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ISM Rally Fades

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06-02-2003                  High    Low     Volume Advance/Decl
DJIA     8897.81 + 47.55  9003.27 8851.45   2066 mln  1867/1018
NASDAQ   1590.75 -  5.15  1620.79 1586.48   2455 mln  1673/1501
S&P 100   485.36 +  2.16   491.75  484.33   totals    3540/2519
S&P 500   967.00 +  3.41   979.11  963.59
RUS 2000  442.63 +  1.63   447.47  441.00
DJ TRANS 2512.33 + 25.98  2526.68 2487.19
VIX        22.23 +  0.53    22.74   20.97
VIXN       33.63 +  1.97    34.23   30.58
Put/Call Ratio 0.67

ISM Rally Fades
By James Brown

Wall Street bulls have finally run out of breath despite more good news in this morning's ISM report. At their peak for the day, the Industrials were up 153 points, the NASDAQ Composite was up 25 and the S&P 500 was up 16. Unfortunately, the afternoon brought out the sellers after the DJIA traded above the 9000 mark. The sell-off was pretty steep with the NASDAQ and other tech related indices losing ground with the rest of the market well of its highs.

On the other hand global markets were buoyed by the U.S. indices strong close on Friday and the early rally on Monday. Asian exchanges were very strong with the Hong Kong Hang Seng up 150 points or 1.58% to 9637. The Japanese NIKKEI closed up 122 points or 1.46% to 8547. Europe exchanges also closed higher. The French CAC 40 gained 1.89% to 3048, closing over the 3000 mark. The British FTSE 100 jumped 2% to 4129. The German DAX vaulted some 2.75% to close at 3064, another breakout over the 3000 level.

U.S. market internals remained positive but were also off their best levels of the day. Advancing issues out paced decliners 18 to 10 on the NYSE and they just barely squeaked by on the NASDAQ at 16 to 15. New highs to new lows remain incredibly bullish with 543 new highs to just 18 new lows. Up volume on the NYSE was 1300 million compared to 694 million in down volume. The NASDAQ's reflected the close race in the advance-decline numbers with just 1.3 billion in up volume over 1.1 billion in down. Overall volume was very strong with 2.0 billion on the NYSE and more than 2.45 billion on the NASDAQ, it's highest volume day of the year.

ISM Report

All of Wall Street was waiting for the ISM report today and they were not disappointed. April's numbers were a disappointing 45.4 and consensus estimates for May were 48.5. Fortunately, the economy is improving better than expected as this morning's report revealed a reading of 49.4. This was the fifth largest one-month rebound in the ISM index in over a decade.

Numbers under 50 represent a contracting economy but traders were willing to look at the 49.4 result as a sign that the slow down in manufacturing is at least improving. What really gave bulls something to snort about were improvements in the new orders index (51.9 vs. 45.2), the production index (51.5 vs. 47), and the drop in prices paid index (51.5 down from 63.5). I thought it was interesting to note that this marks the third straight month under 50 for the ISM index. The same three months that the markets have been advancing (on expectations of an improving economy). The strong ISM report was more than enough to push a negative business construction spending report out of the spotlight. Today's news also marked a third straight month of declines for business construction outlays with April's slipping 0.3% and a seasonally adjusted rate of $862.6 billion a year.

Now that the business media has declared an end to the bear market the noise from the bullish camps is getting louder. One Merrill Lynch analyst was cheering the market's progress with a research note stating stocks have plenty more upside through the end of this year and into the next. Merrill's chief market analyst also claimed that over 80% of NYSE-listed equities are now trading above their 200-dma compared to less than 20% during the lows of 2002. This characteristic is said to belong to a true bull market and not bear market rallies.

Doing its part to lift the markets early on was the biotech sector. Over the weekend the annual meeting of the American Society of Clinical Oncology brought some positive news to light for ImClone and Genentech. Genentech (NASDAQ:DNA) gapped up again and traded above $70.00 before finally closing at $66.73, +6.58% on the session. Investors were reacting to more good news that DNA's Avastin drug boosted the survival rate for colon cancer patients by 50%.

