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Market Wrap

Conflicting Signals

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10-09-2002                High    Low     Volume Advance/Decl
DJIA     7286.27 - 215.22 7500.03 7282.39  2130 mln   300/1817
NASDAQ   1114.11 -  15.10 1135.89 1112.08  1748 mln   836/848
S&P 100   392.69 -  10.19  402.88  392.03   totals    1136/2665
S&P 500   776.76 -  21.79  798.55  775.80
RUS 2000  327.04 -  13.28  340.32  326.88
DJ TRANS 2013.02 - 102.33 2114.67 2008.94
VIX        49.48 +   3.02   49.99  47.94
VIXN       62.22 +   1.06   63.80  61.00
Put/Call Ratio 1.04

Searching for the Bottom
by Steven Price

It appears that the Taft-Hartley market fever was a short-lived condition, lasting little more than a few hours. The President gave the bulls an excuse to try some bottom picking, and the bears a slight short-covering scare. However, after the reality of the situation sunk in, the bulls got out of the way and allowed to selling to commence. The reality is that even though the ships are going to be unloaded, there will be a long delay in getting the back log cleared up, and that will lead to a delay in replenishing merchandise. The food that rotted won't be sold and after the 80-day relief window expires, the workers may not be any happier than they are now. Which begs the question of how hard and fast they will be working under forced conditions. If the retailers can't mount a sustained rebound on the news that the ports will be open through the holiday shopping season, then things do not look good.

The retailers, as gauged by the S&P Retail Index (RLX.X), still look very weak, with the index once again testing support levels at its July low. Tuesday's news was good for a significant bounce, but only put the index back at its opening level from the day before. The group continued its steep decline, led by Wal- Mart ($50.74 -1.86 ), Target ($26.66 -1.55 ), and Home Depot ($23.66 -1.59 ). If the group breaks 250, it could be a long way down from there. Friday will most likely give them a push in one direction, as we will get a look at retail sales for the month of September and the preliminary university of Michigan Consumer Sentiment report. Many stores already reported poor September numbers, so unless we get a big surprise, that data may not have much of an effect. However, the Sentiment report will give us a snapshot as to consumers' outlook on the economy, and thus their willingness to spend heading into the holiday season.

Chart of the Retail Index

One sector that has received a lot of attention is the financials. A bank crisis is certainly one way to lead the market much lower than it already is, and the news from this sector has been terrible. There have been a slew of warnings about non-performing assets (bad loans) and today was no exception. This morning Sun Trust Banks (STI) missed earnings by a penny, but more importantly said, "it seems unlikely we will see a meaningful reduction in nonperforming assets in the near future," adding "A strong economy is clearly not what we have, nor does it seem to be in the cards any time soon."

J.P. Morgan (JPM) saw its debt downgraded by Moody's from "A1" to "Aa3." The downgrade affects $42 billion worth of debt and will make it more costly for JPM to borrow, as it contemplates additional job cuts in its efforts to trim costs. Moody's said that JPM, " has lagged behind similarly rated peers during this cycle. Moody's is concerned that (JPM's) recent problems may further complicate its ability to execute its capital market strategy, which has so far met with only partial success." The downgrade helped send the entire sector lower. In addition, Piper Jaffray cut estimates on JPM, Bank of America (BAC) and Bank One (ONE). The S&P Banks Index (BIX.X) has been flirting with support around 235, and a move below that level could be ominous for the group.

Chart of the S&P Banks Index (BIX.X)

The Dow lost 215.22 points, closing at 7286.27. There had been some support at 7500 and again at 7400, going back to late 1997. Now that that support is gone, I'm looking back to a chart I posted several weeks ago. The head and shoulders pattern in the Dow indicated a downside measuring objective around 7180 and the Nasdaq Composite pointed to 1030. I also posted the last few times the same pattern appeared in the Dow, and noted that the downside objectives were reached each time. You can use this link to review those patterns. click here.

The significant recent support levels in the Dow (7500), OEX (400) and SPX (800) were broken on Monday. At that time I began looking for those levels as resistance, before assuring myself we were headed even lower. The other nagging doubt I had was that while the Dow and Nasdaq had both broken their July 24 intraday lows, the OEX and SPX had yet to do so. Tuesday's rally actually saw the Dow close just over the 7500 level. The action at the end of the day Tuesday saw a massive rally fade after President Bush's announcement regarding the West Coast lockout, and saw the Dow hold just over 7500, at 7501. This hold had me wondering if 7500 would once again act as support. The OEX and SPX both broke their respective support levels, but just barely. Today made it pretty clear that 7500, and even 7400 for that matter, would not hold up for the Dow. The SPX, however, bounced right at the July 24 intraday low of 775.68, trading down to 775.80, before finishing the day a point higher. The OEX has yet to touch the July intraday low of 384.96. Does this mean that we are in bounce territory? I don't think so, but I'd be a lot more confident in my short positions if the SPX has broken the 775 level, rather than bounced right at it.

