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Market Wrap

Finally Its Over

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      12-31-2002   Change   %Chg     High     Low     Range
DJIA     8341.63 -1,679.97 -16.76% 10,673.10 7,197.49  3,475
NASDAQ   1335.52 -  614.88 -31.52%  2,074.32 1,108.49    965
S&P 100   444.75 -  139.53 -23.88%    600.80   384.96    216
S&P 500   879.82 -  268.26 -23.36%  1,176.97   768.83    408
RUS 2000  383.10 -  105.40 -21.57%    523.79   324.90     71
DJ TRANS 2309.96 -  330.03 -12.50%  3,050.40 2,008.31  1,042
VIX        32.03 +    8.74 +37.52%     56.74    18.87     38 

Finally Its Over
By Jim Brown

After 12 months of progressively lower peaks and valleys the major indexes all finished lower for the year, significantly lower. The much awaited second half recovery fizzled and now all eyes are focused on the second half of 2003 instead. The normal holiday rebound died early with the December highs coming on the first day of the month. Instead of seeing visions of sugar plums the last month has turned into a holiday version of nightmare on Wall Street. Somebody please pinch me, I want to wake up.

Dow Chart - Daily for Year

Nasdaq Chart - Daily for Year

Tuesday began badly with the Consumer Confidence posting an 80.3 for December and well below the consensus estimate of 85.9. The biggest culprit was a serious decline in the current conditions components but future expectations also declined. There were some minor improvements like a small uptick in the number of consumers planning on buying a new car in the next six months. This is likely impacted by the expiration of the luxury tax today. Purchasers of luxury cars will now save thousands of dollars on any future purchase over today's price. However, confidence is falling most strongly in the higher income groups aged 35 to 54. This is a reflection of concern about impact on retirement portfolios by the falling equity markets. This is not the low for this cycle but it is very close to the 79.6 low in October. A further drop in the stock market over the next several weeks could send the confidence even lower.

Consumers returned to the malls in force with those return items and a pile of gift certificates. Those post holiday shoppers managed to swell the Chain Store sales numbers by +2.1% last week. This was the best weekly gain since May-4th. Before everyone runs out to buy retail stocks be aware this is simply a result of shoppers spending the cash and gift certificates they received on strongly discounted post holiday sales. This spurt of buying will not go far towards increasing profits of the retailers although it will help in reducing excess inventory.

Tech stocks failed to find the green today after the November semiconductor billings rose only slightly by +1.4% on Monday. The Americas remained the weakest global region and with Asia Pacific the strongest. Global sales have continued to grow very slowly but still are not showing any signs of a real recovery. Chip sales are still over one third below their 2000 levels. Many of the chips being produced and sold are being sold below cost to maintain cash flow and keep production lines open. With no recovery soon there will be an increased number of plant closings and failure or acquisition of smaller companies.

Bernie Ebbers, Ken Lay, Martha Stewart and Jack Grubman are just a few of the names most would rather forget from 2002. We would also like to forget some of the numbers from the markets as well. If you noted the numbers at the top of this article you will see they are for the year and not for the day. The Dow traded in a 3475-point range from its 10,673 high to the low of the year at 7197 in October. It eventually settled with a -17% loss for the year. The Nasdaq performed even worse with a 965 point range (50%) and a -31% drop for the year.

The individual index numbers are bad but considering the last three years top loser honors goes to the Nasdaq. Losing -39% in 2000, -21% in 2001 and -31% in 2002 the Nasdaq has now lost -73% from its 2000 high. It appears more but each number above is a percentage drop from the prior year not from the high. The Nasdaq hit new six year lows in October. The S&P closed -43% from its 2000 high and for the first time ever all sectors in the S&P closed down for the year. The Dow posted the worst December since 1931 and the first three year loss since the great depression.

It would appear on the surface that the worst is over. Surely the markets cannot make it four in a row? At least that is what almost every major analyst is predicting. Of the 67 advisors Business Week surveyed this week only two were not expecting the markets not to finish higher. I sure wish I knew how many of those analysts were expecting 2002 to finish higher one year ago. Obviously you could line up 1000 analysts with a 99% consensus and still not have them match reality for 2003. We simply do not know what 2003 is going to bring.

