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Market Wrap

Is It Real?

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       WE 11-22        WE 11-15        WE 11-08        WE 11-01 
DOW     8804.84 +226.75 8579.09 + 41.96 8537.13 + 19.49 + 73.65  
Nasdaq  1468.74 + 57.60 1411.14 + 51.86 1359.29 -  1.41 + 29.57 
S&P-100  475.03 + 11.31  463.72 +  6.33  457.39 -  0.77 +  2.51 
S&P-500  930.55 + 20.72  909.83 + 15.09  894.74 -  6.22 +  3.31 
W5000   8783.13 +199.08 8584.05 +145.25 8438.80 - 63.40 + 51.56 
RUT      400.00 + 14.08  385.92 +  6.93  378.99 -  4.46 + 10.81 
TRAN    2313.98 - 19.12 2333.20 - 13.68 2346.88 + 31.20 +  2.37 
VIX       26.73 -  4.10   30.83 -  2.73   33.56 -  0.42 -  2.29 
VXN       46.49 -  3.19   49.68 -  2.33   52.01 +  2.15 -  0.53 
TRIN       1.05            0.67            1.80            0.95 
Put/Call   0.70            0.57            1.05            0.71 

Is It Real?
by Jim Brown

The markets pulled back slightly on Friday but the Dow still managed to post a +226 point gain for the week and stretch its winning streak to seven weeks. Considering the gains over the last seven weeks this was an impressive feat. The Nasdaq also managed to close at levels not seen since June. Overall it was a great week and the streak of consecutive years this week was positive has now stretched to ten.

Dow Chart - Daily

Nasdaq Chart - Daily

Friday was a sleeper day. We traded very close to the flat line all day and only a late afternoon drop kept the averages from closing positive. Comments out of Russia contained a warning from Putin to Bush to not attack Iraq without full UN consent. This caused traders who were starting to feel bullish again to decide being safe meant being flat over the weekend. That -65 point Dow drop just before the close managed to push the index to the low of the day.

Friday started off bad but quickly recovered after Cisco was cut to a "sell" by Fulcrum after they said revenue growth for 2003- and 2004 will not be sufficient to offset the impact of declining grow margins. They set a 12-month price target of $11 and said the cost of expensing options could cut earnings by as much as 60%. Cisco was only down marginally by -.35 cents on the news but the tone was set for the day.

Salomon Smith Barney cut PSFT and SEBL on valuation concerns from a lack of any corporate IT recovery. Brocade warned that earnings would fall and the COO was leaving. BRCD lost -27% on the news with a drop to $5.27. All these events cast a spell over the tech sector and the Nasdaq lost -20 points in early trading.

On better note Taiwan Semiconductor, the biggest foundry in the world said an anticipated -7% drop in demand had not materialized and they were adding capacity to accommodate a brisk increase in orders for PC products. Did anybody pickup on that? The expected drop in demand did not appear and capacity utilization was increasing due to orders for computer products. This is not a small side sector manufacturer. This is the largest chip foundry in the world.

This good news offset the negative semiconductor book-to-bill report from Thursday night. That ratio dropped to .73 from .84 the prior month. This was the fourth month of significant decline and indicated there was no recovery in the chip sector in October. This is the STEEPEST three-month decline on record and orders are approaching the lows from last year. It is not expected to get better soon. AMAT said they expected orders in Q4 to drop another -20%. This is directly contrary to the comments from Taiwan Semi today. However, the B-t-B ratio is backward looking and is for October. The TSM data is for the current month and to some extent is forward looking since they are having to add capacity for current order flow.

This brings up the distinct possibility that the October period was the bottom and as the largest foundry in the world and the most likely to see the first swell of orders, the TSM data could be the leading indicator of a coming rebound. According to the latest CIO Magazine Tech poll in October, more CIOs expected to decrease spending in the current quarter than increase spending. This was the first time in eight months the sentiment was negative. If something has suddenly appeared to turn the economy around then it is a stealth attack and it appeared in the last four weeks. Maybe the Fed has decided cutting rates is not working and just decided to replace all the government computers instead.

There are mixed messages coming out of the box makers. Dell gave a glowing outlook for its own business but was criticized for not being even more aggressive. HPQ beat estimates and affirmed guidance for the 4Q and were criticized for "possible" channel stuffing and number manipulation. It appears the bears have taken over the analyst community but then bad news always sells more newspapers than good. Dan Niles has gone on record several times recently as saying a rebound was underway and even called the HPQ surprise in advance. Both Dell and HPQ showed gains in Europe of +15% so obviously there was plenty of market share for both.

