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Back From The Brink

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      10-23-2003           High     Low     Volume Advance/Decline
DJIA     9613.13 + 14.90  9622.16  9551.73 2.05 bln   1527/1651
NASDAQ   1885.51 - 12.60  1893.20  1874.11 1.93 bln   1316/1839
S&P 100   514.88 +  1.48   515.59   511.21   Totals   2843/3490
S&P 500  1033.77 +  3.41  1035.44  1025.87 
W5000   10029.20 + 21.90 10047.48  9955.10
RUS 2000  510.49 -  2.66   513.55   506.81 
DJ TRANS 2828.52 + 10.50  2828.78  2799.99   
VIX        17.68 +  0.01    18.51    17.48
VXO VIX-O  19.10 +  0.04    19.99    19.02
VXN        26.09 +  0.41    26.57    25.58 
Total Volume 4,269M
Total UpVol  1,729M
Total DnVol  2,485M
52wk Highs  271
52wk Lows    30
TRIN       1.12
NAZTRIN    2.26
PUT/CALL   0.85

Back From The Brink
By Jim Brown
Click here to email Jim

If you had told me at 2:AM with the Nikkei off -550 points and our futures falling through the floor that the Dow would only drop -50 points at its worst and close up +15 I would have thought I was dreaming. Sometimes reality is stranger than fiction and today was definitely one of those days.

Dow Chart

Nasdaq Chart

Nikkei Chart

We had yet another math miracle before the open with Jobless Claims. The number came in at 386,000 and a four-week low. You should be confused. Last weeks number was a multimonth low at 384,000 and the week before that was even lower at 382,000. Each was trumpeted as new cycle lows. Unfortunately the 382K from three weeks ago was revised up to 388K the next week. The 384K from two weeks ago was revised up to 390K. These revisions make today's 386K the new four week low at least until it is revised up next week. Using the +6k revision average that should put today's number near 392K. Either way there is a slight upward trend in the claims but nothing serious.

A better number to gauge the strength of the job market was the Monthly Mass Layoffs for September which came in at 868 and considerably better than the prior two months. 82,647 workers were laid off in September compared to 133,839 in August and 226,435 in July. This is a definite improvement in the trend. Whether it means the pace of cost cutting has slowed as we approach a seasonal increase in business or that companies just don't have as many workers they can cut is unclear. Either way the slow down in the pace of layoffs should help ease the pressure in the job market.

The lack of real economic reports today left the markets to fixate on earnings and Wednesday earnings were less than exciting on several front. Companies warning or missing estimates included some high profile names like JPM, MRK, THC, WHR, SGP, KLAC, STX and ERTS to name a few. We had the obligatory comments about "no signs of an economic recovery yet" from Dow component Dow Chemical. SNE said they had 50% excess capacity for the current demand. Bucking the trend UPS saw a strengthening in shipments. While these high profile bad apples drew the headlines the overall earnings were still strong. With over 300 of the S&P companies reported the number meeting or beating estimates is around 64%. If you have been reading my commentary you know that is down from 92% two weeks ago and 66% last week. Still strong but slipping as the smaller companies report. I have not seen Chuck Hill on CNBC this week but should he appear with a lowered estimate for 3Q earnings the sentiment could get a lot worse.

Guidance for the 4Q from those 300+ companies has 36% guiding higher, 22% guiding inline and 42% warning. This means just under half of all companies are warning and very close to the historical trend. In other words the ratios are not as good as some analysts hoped. You have also seen me quote the earnings estimates for the 4Q as +20% to +25% growth based on First Calls published summaries. The 4Q estimate as of the close today had dropped to +18%. Still strong but maybe a hint of further trimming to come.

After the bell today Microsoft announced earnings that beat the street by a penny and initially caused their stock to rise. The company raised guidance slightly and bragged about strong enterprise sales. They said that "while IT spending was only improving slowly over the quarter they did see increasing strength across the consumer sector". The raised guidance left little for traders to be excited about. MSFT raised full year estimates to a range of $1.10-$1.12. The analyst community was already expecting $1.11 so the fanfare fell on deaf ears. The stock began to fall almost immediately once the guidance was disseminated without waiting for the conference call. One factor suggested as accelerating the drop was a more than double than expected drop in unearned or deferred income. This line item is normally used as a slush fund for earnings that can be "adjusted" as needed to make earnings targets. Deferred income is money received before the product is shipped. If a corporation ordered a large amount of various software products late in the quarter, possibly some in short supply or not yet released then Microsoft does not claim the income until the software is shipped. There is always a backlog as companies preorder new products or products for conversions from legacy systems. This "order backlog" is seen as an indicator of strength for Microsoft. High backlog equals lots of orders, low backlog means excess product on hand. (simple explanation) Microsoft had guided analysts to expect a drop of $300 million in this number. The actual drop was over $600 mil and twice Microsoft estimates. Considering MSFT had net profits of $2.6 billion for the quarter I would not think this is a critical problem. Just something for the analysts to question to earn their 15 min of fame. Most informative was their raised guidance. They are only expecting PC growth in upper single digits for 2004. This is not going to be exciting for the tech outlook. They also projected a drop in subscribers to their MSN Internet service. A couple more less than positive comments included, "we missed some forecasts and you (analysts) should be concerned" and "we are not expecting any significant revenue growth for the rest of the year." MSFT closed the after hours session at $27.54 and down nearly -1.50 from the regular session close.

