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Bulls Gain Confidence on Bad News

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      10-29-2002           High     Low     Volume Advance/Decline
DJIA     8368.94 +  0.90  8399.74  8198.04 1.67 bln   1293/1872
NASDAQ   1300.65 - 15.19  1318.93  1279.19 1.52 bln   1485/1780
S&P 100   449.10 -  3.23   452.37   440.90   Totals   2778/3652 
S&P 500   882.31 -  8.08   890.64   867.91 
RUS 2000  367.70 -  0.40   369.01   362.64 
DJ TRANS 2248.18 - 31.25  2282.03  2207.32   
VIX        36.80 +  1.13    38.66    35.94   
VXN        52.57 +  0.95    54.27    52.14
Total Vol   3,423M
Total UpVol   844M
Total DnVol 2,517M
52wk Highs    53 
52wk Lows    177
TRIN        1.93
PUT/CALL    0.73

Bulls Gain Confidence on Bad News
By Jim Brown

Dell Computer retracted comments made by Michael Dell in Asia yesterday. The President of Dell said they were taken out of context and PC demand is steady at the low end of estimates. GE said it had billions of dollars of exposure to "airlines, loans and leases" across several sectors and could rake huge charges for this exposure. Consumer Confidence falls to a nine year low. Retail Sales falls again. Markets rebound +200 points from the lows. We are clearly traveling through an alternate reality.

Nasdaq Chart

Dow Chart

Unbelievable! That is the only way to describe it. Bad news was breaking out all over but the markets failed to crash. Sure we fell to 8200 on the knee jerk reaction to the confidence numbers but selective memory kicked in at 2:30 and the Dow exploded back to positive territory.

Dell, CSCO and QCOM led the Nasdaq down at the open. Dell on the retraction of the "we are seeing a pickup in demand" comments that pumped the Nasdaq yesterday. CSCO on news from UBS that said they were seeing substantial price cuts on the major Cisco products. Rumors of desperation were flying and with CSCO announcing earnings next week there are fears that things might not be "steady" at Cisco. QCOM took a dive on news out of China that they would release their own CDMA technology to avoid paying royalties to QCOM. This negative tech news was nothing compared to the news to follow.

The economic world cracked open with a rupture equivalent to the current Mt Aetna eruption. Consumer Confidence numbers rocked analysts with a drop to 79.4 compared to estimates of 90.0. This was a full five points below last October, the month after 9/11 and a nine year low. Every internal number was terrible. The present situation fell to 77.5 from 88.5. Expectations fell to 80.7 from 97.2. Business conditions and jobs also took a hit as the continued high unemployment and falling stock market took its toll. Consumers expecting business conditions to worsen over the next six months rose +45%.

With confidence the number one indicator for holiday sales it is painting a bleak picture for this quarter. Retail Sales fell another -1.9% from last week and was the largest decline since December 2000. This is also the lowest level since Jan 2002. With consumers still benefiting from the refinancing boom and sales still dropping it shows how bad conditions really are. With little pent up demand, high consumer debt levels and market wealth evaporating it would be real easy for the consumer to close their wallets and become couch potatoes until things improve.

There are strong signs that the real estate bubble is bursting and even if the Fed does cut rates next week the difference in mortgage rates probably cannot fuel another wave of buying. Anybody who has not already refinanced is probably not credit worthy as they have had well over a year to take that step. The Fed is simply running out of straws to grasp for why the economy should be growing.

Techs saw more writing on the wall and that writing was from the World Semiconductor Trade Statistics Committee. They lowered their estimates for global chip growth for 2003 to +16.6% from 21.7% citing failure of the expected recovery to appear. Even worse the Americas were projected to see a -11.3% decline in sales. I said decline, not slower growth. They said the 4Q was on track to come in well below estimates. The Gartner Group ridiculed the estimates saying they were way to high and unachievable. Gartner analyst Richard Gordon said most forecasters were already down to the low teens or 10% range for global growth. Whoever you believe the picture is clear. The tech sector is in trouble and earnings estimates based on unreasonable expectations are in trouble and more warnings are in our future.

Those warnings should be about a month away since the current earnings season is drawing to a close. The Cisco earnings on Nov-6th will be the last major report in this cycle. Dell has already affirmed and should not be a factor on the 14th. Cisco is the next problem and then warning season will start around Thanksgiving. We will have three weeks to coast on the earnings already reported and speculate on the 4Q results.