Other areas strong for both companies and for IBM was the server market. All showed gains and Dell was knocking the cover off the ball. If companies are quietly using their IT budget dollars to beef up their server farms then the next wave will be desktop computers. You don't upgrade the desktops and then try to feed them with servers that are multiple generations old. You do the infrastructure first and then the individual computers. Another problem in the computer sector is price deflation. In 1999 the average 400MHZ desktop replacement for the Y2K upgrade was $2,500. The average 2.4 MHZ desktop replacement today costs less than $1,000 without a monitor. Today I installed a 2.4GHZ, 1GB ram, 360GB of disk, CD burner, DVD player plus all the bells and whistles and it cost me less than $900 using an existing monitor.

PC box makers are faced with trying to produce revenue growth while computer prices are falling 10%-15% per month. In order to get +15% growth they have to sell +30% more boxes than they did the prior period. Just selling the same number of units would cut their revenue by -15% every quarter. It is a cutthroat market and it is not expected to see any sudden price surges. The fact that HPQ and Dell are showing revenue growth at all in the current economy is amazing. Obviously investors have not picked up on this fact of life as Dell stock has dropped -10% since they announced earnings one week ago.

Now, back to the TSM news. I don't want to apply too much to the event just in case it is a blip and not the start of a new trend. If you remember a month ago I reported that they also said they were seeing a flurry of last minute rush orders to fill holiday shipments. So consider this. In October they say they have a flurry of unexpected orders. In November the expected drop did not appear and they are having to add capacity for December. This is normally a slow period for chipmakers with forced plant closings and mandatory holiday vacations. Do you see the possible conclusions here? Rising demand during a normally slow period. It could be a blip, just an inventory replenishment phase, but it could also be the real thing. The Fed has cut rates 12 times in two years and cheap money may finally be doing its job.

I know the preceding paragraphs may be bordering on heresy to some readers but after three years of gloom and doom it may be time to start considering the bullish alternative. Another leading indicator of impending economic rebound is copper. Copper has risen nearly 15% since mid October and there is only one reason for buying copper. You are going to make wire, pipe, circuit boards and things like industrial equipment. Copper has historically led manufacturing rebounds by 6-9 months.

Another measure of a real rally is the small caps. The Russell 2000 stocks. The Russell has risen +23% since the October lows. This is less than the Nasdaq's gain of +32% but still very respectable. When rebound rallies are bear market rallies the big cap indexes tend to outperform the small caps. They are liquid and easy to move in and out with large sums of cash. They are a favorite of funds when there is no conviction. When funds think the rally is for real they spread out into small caps to capture the maximum price appreciation of any future rally cycle. The Russell is up +8% in the last two weeks. There is definitely money flowing into this group. Personally I think the Nasdaq has out performed because the majority of Nasdaq stocks are no longer mid or big caps with many high flyers now priced in the single digits. They are not specifically "small caps" due to the number of shares outstanding but were definitely "small prices" and that attracted larger dollars.

Going forward we are just not going to explode to Dow 12,000 over the Thanksgiving holidays. There are far too few signs of a pending recovery and there are still sectors under attack. Airlines, health care, oil, financial, etc. Fourth quarter warning season starts after Thanksgiving. There is also strong resistance just above us. The Dow has resistance at 9050 and 9205. The Nasdaq at 1485 and 1504. These are significant resistance levels and are not likely to be broken on the first attempt. Many analysts think Dow 9200 will be the high for the rest of the year. That remains to be seen but we could hit that area just as the first wave of warnings hits us. That resistance coupled with a little reinforcement of negative sentiment could slow the momentum. Many think that a recovery will appear by Q3-2003 but that the recent market gains have already priced in that conclusion. It is almost a sure thing that there will be another "spectacular" terrorist event between now and Q3 and with the increased news coverage of what a soft target our malls are the holiday retail season could be a disaster.

The bottom line for me is still optimism. I see bullishness breaking out all over and glimmers of hope on the horizon. Chip orders picking up, auto sales not as bad as expected, home sales are still strong and we have a rising market to help rebuild consumer confidence. This type of good news tends to feed on itself and we have seen many times recently that bad news is being ignored. While I would not go out and borrow against my home equity to invest in the market now I would not bet against it either. We may be headed higher. Maybe not straight up but if the last seven weeks are any indication the trend has definitely changed. Is it real? It is for everybody that bought the dip on October 10th. Don't you wish you had that time machine now.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

"The stock market is that creation of man which humbles him the most". - Anonymous

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