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Market Wrap

Better Than Monday

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      07-08-2003           High     Low     Volume Advance/Decline
DJIA     9223.09 +  6.30  9236.39  9162.94 1.91 bln   1807/1412
NASDAQ   1746.46 + 25.80  1747.44  1713.76 2.02 bln   2106/1144
S&P 100   506.34 +  0.84   507.06   502.52   Totals   3913/2556
S&P 500  1007.84 +  3.42  1008.92   998.73 
W5000    9687.14 + 47.10  9697.35  9592.61
RUS 2000  473.97 +  8.26   474.13   465.13 
DJ TRANS 2565.12 +107.00  2569.67  2466.08   
VIX        21.40 -  0.65    22.31    21.11   
VXN        33.49 -  0.02    34.79    32.91 
Total Volume 4,170M
Total UpVol  2,807M
Total DnVol  1,282M
52wk Highs  975
52wk Lows    22
TRIN       1.01
PUT/CALL   0.63

Better Than Monday
By Jim Brown
Click here to email Jim

No, we did not put more points on the board but we did exceed Monday's volume by a fair amount. Is this a good thing for a day where the Dow barely broke even? That $64 billion question will be answered on Wednesday when the market will have to meet a much higher standard just to break even.

Dow Chart - Daily

Nasdaq Chart - Daily

Economically the day was a pass with no material economic reports and profit taking from Monday a much bigger concern. The leading report Tuesday morning was Weekly Retail Sales which rose +0.7% to a new high for this cycle. The sales were boosted by the July 4th promotions but traders could have cared less. This is not a real market mover under normal circumstances and today was no different. This weekly snapshot will take a backseat to the real monthly numbers on Thursday. We will get to see if the high inventories have burned off from the heavy discounting and what stores are looking at for the balance of the summer. With consumers getting a chunk of extra cash on their paychecks from the recent tax cut, retailers will be slashing prices and running big ads to get their share.

Those same consumers ran up their debt over the month of May with a bounce in consumer credit to $7.3 billion from the consensus estimates of $5.2 billion. However April was revised down to $7.8B from the previously reported $10.7B. The biggest jump was in auto debt which was prompted by continuing big incentives from the major manufacturers. These gains were despite a refinance index that is 400% higher than it was this time last year. Some consumers are paying off debt at a record pace while others are going deeper in debt due to unemployment.

The most positive report for the day was the Richmond Fed Survey which came in positive, only +1 but we can't complain. This was the first gain in five months and the first time the shipments index has been positive since January. Unfortunately new orders were flat and backlogs were severely negative at -15. The ISM showed a minor contraction in June and this survey is only showing a very minor improvement in the Richmond Fed region. The good news is that we are not seeing an increase in the contraction but signs, however slight, of continued improvement. Traders are unsure if the minor improvements will be enough to maintain earnings through the 3Q until the second half recovery begins.

The big story was the multiple merger/takeovers announced today. The biggest impact to the market averages came from the Yellow Roadway acquisition. The +$16 bounce in ROAD sent the Dow Transportation index soaring +107 points and probably had a lot to do with the positive mood on the Dow. While the indexes are not directly related they are intertwined on a sentiment basis. The Dow normally has trouble when the Transports fail to move in the same direction. Traders seeing the large numbers on the TRAN today could have gotten that warm fuzzy feeling about the market in general. If so they did not get it until after 3:PM.

You wonder how many earnings warnings were ignored due to the three takeovers and the positive press they received? If EMC thinks LGTO is a bargain then are all techs a bargain? While I doubt it that was the sentiment running rampant on Tuesday. The Nasdaq roared to another +25 point gain and a high near 1750. Yes, 1750. It is amazing that just a couple weeks ago we were agonizing over a 1685 top and the potential for a drop below 1600 as a critical event. Just yesterday FILE, SGP, WEN, RITA, SMG, SYBN and BMC Software warned on earnings and this morning they were joined by BMS and SCHL but the warning pace slowed dramatically as we move into the earning cycle. The first Dow component announced tonight and Alcoa beat the street by +3 cents. This is not likely to cause a runaway market on Wednesday but traders hope it could become contagious. The hopes are for better than average comparisons due to the very weak Q2 in 2002. With over 55% of the S&P already warning for the 2Q it is clear the load will have to be carried by a very few stocks.

Earnings for the rest of the week include DNA and YHOO Wednesday, ABT, JNPR, MTCH, MTIC, PEP, PWAV, PLUM, PTNX, SONS and SNUS on Thursday. Friday we will get the big gun, GE, and traders are not afraid they will miss but afraid they will say something negative in their guidance. Economic reports are still slim until Friday when we get the PPI. Next week we will get a strong pickup in both earnings and economic reports and the market will have plenty to mull over.

