q.

The TV networks announced that they were nearly sold out of advertising space for the 4Q. They said there was a pickup in bookings led by the automobile companies and chain stores and that prices paid were up from the 3Q bookings. I guess you know what that means. Those of us that are not planning to buy cars or low rider jeans will have to sit though thousands of commercials trying to change our minds before the holidays. I am sure Bowflex and FitnessMadeSimple.com will be high on the cable list as well.

The market soared +346 points but forecasts collapsed. Abbey Joseph Cohen ranks up at the top of the perma bulls with a 12 month estimate for the S&P of 1300. Tom McManus of BAC cut his 12 month estimates to 1000. Those are the optimistic ones. Merril Lynch lowered their estimates today to a target of 860 for the S&P in 12 months. Richard Bernstein said the valuation had improved on falling interest rates but earnings still ruled and expected returns were still too high. JP Morgan cut S&P estimates to 800 on the same outlook that earnings were going to be weak. They said PE contraction was still likely as the earnings backdrop remained weak and there were few signs of a sustained recovery. Considering the S&P closed Tuesday at 847, three of those four estimates don't project a rosy picture for the next year.

After the close Dell raised guidance for the quarter. NOT! It was widely reported that Dell had raised guidance and was highly optimistic about the current quarter. I hate to be the wet blanket but their previous guidance was for $.20 to $.21 cents and analyst's estimates were for $.21 cents. Dell "raised" their guidance to the high end of their range on the basis of increased cost cutting efforts and slightly higher sales. This higher end of the range was $.21 cents and exactly inline with analyst's estimates. They did raise revenue estimates to $9.1 billion from the $8.9 billion that analyst's had expected. They said broad-based momentum across their product line from increased market share was feeding the gains. Dell spun the press release very well and rose more than $1 in after hours. The Nasdaq futures jumped as well but fell back to the flat line after the facts were assimilated.

So what happened today? The general consensus was an asset allocation program. If you remember last week I mentioned that we could see some asset allocation programs at the end of the quarter. This happens when the ratio of stocks to bonds becomes lopsided compared to stated goals of mutual funds and pension plans. With bonds at decade highs and stock markets at 4-6 year lows the possibility of a weighting mismatch is almost guaranteed if you don't have an actively managed fund. Periodically funds rebalance their portfolios by reallocating their assets. With the two-year note trading at 1.69% yesterday and below the Fed funds target rate of 1.75% something had to give. The yield on the ten-year note jumped +0.78 today and in bond terms that is a month of movement. There was heavy selling and that money was put to work in stocks. What triggered the selling in the bonds was the announcement by FNM that their duration spread had narrowed from 14 months to 10 and this was without massive buying of 10-year treasuries. It had been widely rumored that they would have to buy up to $100 billion in treasuries to narrow the gap. This was having a strong impact in holding up the treasuries because nobody wanted to sell if they were going to have to close this gap in the open market.

The majority of the gains today were in the big caps. The Dow was up +4.56%, the OEX +4.54%, SPX +4.0%. The Russell 2000 only gained +1.60%. Typically after major market bottoms the small caps are the leading index not the big caps. Traders on the floor of the NYSE this morning were expecting only a +50 to +80 point day and then another roll over. This was exactly what I was expecting as well. Obviously there were a lot of traders caught off guard and those traders had to cover in disbelief as the afternoon wore on. I suspect the asset allocation triggered the short squeeze but then the squeeze fed upon itself in the closing minutes.

Tomorrow will be interesting. The Dell news after the close spiked the futures to strongly positive and ran the QQQ up to $22.00. After the realization that Dell really was not making that big of a guidance change we could see some of the excitement wane. Normally a big move like we saw on Tuesday is met with profit taking the day after. We are in October and this is a month known for market bottoms. There are no economic reports and the markets will be left to trade on stock news alone. Burlington Northern warned after the close but nothing else of merit. This means there is no evident direction but we could be heavy after today's gains.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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