Outpacing even DNA's gains were shares of ImClone (NASDAQ:IMCLE). IMCLE's European partner, Merck K GaA, revealed at the Oncology meeting that mid-stage testing for IMCLE's anti-cancer drug Erbitux were very encouraging. Shares of ImClone gapped higher and traded to $38.00 before closing at $33.50, up 17.5%. Many believe that IMCLE will resubmit Erbitux to the FDA for approval based on these new results. The FDA shot down the drug in December 2001 citing a need for more evidence.

What's a Monday without another merger? This time software rivals PeopleSoft (PSFT) and J.D.Edwards & Co. (JDEC) are merging in a deal worth $1.7 billion. As usual, shares of the purchaser, in this case PSFT, slipped on the news (-9%) while shares of JDEC popped higher (+7%). One share of JDEC will be worth 0.86 shares of PSFT and JDEC shareholders will control 25% of the combined company, soon to be the second largest software applications firm in the market.

Monday also produced a widely discussed FCC vote on media- ownership. In what is sure to be a strongly contested outcome the five-member commission voted 3-2 in favor of easing ownership rules. This lifted the national broadcast cap from 35% to 45% that now allows for any one company to own stations that can reach nearly half the country. The vote was split among party lines with the two Democrats Michael Copps and Jonathan Adelstein against the move.

Tomorrow's Trading

The ISM report is a huge win for the bulls. Yes, it states that the manufacturing sector of the economy is still contracting but at a much slower rate. If you put on those rose-colored, the glass is half full, maybe-a-second-half-recovery-is-really-in- the-cards-this-time glasses then the ISM report was almost positive (over 50). The FOMC had been waiting for some "clean" economic data (a.k.a. data not tainted by the conflict in Iraq) and this May ISM report fits the bill. Combine this "positive" ISM report with last week's PMI numbers and signs of a slowly improving economy are indeed trickling in. This might have Greenspan & Co. holding off on another rate cut at their upcoming June meeting. Bulls like to have their cake and eat it too. Just because the economy might be improving, even at a glacial pace, they still want another rate cut. If suddenly they're concerned that Alan won't comply it could negatively affect the markets.

Another factor greasing the floor for a big slide is the jump in crude oil prices. Iraqi oil could be a long way off from affecting the global oil supply and is not an immediate threat to OPEC. Rumor has it that OPEC might vote to cut output at their June 11th meeting to keep prices higher in time for the prime summer driving season in the U.S. Light crude prices for July delivery jumped $1.15 to $30.71 today and marks the first close over the $30 a barrel level in six weeks. Natural gas prices are also rising and higher energy costs would slow any economic rebound already underway.

Chart of the Dow Jones Industrials:

Chart of the NASDAQ Composite:

Rumors that Intel might warn or offer some negative comments later this week kept a tight lid on the SOX. The chip sector did not enjoy the early morning strength with the rest of the markets and when the afternoon sell-off hit the SOX led the way down. We noted that all of the main technology sectors were lower today (DDX disk drive index, GHA hardware index, GSO software index, INX Internet index and the SOX semiconductor index).

Chart of the Semiconductor Index (SOX):


Traders need to be careful here. Most of the major indices are all screaming "TOP". The failed rally today combined with big volume is NOT a bullish sign to go long equities. Profit taking is part of the normal course of business as the markets ebb and flow. Currently, we are way overdue for some profit taking and all signs are pointing that our next short-term pull back will be this week. Just look at the DJIA, the SPX, the Wilshire 5000 - all of them are very extended and showing the same failed rally today. Check out the Russell 2000. It's up eight days in a row. You'd have to go back to late 1999 to find that kind of strength in the RUT. Don't get me wrong. The trend is our friend and the trend is currently up but that doesn't mean we should buy stocks (or call options) tomorrow.

Bullish investors need to be patient. Wait for the pull back. Look for your stocks to reach significant support and begin to bounce before evaluating any new positions. When we get an opportunity to buy near the bottom of a rising channel we can usually do so with a tighter than normal stop reducing our risk even more.

Let's be careful out there!


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