Microsoft made news at the bell by announcing they would no longer give employee stock options as incentives. They are going to establish a plan to award actual stock which will vest over a set period of time. While the incentive to employees is approximately the same the impact to MSFT books is substantial. The stock grants will be expensed on MSFT financials in a dramatic departure from the current practices of major companies. MSFT said the new plan would take effect in September and be shown on the June-2004 end of year financials. They said they would also expense the value of previously granted stock options and restate past results to show the impact of those changes. They also said employees with options priced over the current stock price could now sell those options to JP Morgan which effectively ends the current option program for everyone. By taking this step MSFT is waging war on the other major tech companies who have refused to expense options in the past. Many of these companies would have never reported a profit if the cost of their options had been included.

It has been rumored that Cisco earnings would be reduced by more than half if their options were expensed. All the big techs will be under fire including CSCO, DELL, INTC, AMZN, EBAY, YHOO and ORCL if their earnings suddenly take a 50% dive. With the standards board already coming up with an expensing rule this is a preemptive step by MSFT to blunt the damage. MSFT said expensing options in the 1Q would have cost $656 million and reduced earnings from 25 cents to 20 cents. MSFT has an advantage because they are so profitable. All the other companies have earnings that are a fraction the size of MSFT but the options expenses are still very high. This will be very interesting to see how it plays out. Did PE values just double or will stock prices adjust? I think investors will rationally consider the earnings in light of the expensing but those PE numbers are going to be a constant eyesore for years to come.

There were several news events impacting sentiment today. The July-7th survey of newsletter writers showed that the number bearish was at a 12 year low. The ratio of bulls to bears had improved only slightly from the week before where conditions were at the worst level seen since October 1987 and the week before the crash. This is despite the PE on the S&P hitting 32 in recent weeks. That is the same level it was in March of 2000 when the bubble began to burst. Merrill Lynch said today that this was the weakest recovery period on record. Makes you wonder what the earnings are going to look like next week. Despite all the negative news bond yields continue to rise. On June 16th the yield on the ten year note was 3.08%. Today it traded at 3.75% despite a 25 basis point Fed cut in the middle. The Fed wanted to keep rates down and bragged constantly about all the tools at their disposal to do this. Did they lose the toolbox? The almost panic reversal in bonds has puzzled many traders. Despite the gains on Monday the bond money has not been finding its way into equities. Some yes, but only a fraction of the money being raised. Where is it going and why? Traders are now worried that the sell off will take a life of its own and the Fed will not be able to slow the rate increase. While the short-term inflow of some bond cash is positive for the markets the long term impact of rising rates will be very detrimental. We have had the equivalent of three 25-point rate hikes in the last two weeks and the market is still climbing. Or is it?

The volume on Monday was anemic considering the magnitude of the market bounce. In reality the bounce was mostly short covering produced by a giant bounce in the Asian markets and no terrorist attack over the weekend. Retirement cash inflows supposedly made up the rest. If you look at the chart below you can see the Dow peaked at 10:25 in the morning at 9261 and has been down trending ever since. Volume today was strong but that volume came on a flat day for the Dow. Actually the Dow did not turn positive until 3:30 this afternoon. That means the high volume was on a down day. The Nasdaq was the exception. Despite tech earnings warnings and the impending potential for negative earnings surprises techs just continue to gain. The Nasdaq is up nearly +150 points since July 1st. Does anybody think that is excessive? Volume on the Nasdaq was over 2B shares. Today was a market full of divergences that ended well. Tomorrow is the key to the week.

Dow Chart - 10 min

We begin to see real earnings accelerate and a slight pickup in economic reports. These are real potential problems for stocks. We are also likely to see the recent highs on the Dow and S&P retested and that retest will be at the end of a multiple month advance. It will also come at the same time as the typical July peak. Nobody knows if the retest will fail or be successful but the danger is real. In trading all the stars are aligned for a major event. Not necessarily a crash but a consolidation period of several weeks once the excitement of the current rally runs its course. The S&P is up +27% from the March lows of 789. +27% in a little over three months. That kind of gain is similar to the gains in the S&P in 1998 which was not a recession year. You can see what happened in 1998. The upward spike into the July earnings is very similar.

SPX Chart - Daily

We are rapidly careening into the July earnings event and the outcome is very uncertain. Even if earnings are good will they be good enough to satisfy the huge gains since March? Will the 2Q retirement cash flow indefinitely? Will the bond market slow the current crash or will the rapid escalation of interest rates produce stock market uncertainty? Will the Fed appear any day now and wave their magic wand to knock rates back into the cellar. Do they know which wand to use since the last one had the reverse effect. Somebody call Harry Potter because there is a good chance we are going to need some real magic soon. Either way be sure you have the right spell in place as we approach the end of the week to protect yourself against any unplanned retracements.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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