For 2002 all hopes were pinned to a tech/economic revival in the second half of the year because "it had to happen" based on prior business cycles. Obviously it didn't and doesn't have to happen for 2003. I personally think there is a complete computer replacement wave in our future but the longer it takes to appear the less impact it will have. If the economy was to boom in 2003 then pent up buying demand would surge in a short period of time and help feed the fire. It would be like throwing an entire arm full of dry branches on a small fire at once. You would get an explosion of crackling fire with sparks shooting off in all directions. This is what happened in 1999 with the Y2K replacement cycle. There was a specific date by which everything had to occur.

If the economy continues to drag or even slip back into a recession in the first half of 2003 then the replacement cycle will not be everyone moving at once but 100 computers here, 100 computers there on an as needed basis. This is the equivalent of breaking up that arm load of dry branches into matchstick size pieces and feeding them into the fire one stick at a time. The result is a steady fire but no big blaze and not much heat.

The problems we are facing in 2003 are many and varied. Most likely we are 30 days from attacking Iraq. This will not be dropping megatons of bombs on troops hiding in the desert but building to building street fighting. The government is making plans on a short engagement according to the recent news reports but they are planning on using 250,000 troops. We are not going to move 250,000 troops across Iraq and into Baghdad and out again in a couple months. There is always the possibility that Saddam will suffer an early demise and the war will end quickly. We should not count on it.

Then there is the problem with North Korea. While they are grabbing headlines there is little chance of an actual invasion or attack other than a possible surgical strike against their reactor complex. (my opinion) They are trying to trade their nuclear project for even more ransom than they got from Clinton in 1994.

Either way I think those two events and the next two weeks of earnings warnings should keep a lid on the markets in January and early February. By then we will have a better handle on a potential double dip in the economy. With most major indicators showing only a minimal growth in the 4Q (normally strong) there is always a possibility the 1Q could slip back into the negative column again. This would depress the markets and cause another round of plant closings and layoffs. This is the biggest problem as I see it but the Fed is aggressively pumping money into the system to keep it afloat. It is a race to see if they can pump enough to keep it alive before dies from exhaustion. Lately it appears they are trying to inflate a balloon with a hole in it. The harder they blow the faster it leaks.

So, my prognosis for the year is weakness in January for various reasons. The economy and the outcome of the war will decide our fate for February-March and earnings in April will decide if the summer doldrums come early. Everyone will hold their breath toward the end of the 2Q with eyes focused on signs of the expected second half tech rebound. If we see the signs appearing then we could be off to the races. If we don't see the signs then the markets could set up for a potential fourth year down. Nobody wants to face that reality but it does exist.

There is a growing body of investors that believes the Kondratieff Winter cycle will continue until all the debt has been flushed out of the system. With $35 trillion in debt choking the economy this is too much overhead for companies and consumers to bear. Major bankruptcies are starting to reduce the corporate side with WCOM, ENE, CNC, KM, UAL, etc leading the way. Consumers are fighting the battle as well with home foreclosures at a 30 year high and auto repossessions up +30% this year alone. Unemployment is expected by some to rise to 7% and this will put even more pressure on the consumer sector.

Whatever your view of 2003 it should be easy enough to see that the crystal ball is very cloudy. Everybody is counting on a very back end loaded forecast and as we saw in 2002 it was so heavily loaded that we blew out the tires. The same conditions are setting up for 2003. Despite market direction in 2003 there will be stocks going up and stocks going down. Our job is to find the best opportunities to apply the right amount of capital at the right time to capitalize on those opportunities. We look forward to the coming year and see it as one of tremendous potential regardless of the direction. I thank our readers for their support in 2002 and look forward to becoming an even more valuable part of your investment arsenal in 2003. In addition to the current options strategies we will be adding E-Mini futures trading to the monitor on January 13th. Hope to see you there. A very happy and prosperous New Year to everyone!

Enter Very Passively, Exit Very Aggressively!

Jim Brown
Editor

For more information on the Kondratieff Winter:

(http://www.financialsense.com/transcriptions/Gordon.htm)

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