The market pull back in Monday's session was no surprise after Friday's high-volume reversal day. For days market analysts have been parroting the same line (in stereo), "Yes, we're bullish on the markets but cautious on the short-term. The markets have come too far, too fast." The bulls' run on Wall Street appears temporarily exhausted as they pause to catch their breath. Or has it? How deep (or shallow) would be pull back have been had it not been for the downpour of bad news today? The DJIA fell some 82 points to close under the 9000 level as shares of Boeing (BA) and Walt Disney (DIS) led 27 of the 30 components into the red. Seeing green were shares of IBM, which bounced 2.4 percent off support at the $80 level. The NASDAQ composite lost 23 points to close at 1603. The S&P 500 index dropped nearly 12 points to just under 976. Out of the twenty sector-specific indices I watch only one closed in the green and that was the OSX oil services index, which gained 40 cents to close at 96.60.
Chart of the Dow Jones Industrials:
Chart of the NASDAQ Composite:
Chart of the S&P 500 Index:
As you could expect market internals were negative with declining issues rushing past advancing issues by 20 to 8 on the NYSE and 2 to 1 on the NASDAQ. New highs took a big step back coming in at 266 to just 15 new lows. Volume was still decent with 1.6 billion on the NYSE and 1.8 billion on the NASDAQ but down volume swamped up volume almost 5-to-1 on the Big Board and more than 3- to-1 on the NASDAQ. Volatility indices, which had been rebounding from their late May lows, continued to climb higher.
Freddie's Financial Faux Pas
Freddie Mac (NYSE:FRE), the U.S. government-backed home loan lender, lost more than 16 percent to close at $50.26 after announcing the company's plan to clean house with its upper management team. FRE said that its chairman and chief executive officer was retiring, that its CFO was resigning and that its COO was being terminated. The culprit, once again, was revenue recognition (the same issue IBM is being probed for). It appears that FRE's COO is alleged to have been less than honest with the company's audit committee and that he was material in managing the company's numbers in a practice called "smoothing". In this case, FRE under reported past profits to be accounted for later during slow quarters, hence the smoothing out of its relative performance quarter over quarter. While any restatements of FRE's earnings between 2000 and 2002 would likely raise previous results FRE felt that these "profits" would be counterbalanced by slower results in the future.
OptionInvestor suggested buying puts or going short Freddie Mac two weeks ago when the stock broke down through its rising channel on news that it was losing market share to its rival Fannie Mae (FNM). Unfortunately, the broader market's strength was too infectious and lifted FRE back above resistance at its 200-dma and the $60.00 level and we were stopped out. FRE is such a major player in the mortgage market (between FRE and FNM they control more than 40% of the U.S. mortgage market) that one could have assumed that such a shake up would have done even more damage to the stock and investor confidence. It's probable that because any earnings revisions are expected to be higher that the sell-off was less severe than it could have been. Still, the news helped drive investors to the safety of bonds and accelerated some of the profit taking already under way in the overbought home building sector.
Hitting the telecom and wireless sectors today was news that Motorola Inc (NYSE:MOT) would not meet its expectations when it announces earnings in July. In what could be the beginning of a very long and high profile earnings warning season, MOT said it would earn 2 cents a share compared to analysts' consensus estimates of 4 cents for the second quarter. MOT lowered its revenue numbers to between $6.0 to $6.2 billion, down from $6.4 to $6.6 billion. The company blamed excess inventories in Asia, slow sales due to the SARS outbreak and a Japanese earthquake that disrupted its semiconductor manufacturing. Shares of MOT lost 2.36% to close at $8.68.
More Monday Mergers
The ongoing software soap opera between Oracle (ORCL), PeopleSoft (PSFT) and J.D.Edwards (JDEC) continues to take center stage for merger highlights but General Dynamics made its own move in the defense sector today. General Dynamics (NYSE:GD) dropped $1.42 to $67.19 after announcing its plan to buy Veridian Corp (NYSE:VNX) for $1.23 billion and assuming its $270 million in debt. The buyout is worth $35.00 a share for VNX and shares gapped higher to close up 26% at $34.48. As the U.S. defense budgets are likely to swell over the next few years, GD's move to buy VNX may be a smart one. Veridian's products are aimed at the intelligence community and provide surveillance, reconnaissance and more. All of which are critical as America pursues its war on terror. Meanwhile the software sector brouhaha grew louder as Oracle's Larry Ellison requested a meeting with the board of directors for PeopleSoft in an attempt to push its hostile takeover bid to the next level. The CEO of J.D. Edwards, who had planned to merge with PSFT, said ORCL's move was anti-competitive and would not likely pass the U.S. or European anti-trust agencies.
Who said timing the markets was impossible? Professional analysts seem to have impeccable timing. There were nearly forty downgrades released today that only contributed to the market weakness and gave traders even more of an excuse to take profits. Some of the downgrades making the headlines were QLGC, ADBE and a slew of telecom stocks. Goldman Sachs cut semiconductor maker QLogic Corp (QLGC) to an "underperform" from an "in-line". Goldman's analyst claimed that shares were looking pricey and the company may not be able to maintain its profit margins. The analyst at Punk, Ziegel & Co. were less forgiving and cut QLGC to a "sell". The stock lost four percent and was a drag on the SOX, which fell 2.4 percent.
Enduring another analyst sting were shares of Adobe Systems (ADBE). Smith Barney downgraded ADBE on valuation concerns and lowered it to "underperform" from "in-line". ADBE has been a big winner for investors this last year after trading under $17.00 last August. Smith Barney reiterated its $36 price target and shares of ADBE dropped 5% to close at $35.40. Adobe is expected to announce earnings this Thursday, June 12th, after the markets close.
Further undercutting technology stocks was a downgrade from Lehman Brother's on a number of telecom services/communication equipment companies. Slashed from "equal weight" to "underweight" were Nortel Networks (NT), Tellabs (TLAB), Sonus Networks (SONS) and ADC Telecommunications (ADCT). Lehman felt that the telecom services industry was "gradually recovering & should return to positive growth by 2005". The four unlucky stocks above were cut on valuation concerns claiming they had all appreciated too much during the recent rally. Meanwhile in the same note the brokerage actually raised its rating on SBC and upped its price targets on Verizon (VZ) and BellSouth (BLS).
Yet another card in the bear's poker hand is rising energy costs. Last week crude oil (August contracts) prices broke out above resistance in the $28.50-28.65 (a barrel) range and today they closed above $30.00. Industry watchers are anxiously waiting for the OPEC meeting to be held on Wednesday. Also fueling concerns is the rise in natural gas prices. Natural gas is up more than 30 percent year to date and they have more than doubled since February 2002. FinancialTimes ran an article stating that U.S. supplies have hit critically low levels. At the end of March natural gas supplies were down to 696 billion cubic feet of gas, which is the lowest level since recording began back in 1976. Supplies have sunk even lower since then. Look for the financial media to cover Alan Greenspan's testimony on the natural gas shortage before the House Energy & Commerce committee tomorrow.
If you've not already locked in your profits from the three-month market rally then now may be a good time to do so. If not, be sure you're happy with your stop losses. The markets need this pull back to consolidate some gains and give us a base from which the bulls can attempt another leg higher. Now that Motorola has kicked off the earnings warning season it is time for us to become a little more cautious.