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Uncertainty Reigns

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02-26-2003                  High    Low     Volume       Adv/Dec
DJIA     7806.98 - 102.52  7925.81 7793.89    1327 mln  1270/1965
NASDAQ   1303.68 -  25.30  1331.47 1302.83    1775 mln  1260/1912
S&P 100   418.72 -   4.68  425.75  418.14      totals   2530/3877
S&P 500   827.55 -  11.02  840.10  826.68
RUS 2000  380.53 -   2.64  383.44  380.20
DJ TRANS 2039.69 -   2.14 2052.18 2029.76
VIX        37.02 +   0.90   37.50   35.97
VIXN       46.97 +   2.64   47.11   44.86
Put/Call Ratio 0.82


Uncertainty Reigns
by Kent Barton

It may seem like a distant memory, but it wasn't too long ago that investors could focus almost exclusively on earnings results, economic numbers, sales reports, and other fundamental data. Even in the year following the 9/11 attacks, Wall Street seemed to be more focused on finding the answers to questions like "Are we in a double-dip recession?" and "When will the IT sector finally recover?" Those burning questions are still up in the air. But now, as words like "Blix," "Al-Samoud Missiles," and "Regime Change" become part of our daily lexicon, geo-political events have become the driving force behind the market's movement. Sure, earnings and economic reports still matter - just ask anyone who was holding long positions before the abysmal Consumer Confidence numbers were released on Tuesday morning. But recently the market seems to have its collective eyes glued to Fox News, CNN, and MSNBC instead of CNBC. The geo-political uncertainty has created a very choppy market environment that's enough to give even the most jaded trader a case of heartburn. To wit: The market experienced a steep reversal rally on Tuesday, in spite of that dismal Consumer Confidence data. There was no clear catalyst for that sudden round of buying. Depending on your bias, it was either short-covering or bargain hunting. In any case, many of those gains evaporated today as the U.S. moved ever-closer to war with Iraq. And with Dow Component HPQ gapping sharply lower this morning, the bulls never really had a chance to extend Tuesday's gains.

Hewlett Packard's earnings report last night included a net profit of $0.29 cents per share - one cent better than the consensus estimate. What spooked investors was the fact that the company showed only a $17.88 billion increase in revenue. Analysts had been looking for growth of $18.47 billion. This shortfall was especially concerning because a large amount of the $17.88 billion figure was derived from HPQ's acquisition of Compaq, not actual revenue growth. Dissecting the results, industry analysts pointed out that cash flow from operations was quite weak. This prompted Goldman Sachs to downgrade the stock's rating from "outperform" to "in-line" while slashing its full-year estimates from $1.34 to $1.29. HPQ gapped down to a multi-month low of $16.60 after finishing yesterday's session at $18.18. Shares continued to drift lower throughout the day and ultimately finished with a loss of 15.4%. That weakness spread to fellow Dow techs IBM, INTC, and MSFT, making it very tough for the index to extend yesterday's gains.

Annotated daily chart - Dow Jones:

In keeping with the recent trend, the Dow was unable to build on Tuesday's powerful intraday reversal. The index finished near the worst levels of the session after giving back a large chunk of yesterday's gains. The bears will now be targeting the Tuesday lows at 7720. A violation of this level would set the stage for a test of the multi-month lows near 7630.

In last night's Market Sentiment, Steve Price discussed how the Dow Transports (TRAN) are commonly used to gauge the conviction behind moves in the Industrials. Another sector that is thought to provide "confirmation" of broader market activity is the financials. Perhaps more than any other group, banking stocks reflect investors' opinion of where the economy is headed. Generally, any rally in the major equity indexes that isn't accompanied by a strong rebound in the financials is thought to be highly suspect. The performance of domestic financial stocks is gauged by the BIX.X, while worldwide money-center banks such as Citigroup and JP Morgan are represented by the BKX.X. The Iraq drama is being played out on an international stage with dozens of countries as the supporting cast. As such, it's not surprising to see that the index has come under pressure as war in the mid-east becomes increasingly likely.

Annotated daily chart - BKX.X:

This chart bears more than a passing resemblance to the Dow Jones, with the exception that the BKX.X has found short-term resistance at its 38% retracement, while the 50% retracement has put a ceiling on the $INDU. However, it's interesting to note that the BKX.X has recently shown a slight trend of relative weakness. From its relative high on February 21st to yesterday's low, the index gave back 4.7%. By way of comparison, the Dow lost 4.0% from its own relative high to yesterday's low. The BKX continued to underperform on Wednesday. On a technical basis, the bears will be waiting to take advantage of either a breakdown below the relative low of 690 or a rollover from resistance near 730.

As if financial bulls didn't have enough problems to contend with, the brokerage group came under fire today after the Wall Street Journal reported that Morgan Stanley is looking at a possible SEC lawsuit accusing the company of "laddering." Laddering involves giving IPO's to large banking customers who have indicated a desire to buy more shares. Already reeling from an industry-wide decrease in trading volume, the last thing MWD shareholders want to see is an SEC lawsuit. The airlines, another beleaguered sector, were pressured today by speculation that AMR could soon join UAL in Chapter 11 bankruptcy. It's hard to imagine that things will get much better for the group as long as oil prices remain pegged at long-term highs.

