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Rationalize This

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      09-25-2003           High     Low     Volume Advance/Decline
DJIA     9343.96 - 81.60  9458.49  9342.98 1.86 bln   1016/2170
NASDAQ   1817.20 - 26.50  1856.22  1817.20 1.98 bln    814/2393
S&P 100   502.62 -  2.84   508.96   502.61   Totals   1830/4563
S&P 500  1003.26 -  6.12  1015.97  1003.26 
W5000    9726.36 - 81.30  9848.08  9726.22
RUS 2000  495.05 - 12.81   509.34   495.05 
DJ TRANS 2697.12 - 48.80  2749.87  2697.12   
VIX        22.26 +  1.04    22.27    21.04   
VXN        30.65 +  1.29    30.72    29.16 
Total Volume 4,202M
Total UpVol    910M
Total DnVol  3,202M
52wk Highs  298
52wk Lows    28
TRIN       1.20
NAZTRIN    1.71
PUT/CALL   0.84

Rationalize This
By Jim Brown
Click here to email Jim

I wrote after the rebound on Tuesday that I was having trouble rationalizing the market rally based on the historical calendar trends but was prepared to tough it out if necessary. Finally, a historical trend returned and we are staring at a serious rationalization problem for the bulls. The shoe is now on the other foot.

Dow Chart

Nasdaq Chart

There was not a flurry but a flood of economic reports today and the general outlook was not exciting. The mixed picture began with a throwaway Jobless Claims report. I say throwaway because the analysts were quick to claim the hurricane wild card as throwing the numbers into doubt. I agree with that analysis. With ten states boarding up windows in advance and cleaning up debris in the aftermath there was no way the new Jobless Claims were going to be relative. This brings into question the high number at 381,000 with more than ten states closing up shop. What would it have been without the storm? The aftermath cleanup and lack of power could keep the numbers down for the next two weeks. If we do see a rebound over 400K next week then we are in trouble because the non-storm numbers would have been even higher. The bulls should have looked at this number as a gift.

The Chicago Fed National Activity Index fell below zero once again at -0.28 after peeking only slightly into positive territory last month at +0.05. This was the lowest reading since May at -0.34. The indicator is composed of 85 components and 53 showed below average growth. 49 dropped between July and August and of those that improved 14 still did not show growth. If it were not for the housing market the nation would be sinking in economic quicksand. Employment data continues to pressure the recovery and there is no jobs recovery in sight. This continues to pressure the manufacturing sector and until this broad based sector recovers we will continue to wander.

Also pointing to this continuing employment problem was the Help Wanted Index, which fell to 37 and only 2 points away from the current cycle low. If the HWI is a leading indicator for hiring then the jobs picture is not looking up. Companies are continuing to be pressed to cut costs and wages and very high insurance and benefit rates are an easy target for those cuts. Until demand begins to ramp up to the point where the existing staff cannot handle it I do not expect any gains in these numbers. In contrast to the HWI the Mass Layoff numbers for August were significantly improved at 133,839 compared to 226,435 in July. This is a significant improvement but still a large number of layoffs. This is the lowest number since March at 113,026. It could have been impacted by the blackout and by cyclical end of summer vacations as well. The government layoffs were the highest since the program began in 1995. I checked August of 2002 and that was also a multi month low which began to escalate rapidly into the 225,000 peak in Jan-2003. The August-2003 number was also higher than the Aug-2002 level. Based on the historical trend I do not put too much faith in the drop.

Proving the weak demand picture was the drop in Durable Goods Orders by -0.9% in August. Shipments fell substantially more at -2.9%. This was the first decrease since April. Were it not for the jump of +2.9% in primary metals the drop would have been even more substantial. Six of the seven components fell with aircraft and motor vehicles falling by -6.6%. Communications fell by -4.8% and computers -2.3%. Does this look like we are rushing into the 4Q recovery?

