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Orange? I See Red

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       WE 02-07        WE 01-31        WE 01-24        WE 01-17 
DOW     7864.23 -189.58 8053.81 - 77.20 8131.01 -455.73 -198.21 
Nasdaq  1282.47 - 38.44 1320.91 - 21.23 1342.14 - 34.06 - 71.55 
S&P-100  418.79 - 13.78  432.57 -  3.57  436.14 - 21.22 - 13.05 
S&P-500  829.69 - 26.01  855.70 -  5.70  861.40 - 40.38 - 25.79 
W5000   7873.42 -251.65 8125.07 - 50.67 8175.74 -354.59 -228.10 
RUT      358.78 - 13.39  372.17 -  2.89  375.06 - 13.04 -  8.34 
TRAN    2139.97 - 33.38 2173.35 + 10.02 2163.33 -181.20 - 49.14  
VIX       38.80 +  3.02   35.78 +  0.01   35.77 +  7.09 +  1.55 
VXN       48.26 +  1.45   46.81 +  1.76   45.05 +  2.21 +  0.56 
TRIN       1.57            0.89            1.69            1.60   
Put/Call   0.94            0.84            0.83            0.83   

Orange? I See Red
By Jim Brown

The Homeland Defense Dept raised the terrorist threat level to orange on Friday but all I see is red ink across the board. The Jobs numbers blew out estimates but traders recoiled in terror. Is there any end to this nightmare on Wall Street?

Dow Chart - Daily

Dow Chart - 60 min

Nasdaq Chart - Daily

It was a blowout! Over 143,000 jobs were created in January according to the nonfarm payroll report but wary traders were quick to discount the numbers. The jump in numbers was primarily in the retail sector and was predicated on a lack of hiring in December. Let me see if I can explain it. The jobs number is the net of the new jobs created and existing jobs eliminated. Say in any given month 500,000 jobs were created and 450,000 jobs were eliminated. The net result would be a jobs number showing a +50,000 new jobs. These numbers are adjusted for seasonality as well. If there are typically an additional 250,000 retail jobs created in November/December for holiday overload then those 250,000 jobs are eliminated in January. Instead of having the jobs number for November show an increase of +250,000 jobs when everybody knows they are just 60 day temps, they adjust the Nov/Dec/Jan numbers by 250,000 to remove this bump from the reporting process.

Now assume in 2002 there were only 100,000 jobs created for the holidays. After deducting the 250,000 expected jobs you get a -150,000 negative job number for December. Fewer jobs created minus the average number of jobs that should have been created based on historical norms. We saw this in the December number when it came in at -101,000 instead of the +37,000 expected. A net difference of -148,000. Now that the holidays are over there are normally 250,000 jobs eliminated so the bean counters adjust the actual numbers by +250,000 again to keep things level. The problem is the reverse of Decembers. Since only 100,000 were actually created only the same 100,000 were eliminated. That is 150,000 under the normal adjustment so the jobs number shows a gain of +150,000 when there was actually no jobs created. It was a historical adjustment by the bean counters only. No jobs! Since they were never hired the job loss number in December was wrong and since they were no jobs to be eliminated the January number is wrong. They also revised the December Jobs lost down to -156,000 from -101,000. When netting the two "adjustments" together -156,000 and +143,000, the phantom gain for January, you get an actual loss of -13,000 or -6,500 for each month. This realization of reality is what took the bloom off the markets at the open on Friday. Smoke and mirrors, although well intentioned, bit them in the end.

A big talking point from the report was the drop in the unemployment rate to 5.7% from 6% and how it was such a large improvement. Wrong again. You cannot lower the real unemployment rate without creating jobs. Jobs were not created as we saw above. The UNP numbers changed from 8,711,000 to 8,302,000 due to workers unable to find jobs, tiring of the process and dropping out of the system. It was not due to 409,000 or nearly 5% of the total suddenly finding jobs in January. Remember the Challenger layoffs for January soared +42% to -132,222? Five percent of the workforce did not suddenly find work when mass layoffs alone grew to 132K and this does not count normal business reductions. The Challenger report only tracks mass layoffs where a company cuts say 10% of its total workforce.

Speaking of layoffs Goldman Sachs announced it was cutting 20% of its traders in its derivatives group due to lack of volume and the declining markets. GS also cut -908 jobs in the 4Q or 4% of its staff.

Wholesale Trade numbers came back to earth on Friday with a -0.8% drop in December. Analysts claim sales are improving with inventory levels up slightly but with a headline number three times lower than the expected +0.4% increase it would be tough to convince me.