The only positive thing from today's confidence report was the increased possibility of a rate cut next Wednesday. If it did happen there is almost unanimous agreement that it will have no real impact. With Fed funds at 1.75% today you have a real rate of zero after backing out nominal inflation. Cutting rates again will only impact the sentiment on Wall Street and on Main Street around the country. Since it takes 6-9 months for any cut to be seen in the economy it is entirely conceivable that the Fed could be raising rates again before any cut next week would be felt. The rate cut may be a no show next week despite the expectations. With only three real bullets left in the Fed gun, they would never cut below 1.00%, it means the Fed must be very careful about using them. If they gave us an "insurance" cut next week and there was a terrorist attack two weeks later then they would have even less ammo to combat it. With an Iraq war almost a certainty they need to save ammo to combat that event if it goes bad. Consumer Confidence fell to 55 during Desert Storm. Lastly, there has been no Fedspeak to telegraph an imminent rate cut. The Fed almost always gives the market guidance in advance that they are considering a cut. Instead there has been an abundance of "more than adequate stimulus" already in the economy. That is Fed shorthand for "we are not cutting again." A drastically bad nonfarm payrolls report on Friday is about the only thing that could prompt the Fed to act. Care to speculate how the market will react with no cut on Wednesday?

The "rate cut" theory was all Wall Street could talk about today. Unfortunately this talk resulted in taking any cut out of contention as a market mover. Whenever Fed funds futures show nearly a 100% chance of a cut, (85% tonight), THAT CUT IS ALREADY PRICED INTO THE MARKET! Think about it. Consumer Confidence hit a nine-year low, GE warned, Dell retracted, CSCO downgraded, chips were slashed and the Dow closed up on the news. Why?

Glad you asked. My email has been burning up all day with readers ready to grab the Prozac, shoot their computers or worse. "Why in the heck..." is the basic question. There are multiple answers to this question. First is the historical seasonality of the October rally. Much more often than not the end of October brings an end to bear markets and beginning of new bulls. This sets up retail and institutional traders who have been sitting on the sidelines waiting patiently as monster dip buyers. Everyone who did not buy the bounce off the Oct-10th lows thinks every dip is their last chance to climb on the train. According to Wall Street Digest there is $6.5 trillion in cash sitting on the sidelines and waiting for the signal the recovery is underway. Having that much cash burning a hole in investors pockets is sure to find a few willing spenders with every dip.

There is still the year-end for mutual funds on Oct-31st. They may have completed their tax selling but they have not completed marking up their portfolios for year end. This means they are using idle cash to bid up stocks at every opportunity to keep prices as high as possible until their books close. Every $1 of gain in a stock price before Thursday's close adds to their claimed returns for advertising. This was the underlying bid I was expecting for the week last Sunday. The best way for funds to make maximum use of their funds is to implement aggressive buy programs at critical support and resistance points. This is exactly what we saw today. The Dow was moving sideways to down at about 8225 at 2:30 and the Nasdaq was setting new lows. At 2:45 several huge futures orders hit and triggered the buy stops on the S&P. Just when the momentum failed and shorts started taking new positions they did it a couple more times until the Dow hit tough resistance at 8400 that they could not break. It looked like three aggressive futures programs at 3:PM, 3:15 and 3:30. Was it funds? Was it the plunge protection team? Both? Nobody knows but it was not a million retail traders thinking that 3:00, 3:15 and 3:30 were suddenly prime dip buying opportunities because all the bad news was out.

You do have the few retail traders who think a Fed rate cut is the magic bullet for the markets and will support the market by nibbling at stocks all week. I get emails every day complaining that we are not more bullish and don't we know this is a new bull market. I won't get into that here but the perma bulls are still alive and kicking. They are counting on October living up to its reputation as being the bear killer.

This brings us to Wednesday. Earnings are still with us but the bigger blue chip companies are done. The majority of the earnings left are second and third tier companies and the quality of the earnings tends to be lower than the early reporters. The possibility of major positive surprises are slim. We are faced with the death by 1000 cuts torture as these smaller companies report. The bloom is off the rose and we will be left with the battle between sellers at resistance and funds trying to propel rallies off support. Since any rate cut is already priced in I would think Thursday/Friday could be a challenge. This is definitely not a week for the faint of heart.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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