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It's Not the Economy... For Now

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03-26-2003                   High    Low     Volume Advance/Decl
DJIA     8229.88 -  50.35  8284.99  8187.73   1546 mln  521/999
NASDAQ   1387.45 -  3.56   1397.94  1383.35   1374 mln  806/545
S&P 100   442.07 -  2.70    445.43  440.46    totals   1327/1544
S&P 500   869.95 -  4.79    875.80  866.47
RUS 2000  368.18 -  3.61    371.79  367.65
DJ TRANS 2203.88 +  1.81   2214.48 2190.91
VIX        32.16 -  0.50    33.52   32.05
VIXN       43.94 -  1.06    45.56   43.43
Put/Call Ratio 0.86

It's Not the Economy... For Now
By Steven Price

The market seems to be betting on an economic recovery when the conflict in Iraq is finally behind us. Unfortunately this morning's economic numbers let us know that the recovery is still a ways off. The market took an undecided approach to the data, while it continued to focus on the war in Iraq.

One of the biggest factors preventing an economic collapse in the United States over the past year has been the strength of the housing sector. With consumers able to tap into their homes for re-financing dollars and also sell their houses in a sellers' market, there has been a reliable source of emergency dollars since interest rates - and mortgage rates - began dropping to multi-decade lows. Apparently some of those dollars have finally begun to slow. After a year in which it seems everyone with the ability to re-finance or buy a new house did so, we are starting to see declines in the housing market that have become measurable in numbers released over the past couple of days. February new home sales fell 8.1% to an annual rate of 854,000. This follows a 12.6% decline in January and is the lowest level since August 2000. The weather in the Northeast was partially to blame, as that area saw a decline of 37% to its lowest level since 1996, but with consecutive declines to multi-year lows, the trend seems obvious. The trend also seems to confirm comments that Alan Greenspan made earlier this year that we could not expect to rely on money from the housing market to the same extent we have over the past year. Further evidence that the market is cooling is the 352,000 homes that stood for sale at the end of the month, which is the highest number since June 1996. The 20 basis point jump in the 30-year mortgage probably won't help the recent declines, either. Recent data did show a drop in mortgage delinquencies, but the data does not include those mortgages in any stage of foreclosure. According to the Mortgage Bankers Association, "The percentage of loans in the process of foreclosure was 1.18 at the end of the 2002 fourth quarter, up from 1.15 percent at the end of the third quarter. This most likely indicates that loan foreclosures, which lag unemployment and delinquencies, are peaking."

We also got data on durable goods that was not terribly encouraging. Monthly orders for durables dropped 1.2% in February and reflected drops in demand for computers (-12%), machinery (- 2.5%), automobiles, electronics (-1.9%) and metals (-2%). Shipments of durables also fell, dropping 1.6%, accompanied b a drop of 0.3% in unfilled orders and a 0.1% decrease in inventories. Just to clarify, these are not signs of growth. If we factor out defense, the non-defense capital goods number showed a decline of 5.2% (although without the 26% drop in commercial aircraft orders the decline was 2.8%). Orders excluding defense dropped 2.7%, wiping out January's 2.2% gain and more. These numbers show that while many economists are hoping that businesses will increase spending with the war behind us, it has yet to happen.

The University of Michigan Consumer Sentiment report that comes out on Friday may give us an indication of just when we can expect to see a turnaround in spending. As long as consumer spending remains questionable, companies will refrain from placing orders for new capital equipment. After the lowest Consumer Confidence reading in ten years on Monday (which reflected data only up to March 18), Friday's data, which is more consumer heavy and reflects data tallied up through this week, may give us an idea of just how consumers are reacting to the war thus far.

