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Earnings Shell Game Continues

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      10-17-2002           High     Low     Volume Advance/Decline
DJIA     8274.89 +238.90  8318.45  8038.24 2.09 bln   2235/1000
NASDAQ   1272.29 + 39.90  1283.21  1263.46 1.77 bln   2467/ 956
S&P 100   446.21 + 10.02   450.28   436.19   Totals   4702/1956 
S&P 500   879.20 + 19.18   885.35   860.02 
RUS 2000  362.57 + 11.72   362.57   350.85 
DJ TRANS 2279.53 + 78.20  2283.36  2203.97   
VIX        40.16 -  1.81    41.37    39.74   
VXN        56.22 -  0.65    58.39    54.00
Total Vol   4,111M
Total UpVol 3,223M
Total DnVol   861M
52wk Highs    91
52wk Lows    239
TRIN        0.88
PUT/CALL    0.66

Earnings Shell Game Continues
By Jim Brown

Winners, losers and snoozers were the standard of the day. The IBM earnings last night set the stage for a nine-minute rally but the impact of its +7.30 gain lasted all day. Microsoft announced a huge earnings win after the bell and traded up +2.50 in after hours. SUNW beat estimates by two cents but warned that another -4000 would lose their jobs.

Dow Chart

Nasdaq Chart

The big news was no news at all from IBM. They beat the street and did not warn going forward. They were not positive but they were not very negative either. Traders had been expecting some trouble at IBM and there was obviously a lot of short positions. IBM roared to a +7.30 point gain and powered the Dow to +285 numbers at the open.

The rally lasted all of nine minutes. We went from zero to +285 and crashed into the resistance wall at Dow 8300, OEX 450. The Dow dropped back to 8250 by 9:54 and then traded in a very narrow 50 point range for the rest of the day.

Dow Intraday Chart

The hot news after the bell was the huge earnings win from Microsoft. Their 50 cent earnings beat estimates of 43 cents by a mile. The reason was a one time last chance sale of software licenses. Their old license plan changed as of June 30th and there was a rush to buy software at the old terms. They beat the revenue number of $7.1 billion with $7.75 billion as well. The key point here is that this is not a repeatable event. MSFT lowered their guidance for the 4Q to 45-46 cents and the street was expecting 50. That was ignored. The MSFT CFO said on the conference call that the "tech spending environment remains tough". The stock did bounce in after hours but only about $2.50 as traders realized that it was not from new business as much as just a change in sales methods.

Another tech heavyweight on a diet, SUNW, beat the street by two cents but announced another round of layoffs. The company posted a loss only one quarter after returning to a profit. They declined to give expectations for the current quarter saying business had "unexpectedly" failed to improve in September. CEO Scott McNealy said "I am so far out of the forecasting game it does not even make sense" when asked about his take on the business outlook. The CFO said they were not seeing the normal seasonal uptick in purchases. SUNW said it would cut -4400 more jobs and take a $300 million charge in the next quarter. They said they were considering cutting capex spending from $2 billion in 2002 to $500 million. Sounds like there is still trouble in tech land.

Adding to this consensus was an earnings miss by SEBL. They posted earnings of 3 cents compared to estimates of 5 cents and guided analysts lower. It appears the software sector is still tough if you are not Microsoft. CHKP warned that earnings would fall below estimates for the quarter. PSFT guided analysts to 14-15 cents when analysts had expected 14 cents. They qualified it by saying it was still very challenging to make predictions. Even EBAY guided analysts lower to 1.12-1.15 from analyst's estimates of 1.17. Gateway lowered its guidance for the next quarter to a loss of -10 to -13 cents when analysts were expecting only -9 cents.

There was also a guidance warning from Broadcom. They are a major supplier to Cisco and the immediate thought was that Cisco was in trouble. In the conference call they said their networking chip business was stable but weakness in the sales of set top boxes was going to hold their sales flat in the 4Q. So Cisco may not be in serious trouble but consumers are slowing down on TV equipment. That touches an entirely different cord for the 4Q.

The lowered guidance from BRCM as well as numerous other chip stocks over the last several weeks was borne out in the book-to-bill number. The headline number came out at only .84 with a drop of -19% in the orders for September. This was the second month of decline after seven months of increases. August bookings were also revised down. Getting to be a habit on the number circuit lately. In reality the headline number of .84 is significantly wrong when painting the real picture. The number is a three-month moving average and considering the last four months were 1.27 (May), 1.26, 1.22, 1.02 (Aug) to get a three month average of .84 the current real number has got to be much lower. Since we do not know the real numbers for any month it is hard to decipher how bad it was. I heard one analyst speculating that the September number may have been as low as 50. Here is the source: http://www.semi.org/web/wpress.nsf/url/booktobill

The book-to-bill means for every $1.00 of orders shipped only 84 cents of new orders (actually significantly less) were received in Sept. This would mean that excess capacity is stacking up and more capex spending cuts are imminent. Excess capacity cost money and produces no revenue and that impacts earnings. With the Intel warning, the SUNW admission that there was no business at the end of the quarter the economy is not improving despite how bad everyone wants it.

The Jobless Claims rose again this morning with the continuing claims rising to a 20 year high. There was an explosion of housing starts, the highest since 1986, but there is not going to be anybody with a job to buy the houses. Sears shocked everyone this morning by missing numbers by 21 cents. These were the numbers they affirmed just ten days ago. The problem was a larger than expected default rate from their credit card customers. They had to take a much larger reserve charge due to a rapidly rising rate of consumer bankruptcies. Capital One Financial said yesterday that they were abandoning the sub prime credit market because of the rapidly increasing credit risk. Think the consumer is going to rush to the rescue in the 4Q?


Need more proof? The Philadelphia Fed Survey came in with a drop to -13.1 compared to estimates of a gain of 2.3. This indicates a rapid contraction in the manufacturing sector. How many times do we have to take the patients temperature before we agree that they are still sick? The airline sector was represented by earnings from NWAC, CAL and LUV and it was not a pretty picture. Tomorrow DAL announces earnings and they announced today they were cutting -8000 more jobs.

What will Friday bring? The futures are up +9.50 as I write this but the semi stocks will not be impacted from the late book-to-bill report until tomorrow. Still I expect the markets to open up on the strength of the Microsoft numbers as retail investors rush to buy this huge win, oblivious to the fact that it is a one time event and they lowered guidance for the 4Q. The Dow closed at 8271 and has very strong resistance at 8300, 8350 and 8400. With MSFT in the Dow we should get the mandatory morning gap which will be completely impossible to trade and then another pause for a direction check. With over 35% of the S&P announcing earnings this week and almost all the major players there will not be the high visibility targets of opportunity next week. This could pose a problem for traders looking for new hope. Don't get me wrong. The October madness is in full control. Fundamentals and economics don't count. The majority of tech stocks are trading at nearly twice the PE that they had as of Oct-2000 yet the economy is extremely worse.

Surprised? QCOM at 236, MSFT at 40, INTC 49, and that is for companies that still have earnings. Something you might want to think about is that Oct-19th, 1987 the Dow dropped -22.6% in one day. This is not 1987 and the chart comparisons are not even close but I bring it up to note that sudden changes in altitude tend to occur in the 2nd and 3rd weeks of October. Rebounds tend to occur in the last week. We are 2.5 weeks into the month with two weeks to go and we got zero follow through from the opening bounce this morning. That does not paint a pretty picture.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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