The most positive events of the day were the jump in New Home and Existing Home sales. New Home sales rose to 1.15 million annualized and the second highest number on record. Existing Home sales rose to 6.47 million, which was a new record. The gain in these numbers is purely based on the bounce in rates. As I have said before a bounce in rates after a period of sustained lows always prompts a race to buy houses and lock in the rates before they go higher. Everybody in America understands that rates are going up very soon and they are not going to wait around for 7% or higher to buy. Once the rates really begin to rise the housing market may not die but the rate of sales will slow significantly. The housing market is the main supporter of the economy currently and with consumer spending slowing we will continue to depend on housing to keep it moving. It is up to the Fed to understand this keep rates as low as possible for as long as possible.

Friday we will get the final Q2 GDP revision and the consensus is for it to be unchanged at +3.1%. The last revision surprised to the upside from +2.9% to +3.1%. If the final revision goes the other way and breaks back under 3.0% then the estimates of +3.9% for the 3Q will be called into question. Remember, after tax corporate profits fell by -3.4% in the 2Q GDP. Spending rose +3.8% while profits fell. The 3Q GDP is going to be a very important milestone for the markets.

The markets are expecting +19% earnings for the S&P in the 3Q according to First Call. For the last few days there has been an increase in the rate of warnings and the market is paying attention. 181 S&P companies have added or raised their dividend since January. The markets have bought the earnings expectations and the dividend increases since March. Just like playing poker, once the last bet is placed it is time to show the cards. It is time to see if the recovery began to gain speed in the 3Q or was it just more cutting costs and laying off workers that produced the earnings.

Federal Signal, FSS, cut estimates due to falling spending by governments and private business. AO Smith, AOS, cut its estimates by more than half. Darden Restaurants cut estimates saying recent promotions had failed to attract additional customers. Viacom, VIAb, cut estimates saying growth had slowed and was not likely to reach prior forecasts. Other companies warning today included AZZ, BSG, NEWP, PCIS, PHHM, PSTA and TUP. Not all the news was bad with raised guidance from BBY, CYBE, MKC, MUR and RAD. It was just the ratio of warnings to upgrades that bothered investors.

BBY better get all the glory it can with its raised guidance today because Dell went public with the new products announcement. They are planning to offer flat screen TVs, hand held computers and an online music service. They plan on hitting the consumer market before the holidays and with the Dell momentum it is due to be a big push. Dell said it was conceivable that Dell could rise to the number one position in home electronics very quickly. Whoa! Big claims from Michael Dell and I am sure Gateway was paying rapt attention. Still there are some big targets out there that are ripe for the Dell marketing machine. Sony, Mitsubishi and Panasonic are the top three and Michael Dell is walking onto a field full of goliaths. This just happens to be where he is most at home. Dell has slugged it out to Compaq, Hewlett Packard and IBM and came out on top. The market was controlled by these giants when he started just like Sony and the others control the home electronics market today. Dell also took aim at Apple with the entry into the music business with the Dell Digital Jukebox and the Dell Music Store. Going head to head with the Ipod, RNWK and ROXI. Go get them Michael! Electronics retailers BBY and CC closed down for the day but then who didn't?

Speaking of category killers Sony announced an entry into the digital recorder business with a competitive product to TIVO. The entry was expected eventually and the impact to Tivo's business could be huge. The market has been restricted to only a couple players in the field and the margins have been high. Fortunately more competition will knock those prices down to a reasonable level.

Not just a category killer but a category eliminator the digital camera has knocked Eastman Kodak down for the count. EK announced this morning that they were cutting their dividend to 50 cents from $1.80 and said they were no longer going to try and grow the film business. They conceded that Fuji was winning the film battle and said they were going to focus their energy on the digital revolution after decades of being the leading film producer.

Another revolution is taking place at the NYSE. The lead director and head of the compensation committee, Carl McCall, announced his resignation and rumors are flying that there are more resignations in the wings.