Meanwhile, the NASDAQ gave back 1.9% amid a relatively quiet news day for the tech sector. The technical picture for the Composite is similar to that of the Dow, with a clear downtrend emerging over the past four sessions. There are also some developments in the semiconductor index that should have the bulls on their toes. The SOX.X underperformed the broader market today with a loss of nearly 3%. Not only did the index retrace Tuesday's gains, but it also set a new relative low. Continued weakness in the SOX.X could send the NASDAQ down to its own relative lows near 1260.

Annotated daily chart - SOX.X:

Across the Atlantic, British Prime Minister Tony Blair is facing opposition from his own Labour party regarding the use of the country's military force in an Iraqi war. Blair has been one of America's staunchest allies in the aftermath of the 9/11 attacks. This loyalty has held firm, even while polls show that the overwhelming majority of the British public opposes war without the auspices of the U.N. Meanwhile, the minority Conservative party is largely in favor (favour?) of regime change. Strange bedfellows indeed! That support from the Tories was enough to pass a Parliament amendment today echoing President Bush's call for a second U.N. resolution. Still, with 199 members of Parliament voting for a separate amendment opposing the war, Blair is in some very hot water.

There were other developments today that suggest military action will be taking place sooner rather than later. Turkey moved its ambassador out of Iraq and pulled its oil tankers away from the area. The U.S. has offered Turkey billions of dollars in aid in exchange for the use of the country's airbases. Saudi Arabia also said it would allow an American air force presence within their borders. In Baghdad, Saddam has inexplicably refused to comply with UN demands that he destroy the country's al-Samound missiles, which have a range beyond that of the mandated limit. Tony Blair speculated that he's keeping this as a trump card to use just before military action appears imminent. With several thousand troops knocking on the front door, Hussein might suddenly throw up his arms and say "Okay, I'll destroy the missiles! Look at how well I'm cooperating." However, there were reports today that the U.N. and independent weapons analysts believe this missile might be part of a secret effort to design a delivery system with enough range to hit Israel. Chief U.N. Weapons Inspector Hans Blix wants the missiles destroyed by Saturday. Will Hussein comply? Stay tuned.

As a sweltering middle-eastern summer approaches, the timeframe for war in Iraq is ticking away. Hans Blix says that several more months of weapons inspections are needed to ensure that Hussein has fully disarmed - and that's assuming that they get full cooperation. This is simply unacceptable for President Bush. Despite its overwhelming military force, an Iraq invasion would become substantially more difficult during the summer. Analysts have even drawn parallels to World War II, when the German army was defeated on the frozen Russian tundra. While this situation is vastly different, the White House does not appear willing to delay the war much longer. At a speech in Washington tonight, Bush is going to discuss his belief that regime change in Iraq will lead to greater chances for peace in the middle-east; namely between the Israelis and Palestinians. The President is also slated to talk about other benefits of toppling Saddam while also seeking to allay concerns of other Arab governments that war will plunge the region into turmoil. To the contrary, Bush believes that regime change in Iraq will help spread democracy to surrounding countries such as Iran.

Make no mistake: This approach represents a clear turning point in American foreign policy. It's true that the United States, particularly during the Reagan years, played an instrumental role in liberating the citizens of Eastern Europe from Soviet rule. The key difference is the fact that those people liberated themselves without direct assistance from the American military. In the post-9/11 world the U.S. is taking a more pro-active role towards eliminating perceived threats. What does this have to do with the stock market? Everything. Iraq will be the first test for the Administration's new strategy, and a fear of the unknown has given the market a serious case of the jitters.

Some investors are looking for a repeat of 1991, when the market began moving higher shortly after the hostilities began. Until that happens we're likely to see a lot more choppy trading with a bearish bias. But it's equally uncertain whether Gulf War II will be an easy victory for the U.S. After all, urban combat with Saddam's elite Republic guard in Baghdad would prove to be far more difficult than the open-desert warfare that was seen twelve years ago. The other wild card is that Iraq could use biological or chemical weapons on U.S troops. But speculation aside, there are a few technical signs that traders can watch for to indicate that we may be approaching a market bottom.

One such indication would be a large upward spike in the volatility index. So far the VIX hasn't punched through its long-term descending trend of lower lows. A powerful move up to the 45-50 area would suggest growing fear among investors. This was last seen in October, just before the Dow bounced back from a multi-year low. A large increase in volume, especially if it coincided with a steep broader market sell-off, would also help to confirm that the war worries have finally been conquered. Lately volume has been relatively light, indicating that many of the large institutional players are simply sitting on the sidelines and waiting for the right time to act. Until that occurs it looks like the market is doomed to continue its erratic and unpredictable behavior. But remember...with difficulty comes opportunity. Savvy traders have been able to profit from the recent gyrations. Large intraday swings will continue to provide actionable entry points. Just keep an eye on those short-term resistance/support levels, and as always, don't hesitate to cut your losses if a trade goes sour.

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