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Market Wrap

Longest October on Record

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      10-31-2002           High     Low     Volume Advance/Decline
DJIA     8397.03 - 30.40  8493.92  8336.34 1.85 bln   1776/1417
NASDAQ   1329.71 +  3.00  1347.58  1323.09 1.68 bln   1746/1589
S&P 100   451.23 -  1.37   457.21   447.52   Totals   3522/3006 
S&P 500   885.80 -  4.91   898.83   879.75 
RUS 2000  373.49 -  0.68   376.71   373.05 
DJ TRANS 2260.07 - 17.20  2301.41  2249.54   
VIX        35.91 -  0.17    36.70    35.14   
VXN        52.00 +  1.70    53.67    51.52
Total Vol   3,767M
Total UpVol 1,922M
Total DnVol 1,751M
52wk Highs   118
52wk Lows    146
TRIN        1.75
PUT/CALL    0.87

Longest October on Record
By Jim Brown

I know that is not a real fact but it sure seemed that way. I felt like I have been waiting for today to come for months. The year end for many large funds has passed and all the dressing up for statements is over. Unfortunately the waiting is not over. Normal, whatever that means to you, probably will not return to the markets until Thursday of next week.

Dow Chart

Nasdaq Chart

What a day to be a fund manager. The economic reports are the worst in months and you have to buy stocks to appear fully invested and ready for the new bull market. It is like getting caught doing something wrong in front of your friends in high school and being told to report to the principal's office before going to class tomorrow. You have to keep up pretenses for the rest of the day to avoid losing face with your crowd but knowing that you are going to get serious licks by the principal the next morning. I am obviously dating myself and speaking from personal experience. They probably don't give "licks" any more in high school but I racked up 17 consecutive days once in the mid 60's.

Back to the point. Funds that were forced to go long today to save face are likely to get whacked at the open tomorrow. The terrible economic news is eventually going to strike home and Friday could be the start of that process.

The day began with a GDP for Q3 that at 3.1% was far below consensus of 3.7%. Inventories rose only $1.9 billion which indicates that businesses are not expecting any recovery anytime soon. This was down from $4.9 billion in Q2. This paints a lower profit picture for Q4 since lack of inventory prevents sales growth. What GDP growth there was came from auto sales which were 22.7% of the growth. Economists have been saying that the quarter began with a bang and ended with a sigh. The majority of the gains came in July when growth spurted to +4% for several weeks on the back of summer auto sales but slowed to the current estimates of only 1.7% by quarter end.

This paints a very negative picture of the current economy. Auto sales have dried up. Mortgage applications fell -20% last week and it was the third weekly drop in a row. The housing bubble is bursting and the refinancing wave is over. Estimates of GDP for the 4Q are less than 2.0%. Several analysts pointed to a 6% jump in business equipment and software as evidence of a recovery but they forgot about the one time sale that Microsoft held when it changed its licensing method. Remember the record bounce in MSFT earnings reported this month from that one time event. Ditto for the internal GDP numbers. Take that away and the overall number would even be worse.

The Chicago PMI also fell significantly below estimates of 49.5 to 45.9 and indicating a signification contraction in the Midwest economy. This is the lowest level since January and as the second month in negative territory signals the end of a seven month recovery. The PMI also showed continued weakness in payrolls.

The combined GDP, PMI and higher than expected Jobless Claims numbers today paint a dreary picture for Friday's critical reports. The PMI is a leading indicator for the more important ISM numbers and the ISM was already showing negative growth last month at 49.5. The nonfarm payrolls, estimated at -15,000 for tomorrow, could also be at risk despite a slight rise in help wanted ads. We will also see the Personal Income and Spending and Construction Spending on Friday. October vehicle sales could be the last nail in the coffin. It will be a very full morning.

The Dow finished the month about 30 points from posting the best October on record, ever. Coming in second best was no small feat with a +10.6% gain. This was the best monthly gain for the Dow since Jan-1987. Unfortunately, every time the Dow has posted a double digit gain since 1926 the following month showed a high single digit drop. Every time! That does not mean November is a guaranteed drop but I would not bet against it based on the fundamentals. The outlook for the 4Q is so bad that even food stores are issuing warnings. Albertsons said it expected profits to drop based on a steeper than expected drop in sales. It also cut expectations for the entire year. Wal-Mart was blamed in part for stealing business from food chains but even Wal-Mart has warned that sales are falling.

The wild card here is the Fed meeting on Wednesday. If there was no impending Fed meeting the market numbers would already be more scary than anything that will come knocking on your door tonight. There are so many conflicting guesses about the Fed's move that the outcome is far from clear. The market has priced in more than a 25 point cut but almost zero chance of a 50 point cut. There are many analysts that think the Fed will not cut at all and will stick with the "current stimulus is adequate" mantra and not risk scaring investors with an "oh my gosh, it is really bad" type of reaction. Since there has been no Fedspeak leaning toward a rate cut there is a feeling they will hold pat and put pressure on the ECB to cut rates first. The Fed does not want to weaken the dollar any more unless the ECB follows suit. Not cutting next week would put the pressure on them.

Many feel they will cut 25 points to show they feel our pain even though it would have zero impact on the economy for at least six months. At 1.75% we already have the lowest funds rate in decades and according to all published Fed comments they feel it is sufficient to fuel the recovery.

This is the way it is shaping up for me. A .25% cut is priced into the market already. A .25% cut would leave the markets depressed and we could see a negative reaction. A .50% cut would bring out concerns of deeper problems than we can see and while there might be an immediate bounce in the markets it should not last more than a couple days before current fundamentals take hold again. With no rate cut we could get the instant drop as the current expectations are taken out of the market but then a rebound as the Fed will go on the campaign trail to promote the "current stimulus is adequate" story.

Whatever will happen is of course still four trading days away. This means the verbal battle will continue in the press with everyone getting their 15 min of face time on TV. They will rationalize the drop in consumer spending and try to spin the kinder gentler slow growth economy as "recovering" instead of dipping. The confusion is going to keep investors on the sidelines and without positive Fedspeak there will be plenty who will close positions and move to the sidelines to avoid the possible unknowns. Add into this the gains in the last two weeks as mutual finds stacked their portfolio decks and you have a very good chance of that house of cards collapsing.

Friday could be explosive or implosive. If the economic reports come in better than expected then the initial reaction will be to celebrate but they will then start discounting the chances of a rate cut. Mass confusion. If the reports are worse than expected the hopes for a rate cut will rise but the economic fundamentals will have worsened. We have not seen any strong impact from the last 12 cuts and one more is not likely to do any better. What we are going to have is four more days of trading confusion with a probable downward trend. Remember, a 25 point cut is already priced in and everything else is just smoke. You have to ask yourself why anyone would risk the precious capital they have left by going long in front of the Fed meeting. Also, remember the Fed needs to save its ammo for a response to a future terrorist attack and in case the war in Iraq goes badly. They do not want to be in the same shape as Japan with a zero interest rate, no more bullets and the economy still falling.

Now that I have totally confused you I think that you should also remember that the election is on Tuesday. Incumbents typically do badly when the markets are crashing on election day. That sets up another possibility of artificial manipulation that only conspiracy theorists will admit to. Can we please just fast forward to next Thursday and end the pain of uncertainty? No such luck I am afraid.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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