One of the areas I've given a lot of attention lately is the oil market. It is a reflection of how the well the war is going from an economic standpoint and reflects costs to businesses which have played a role in many recent earnings releases. Today's example of that factor came from Temple-Inland (TIN), which announced it would see a first-quarter loss, as opposed to the $0.15 gain expected by analysts. It blamed higher energy and pension costs, with energy costs making up more than 2/3 of that equation. Today's intraday drop in the broader markets once again accompanied a rise in oil prices, as reflected by the crude oil futures. May Crude Oil Futures rose 0.62 per barrel, following several disappointing overseas developments. The first was the fact that the Iraqi military has begun burning oil fields in Rumalia, which produces slightly more oil per day than the state of Texas. Add to that the advancement of Turkish troops toward northern oil fields in Kirkuk and suddenly the control of oil fields by the U.S. looks murky. While it is unlikely that anyone but the U.S. will eventually control those supplies, assuming control may take longer than planned. Crude Oil Futures reflected that activity and traded pretty much in tandem (inversely) with the Dow for most of the day. While this certainly is not a traditional measure of the equity market, such as activity in the bond market, it seems to be serving that purpose during the conflict with Iraq. In fact, the failure to break the $29 per barrel level mid-day timed closely with the bounce in the Dow. The events in Iraq have even trumped the news coming out of Venezuela, which announced that it intended to start exporting gasoline by the end of the month. Last year that country exported 16.7 million barrels of gasoline, so it could have a noticeable impact once those exports begin. I imagine things would be much different if the U.S. was invading France. We may be tracking the price of wine stocks instead.

Chart of Crude Oil Futures

It seems that each day we get some additional news that tells us the war will be a more drawn out affair than expected. Today we heard that Iraqis have had success in destroying U.S. tanks and are planning on blowing up bridges as the U.S. closes in on Baghdad. That news continued to drive us today and the market reacted intraday to rumors and developments yet again. While we traded in a very tight range for the most part, we did make a couple of trips outside that range on war-related news/rumors. We saw a quick intra-day drop on a rumor that the government was raising the terror alert to red status, which is the highest level of alert. That rumor turned out to be false and we got a sudden bounce. That bounce was followed by news that the U.S. had attacked an Iraqi convoy of 1,000 vehicles moving south to engage U.S. troops and we rallied all the way back into the green temporarily.

Intraday Chart of the Dow

We did get another look at a support level that has held up well over the past week. On the way up last week, we saw several pullbacks to the OEX 437-440 level that has been pivotal over the past several months. Even on the code red rumor, the pullback stopped at OEX 440.46. The 50% retracement of the August highs and October lows in the Dow and OEX have acted as both support on the latest rally and also as resistance during a consolidation period at the end of January and beginning of February. That retracement comes in at OEX 437 and has put a floor on the market since the big breakout. Traders looking for a pivot point in a market that is hard to assess can use that level as the closest indicator to where we now stand.

Chart of the OEX

The Nasdaq Composite also continues to find a ceiling at the 1400 level. That level has acted as resistance (within a couple of points) in six of the last seven sessions. The first bullish move in the equities that sticks will likely have to involve a break back above that level. We did get through it on March 21, when we ran into the 1426 level that has been even more pivotal. However, since the pullback on Monday, we have been unable to crack it again, although we have tried the past two sessions, with highs of 1400 and 1397.

In business news, Sears said it is considering selling its troubled credit card unit. The $30.8 billion dollar portfolio, which garnered attention for its possible defaults in 2002 that required the company to set aside millions of dollars, is expected to fetch around $6 billion. While the money will help clear up the company's balance sheet, critics are pointing to the $1.5 billion in profits - 60% of the company's total - that Sears will lose and saying that the loss of revenue may make it more difficult to turn around other sectors of its business. While Sears is hoping that the portfolio sells at a premium, the poor economy and increasing bankruptcies might weigh against the price a big credit card issuer, such as Citibank or Bank One, might be willing to pay. Investors loved the news, however, jumping into the stock, which gained $2.69.

Another factor that continued to weigh on the market was yesterday's vote by the Senate to cut the President's tax-cut plan in half. Those cuts could severely reduce his plan to eliminate the double taxation on dividends. The plan, when announced, led to a big rally due to the sudden inflated value of dividends to both corporations and the shareholders that receive them. If those dividends don't receive the tax benefits President Bush is pushing for, they can suddenly lose as much value as they seemed to have gained, taking value out of the stocks that pay them.

For the first time in a while, we traded in a tight range, with only a couple of intraday swings that qualified as significant moves. And those moves were mostly news-based. Volume was also on the light side at 1.2 billion shares on the NYSE and 1.4 billion shares on the NASDAQ. The aimless drifting for most of the day seemed to signal exhaustion and a waiting period for the next big development in the war effort. While the economic data we saw suggests a worsening economy, all attention remains on the war as it appears to be the last great hope for the economy. If the theory that businesses will start spending once it is over pans out, then we may make another run at last year's highs. However, with no hard evidence yet that that is the case, the market will continue to trade on hope, or the lack thereof.

Steve Price

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