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Danger Zone

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      03-27-2003           High     Low     Volume   Adv/Dcl
DJIA     8201.45 - 28.40  8251.80  8104.05 1.46 bln 1696/1518
NASDAQ   1384.25 -  3.20  1392.46  1369.31 1.41 bln 1584/1554
S&P 100   441.01 -  1.06   444.14   435.95   Totals 3280/3072
S&P 500   868.52 -  1.43   874.15   858.09 
W5000    8224.04 -  8.80  8270.38  8128.09
RUS 2000  369.50 +  1.32   369.73   365.09 
DJ TRANS 2183.05 - 20.80  2203.15  2169.09   
VIX        32.15 -  0.01    33.94    31.50   
VXN        43.87 -  0.07    45.62    43.67 
Total Volume 3.107B
Total UpVol  1,294B
Total DnVol  1,716M
52wk Highs  142
52wk Lows   126
TRIN       1.43
PUT/CALL   0.79

Danger Zone
By Jim Brown

Multiple comments from various levels of the administration as well as arm chair generals all say the war is entering a dangerous period as the battle for Baghdad is about to begin. This approach to the danger zone around Iraq pushed the Dow to the danger zone around 8100. Fortunately both the Dow and the Marines managed to avoid a disaster for one more day.

Dow Chart - Daily

Nasdaq Chart - Daily

The day started off with a serious drop on news in the Washington Post that the war could take months and we were about to see many more casualties. The Dow dropped -120 at the open but managed to recover to positive territory by mid afternoon. Traders kept asking why with economics still getting worse.

The Jobless Claims fell to 402,000 but that is still the 6th week over 400K and still showing a contraction in the labor market. The four-week moving average fell slightly to 423,000. Continuing claims fell to 3.521 million but remain at levels higher than the 1990 recession. With the potential for a multi month war this puts even more pressure on employers to trim the workforce until conditions improve. The Help Wanted Index for February fell back to 40 and only one point from its cyclical low set in December. The lack of hiring is shown in the lack of advertising. The ManPower survey shows weakness continuing through the 2Q and saw no hiring anywhere but Salt Lake City. According to the survey there is expected to be some small gains in late 2003 but no major expansion until 2004.

We saw the impact of this unemployment rate on Wednesday when Sears underwent plastic surgery to remove a major pain in the neck. They announced they were selling their credit card business and would be taking offers. They are seeing a 20% charge off rate on their existing accounts. That is 1 in 5 accounts. Think times are not tough?

The Chicago Fed National Activity Index fell into negative territory again with only one positive month since last July. The index fell to -0.62 from +0.53 last month. This was due to drops in industrial production and a drop in employment by -308,000 jobs. There is beginning to be more fear that the economy is slipping back into recession. The 4Q GDP was finalized at a +1.4% annualized growth rate and the first quarter is not shaping up to be a strong quarter either. Many economists feel a multi month war will push growth in the 2Q into negative territory. The big drop in spending for durable goods, autos and now houses is now mushrooming into a serious problem.

Part of the rally last week was attributed to the drop in oil prices once the southern Iraq oil fields were under coalition control. Prices fell to near $27 but today prices were back to $30.37 due to instability in Nigera, low inventory levels and the prospect of having Iraq's production off line for months. Also a factor is the massive use of fuel in the war. One defense dept spokesman said the coalition is using the equivalent of seven million barrels of oil a day. The front line ground forces in Iraq are using one million gallons of diesel and gasoline a day with all other ground forces using another six million gallons. The fuel for the front line combat troops has to be trucked up to 300 miles from Kuwait. The tankers offload it and then make the return trip to reload. The roads are cross-country in most cases and not paved. Not a fun job. If the price of oil remains over $30 the price premium will be extracted from the stock market again.

Oil is not the only thing going up. Mortgage rates are rising off their lows and with them the refi door is closing. We saw new home sales drop this week -8.1% and existing home sales fall -4.3% on Tuesday. This does not bode well for any economic recovery. The big hiss you hear is the air leaving the housing bubble.

