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Market Wrap

Relief or Reaction?

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       WE 02-14        WE 02-07        WE 01-31        WE 01-24 
DOW     7908.80 + 44.57 7864.23 -189.58 8053.81 - 77.20 -455.73  
Nasdaq  1310.17 + 27.70 1282.47 - 38.44 1320.91 - 21.23 - 34.06 
S&P-100  422.57 +  3.78  418.79 - 13.78  432.57 -  3.57 - 21.22 
S&P-500  834.89 +  5.20  829.69 - 26.01  855.70 -  5.70 - 40.38 
W5000   7896.94 + 23.52 7873.42 -251.65 8125.07 - 50.67 -354.59 
RUT      358.50 -  0.28  358.78 - 13.39  372.17 -  2.89 - 13.04 
TRAN    2102.60 - 37.37 2139.97 - 33.38 2173.35 + 10.02 -181.20 
VIX       37.10 -  1.35   38.80 +  3.02   35.78 +  0.01 +  7.09 
VXN       48.38 -  2.59   48.26 +  1.45   46.81 +  1.76 +  2.21 
TRIN       0.58            1.57            0.89            1.69    
Put/Call   0.97            0.94            0.84            0.83    

Relief or Reaction?
By Jim Brown

It was a new form of terror attack. Terrorists poured massive amounts of money into stocks on Friday in a devious psychological attack. With everybody expecting the worst, the best came to pass as is normally the case. Once everybody finally decided a retest of the October lows was inevitable buyers appeared.

Dow Chart - Daily

Nasdaq Chart - Daily

Economically Friday was a good day with Industrial Production soaring +0.7% in January according to the headline number. The jump was actually a reaction bounce from the -0.4% decline in December which was likely a calendar issue. Averaging both gives you a more realistic +0.15% growth. Analysts credit the strong gains to a jump in auto parts and higher output by power companies due to the cold winter weather.

Business Inventories jumped +0.6% in December, which was strongly over expectations of only +0.1%. On the surface this would appear good that businesses are stocking up for a coming increase in demand. Unfortunately the rise came from a slowing of existing sales to only a +0.2% gain and that caused the inventory levels to grow. This was not a bearish report but yet another cautionary item.

The most bearish report was the Michigan Consumer Sentiment which came in at 79.2 for the first two weeks of February. This is a new nine-year low and a drop from 82.4 in January. This should not surprise anybody with high unemployment, war worries, terrorist alerts, weak economy and a falling market. Higher gasoline prices hit consumers with every fill up and being told to buy duct tape and plastic is not a confidence builder either. Bankruptcy filings came in at 8.7% for the last quarter and the full 2002 calendar year set a new record. Money is tight for most people and stock profits are not flowing.

Friday was a slow news day if you were looking for stock news. It was totally focused on the different speeches coming from the UN and the perceived reactions to the different presentations. I am going to try and keep this brief but it is relative. To put it bluntly the US was slam dunked by the inspectors and the opposing countries. There was actually applause in the normally reserved climate of the meeting room. Unfortunately the applause was for speeches against the US position.

The most prevalent market view towards the war WAS to get a coalition quick then launch the attack and get it over with so the nation could get on with business. In a few short hours that view changed to "this could take months before the shooting starts" and fears that the drag on the markets would last all summer. By mid afternoon the view had changed again to "there may not be a war any time soon and over the next several months the need for a war may disappear completely." No war means no market drag, let's buy stocks.

We could debate the various possibilities that energized traders but the bottom line is that investors decided to spend some money after the fear of an immediate war has passed. While I have no problem with the concept I was surprised at the magnitude of the bounce just before a three day weekend during a high terrorist alert. This would not be a normally bullish day.

However there was news on the alert front as well. It appears that some of the information that officials relied on to issue the alert was bogus. The Al Qeada captive who told investigators that a radiological/chemical/biological weapon would be deployed, failed a lie detector test. He had told officials that Washington, New York or Florida would be hit by a "dirty" bomb sometime this week but it was a concocted story. He said a cell in Virginia or Detroit had found a way to smuggle the equipment into the country and they were going to target specific government buildings and religious events. It was reported that officials decided to leave the orange alert over the weekend as a precaution.

The combination of these two events transformed the current market sentiment from bearish to bullish. Suddenly there was no war overhang. Maybe I should say "immediate" war overhang. Traders would always rather put off worrying about problems as long as possible. With the expected start of the war just two weeks away it was fully priced into the market. Now with the war 60-90 days away or maybe never that war premium can be taken out again.

The wildcard in this equation is the 200,000 troops already in the region and the full weight of the US military moving full speed towards an attack in two weeks. The administration has found itself between a rock and a hard place. Those troops cannot be left there indefinitely. The cost to just run in place is horrendous. Troops keyed up for action and then left to bake in the sun for months would lose their combat edge. Units would have to be continually rotated back to the states and replaced with new troops and equipment. The military showed up for the game but the gates to the stadium are locked.