Unlike the earthquake on the NYSE there was a real 7.8-8.0 magnitude earthquake in northern Japan at 2:50 PM our time today. This is a major quake and Tsunami warnings were in effect for Japan, Russia, Guam, Mariana Islands and Wake Island. Tsunami watches were in effect for Hawaii, Taiwan and the Philippines. The earthquake occurred at 4:50 Japan time and only a few hours before the Nikkei was scheduled to begin trading. After trading down -192 points last night and expected to trade down again on our loss the earthquake could accelerate this drop.

The markets today were ugly. They did not start out that way but ended up in a world of pain. The initial dip was a continuation of yesterday's drop but the indexes fought off a strong wave of program selling to rebound back into positive territory at midday. The Dow and Nasdaq both stalled just below a 38% retracement of the big drop and lingered in positive territory just long enough to sucker in any bulls that thought the dip was over. The high of the day was about 12:15 and the bleed began once again. The big drop came at 3:30 when the Dow broke 9400 for the last time. It closed at 9344, Nasdaq 1819 and S&P just barely over the psychological 1000 level at 1003. Some blamed it on the earthquake, others on end of quarter portfolio rebalancing. Wasn't that what they used as a reason for the bounce on Tuesday? Either way it was nasty and the Emini futures closed well under 1000 at 997.75. This does not bode well for Friday.

The biggest losers were the tech stocks and the small caps. The very indexes that saw the biggest gains in recent months. The Russell dropped nearly -13 points today and is down -4.8% for the week. The Nasdaq fell -26 but is down -5% for the week. These are not good numbers for the bulls. It represents a definite selling of the winners. The markets have not had two consecutive quarters of gains in several years and some analysts think that funds are willing to forego the 4Q and lock in substantial profits now to protect their year. Most believe the markets will finish higher for the year but not much higher. The general consensus is around 10,000. This creates risk for the funds. With many stocks up +50% to even +100% since the October and March lows the funds are faced with a risk reward scenario of a potential +7% gain for the rest of the year or the potential for a much larger drop if the selling becomes widespread. Techs and small caps have already dropped -5% this week. What does the future hold?

OPEC is cutting production on oil to drive prices back up. The economic recovery is starting to show signs of weakness and job growth is nonexistent. The Fed is not likely to cut rates again even though they feel the risks of deflation outweigh the risks of inflation. Japan is tanking and after today its economy could suffer even more depending on the earthquake damage. The dollar/yen battle is continuing and bonds are slowly climbing which indicates doubt about the future. 3Q earnings will begin to appear in seven days and only First Call is really optimistic. Investors are becoming more cautious. The bottom line is more risk than reward for funds which have to perform to please their investors. The competition for dollars is going to be fierce in January as investors unhappy with their returns for 2003 start looking for another place to park money. Those that lock in +30%, 50% or even 60% gains over the next couple weeks could win the bragging rights contest in January if the 4Q fails to move up substantially.

That brings us right back to the historical trends scenario once again. Funny, I did not get a single piece of bullish hate mail today. With the Dow down -342 points from Friday's highs there is little to be bullish about. That is only -3.5% for the Dow but it is a chink in the bullish armor. I have no claims to a crystal ball for forecasting the potential lows for October if the decline continues but I can guarantee it will not be straight down. The most likely serious support is 9000-9100 and that is where I expect the eventual battle for control to be fought. It you take traditional market metrics for gains and eventual pullbacks the numbers are scary but even the bears do not expect traditional numbers to repeat. A simple 38% retracement would see a Dow drop to near 8800 where a 25% retracement of the gains from March would stop around 9100. You draw your own conclusions but with -342 points in a week and we are not even in October yet anything is possible.

For Friday the GDP and the earthquake will rule. However with the -342 point drop there could be come profit taking from shorts eager to put an X in the win column for a change. Monday marks a new round of economic reports for the week with a new ISM, Factory Orders and Nonfarm Payrolls being closely watched for signs of weakness. That should be a great start for October. Stay tuned.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
Editor



 
 



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