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Market Wrap

Unexpected Bullishness

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        WE 7-18         WE 7-11         WE 7-04         WE 6-27
DOW     9188.15 + 68.56 9119.59 + 49.38 9070.21 + 81.16 -211.70 
Nasdaq  1708.50 - 25.43 1733.93 + 70.48 1663.45 + 38.19 - 19.46 
S&P-100  501.50 -   .98  502.48 +  6.40  496.08 +  4.47 - 10.78 
S&P-500  993.32 -  4.82  998.14 + 12.44  985.70 +  9.48 - 19.47 
W5000   9546.66 - 64.23 9610.89 +148.38 9462.51 +104.02 -153.14 
RUT      464.76 -  9.01  473.77 + 17.42  456.35 +  7.60 -  0.81 
TRAN    2576.29 + 30.71 2545.58 +130.27 2415.31 -  1.72 - 25.25 
VIX       21.36 +   .64   20.72 -  0.89   21.61 -  0.10 +  0.62 
VXN       33.41 +   .61   32.80 +  0.33   32.47 +  1.54 -  1.41 
TRIN       0.60            0.94            1.98            1.93 
Put/Call   0.61            0.98            1.07            0.99 
Avg Highs   522             791             435             291
Avg Lows     29              21              25              22   

Unexpected Bullishness
By Jim Brown
Click here to email Jim

Let's see if I got this right. Intel beat estimates by a penny and the market dropped. IBM announced a headline number that was inline with estimates and the stock was killed and the market dropped. MSFT misses earnings by a penny and market celebrated. What did I miss?

Dow Chart

Nasdaq Chart

Consumer Sentiment also missed the mark slightly on Friday with a headline 90.3 for July compared to the consensus estimates for 90.9. Not a big miss on the surface but the whisper number was in the 92 range. The present conditions component rose to 102.1 from 94.7 but the expectations component fell to 82.7 from 86.4. The consumer is beginning to feel better about things with the market moving up and tax cut dollars about to hit their paychecks. They are becoming less convinced that the year end recovery is going to happen.

The ECRI Weekly Leading Index posted a strong gain to 126.8 from 124.9 mostly due to the bounce in interest rates and the drop in Jobless Claims. This report is not a market mover since it is a summary of all the prior data from other reports. Still it is confirmation that the economy is continuing to stabilize.

While it would be hard to build a case for the Friday rally on these two reports, each is one more brick on the path to recovery. In fact it would be hard to build a case for the Friday rally on anything but options expiration volatility and asset allocation programs. Friday is tied with October 9th as the worst trading day of the year over the last 22 years with only a 23.8% chance of the S&P closing up. For whatever reason it has closed down more than 75% of the time in the past it made up for many of those negative days with Friday's performance.

The surprising bullishness came despite negative comments from almost every quarter. We had negative comments from MSFT, IBM, INTC, NOK, MOT and dozens of other techs and that knocked the Nasdaq to a -25 point loss for the week but it still managed a close over 1700. The Dow actually recovered enough on the strength of CAT, MMM, PG and WMT to post a slight +60 point gain for the week.

Part of the bullishness came from an analysis of earnings already announced. With over 30% of the S&P already announced the 2Q earnings are coming in at +9.9% year-over-year despite estimates of only 7%. Surprised? You should be because the earnings have been far from exciting to date. Probably more visible are the earnings warnings that have been running 2:1 over those who are raising guidance. So why are the earnings so "good"? The key words here are year-over-year. To put it bluntly the 2Q of 2002 was very bad and provides a very poor comparison to the current reporting cycle. If XYZ Company has averaged 25 cents of earnings in the 2Q for years and only managed 5 cents in 2Q-2002 then a six cent earnings for this cycle would be +20% earnings growth. It is far from great earnings considering the 25 cent prior average but it is all in how you spin the numbers. If analysts can put a spin on the ball by picking their comparisons then you can count on them doing it. The next two quarters are going to be a lot tougher with expectations of +13.4% for Q3 and +21.2% for Q4.

