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Market Wrap

The Great Pretenders

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10-16-2002                High    Low     Volume Advance/Decl
DJIA     8036.03 - 219.65 8232.10 8013.41  1787 mln   303/1460
NASDAQ   1232.42 -  50.02 1253.61 1229.06  1406 mln   385/1008
S&P 100   436.19 -   7.07  447.26  425.54   totals    688/2468
S&P 500   860.20 -  21.25  881.27  841.44
RUS 2000  350.85 -   9.67  360.63  346.53
DJ TRANS 2201.30 -  85.16 2285.25  2182.73
VIX        41.97 +   2.23   49.71  46.28
VIXN       56.87 +   0.50   59.76  56.87
Put/Call Ratio 1.25

The Great Pretenders
by Steven Price

It appears that several of yesterday's contenders have been exposed as pretenders, instead. Stocks such as General Motors (GM), Citigroup (C) and Motorola (MOT) have seen a quick end to last week's rally, as earnings from both the companies themselves, and competitors, have shown the spotlight a little brighter on the fourth quarter outlooks. Last night's Intel earnings miss and comments about the fourth quarter got the ball rolling, but it should have been apparent even before that release that the good news wasn't really so good.

Citigroup (C) included the sale of assets in their earnings release, which is a one-time occurrence. If they are relying on this type of income to meet earnings, then I get the feeling they are looking hard for ways to prop up the stock. With so many problems relating to bad debt and trading losses permeating the banking sector, it is hard to imagine that Citigroup doesn't face many of the same challenges. They have not (yet) announced problems in those areas, which makes me think there may be a time bomb somewhere on the horizon. Especially considering the broad base of problems at J.P. Morgan, which released figures today.

J.P. Morgan Chase (JPM) beat earnings estimates, but profits still fell 95% from a year ago. The company announced 2000 additional job cuts, and hinted that there may be more to come. Vice Chairman Marc Shapiro said," We're going to continue to adjust our expenses to fit our revenues." The company said it was committed to maintaining its dividend and the regular payment of that dividend at least for this quarter. JPM's investment banking unit lost over $250 million, compared to a $700 million profit a year ago. Underwriting revenues also fell 18%. Trading revenues fell from $1.5 billion a year ago, to $370 million and fixed-income profits fell 50%. One of the biggest problems for JPM was bad debt, which cost the company over a $1 billion. Shapiro said that the company was aggressive in getting large write-offs on the telecom sector in the rear view mirror, but that loans to energy trading firms were now starting to create problems for banks.

General Motors beat earnings yesterday by $0.21, which seems to be a huge margin. However, the full year estimates would indicate a fourth quarter below expectations, when taking into account the third quarter numbers. The stock was also downgraded recently, citing deteriorating auto industry fundamentals and pricing pressure on new and used cars. The company is already offering zero percent financing, which doesn't leave much room to account for lower prices without further damaging the bottom line. Standard and Poor's, which cited increasing pension liabilities and weakening North American demand for autos, cut the company's long-term debt today. S&P also said it may be cutting ratings on Ford (F), as well. Ford beat earnings estimates today, but still lost money in the third quarter. The loss came out to about $53 for every vehicle built in North America. It also announced that the return on its U.S. pension fund assets was down 15%, increasing its underfunded status to $6.5 billion, from $3.2 billion at the end of the previous quarter. About 70% of the fund's assets are invested in stocks. The CFO said the company had enough cash to deal with the pension shortfall. If the stock market does begin to turnaround, a continued rally could bail GM and Ford out of some of their current pension fund problems. However, it is a tenuous position to be in, considering the weak economic fundamentals. GM is looking at a current shortfall of around $20 billion.

Boeing (BA) released earnings, which fell 43% from the year ago period. The company saw its commercial airplane revenue sink 24%, as it delivered 73 commercial jets during the quarter - 47 fewer than last year. However, it lowered the delivery estimate for next year from 275-300 planes, to 275-285 planes, and said 2004 should see a similar range. For the first time ever, in 2003, Boeing's military and aerospace aircraft division will surpass its commercial division. Another first is that rival Airbus will ship more planes than Boeing in 2003. The company also said that its commercial satellite and launch business would continue to struggle for several years.