Gold also rose today as Middle East investors took delivery and began moving the actual gold to safer climates. The anti US feelings are prompting the move as well as fear of confiscation. When the US froze Iraqi assets last week it put some fear into Arab holders that their assets could be next. Since some inventory gold is "loaned" to traders the removal of the actual commodity from circulation forces traders to cover elsewhere.

The markets slide into the early March lows was due in part to the third consecutive month of outflows according to ICI today. They said there was -$11.1 billion in equity fund outflows in February. At the same time there was +$17.8 billion inflows into bond funds. It appears there are a lot of traders expecting more market troubles ahead.

A new threat to the market is coming from the new virus out of Asia. The CDC says there are over 1700 confirmed cases and probably thousands that have not yet been diagnosed. It is spreading quickly and the Asian economy is already suffering. Retail sales are down -2% due to consumers not wanting to be in crowds. Hotel bookings are down -5 to -7% and airline bookings have dropped as much as -20% to Asian countries. Adding this drop in commerce to the war impact and the global loss could be substantial. DB has already predicted a drop of -0.5% to the GDP of the Hong Kong area. The Asian economies were not robust to begin with and a ramp in the number of diagnosed cases could slow it even further.

In the US the major problem impacting Thursday's market was the realization that the war could take months and casualties could run in the multi thousands. I reported a couple days ago a conversation by several analysts with casualty estimates in the low range of 5,000 to 7,000 and a high range of 17,000 with no coordinated surrender. Considering how the market reacted to the deaths and capture in the last week they are not going to react well to multiple hundreds killed in this and that battle once the real war starts. There has only been light resistance to this point. Saddam knew we were coming and pulled all his major forces back to the 50 miles around Baghdad. In war standards we have not seen anything yet. Americans are spoiled by the limited casualties in 1991 and the prospects for a video game war. This is not it. Saddam has three times more men on the ground than we do and air power can only do so much once we get into the populated areas. Americans are spoiled to instant gratification and once they see it is not instant and not painless the odds are good the market will reflect this change in sentiment.

The Dow tested strong support at 8100 this morning and came through with flying colors. The rebound off 8100 powered the Dow from -120 to +22 by late afternoon but the external forces were too strong. We had a news release late in the afternoon that the Iraqis were shooting down more missiles, drones and helicopters than we had anticipated. Al-Jazzera ran film of a downed drone and another downed helicopter and the market tanked. According to the US military it was the same helicopter from last week but they admitted they had lost several drones. With Russian and Iranian companies selling them antiaircraft and antitank missiles it appears the odds are more evenly matched than we thought. That news put more fear into traders about the eventual human cost. Rumsfeld was on TV numerous times with the longer, harder, costlier war message and that did not help either. Still the Dow managed a very respectable rebound from strong support.

The Nasdaq tried valiantly to retest 1400 again but fell short. The Russell was the only major index to finish in the green. The markets are expected to drift down overnight with problems in the Japanese banking system. The fourth largest Japanese bank announced after the close yesterday that they would lose money for the third year in a row and a group of eight largest banks would lose trillions of yen in 2003. This was seen as pressure on the Nikkei for Friday trading. This is the year-end in Japan and traders felt there would not be any major selling until Tuesday.

That same scenario is alive and well in the US markets and could have been instrumental in providing the big rebound. We are only celebrating the end of a quarter but funds still dress up their statements with a few well placed buys. However, according to the Stock Traders Almanac recent March trends have not been exciting. Fear of April selling seems to be keeping funds in the conservative arena. Another factor that might keep funds from making a bull run is the recent rally. They could have loaded up last week to avoid missing the train and with negative fund flows have no cash left for the actual month end. More likely Friday support will come from shorts going flat before the weekend to avoid any Saddam removal announcement. Trade what you see not what you think.

Enter Very Passively, Exit Very Aggressively!

Jim Brown

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