Chart of the Dow

Chart of the SPX

Chart of the OEX

An unusual development in the breadth area was the advance decline ratios. While the NYSE ratios were consistent with approximately 8:1 decliners to advancers and 6:1 declining to advancing volume, the Nasdaq wasn't quite so clear. The ratio of 3:1 decliners to advancers didn't quite match up to a declining to advancing volume that was nearly equal at 1.01:1.

One of the catalysts for today's drop was a downgrade of General Electric (GE). Morgan Stanley lowered 2003 earnings estimates from $1.79 to $1.70, citing concerns over deterioration of its power and aerospace businesses, losses to GE Capital's portfolio and weakness in the company's short-cycle business. The stock gave up $1.35 to close at $22.00.

The automakers also took a major hit. Morgan Stanley cut its estimates on Ford (F), General Motors (GM), and DaimlerChrysler (DCX), citing lower production forecasts. Lehman also lowered its outlook for GM's cash flow for 2003-2006, due to the declining value of Hughes Electronics, pension funding worries and the exercise of a put on its stake in Fiat. Ford was hit by concerns about its debt, after its bonds were quoted in junk-bond type pricing methods. Ford is the largest issuer of corporate debt among U.S. companies, with over $60 billion outstanding. GM lost $2.59 to close at $31.01. For those readers holding the OI GM put play, we have closed the play for a $10.51 gain, looking to take profits on direction and increased option premiums. Ford lost 0.60 (8%) to close at $7.15 and DCX lost $2.07 to close at $30.17.

Abbott (ABT) reported positive news for shareholders, but not such great news for employees. Its earnings grew 14% in the third quarter, from $0.40 per share to $0.46 per share. It also said it expects earnings of $0.55-0.57 in the fourth quarter. This news was tempered by the announcement that it would be laying off 3% of its workforce, which amounts to 2,000 jobs.

Democrats Senate Majority Leader Tom Daschle and House Minority Leader Dick Gephart are calling for the president to replace SEC Chairman Harvey Pitt. Again. The cries to replace him started last summer, citing the corporate accounting scandals and accusing him of being too tight with the accounting industry. These requests mirrored sentiment on the trading floors that the SEC allowed far too many rule changes in favor of the big investment banks, not to mention suspicious activity reports that went nowhere over the years. The latest requests seem to simply be a game of hardball, with regard to who will be appointed as chairman of the new five member public accounting board. The Democrats would like to see John Biggs, former chairman of TIAA- CREF, one of the nation's largest pension funds, representing teachers. The accounting lobbies have started a campaign to stop Pitt from selecting Biggs, a corporate reform advocate and outspoken critic of the accounting industry.

After the bell, there was some good news, as Yahoo (YHOO) said quarterly sales grew 50% from a year ago. The company beat estimates by a penny, earning $0.05 per share. This was a welcome change from a loss of - $0.04 a year ago. Quarterly sales grew from $166.1 million a year ago, to $249 million, and beat estimates by $10 million. Chip technology licensor Rambus (RMBS) also beat estimates by a penny.

Dell announced that it will be selling printer cartridges to go along with the printers it offers from its new Lexmark (LXK) deal. It will not, however, offer cartridges to match printers made by competitor Hewlett-Packard. It also said it will be reducing IT service fees, in an attempt to grow a portion of its business that has not been a major revenue source. In the current environment, with IT spending on the decline, this should only serve to reduce revenue further at Dell's competitors, who may be forced to reduce prices as well.

The Market Volatility Index (VIX.X) has approached 50 once again, but has failed to break through for the third day in a row. The index value is derived from the implied volatility of eight at the money OEX options in the first two months, and it appears that several large premium sellers are coming in selling options each time it gets close to 50. Today's high was 49.99, following highs the last three days over 49. The VIX closed today at 49.48. The last few major market rallies have come after the VIX has spiked into the high 50s, with the exception of the rally following August 5 of this year, when the high was just under 50. However, even that rallied started back in July after a high reading of 56.74 in the VIX.

Things certainly look bearish, but with the SPX bouncing at the July lows, we could be in for a bear market rally. While I'm still leaning short, a break of SPX 775 will make me more comfortable in that conviction. I have tightened the stops on my shorts and will get out of the way quickly if we do break back above SPX 800, or Dow 7500. At least until I see a better short entry. Grrrr.

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