The warning news on Friday was thick and I am talking about earnings and not terrorists. After the bell on Thursday Dell and EDS made cautious comments and those were followed on Friday by TECD who warned profits for the current year would be off as much as -25% due to slipping demand an falling prices. PIXR warned that earnings would be half of analyst's estimates. PCTY warned that economic and political uncertainty was hurting business and they said earnings could come in -30 cents under analyst's estimates of $1.09. PCTY is the largest party goods chain. Clothing and shoe retailer Genesco warned that weak sales in its Johnston and Murphy shoe business and slowing apparel sales overall would push earnings -10 cents under estimates. Mohawk warned that earnings would slip on waning demand for carpet and earnings would be well below estimates. Lack of demand for carpet? Have you looked at the home builders stocks lately? I could go on but you get the picture.

Slow sales, lack of demand, sound familiar? Want real proof? Consumer credit for December dropped by -$4 billion when analysts expected a gain of +$4.3 billion. This was the second consecutive decline. Think about it. A -$4 billion decline in the biggest spending month of the year. There are multiple reasons from high unemployment and fear of being unemployed causing consumers to spend less especially on credit. Secondly the mortgage-refinancing boom has provided cash to pay off these debts and reduce monthly payments for cash strapped consumers. Low sales? You bet and according to who you listen to the future is likely to get worse.

95,000 retired workers and dependents for Bethlehem Steel found out after the bell on Friday that their health and life insurance benefits were going to be terminated. The steel company says it cannot pay the obligations now or in the future. Considering the cost in health insurance and the risk of not having it, this is going to be a major blow to this group. The sad thing is we are going to see more of this type of scenario if the economy continues to struggle. About one year ago LTV began the cycle by ending benefits to 85,000 retired workers.

The markets attempted to rally off the Jobs numbers but right at the open the government raised the threat level for terrorist attack to orange or high. According to John Ashcroft the government has received "specific and credible" information regarding the possibility of multiple large attacks next week involving chemical, biological or radiological agents. They said there were indications the terrorists were going to attack unprotected targets like high rise apartments, office buildings, hotels and/or places were regular people congregate in large numbers. This warning about attacks next week was repeated over and over in the press and the markets appeared to drown in the negativity. I am actually surprised we did not close lower as traders went flat for the weekend to avoid the event risk.

The events were supposed to be staged to match the close of the Muslim holy days which end on Feb-14th. The Feds said the amount of communication traffic referring to a large attack in America had mushroomed to the same levels seen just before the 9/11 attack.

The markets never had a chance. With the mixed to bad economic numbers, a continued parade of lowered earnings guidance, more Iraq worries and now the heightened terrorist alert. The Dow only dropped -65 points but closed under several levels of critical support. The most critical was the close below the 61% retracement level at 7902. This sets up the Dow for a fall to 7600 or below. It has clearly fallen out of its consolidation range between 7950-8150. The Nasdaq also broke convincingly under the 1300 support level and now has a high risk of retracing to 1200. It was an ugly day all around. The SOX sank to a four month low of 260, the banking index $BIX.X fell to a low not seen since October. Hardest hit was the Russell-2000 which fell -3.6% for the week. This should send up red flags for everyone. If small caps are getting smaller then funds and retail investors are moving to the sidelines in volume. Funds stash cash in large caps for liquidity in times of stress and they invest in small caps when expecting better times ahead. This reversal of fortunes is a serious red flag.

The oversold conditions are increasing but not at an alarming rate and that alone points to an additional drop. The Put/Call ratio closed Thursday at 1.53 and Friday at .98. These are high numbers but not off the scale. The TRIN is chalking up some high numbers as well but far short of climax bottoms. The VIX edged even closer to 40 on Friday but is well off the 50-56 ranges reached last July and October. The bottom line is more potholes ahead.

Next week starts out with a quiet period in regards to economic reports with nothing material for the first three days. Thursday and Friday will regain this week's intensity. Greenspan will take center stage on Tuesday at 10:AM when he delivers the first of his semiannual reports to congress on monetary policy. With the recent negative economic news this is going to be a heavily watched event. He will be hard pressed to convince the panel the economy is recovering nicely. He has always warned lawmakers about budget deficits and the need for fiscal discipline and that is not what is happening in the current environment. The general consensus of opinion is that the economy can withstand a quick 4-6 week war but a longer engagement of 2-3 months would plunge the country into a deep recession. Panel members will likely quiz him on his impressions.

Mondays have been positive lately as traders who went flat for safety on Friday reenter on Monday. Assuming nothing happens over the weekend this trend should continue but after 10:AM all bets are off. The terrorist warnings are likely to increase the closer we get to next weekend. The inspectors will report to the UN again on Friday but while we don't know the answers already we know the conclusion. The US is set to push for a resolution calling for military force to disarm Saddam the following week and that would actually be bullish. It would mean a coalition to share expenses and blame and a final global sanction to the war. That resolution is two weeks away or more and plenty of time for some major swings in the market. Find your airsick pills and fasten your seatbelts.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

"The worst trades are generally when people freeze and turn to prayer and hope rather than take action." Robert Mnuchin


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