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Market Wrap

Cracks in the Foundation

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       WE 11-08        WE 11-01        WE 10-25        WE 10-18
DOW     8537.13 + 19.49 8517.64 + 73.65 8443.99 +121.59 +472.11
Nasdaq  1359.29 -  1.41 1360.70 + 29.57 1331.13 + 43.27 + 77.39
S&P-100  457.39 -  0.77  458.16 +  2.51  455.65 +  6.63 + 26.34
S&P-500  894.74 -  6.22  900.96 +  3.31  897.65 + 13.26 + 49.07
W5000   8438.80 - 63.40 8502.20 + 51.56 8450.64 +126.86 +450.75
RUT      378.99 -  4.46  383.45 + 10.81  372.64 +  9.27 + 18.44
TRAN    2346.88 + 31.20 2315.68 +  2.37 2313.31 + 34.22 +124.42
VIX       33.56 -  0.42   33.98 -  2.29   36.27 -  3.55 -  3.62
VXN       52.01 +  2.15   49.86 -  0.53   50.39 -  4.94 -  3.54
TRIN       1.80            0.95            0.89            0.80
Put/Call   1.05            0.71            0.77            0.68

Cracks in the Foundation
by Jim Brown

Cracks in the Foundation
by Jim Brown

Thanks to a closing spike the Dow managed to close the day in negative territory but finish the week in the green. This makes the fifth positive week in a row for the Dow. The other indexes were not so lucky and all broke four week winning streaks and appear to be leading indicators that the recent rally may be developing cracks in the foundation.

Dow Chart - 90 min

Nasdaq Chart - 120 min

Friday began strong despite another round of warnings but the gains proved impossible to hold. Leading the list was McDonalds who warned for the seventh time in eight quarters that earnings were going to miss estimates. They are going to close 175 stores and layoff 600 full time employees. Blaming slowing sales, cheaper prices and competition they said October revenue would be below estimates. Dow Jones reported that customer traffic was actually up in October but the average check was lower due to the new $1 menu options. The fast food war is heating up and Wendy's just announced less than expected results on Thursday. The Burger King buyout is also suffering from the war.

Safeway warned that sales for the quarter and full year would be less than expected because previous growth estimates were too high. This is a continuing trend in the food sector and other retailers got hit for losses as well. WIN, KR, GAP, ABS, SVU and even distributor FLM traded lower. Because some of the week chain store sales comes from increased competition from Wal-Mart that stock closed up slightly. WMT has not been saying bullish things lately and it appears that gaining share is the only thing keeping them out of trouble.

The heat in the kitchen is rising in many companies and the chefs in charge of cooking the books are bailing out in droves. Beleaguered Tenet Healthcare has been under the gun all week for accounting questions and THC announced that the COO and CFO had resigned. Not a good sign and the stock, which had been trading at $50 two weeks ago closed at $14.84 on Friday. Other healthcare companies were also hit by friendly fire and guilt by association. Video game maker THQI, which has been under fire for lowering revenue estimates announced their COO had left the company and they were going to dissolve the position. THQI dropped nearly -10% on the news.

After the bell on Friday Duke Energy announced that it had received a subpoena as part of a grand jury investigation into energy trading in California. Expect more on this topic as investigations progress. Xcel Energy denied an article in the Wall Street Journal that it had filed for Chapter 11 bankruptcy. Seems like that would be really easy to check before putting it in print. Xcel claimed they had not filed and had no intentions to file. They claimed they were working with creditors to plan a restructuring proposal and it would take weeks before any decision was known.

Other than the stock news above the markets were quiet on Friday and the major news was the unanimous vote on the Iraq resolution by the UN Security Council. This should be more correctly labeled the "Gotcha" resolution since it puts Saddam in a box from which there is no escape. Iraq has seven days to "accept" the resolution. Once accepted they have 30 days to declare all their weapons of mass destruction and set them up for future destruction. Once they are declared the inspectors will inspect them and destroy them. The key here is the default provision. If Iraq accepts the resolution and fails to declare ALL their weapons and the inspectors find out they lied then all bets are off. The next communication Saddam will receive will be in the form of a cruise missile in his office window. Not really but you get the idea.

For somebody that has spent billions rebuilding his weapons supply and hiding them from outside sources he is not going to simply say "sure, here is the keys to 33 of my palaces and these are the weapons you will find there." We will probably get the bluff, reluctant acceptance and then incomplete disclosure of the stuff he deems replaceable. He will hope to run the same shell game he did before where trucks were driving out the back gate while inspectors were being questioned at the front gate. The inspectors are going to play by different rules this time. The resolution gives them no knock, any one, any time, any place authority to search and this is something Saddam has violently rejected for obvious reasons. It appears that by Dec-23rd the inspectors will walk up to several "undeclared" weapons sites using information from undercover operatives, defectors and the Iraq opposition and "discover" undeclared weapons. The U.S. will say I told you so and with prior approval from the U.N. will proceed to war. The inspectors must report back to the U.N. by mid February on what they found but nothing prevents them from declaring violations at any time.

