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Santa Has Left the Building

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12-18-2002                High    Low     Volume Advance/Decl
DJIA     8447.35 - 88.04 8531.38 8407.72  1661 mln   344/1304
NASDAQ   1361.51 - 30.54 1380.63 1355.55  1498 mln   210/1277
S&P 100   452.78 -  5.82  458.60  450.73   totals    554/1581
S&P 500   891.12 - 11.87  902.99  887.82
RUS 2000  383.93 -  7.32  391.25  383.63
DJ TRANS 2305.71 - 37.67 2343.28  2299.09
VIX        31.75 +  1.59   32.33  30.89
VIXN       49.64 +  1.50   50.82  48.39
Put/Call Ratio 0.86

Santa Has Left the Building
by Steven Price

Looks like Santa Claus left town and all he left us was the red suit. LOTS of red! The broader markets sold off today, following a slew of earnings disappointments and warnings, as well as a spike in oil prices. That feel good rally on Monday turned out to be a head fake, as we once again retested Friday's lows, failing that test before a mild rebound. We have once again fallen to a significant support level in several indices, with the Dow and SPX re-testing support from late October/early November and the Nasdaq flirting with its 50-dma for the first time since late October.

The Dow fell through its 50-dma of 8471 to its 100-dma at 8411, before getting a bounce, reinforcing the notion of support around 8400. While we got two bounces there today, neither of those bounces were terribly powerful and the average finished down 88.04 points on the day. With quite a bit of support between 8200 and 8400, a move under 8400 could have us range bound once again, albeit at a lower level. However, if we are going to get the traditional rally heading into the end of the year, then these support levels would be a logical bounce point.

Chart of the Dow

It seems that each week brings news of a large bankruptcy and today was no exception. Insurance and financial services firm Conseco filed for bankruptcy Tuesday evening and with $52 billion in assets is the third largest filing in U.S. history. The bankruptcy includes the parent company, as well as Conseco Finance and its consumer finance subsidiaries. Conseco's insurance operations were not included in the filing. Conseco Finance will be sold, but the company did not say how much it would receive for the unit, but said the amount would be equal to the amount of the unit's secured debt. The bankruptcy has been expected for months, but the filing only added weight to an uncertain market. One of the problems that Conseco dealt with was bad debt from its acquisition of Green Tree Financial, which specialized in mobile home loans. Underperforming debt has been a repeated mantra over the past year and made its way into the news again today.

The Bank of New York (BK) warned that it would miss fourth quarter earnings estimates due to exposure to the United Airlines bankruptcy and the rest of the airline industry. The company said it is exposed to $761 million in leases to the industry, with about $414 million related to major U.S. carriers. BK said it would take a charge of $240 million for the fourth quarter, and it would also set aside $390 million for problem loans. The stock dropped 15% and highlighted yet another problem area for the banking area. During the fall, we got a number of warnings about under-performing business loans to the telecommunications, energy and retail industries. That led to an industry slide and now we are seeing a new factor. While it may not surprise anyone that airlines are having a tough time, investors may not have planned on the effect it would have on its lenders. Many other large banks also have exposure to the airlines, as well, and we could be seeing the beginning of another round of warnings. There have also been some recent warnings about loans in the private banking sector (loans to high net worth individuals), which have begun to underperform as individuals with formerly high paying jobs in the tech sector have been unable to make good on payments. It appears the banks are anything but out of the woods, and if the rash of bankruptcies continues it could start the snowball rolling downhill for lenders.

The big tech story came from Micron, which missed earnings after the bell on Tuesday, and sent the Semiconductor Index (SOX) crashing. The number two maker of memory chips said it would lose 52 cents a share, compared with analyst expectations of a 23-cent loss. Micron said this was partially due to a write-down of $91 million in inventory and a 12% drop in the average selling price of its products. The news was bad enough to send the SOX down 7% and straight through support at the 50-dma, 100-dma and 300 level. The sell-off just continued the hammering in a sector that has seen a drop of 24% in just over two weeks. The SOX has been leading the market and has been an excellent indicator of overall demand in the chip sector. In fact, there was a JPM note reported on CNBC this morning that said the SOX had been down over 2.5% 55 times in the past year and on 53 of those days the S&P 500 followed with a similar loss. The breakdown in support here can't be a good sign. After such a large recent loss, those support levels would have been logical bounce points if it were going to bounce.

Chart of the SOX

The one positive that could send us higher is the Oracle earnings release after the bell. ORCL beat profit estimates by two cents and also beat revenue expectations by $100 million. The company also said earnings for the current quarter would be in the 9-10 cent range, which was slightly higher than expectations for 9 cents. CEO Larry Ellison said the company's database business started to grow again this quarter and CFO Jeff Henley said he expects software spending to continue to improve, "We hope this is the turn we have been assuming... We see people have worked off lot of these excesses and see people start buying again." If this turns out to be the case then a turnaround is certainly a possibility, however, we are getting mixed signals from the industry and it's clear that while some companies are seeing an improvement, much of the tech industry is still suffering. I think back to an interview I saw with Steve Jobs, CEO of Apple Computer, who said last month that he keeps hearing the recovery is 6 months off, but that he's been hearing it for 2 years and still hasn't seen any real signs.

Another of the factors leading to today's sell-off was comments from the White House that Iraq's declaration of its weapons program fell short of the required full and complete accounting and that Saddam Hussein may have blown his last chance. Even Colin Powell, who has seemed to be the most reluctant member of the presidential triumvirate said, "Our analysis of the Iraqi declaration to this point, almost two weeks into the process this weekend, shows problems with the declaration - gaps, omissions. And all of this is troublesome... In my conversations with other permanent members of the Security Council, I sense they also see deficiencies in the declaration." While it may not be a surprise that the White House took a tough stance with the declaration, it now seems that war is getting closer. Officials said war was not imminent, but the oil futures markets didn't seem to agree. January Crude Oil Futures traded as high as $31.25 per barrel, the highest level since November 2000. This was also partially due to the Venezuelan general strike, which has reduced that country's exports from 3 million barrels a day to just 400,000. Venezuela supplies about 15% of U.S. imports and the drop off has led to a drop in U.S. domestic crude inventories. The price increase has made its way into unleaded gasoline and heating oil prices, which jumped by 2.58 cents per gallon and 1.58 cents per gallon, respectively. OPEC's recent agreement to curb quota cheating indicates we won't be getting much relief from the organization, as it feels the world oil market is becoming flooded. If prices stay close to $30, we can expect an effect on the earnings of many companies, as is reflected in the chart below. It is not merely a coincidence that the last time oil peaked in late September and early October we were in a market swoon and the market rally from the middle of October to the beginning of November took place as oil prices fell. After oil prices crept higher, the equity market gave one last gasp before rolling over and heading toward current levels.

Chart of the Dow and Oil Futures

Now that we are once again testing pivotal levels, traders looking to play a bounce need to keep an eye on a number of markets. I would expect some bounce from the Dow 8300-8400 level heading into the end of the year, but if the techs are led lower by the SOX, then we may not get that bounce. The oil markets reflect not only business costs, but also world events, which contribute to market direction and should be kept on traders' radar screens, as well.

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