The Friday gains were subtle and caught many traders off guard. The midday volume was almost nonexistent and the overall volume was the third lowest since May-1st. On Thursday the declining volume beat advancing volume nearly 6:1. On Friday with nearly one billion fewer shares trading, the up volume beat down volume nearly 3:1. There was a strong shift in sentiment but we only reversed about 50% of the Thursday sentiment. Also, despite the bullish day there were fewer new highs than there was on Thursday. New lows hit another two month high. When taken in context the Friday was not nearly as bullish in the internals as it was on the surface.

One of the weakest sectors for the week was the semiconductors once the Intel bounce failed. Various semiconductor makers said visibility was still bad, no pickup in demand and there were several subsectors like communications that performed worse. Other companies said business was good and they were seeing an increase in some types of orders. The general consensus was the improvements were spotty and selective. After the close on Friday the Semiconductor Book-to-Bill report was released and it only showed a 0.93 headline number. This was only slightly above the 0.90 from May. More troubling was the large drop in both orders and shipments. Orders fell by -0.4% in June and shipments fell by an even larger -4.3%. Had we not seen such a steep drop in shipments the BTB number would have dropped from May. YTD orders are down -18% from the same period last year and bookings are down -39%. Remember, last year was a very poor comparison and we are well below those numbers. The shipments in June dropped to their lowest level since Feb-2002 and orders fell for the 4th consecutive month. This was not a positive report despite how the talking heads will try to spin it on Monday.

I gave you the negative comments from INTC, IBM and MSFT in the Thursday commentary and they did not paint a pretty picture. On Friday there were some additional news items. Fairchild Semi said they were looking for a decline in revenue for Q3 of -4% to -6%. They said they were receiving some new orders but the pricing remained challenging. You have to give it away to sell it. XLNX lost ground after it said revenue would be only flat to slightly higher. PMCS said revenue would be flat and at the low end of prior estimates and they based their cautious outlook on corporate spending and difficulty in gauging demand. Dell CEO Michael Dell said that U.S. corporate spending on technology appears to be stabilizing but it is going to take a couple more quarters to see improvement. Dell President Kevin Rollins said that while the stabilization in the U.S. is very hopeful they are not seeing any change in the European markets. The bottom line is slow and steady but not the 100% profit growth that analysts have been predicting through Q2 of next year.

I have to admit I was surprised to see the rebound on Friday. I expected some short covering before the weekend to capture profits from the four day slide. The magnitude of the rebound, +130 points to 9180 surprised me. However, the Dow was the only major index to gain for the week and it was on the strength of only a handful of stocks. Looking forward we still have multiple problems. The PE on the S&P is 32 and growing. The PE on the Nasdaq is 54 and growing. Both those numbers are at the same extreme level as the top of the Internet bubble. Interest rates are rocketing with the ten year hitting 4% on Friday. Oil is still $32 a barrel and acting like an undeclared tax on the economy. There are simply a large number of reasons why the market should not rush immediately higher and a large number of reasons why it should consolidate before going up at all.

On Thursday the Dow was threatening to break support at 9000 and the Nasdaq closed under 1700. Both pulled away from those key levels on Friday and appeared to catch their second wind. Maybe by now it is their 8th or 9th wind but either way they caught it. If this was option related then we could consolidate on Monday and then begin to slide again. If it is a real summer rally then no amount of negative earnings news next week will be able to push us below those levels again. It will however be a touchy week. Next week is devoid of any material economic reports. We will be left to churn based on stock news alone. Recently we have not done well without economic guidance even when that guidance was bad. With strong resistance just above us it may take a lot more than just inline guidance from the next one third of S&P companies that announce next week. Enjoy the rally if it continues but keep looking for the storm clouds to appear. This is the dog days of summer and those severe thunderstorms can appear suddenly and without warning.

Enter Very Passively, Exit Very Aggressively!

Jim Brown


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