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Markets Rally On Bad News, Again

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       WE 10-25        WE 10-18        WE 10-11         WE 10-4        
DOW     8443.99 +121.59 8322.40 +472.11 7850.29 +321.89 - 63.58
Nasdaq  1331.13 + 43.27 1287.86 + 77.39 1210.47 +774.16 -  9.13
S&P-100  455.65 +  6.63  449.02 + 26.34  422.68 + 19.46 -  4.03
S&P-500  897.65 + 13.26  884.39 + 49.07  835.32 + 35.04 - 14.70
W5000   8450.64 +126.86 8323.78 +450.75 7873.03 +274.41 -175.00
RUT      372.64 +  9.27  363.37 + 18.44  344.93 -  3.05 - 14.29
TRAN    2313.31 + 34.22 2279.09 +124.42 2154.67 + 16.99 - 13.39
VIX       36.27 -  3.55   39.82 -  3.62   43.44 -  2.84 +  3.14
VXN       50.39 -  4.94   55.33 -  3.54   58.87 -  1.41 +  2.42
TRIN       0.89            0.80            0.41            1.98
Put/Call   0.77            0.68            0.93            0.97

Markets Rally On Bad News, Again
by Jim Brown

The headline economic number on Friday was the Durable Goods report for September. It was ugly, really ugly with a drop of -5.9% for the month. This was well over the expected drop of -2.0%. It is the largest decline since November 2001.

Dow Chart

Nasdaq Chart

While that number sounded bad on the surface there was actually some good news buried in the facts. A major factor for the decline was the nondefense aircraft orders which dropped -46% and greatly impacted the headline number. Aircraft is very volatile due to timing and dollar volume. There had been two months of large gains previously. The good news was a +9.3% gain in new orders for computer equipment. While this may have been a light under the door for the tech sector the -52% decline in communications equipment far overshadowed the gains in PCs. Nondefense capital goods also fell -12.6%. With computers the only glimmer of hope in a sea of red there was not much to cheer about. That is unless you are a tech bull.

The bulls took the one positive number out of the report and the Nasdaq led the charge on Friday. There was an initial spike and mandatory dip at 10:AM but the Nasdaq never looked back after that. Other good news rescued the chip sector once again. Micron was upgraded by Merrill and Salomon Smith Barney due to improved selling price assumptions. They felt below trend capacity expansion signified a favorable environment for pricing. They felt the top DRAM manufacturers like Micron would benefit. A chip upgrade? You mean I don't have to buy bad news? That appeared to be what bulls were thinking. The SOX closed up +14 at 292 again and closing in on the critical resistance at 300.

Amazon got taken to the woodshed with multiple downgrades from the constant lack of profit. The stock traded as low as 18.50 before recovering to close at 19.31. This was not as bad as it could have been considering the number of negative comments being made.

Also helping the bulls was the news from Emulex. They beat estimates on Thursday night by 3 cents and they raised guidance for the current quarter. If you remember QLGC also raised guidance a week ago. They both expect 2% to 5% top line growth. ELX claimed they were grabbing market share and seeing a strong ramp of new products. ELX jumped +30% (+4.08) to $17.95 and QLGC gained about +2.00. Throw another log on that Nasdaq fire.

The health insurance sector was not so lucky. Cigna warned of serious problems last night and again on Friday for the current quarters and for all of 2003. The stock got crushed and dropped -$26.60 to $39.30, a -41% drop. This set the tone for the broader market in the early morning and only the strength in techs kept the market from tanking.

The markets moved sideways with only a slight uptrend until about 2:PM and the announcement of the plane crash and death of Senator Wellstone. With the election so close and the control of congress in real doubt any republican win in Minnesota would improve the republican odds. The market weighed the possibilities and quickly started putting money in sectors that might benefit from a republican control win in November. While the accident was tragic the facts remain and the market acted on it. Wellstone was strongly liberal and proud of it. He was a critic of big business and a strong conservationist. The possibility of a pro business, pro defense, pro tax cut republican senator in Minnesota was not lost on traders. In reality the same election confusion continues. There is a possibility that Governor Jesse Ventura, an independent, could now pick an independent or green party candidate to replace Wellstone.

In addition to the Durable Goods numbers we also got New Home Sales, which increased to a new record high. The rate of increase was much smaller and there were numerous comments about the slowing boom. Existing home sales also increased very slightly with a +1.9% gain. Sales in the West (-4%) and Northeast (-2%) actually dropped but the headline number was helped by a giant +10% gain in the Midwest. With mortgage rates climbing slightly these numbers are expected to slow and the drops in those two regions could be a leading indicator. The revised Consumer Sentiment number for October was inline with estimates at 80.6 but still showed a decline over Sept. It is now down five consecutive months. The current conditions component dropped -3.4 to 92.4 and the lowest level since 1992. The expectations fell -6.8 points to 73.1 and the lowest level since 1993. Definitely nothing to cheer about here and added to the rapidly slowing Durable Goods orders it shows a consumer that is pulling back into their shell and restricting spending.

The outlook for next week is good. That might surprise many readers but there are several factors at work which will keep a bid under the market until after November 6th. The first is the election. The big money will want to maintain the market bounce to give politicians the best chance of reelection. Secondly the Durable Goods orders and Consumer Sentiment today have peaked hopes for a rate cut on the 6th. Next week we will get another Consumer Confidence on Tuesday, GDP, PMI and ECI on Thursday and Nonfarm Payrolls, Personal Income and Spending, ISM and Construction Spending on Friday. A week full of reports where there is no wrong answer. Positive reports will be seen as signs of a recovery. Negative reports will be seen as a guarantee of another rate cut on Wednesday the 6th.

Adding to the underlying bid is the extremely high short interest and high put/call ratios of the QQQ/DIA/SPY securities. The QQQ has short interest of nearly 180 million shares with volume of only 70 million on Friday. This is a huge amount of short interest and would take at least ten days to work it off on strong bounce. Adding to this is the 75 million short interest on the SPY with volume on Friday of only 43 million. The DIA has 20 million short with volume of 12 million. The P/C ratio on the DIA is high at 1.64. What this all means is that a sudden uptrend over Dow 8550 next week could explode if the shorts started covering for real. If you were heavily short next week and the market was moving up and there could be a rate cut on the 6th, would you cover?

Obviously not everyone would since many traders are short from much higher levels. But, many traders, already nervous about the gains in the last two weeks, will become even more nervous on any rally next week. I think the number one thing traders need to think about next week is not fundamentals. Fundamentals still stink. They need to think about a short squeeze reaction "IF" we get a bounce over 8550 on Monday. The key is the bounce. We came to a dead stop at that level twice last week and failed to break 8450 on Friday. The rally road is not paved with gold just yet. There are traders still selling into every bounce and the bulls will have their work cut out for them.

The bearish case is still the fundamentals. Many indicators are pointing to a double dip recession and economic reports next week could make the case even more clear. Still the bears are not likely to make a strong charge in front of the Fed meeting. They may bide their time and wait for the Fed and then sell any bounce. Also, Walter Mondale could easily step up to the plate and take Wellstone's place in the election and he would be very tough to beat. Suddenly the questionable "republican" rally from Friday could become a republican loss on Monday. The elections in Brazil will be over the candidate could thumb his nose at the IMF and take the entire country and continent down with him.

My thoughts for Monday are to stay long over Dow 8550 and short under Dow 8500. The upside target if we did get a rally would be strong resistance at 9000-9075. That should draw serious attention from the bears and without 5:1 or better up volume I doubt it will fail. Trade what you see, not what you want to see.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

"Wall Street's graveyards are filled with men who were right too soon " - William Hamilton

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