This eventuality has been priced into the market for quite some time and the movement in oil prices today confirmed it. Oil rose a meager +44 cents after the announcement. The U.S. has been moving troops and equipment for months and the fact that we may go to war is now taken for granted. Most analysts think it will be short and harsh and will be over by April 1st. The resolution was credited with causing the Friday sell off but I personally doubt it was related. If anything it put off any attack until February or later and improved the chances of a possible coalition to accomplish the task. If anything it was another win by the Bush administration in a week already full of successes.

More troubling to the markets was extended analysis of the 50 point rate cut. The wording of the announcement along with the minutes of the September meeting make it clear that the Fed did not come to this decision over time. Analysts feel it was something specific that suddenly turned a split decision over a 25 point cut at the last meeting into an unanimous decision for a 50 point cut this week. The overriding question is what? Yes, economic reports have been turning down but the majority are still pointing to growth. Jobs are not that weak and productivity is high. Is there a banking problem? Is there another Long Term Capital about to implode somewhere? Is Brazil going to renounce the IMF and go it alone without strong economic changes? Analysts fear that the Fed knows something they are not telling.

The Fed commissioned an analysis of Japan's death spiral recently and it is possible they learned enough from that analysis that it scared them into action. One of the lessons from Japan was that a long succession of minor rate cuts only when absolutely necessary left them with a flat economy and no cuts left. The lesson many are suggesting is that when faced with a sluggish economy and dwindling ammo you make the maximum use of that ammo in the shortest period of time. The 50 point cut was totally out of character for the current Fed and Greenspan. Something changed and if the maximum use theory is to be believed then the Fed thinks there is something to worry about. Whether it is just the failure of the economy to bounce or something else in our future we don't know. The uncertainty is weighing on the markets. What was the Fed afraid of and should we be worried.

Friday could have been worse. There was a concentrated effort to keep the Dow over 8517 so that the winning streak could be kept alive. Big money wanted investors to read "five week winning streak" in the paper this weekend instead of "markets fall on Fed concerns." Actually the closing levels on all the major indexes should be a warning message to investors. The current pivot points for the major indexes were Dow 8600, Nasdaq 1380, S&P 905 and OEX 465 as of Friday morning. Moving below these numbers signifies a break in the short term trend and the possibility of weakness ahead. All the indexes closed well below those levels on Friday.

The selling on Friday was far from convincing and could have been just post Fed profit taking. The lackluster market action drew numerous commentators and analysts in front of the TV cameras to expound on why we are going to Dow 5000 or 10000. We are a country with 44 million investors and days like Friday bring out nearly that many analysts and all with differing opinions. Trying to apply too much importance to Friday's action will have you chasing ghosts and dreaming in candlesticks. The only thing we can infer from Thursday and Friday is that investor's enthusiasm cooled from the October rally intensity and with the Fed meeting and election over they took the day off to spend some of their gains. If you want to really drive yourself crazy just ponder why the bears were unable to cause a stronger drop with no real opposition.

Next week is going to be a yawner. Monday is Veteran's Day and the bond markets will be closed. The stock market will be open but volume should be light. The economic calendar is blank for the Mon/Tue/Wed but will make up for it on Thursday and Friday. Thursday we get Jobless Claims, Import/Export prices, Retail Sales and the Philly Fed Survey. Friday we have Business Inventories, PPI, Industrial Production, Capacity Utilization and Michigan Sentiment. These reports should not be earth shaking since we already know the recovery is limping along and almost nothing they can say will make the Fed rush to cut rates again. The only surprise in my opinion would be for them to be positive and the markets might celebrate that.

Earnings are likely to be the real focus with AMAT on Wednesday after the bell. They already announced this week that they were cutting -1750 jobs due to a continued slump in chip sales. Dell announces on Thursday after the close but is expected to announce inline after numerous affirmative comments. A couple of other notables are NTAP on Tuesday and INTU at Wednesday. Earnings are far from over with over 100 companies reporting this week. We have seen in the past that the later in the cycle companies report the better the chance of weaker results.

The forecast for the markets is mixed. It is an options expiration week and there are likely to be many positions which need to be squared away. The bullish sentiment still exists but the reasons for buying now are much less compelling and mostly seasonal. The end-of-year rally crowd is expecting a rally and they will likely buy from habit to reap the seasonal rewards regardless of the outlook. This may give us a bullish undercurrent. Funds saw inflows of $3 billion this week, which is a dramatic change in direction after many weeks of outflows. This could have been related to the pre-Fed expectations. In the post Fed week ahead there may be some inflows from investors expecting the 50 point cut to be a magic wand for the markets. If investor confidence has been increased by the rate cut then the urge to get in quick should be seen this week. If we don't see buying begin by Wednesday then the outlook could be grim. This is a show me week and everyone sitting on cash with an itchy trigger finger will be looking for confirmation that the year end rally has begun. If it does not appear then the excitement will fade and investors will go back to the couch instead of the computer.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

"The market is a voting machine, where countless individuals register choices, which are the product partly of reason and partly of emotion." - Graham & Dodd

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