The Dow rally finally reversed direction today, as it ran into some important technical levels. The 1000-point gain of the last several days lost steam as it neared previous support, right around 8300. In fact there are quite a few technical indicators between 8200 and 8400. The 50-day moving average of 8277 was the first barrier. The recent drop from August-October, which saw the Dow fall from 9077 to 7197, was the down leg of a head and shoulders formation, with the right shoulder base at 8305. That 8305 level was also the 50% retracement of the July-August rally and served as support on 7 out of 10 days prior to the head and shoulders breakdown in September. In addition to these levels, there was also the 61.8% retracement of the recent drop, just above at 8359. So the fact that we pulled back today was somewhat predictable, when looking at the overextended rally on no real good news, and the significant resistance overhead.

Chart of the Dow Jones

Last night, Jim Brown pointed out in his Market Wrap the similarities between the appearance of the late July rally and the current rally. What he couldn't point out yesterday was that today's pullback would stop at the same level as the rally in July did (8030 vs. 8036).

Dow Comparison

After this morning's releases, the market geared up again for another big release after the bell. IBM beat expectations by 0.03 per share. After selling off, following a dividend cut form EDS, last month, Big Blue has come back strong. The stock traded as low as $54.01 before the recent rally. It finished the day at $64.90, down $3.58. However, after the earnings release, the stock traded as high as $70 after hours. Profits were still off 19% from last year, but investors apparently felt it had been oversold.

This probably means a rally in the morning, but whether or not the Dow can get through that 7300 level should tell us a lot. We have already seen a break in the trend of lower highs, and if we can set some higher lows the pullback, we could start to see the building blocks of a rally. What makes me still highly skeptical is that the majority of reporting companies are still seeing poor results ahead. Even if the market is somewhat oversold, the trend of reductions in capital spending continues. If the fourth quarter and 2003 estimates are being reduced now, it is likely that firms are still hoping for the best and the current reductions don't reflect the true dangers ahead. After all, there is no reason for a company to let the cat completely out of the bag if there is a chance that things can turn around between now and then.

On Monday, I included a graph of the Semiconductor Sector Index (SOX.X) that showed the index on the verge of a breakout. I looked back to the rebound attempt in late September as the measuring stick for the pattern of lower highs. The closing high of 256 and intraday high of 263 were both broken with Tuesday's rally. The index also broke out of its descending channel. So it appeared got that breakout yesterday, only to have the party spoiled by Intel's earnings miss and cautious comments going forward. Motorola (MOT) also warned that it would miss expectations for the fourth quarter and next year, and investors hammered it to its lowest level in 10 years. However, after the close today, QLogic (QLGC) beat expectations and was trading up over $2.50 after hours. Advanced Micro Devices (AMD) posted a larger than expected loss, but sales were in line with projections and it predicted higher sales and a smaller loss for the fourth quarter. This news, combined with IBM's surprise, may indicate that today's sector reversal may simply be a pullback on the way back up. It is hard to believe that is the case, with Intel's cautious comments being echoed by Novellus (NVLS), but we try to remember to trade what we see and the SOX may be giving us some long opportunities (I'm waiting for lightning to strike me for even mentioning chips as a long play). A bear could point to the rebound attempt in August as the high which would have to be broken in order to break the trend, as well as the 50-dma looming overhead. The 50-dma provided resistance to that rebound attempt in August, so I'm a little torn at the moment, but we should be aware of these different levels in deciding which way to play the sector. A decisive break above the 50-dma would certainly provide bulls with a little more fuel.

Chart of the SOX

Earnings season tends to bring an awful lot of whipsawing. Things look bleak, and then all of a sudden the world is a brighter place. Intel warns, and then IBM beats expectations. If Microsoft has positive comments on Thursday, we may see the bulls in full stampede on Friday morning, only to sit back and think about the overall economic picture over the weekend. While we have seen some technical barriers crossed, I still have a hard time believing in a long-term rally. When the unemployment lines shrink, and businesses begin talking about increasing capital spending, then I may start buying out of the money calls again. Until then, trading the swings for short-term moves still seems the most prudent plan. Today's pullback fell short of 8000, indicating we may now be seeing support at a previous level of resistance. To the upside, the 8300-8400 range will be tough to break through. Look for a bounce in the morning, on the heels of Big Blue, but look for the above outlined resistance to come into play soon thereafter.

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