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Back to the Future

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      09-23-2003           High     Low     Volume Advance/Decline
DJIA     9576.04 + 40.60  9583.48  9511.41 1.60 bln   2002/1189
NASDAQ   1901.72 + 27.10  1901.73  1875.15 1.86 bln   2069/1201
S&P 100   516.12 +  2.81   516.61   512.19   Totals   4071/2390
S&P 500  1029.03 +  6.21  1030.12  1021.54 
W5000    9993.48 + 65.70 10000.16  9923.72
RUS 2000  519.36 +  5.71   519.49   513.65 
DJ TRANS 2800.38 + 21.20  2804.13  2779.70   
VIX        19.47 -  0.18    19.97    19.31   
VXN        26.98 -  0.96    28.04    26.90 
Total Volume 3,735M
Total UpVol  2,702M
Total DnVol    956M
52wk Highs  606
52wk Lows    15
TRIN       0.90
NAZTRIN    0.43
PUT/CALL   0.85

Back to the Future
By Jim Brown
Click here to email Jim

The markets closed almost exactly where we closed last Tuesday. After an entire week of thrills and chills we are right back where we were last week. Literally the Dow missed it by 7 points, S&P by .29 of a point. The Nasdaq was the star performer with a +15 point gain. The gains were less than the losses yesterday so despite the green close we are still down for the week. Relief bounce or dip buy is still undetermined. The Nikkei was closed today and as the source of our Monday weakness all eyes will be on the Japanese index tonight.

Dow Chart

Nasdaq Chart

The only economic report today was the Weekly Chain Store Sales which fell -1.8%. Analysts attributed the loss of sales to the hurricane, the monthly paycheck cycle and falling numbers of tax rebate checks. Last week they were claiming the underlying strength in retail sales was due to the hurricane and buying of building materials. They also said it was natural for a slump after a period of small growth. While I agree with all of these things isn't it amazing how the excuses come pouring out whenever there is an estimate miss? Wal-Mart held up the sector today with comments that sales were tracking at the high end of estimates.

The real economic report today was an earnings warning from Verizon. The company said its 2003 earnings would fall short of prior estimates due to weak demand for services and rising labor contract costs. Verizon is the largest phone company and the weak demand could be signs the recovery is not gaining speed. They are seeing increased demand for wireless services as many customers switch to cell phone only and cancel existing land lines. It expects to add 4.5 million subscribers in 2003. Can you hear me now? Good for Verizon if you can and that commercial has new users flocking to the cell phone business. Unfortunately they have to constantly update their cell infrastructure while their expensive land lines are going dormant. It is a good news, bad news joke that will eventually benefit shareholders once the trend stabilizes. Still the other phone companies were weak today on fears that what is happening to the big guy will probably impact the smaller fish as well.

Paychex reported a +6% rise in earnings due to a +24% spike in payroll services. While several high profile analysts were quick to say this was an indicator of a jump in hiring I beg to differ. I find it hard to believe that there was a 24% jump in employment this quarter. The economic numbers just do not show it. I believe their increase was due to a continued drop in jobs as small businesses cut out the clerical accounting help in favor of using a cheaper payroll service instead. It is just another in a long line of cost cutting measures to keep the doors open. I am sure a lot of it was due to their beefed up marketing campaign as well but that still supports the corporate cost cutting scenario.

Dell may be about ready to take a page out of the Gateway play book. A Reuters report said Dell may be laying the groundwork to enter the flat screen TV market place, digital music players and handheld computers. Dell would love to get into the high dollar flat screen TV market like Gateway and then take on the big boys at their own game. Dell is the master at turning the manufacturing process into a pure commodity driven model with just in time shipping of components assuring the lowest price on a daily basis. They maintain a constant stream of price quotations from suppliers and because of Dell's volume the suppliers will cut their own profits to the bone to get the deal. Once Dell gets into the flat panel TV business the prices should start dropping quickly. The price war could be drastic. Dell was up on the news and nearing a 52-week high at $35. Would the last one out at Gateway please turn off the lights.

The Nikkei was closed today and the US markets had to find their own way with no guidance from Japan. Regardless of the minor market gains today the dollar/yen fight is not over and it will come back to bite us. The Yen hit a three-year high to the dollar on Tuesday and comments from Japan would indicate it could go higher. The problem is the imbalance of trade and the US debt. If we buy a Japanese car the car company gives the US dollars to the Bank of Japan in exchange for Yen to pay their employees and suppliers. Normally a bank would then sell the dollars on the open market and buy back yen to replace the ones given to the car company. This cheapens the dollar and raises the value of the Yen and balances the currencies. However, to avoid this the BOJ has been buying US bonds with the dollars which effectively takes them out of the market and provides the US with a willing lender to support our deficit. This keeps interest rates down and the US functioning normally. It does not hurt Japan whose Yen is pegged to the dollar to keep those dollars from reentering the market.