The Powell team is in full court press to get a new resolution passed that will allow the use of force. According to news reports on Friday this effort will be dead on arrival. Four different countries have already threatened veto of the measure. Now the US has to decide to go it alone or back down. We all know how tough to swallow a retreat would be. Conversely an attack by the US on its own with no help would be viewed very badly on the world stage. There are several major antiwar demonstrations around the world this weekend with over a million participants in a single event. In my opinion the Bush administration has been checkmated by an Iraq regime that has made good use of four years without inspectors and hidden everything very well.

I relate this not to bombard you with a constant barrage of political viewpoints but to relate how the market might react and why. I think what you saw on Friday was this realization sinking in to investors consciousness. Traders were putting 2+2+2 together and getting "buy" instead of 6. That buying also took the form of short covering. Those who were expecting that last downdraft between the UN update today and the start of the war in two weeks suddenly found themselves without a war. Instead of a smoking gun from the inspectors they found reluctant cooperation from Iraq and outright defiance from the inspectors. Instead of a new resolution for war there is more than likely going to be a resolution for peace. The smoking gun that would have every nation on earth riding down on Iraq with legions of soldiers was found this week. Unfortunately it was in North Korea. Instead of trying to link Al Qeada to Iraq maybe they should have been looking for the Korean connection to prove their case. (grin)

There may actually be a smoking gun about to appear. Or, more correctly a loose canon. According to www.debka.com there really was a defection on Thursday and it was Adib Shaaban, the right hand man of Uday Hussein, Saddam's son. According to Debka, which is a highly biased and not always verifiable source, Uday was in charge of the hidden weapons and as his right hand man Adib would be better than a smoking gun. While this story is unverified you can read about it on their website. If it is true you can expect serious changes in the deadlock soon.

Where to now? Obviously that is the $64 question. We were trapped in a trading range between 7950-8150 for two weeks in late January and early February. We fell out of that range last week and dipped to a 75% retracement of the October lows. With economic reports showing glimmers of hope those lows may be way overdone. Earnings have not come back yet but even with the negative economic overtones they are not falling out the bottom. For the 1Q 40% of the pre-announcements have been warnings. 23% have raised guidance and 37% affirmed estimates. That means 60% are doing ok, not great but ok. The 40% that warned is higher than normal but not the end of the world. It is the economy after all and the Iraq ate my earnings excuse will not fly for the 2Q. If the economy was on the verge of collapse because of the impending uncertainties of war the will removing the war card give it an injection of speed?

You should be very confused by now. It boils down to these decisions. Will the US be able to get a new resolution? I strongly doubt it without inspectors uncovering a surprise stockpile over the weekend. Will the UN pass a resolution specifically prohibiting use of force and canceling the war? I doubt that because the US could veto it. Will the US decide to mount up and ride into Iraq with all guns blazing and risk major consequences with major allies? I doubt that as well. There was even an implied threat of force against the effort by Russia. What a twist! We would have to loan them money to buy gas to attack us. The administration may have to give up trying to assemble the coalition of the willing and settle for a coalition of the reluctant if they proceed with the attack.

The betting on the street is less than a 20% chance of a war at this time. That means there is an 80% chance of the market rallying on this news next week. That rally should reach 8150 at a minimum and possibly 8300. The majority of the gains are not going to be made on better earnings or a better economy but simply on an equalizing of the war premium. We are very oversold long term and there is substantial cash waiting on the sidelines for a signal. That signal was the +158 Dow gain on Friday. That was the shot heard around the world.

Obviously I over stated the simplicity of next weeks decision. The political war will continue over the weekend as the administration attempts damage control and offers the dissenting countries some type of bribe to regain their support. How eager would you be to come back to our side after the various diplomats and talking heads slandered you in the world press. If you cave in now you would lose face on the global stage. The markets are going to love this war of words instead of bullets. However, if the US appears to be winning the political battle the market will be quick to remove its bullish horns.

I will be so glad to get back to regular markets with real fundamentals. I would love to worry about NVDA beating estimates instead of nuclear missiles in Korea. I would much rather watch Gateway and Dell duke it out on CNBC than round the clock replays of the UN meeting. Give me Larry Ellison or John Chambers instead of Tariq Aziz any day. You know it has gone too far when you start reminiscing about the good old days of 2001 when all you had to worry about was a bear market. Things have certainly changed in the last 18 months.

There will be a lot of late night hours spent over the long weekend as politicians ply their trade. By Tuesday morning this may all be mute and conditions reversed again. There are still hawks expecting the war to start as early as this weekend. If not then Tuesday should be a good day for the bulls.

Sell Too Soon!

Jim Brown

"If you bet on a horse, that's gambling. If you bet you can make three spades, that's entertainment. If you bet IBM will go up three points, that's investing." Blackie Sherrod


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