Wednesday's earnings and market action led to massive drops overseas. The Nikkei suffered the biggest one-day drop of (-554) since 9/12/01 and the day after the WTC attack. This was a huge event and all the Asian and European markets suffered. To some extent it was triggered by our drop on Wednesday. Still the outlook looked VERY negative at the open and a triple digit Dow drop looked like a certainty. When the Dow opened down -50 it was immediately met with a very large buy program that consumed immense amounts of selling volume as it powered the markets higher. Within 20 min the Dow was back in positive territory and the buying stopped. Almost immediately another drop began and again only 10 min later another large buy program blasted the average to a new high. Bears were dumbfounded and shorts thinking they had a free ride after the drop in Asia were starting to think about covering. Over the next hour the indexes bled points but very slowly as nobody knew what was happening. About 11:20 the Dow touched a new low and immediately was met with more buy programs. By noon traders were glazed over and the Dow was stuck just below 9600 where it hovered for two hours. Traders simply did not know what was happening. Shorts and longs alike were afraid to trade and volume slowed to a crawl.

About 2:PM there appeared to be a surge in short covering in front of MSFT earnings but the bears gained confidence when the Dow could not break to a new high. They were able to knock it down once again but each dip was met with new buy programs. Market on close orders were weighted to the buy side and bears gave up. S&P Futures were 1032 at the cash close and they managed to close the Dow back over 9600. Amazing. Unfortunately once the earnings began to hit the wire the selling began again in earnest and once MSFT spoiled the party the futures hit a new low for the day at 1018.75 and significantly down from the close. As I type this at 6:30 they have recovered to 1021.50, -7.50 with Nasdaq futures down -17.00.

What a day. Volume was very strong with over 2 bil shares on the NYSE and 1.93B on the Nasdaq. Because of the huge buy programs the down volume was only 4:3 over up volume. It appeared at the close that somebody with big money had rescued the markets just when they needed it worst. The reaction to the after hours earnings brings that rescue back into question.

There are multiple reasons for the after hours negativity. First, MSFT did not uphold the standard set by Intel and Yahoo. Great earnings expectations had been priced into the market and we are seeing those great expectations slowly deteriorate into just good news sprinkled with some weaker than expected guidance. Is this going to cause a further dip? Odds are good but after today I would not bet on it. Deep pockets bought the open this morning to hold up the markets. Not to buy stock at bargain prices but to hold up the market. Think about it. If you were going to buy billions of dollars in stock today and the market was showing a triple digit drop before the open, possibly a -200 day or more, then why would you buy immediately at the open at -25? Would you not rather wait for an hour or so to get a better price? Wouldn't you be afraid that the negativity at the open could cause that drop AFTER you spent those billions and put you in a significant loss before the day was over? Any reasonable trader with far less money at stake would have waited for the drop to slow before buying the dip. This smacks of market manipulation by somebody. Somebody with very deep pockets. The conspiracy theorists, including me, were speculating that the Fed could be propping up the markets to keep the recovery hopes alive. Another possibility is Japan. With the Nikkei tanking -5% overnight from multiyear highs on fears about a weak U.S. recovery then what better way to spend some of those billions in dollars they have been hoarding than to buy the U.S. market. They have been spending billions each week trying to control the currency rates and boosting our markets would certainly help their markets.

Another possibility was mutual fund related. Funds have been beaten so badly for the last two years that they are scared. They are riding a huge rally wave that could have been about to crumble. Investors had poured in more than $4.3 billion into funds each of the last two weeks and funds had a vested interest in keeping the markets up. A sharp correction could stem the flow of money and blunt investor sentiment for a couple more months. The only question is did the funds have enough money to orchestrate the massive buying and head off the opening crash? If so which one? Was it a team effort and if so then how did they coordinate it? Far too many questions and no answers.

The real question is what about tomorrow? What a tossup! We have yet to see how the Asian markets are going to respond to tonight's earnings. Futures have stabilized at about 1021 for the time being and while negative they have at least quit falling. Traders are confused. Each time the markets reached resistance today the retail buyers disappeared. The buy programs provided the reversal momentum but nobody jumped on the train at the highs. Shorts were never forced to cover because resistance levels were never broken. If Asia shakes off the earnings from MSFT and others and their oversold conditions from Thursday then we may have a chance. If the deep pockets from this morning are still around at the open on Friday then they might be able to build on any Asian gains. If the reverse happens and Asia tanks again then it may take more than deep pockets to slow us down at Friday's open.

T.G.I.F, at least most big drops do not occur on Fridays. Fridays are not immune but they tend to be less severe. Traders leaving early for the weekend and trying to capture profits for the week tend to equalize the opposing pressures. Odds favor a range bound day without a big move in either direction but then odds favored a huge drop at the open today and it did not happen. Amazing how that VXO at 17.50 worked on Wednesday. But then most assume it was just a coincidence. (grin)

Now that MSFT has announced the earnings week is winding down and there will be little to capture investor attention. Less than 50 companies report on Friday and there are no major names. With six days left in October I would not count this month out just yet. Keep your fingers crossed and seatbelts fastened.

Enter Very Passively, Exit Very Aggressively!

Jim Brown
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