The current problem comes from a strong rumor that the Asian countries are becoming increasingly wary of the US debt as the deficit rises. The Democrats announced today that the Iraq action could cost $400 billion or more and drive the deficit to even higher levels. Several analysts have said they expect a $1 trillion deficit in 2004. With a trade war heating up and potentially high tariffs being discussed for Asian goods the worry is that Japan could stop buying US bonds. Since 46% of our bonds are purchased by overseas countries with Japan being a major portion of that number, any drop in purchases could drive up interest rates. Considering Japan is one of the largest US bond holders at over $500 billion according to some estimates they could make the dollar/yen problem even worse if they sold bonds and then sold the dollars in the marketplace. China would love to jump on the wagon as they have been buying something like $120 billion a year of US debt. Together they have a big club over the US economy. If they wanted to resort to financial terrorism or react to any new tariffs they could dump bonds/dollars and our interest rates would rocket to new highs and stop our recovery in its tracks. While they are not likely to do that because they A) have no other place to invest the money and b) depend on our dollars to finance their retail trade. They could exercise the threat of it to gain concessions from us. In order to do this they might tighten the purse strings just enough to get our attention. That is what traders are worried about. The US debt market is already heavy with the massive debt offerings (corporate and government) and any reduction of buying from Asia could be enough to offset the delicate balance. Stay tuned.

The market recovery today was branded as new money coming into the market to buy the dip. It was also speculated that it was end of quarter window dressing by funds. Whatever the reason the Dow retraced almost exactly 50% of its Monday loss which would have been 9576. It closed at 9571. The Nasdaq was much stronger and came within five points of retracing 100% of the drop. Internets, chips and biotechs all rose with Internet stocks surpassing the Friday levels. Other sectors that were strong included hotels, gaming and airline stocks. AMZN rose to nearly $51 on no real news and dragged YHOO along with it. Adding to the upbeat markets was a rise in the hotel and gaming stocks with FS, HOT, MAR, HLT hitting new 52-week highs. The only really negative sector was defense after there were some negative comments about the procurement process having run its course. LMT and GD were two of the biggest losers.

The bottom line for me was an apparently successful day for the markets. They shook off the panic drop from yesterday and moved back on the attack again. After an initial bounce at the open the indexes sold off and tested yesterday's lows but the test was brief. We did not rocket off the bottom but the trend was positive and gained speed on short covering when the Dow broke the 9550 level to the upside. The bounce was short lived as heavy sell volume appeared just before the close but the bulls still managed a respectable showing.

Wednesday has no material economic reports with Mortgage Applications the only number to be released. That should show an increase with the drop in rates. The key will be the Nikkei tonight. Tonight is the first time it has traded since the -400 point drop on Sunday night. If it rebounds off the bottom then we could expect our markets to open up in relief that the potential bond bomb has been diffused. If funds are really marking up their portfolios for the end of the quarter statements then we are likely to go back to the recent highs tomorrow. With a heavy slate of economics on Thursday they will probably want to get in early and hope for short covering to push them higher before any bad news. The last two days of the week may not see any buying as the major earnings warnings come to a close. That would be the prime time to confess before the real earnings begin in October.

For a potentially bad period in the markets this week started off bad but recovered well. The volume was light but the internals were strong with up volume three times down volume. For tomorrow Dow 9600 will be resistance as well as Nasdaq 1905. The S&P has resistance at 1032 and again at 1040. The rebound is confounding the bears and the bulls alike. Even the most adamant bulls feel like we should see a multiday bout of profit taking to insure a better base for later but the market is refusing to drop. Dip buying is alive and well and shorts are paying dearly for their conviction. AMZN rose nearly +3 on volume of 20 million shares. It is in the top ten stocks with the most short interest and those shorts are getting squeezed. I have been telling people this week not to get married to any short positions just because this week is marked with big red Xs on the calendar. What you believe about market direction is not important if the market is going against you. Capital preservation is important. The Dow and the Nasdaq are continuing to build monster bearish wedges but showing no signs of breaking down. Based on the charts above we could easily test 9700/1925 on the next uptick. The charts are painting a very tantalizing scenario for shorts and luring them back into the market on every downtick only to be surprised over and over again.

With this being the 3rd year of a presidential term and the administration doing everything possible to juice the economy I firmly believe we are going to see a continued bullish tone to the market. I just expected a normal October dip from mutual fund portfolio rebalancing first. But then, it is not October yet and I can still rationalize the end of quarter markup scenario as the reason for the bounce. I just keep wondering what reason I am going rationalize next week.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
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